IndexNo Topics123456789
101112131415161718192021222324252627282930313233
Active managementAsk price
Balance of paymentsBank Reconciliation
Basic Rule Of AccountsBid Price
Bond marketBond option
Bond option - Embedded optionsBook building
Bretton Woods AgreementBRIC
Buy SideBuying back shares
Capital Account ConvertibilityCapital budgeting
Capital flightCapital gains tax
Capital stockClosed-end fund
Collateralized debt obligationCollateralized fund obligation
Collateralized mortgage obligationCollateralized mortgage obligation - Purpose
Commercial paperCommodity market
Common derivative contract typesCommon stock
Comparison of Cash Method & Accrual Method of accountingCompetence and capital
Corporate ActionCorporate bond
Corporate restructuring
343536373839404142434445464748495051525354555657585960616263646566676869
CostCountry Market Caps
Credit derivativeCurrency codeCurrency futureCurrency pair
Currency swapsDerivative
Derivative OptionDividend yield
Documents that can be presented for paymentDollarization
Electronic tradingEquity investments
Equity swapEurodollar
Examples of treasuriesExchange (organized market)
Exchange rateExchange rate - Quotations
Exchange-traded derivative contracts (ETD)External Commercial Borrowing
Features of primary marketsFinancial crisis of 2007–2010
Financial engineeringFinancial future
Financial instrumentFinancial market
Financial Market IndexFixed income
Fixed income - TerminologyFloating rate note
Foreign direct investmentForeign exchange controlsForeign exchange market
Foreign Institutional Investor
707172737475767778798081828384858687888990919293949596979899
100101102103104105
Forex swapForward contract
Forward rate agreementFund AccountingFutures contract
Futures contract - MarginFutures contract - Standardization
Global financial system - InstitutionsGlobalization
Government bondGovernment-sponsored enterprise
Great DepressionHedge - Agricultural commodity price hedging
Hedge (finance)Hedge Accounting
Hedge FundHedging a stock price
How a forward contract works?How a market maker makes money?
InflationInflation 1
Inflation-indexed bondInstitutional investor
Institutional vs. RetailInterest rate derivative
Interest rate futureInterest rate swaps
International financeInternational Trade Payment methods
InvestmentInvestment banking
Investment banking - Organizational structureInvestment banking - Organizational structure - Back OfficeInvestment banking - Organizational structure - Front office
Investment banking - Organizational structure - Middle officeInvestment management
106107108109110111112113114115116117118119120121122123124125126127128129130131132133134135136137138139140141
Investment strategyInvestment vs. Speculation
Investment PortfolioInvestor sentiment
IOUISO 9362 - BIC
Knowledge capitalLate-2000s recession
Latest news from International Capital MarketLetter of creditLoan servicing
Major stock exchanges of the worldMarket maker
MaturityMortgage Bank
Mortgage-backed securityMortgage-backed security - TypesMortgage-backed security - Uses
Open-end fundOver-the-counter
Over-the-counter (OTC) derivativesPassive management
Pension fundPerpetual bondPreferred stockPrice discoveryPrimary Market
Primary market trendPromissory note
Purchasing powerRaising the capital
Repurchase agreementReturn of capital
S & P 500Secondary Market
Secondary market offering
142143144145146147148149150151152153154155156157158159160161162163164165166167168169170171172173174175176177
SecuritizationSell side
Settlement - physical versus cash-settled futuresShadow banking system
Share repurchaseShare repurchase - Purpose
Short SellingShort-Term Investment Fund (STIF)
Society for Worldwide Interbank Financial TelecommunicationSpeculationSpot market
Stakeholder (corporate)Stock exchange
Subprime lendingSubprime lending - Student loans
Subprime mortgage crisisSubprime mortgage crisis - Causes
Subprime mortgage crisis - ResponsesSupply Side vs. Demand Side
SwapSwap market
SwaptionSweeps
TariffThe basic trades of traded stock options (American style)
The role of stock exchangesTIPS and STRIPSTrading - Options
Trading curbsTreasury
Treasury managementTreasury stock
Types of Corporate actionTypes of financial markets
Types of hedgingUnderwriting
178179180181182183184185
United States of AmericaWealth ManagementWho trades futures
World BankWorld Bank 1
World currencyYield to maturity
Zero-coupon bond
Let's understand the Concept...
Active management:
Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
Investors or mutual funds that do not aspire to create a return in excess of a benchmark index will often invest in an index fund that replicates as closely as possible the investment weighting and returns of that index; this is called passive management. Active management is the opposite of passive management,
because in passive management the manager does not seek to outperform the benchmark index.
