11. What is the FED Video Lecture | Become an Expert: Value Investing - Business Basics

welcome the course one unit three lesson
three what is the fed in this lesson we
have four lesson objectives
the first lesson objective is what is
the fed the second lesson objective is
what is the mission of the fed the third
lesson objective is how does the Fed
change market conditions with interest
rates and the fourth lesson objective is
what does the Fed tell us about mr.
market so let's get started okay so
there's a lot of people that have no
idea what the Fed really is and the Fed
is nothing but a short term for the
United States Federal Reserve what the
Federal Reserve tries to do is manage
the US currency and ultimately control
the US economy and the reason for the
Fed if you go back to prior to 1913 if
you went around the United States you'd
have found 30,000 different currencies
in circulation local governments could
issue currency state governments could
issue currency pretty much anyone out
there could issue whatever type of
currency they wanted and what you had
was sometimes the currency would be
completely worthless sometimes it would
actually hold its value and this led to
a lot of unrest throughout the country
because there was no regulation or any
standards for the rules for creating
currency and so after 1913 after the
Federal Reserve was created there was
one federal currency which was the
dollar and that and itself brought some
stability to the country and so that
that's really the reason that the Fed
was created now there's a lot of
different reasons and a lot of
interesting things you can read out
there about the Federal Reserve but
that's that's their primary purpose is
to bring stability to the country now
whether they're doing that or not that's
that's arguable but that's that's the
mission so some of the stuff that a lot
of people might find really amazing
about the Fed is that it's a private
institution although the the directors
are appointed by the President and
confirmed by the Congress that once
those people were in that position they
stay there for 12 years and once they're
in that position they don't answer to
the president they don't answer to
Congress they are now there
entity so after that nomination process
takes place the Fed the the people that
are in there running it are really they
can do anything they want the the Fed is
a private institution in its own by 12
Regional Federal Reserve banks
commercial banks form banks and even
individuals especially if you go back to
the early when the Fed was created you
had some very wealthy people that
actually set all this up and there's a
very interesting book that's written on
this it's called the creature from
Jekyll Island which kind of gives you a
different perspective on the Fed it's
pretty interesting read so where does
the money come from that the Fed prints
and puts out there and some people are
really surprised though that the Fed
actually has the ability to simply print
money from thin air they can just print
more money if they want and I mean
that's that's what you saw in 2008-2009
whenever they were pumping a lot of
money into the into the system they're
printing that money in there they're
issuing it out in order to put more
money into the system so people will
spend it much the feds activity is not
made public so they hold closed-door
meetings where people cannot go in there
and listen to it all they know is after
that they came out they go just a
general idea of hey interest rates
aren't going to rise or they will rise
and there's a lot of people out there
that we even debate whether the Fed is
even constitutional but that's not
really the point of this video I just
kind of highlighted these few things
here to kind of throw out some
intriguing facts that make you wonder
maybe you'll read some more up on it but
this is the four things that the Fed
really tries to accomplish they want to
maximize employment and stabilize prices
they want to supervise and regulate
banks they want to maintain the
stability of the financial system and
they're also there to service the debts
for the US federal government so the the
thing that we're really going to focus
on for this lesson because it relates to
the stocks and bonds and investing is
maintaining the stability of the
financial system so how does the Fed
stabilize the financial system if
there's one thing that the Fed really
understands and there trust me there's
some very smart people running the Fed
they understand this model right here
really well
this is the fear and greed model that
we've been talking about the two
previous lessons and here's mr. market
and as you can see there in two thousand
six seven and eight
he had mr. markets screaming for
everybody to join in and to take the
market higher and the Federal Reserve
knew that they absolutely knew that
there was a bubble coming in the economy
and they also knew that there was a
recession that was going to be following
it and so they were trying to affect
that and the way that the Federal
Reserve was trying to prevent that
bubble from happening where they were
adjusting interest rates and so whenever
the market was climbing and getting
really high they were trying to raise
the interest rate so that they could
kind of slow it down and then whenever
it crashed they were trying to lower
interest rates in order to induce
spending so in order to understand this
better I'm going to give you a little
example here okay let's just say that it
was Christmas time and you got a $5,000
bonus for your job and you've always
been wanting a new car and you've been
eyeing up the car there on the right and
so the question I'm going to ask here is
what is that car worth to you let's just
assume that you have made an agreement
with yourself that no matter what you're
not going to spend more than thirty five
thousand dollars on this car so let's
just say that the value for you for
buying that car was thirty five thousand
dollars so you're going to use your five
thousand dollars as a down payment on
that new car that you can hopefully go
out and buy for under thirty five
thousand dollars so let's look at what
happens here when you go to the
dealership and you show up and you look
at the car price and it's perfect it's
thirty thousand dollars which is under
the amount that you wanted to pay and
I'm going to use a real extreme interest
rate here just to kind of highlight and
exemplify something for you but let's
assume that the best interest rate you
could get on this car would be fifteen
percent okay based off of that high
interest rate your monthly payment on
that car for a five-year loan would be
five hundred and ninety four dollars a
month and the total interest that you
would pay over that five year period
would be ten thousand six hundred and
eighty four dollars so the adjusted
price on this car isn't it's not a
thirty thousand dollar car it's actually
a forty thousand six hundred eighty four
dollar car
and so because that price was higher
than what you valued that car out of
being $35,000 you don't buy it because
it's too expensive that monthly payments
way to buy so let's look at this from a
different angle let's say we still go
back to the dealership and the price for
the car is $30,000 but now this time the
interest rate that you can get on the
car is 1% with the interest rate only
being 1% your monthly payment now is 427
dollars and the total interest that
you'd pay over a 5 year period is only
641 dollars so now the adjusted price on
this car is only thirty thousand six
hundred and forty-one dollars which is
under the 35 thousand that you felt the
car was worth and that you were willing
to spend and therefore you buy the car
so let's look at this scenario
side-by-side we have the same car with
the same market price which was $30,000
but we have different interest rates one
being 15% the other one being 1% and so
we got a different value at the end and
therefore different spending habits in
the one case you bought the car and then
the other case you didn't buy the car
even though the car was the same exact
price so those interest rates changed
your spending habits and so the Federal
Reserve understands this they understand
that if they can adjust the interest
rates they can adjust your spending
habits and so if we look over here this
is Ben Bernanke who's the chairman of
the Federal Reserve and so he's the head
guy making these ultimately making the
decisions on how the Federal Reserve is
going to adjust the interest rates and
so when we look at our Dow Jones we can
see how the market was climbing and
getting very high and of course mr.
Bernanke realized this and so at this
point he was trying to raise interest
rates he was trying to make them fairly
high and if you remember from the first
lesson from unit 2 lesson 1 with the
bonds around this time interest rates
were around 5% back in the 2007 time
frame and this was his attempt in order
to slow this bubble that he knew was
there so we look at the mindset that he
had and it's we need to stop this bubble
from happening and the way that he does
that is he raises those interest rates
so borrowing money is
and so and people spend less which slows
down the economy and hopefully the
recession doesn't happen but in this
case we actually had a very harsh
recession and after that happened then
the Federal Reserve's reaction is okay
we need to stimulate the economy we need
people to spend money so what do they do
they lower the interest rates because
they need all that money to get out in
the system and they need people to start
buying things so that the economy then
grows again so if there's one thing that
the Federal Reserve knows is that mr.
market is wrong and they're trying to
counteract mr. market by adjusting those
interest rates so you can see here we
have the Fed keeps raising interest
rates
the feds pretty much telling you that
you're in a greed cycle when the Fed is
lowering the interest rates they're
pretty much telling you that you're in a
fear cycle so the real question comes
down to which assets do you want to own
and when so in this scenario let's look
at the interest rates when interest
rates are really high what type of asset
do we want to be buying at this point
and the answer is that we want to be
buying bonds the reason you want to be
buying bonds when interest rates are
high is probably your going to have a
coupon that's paying you a very high
interest rate if you don't understand
this part you need to probably go back
to unit 2 or also unit 1 in order to
understand these principles that I'm
talking about so you understand what a
coupon is and things like that but when
you buy a bond at a high interest rate
you're going to be receiving a very good
coupon which is going to be paying you a
great return and then the added bonus is
whenever those interest rates drop in
the future which is going to happen
eventually
and those interest rates drop the market
price at that bond is going to go up and
then you actually have the liquidity to
sell it and put it into a stock which is
the really the end goal is to get that
into a company so now let's look at when
interest rates are low this is when you
want to be buying stocks because if
you're in bonds you got a really low
coupon and you don't want to be doing
that that the stocks are very cheap at
this point they're undervalued and so
what you want to do is you want to go
out and find a company with very low
debt positive earnings and that has a
strong price-to-book ratio which we had
talked about all throughout unit 1 and
you're going to get a very strong
by that has a really good intrinsic
value and you're going to end up making
a lot of money on that whenever the
market recovers so how do you know
what's considered a high or low interest
rate and this is really building up into
what we're going to discuss all through
course two is that this is a relative
comparison which you're going to be
doing in order to properly value a stock
or a bond for that matter is that you're
going to be constantly comparing the
return you expect to get with a stock
versus the return that you expect to get
with a bond so let's assume that based
off of the market price let's just say
we're kind of in a greed cycle the
stocks are trading really high and so
the best return you could expect to get
with the stock is maybe 5% based off of
the high market price but then when you
look at a bond let's assume that the
bond is at five point five percent
because of the market so in this
scenario a bond has less risk generally
speaking than a stock and so this would
be a very easy decision that you would
want to be buying bonds because of the
interest rates and so by eight by you
being able to relatively compare a stock
versus a bond it's always going to put
you on the right side of the fence
whether it's time to be buying stocks or
whether it's time to be buying bonds and
that's truly the art of asset valuation
and we're going to get into this so much
more in the course too and I really look
forward to seeing you over in those in
those lessons because it's really going
to start teaching you the important
stuff that you really need to understand
so that concludes course 1 unit 3 lesson
3 what is the Fed and in this lesson we
learned about what is the Fed we learned
what is the mission of the Fed we
learned how does the Fed change market
conditions with interest rates and
finally we learned what does the Fed
tell us about mr. market and so I really
enjoyed this first course this is the
this completes course 1 and I look
forward to seeing you over into course 2
where we're really going to start
learning some of the important things
for our intermediate lessons with bonds
and stocks