Ideally, the active manager exploits market inefficiencies by purchasing securities (stocks etc.) that are undervalued or by short selling securities that are overvalued. Either of these methods may be used alone or
in combination. Depending on the goals of the specific investment portfolio, hedge fund or mutual fund, active management may also serve to create less volatility (or risk) than the benchmark index. The reduction
of risk may be instead of, or in addition to, the goal of creating an investment return greater than the benchmark.
Active portfolio managers may use a variety of factors and strategies to construct their portfolio(s). These include quantitative measures such as price/earnings ratio P/E ratios and PEG ratios, sector investments that attempt to anticipate long-term macroeconomic trends (such as a focus on energy or housing stocks), and purchasing stocks of companies that are temporarily out-of-favor or selling at a discount to their intrinsic
value. Some actively managed funds also pursue strategies such as merger arbitrage, short positions, option writing, and asset allocation.
The effectiveness of an actively-managed investment portfolio obviously depends on the skill of the manager and research staff but also on how the term active is defined. Many mutual funds purported to be actively managed stay fully invested regardless of market conditions, with only minor allocation adjustments over
time. Other managers will retreat fully to cash, or use hedging strategies during prolonged market declines. These two groups of active managers will often have very different performance characteristics
Index
Ask price:
The ask price is the lowest price a seller of a commodity is willing to accept for that commodity.
Let's understand the Concept...
Ask price, also called offer price, offer, asking price, or simply ask, is a price a seller of a good is willing to accept for that particular good.
In bid and ask, the term ask price is used in contrast to the term bid price. The difference between the ask price and the bid price is called the spread.
Stock exchange -
In the context of stock trading on a stock exchange, the ask price is the lowest price a seller of a stock is willing to accept for a share of that given stock. For over-the-counter stocks, the asking price is the best
quoted price at which a Market Maker is willing to sell a stock.
Mutual funds -For mutual funds, the asking price is the net asset value plus any sales charges. It is also called asked price or
offering price or ask.
Commodities -
Auctions -In auctions the ask price is the reservation price. Some auctions may not have such a price. This price is the
minimum that the seller will agree to for the object being sold.
Index
Let's understand the Concept...
Balance of payments:
A Balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers. The BOP summarises international
transactions for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as +ve or surplus items. Uses of funds, such as for imports or to invest in foreign
countries, are recorded as a -ve or deficit item.
When all components of the BOP sheet are included it must balance - that is, it must sum to zero - there can be no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced in other ways - such as by funds earned
from its foreign investments, by running down reserves or by receiving loans from other countries.
While the overall BOP sheet will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account. This can result in surplus countries accumulating hoards of wealth, while deficit nations become increasingly indebted. Historically there have been different approaches to the question of how to correct imbalances and debate on whether they are
something governments should be concerned about. With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances are now high on
the agenda of policy makers for 2010.
Index
Let's understand the Concept...
Competence and capital:
The introduction of the term is explained and justified by the unique characteristics of competence (often used only knowledge). Unlike physical labor (and the other factors of production), competence is:
Expandable and self generating with use: as doctors get more experience, their competence base will increase, as will their endowment of human capital. The economics of scarcity is replaced by the economics of self-generation.
Transportable and shareable: competence, especially knowledge, can be moved and shared. This transfer does not prevent its use by the original holder. However, the transfer of knowledge may reduce its scarcity-value to its original possessor.
Example An athlete can gain human capital through education and training, and then gain capital through experience in an actual game. Over time, an athlete who has been playing for a long time will have gained so much experience (much like the doctor in the example above) that his human capital has increased a great deal. For example: a point guard gains human capital through training and learning the fundamentals of the game at an early age. He continues to train on the collegiate level until he is drafted. At that point, his human capital is accessed and if he has enough he will be able to play right away. Through playing he gains experience in the field and thus increases his capital. A veteran point guard may have less training than a young point guard but may have more human capital overall due to experience and shared knowledge with other players.
Competence, ability, skills or knowledge? Often the term "knowledge" is used. "Competence" is broader and includes thinking ability ("intelligence") and further abilities like motoric and artistic abilities. "Skill" stands for narrow, domain-specific ability. The broader terms "competence" and "ability" are interchangeable.
Index
Bid price:
Let's understand the Concept...
A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for a good. It is usually referred to simply as the "bid."
In bid and ask, the bid price stands in contrast to the ask price or "offer", and the difference between the two is called the bid/ask spread.
An unsolicited bid or offer is when a person or company receives a bid even though they are not looking to sell. A bidding war is said to occur when a large number of bids are placed in rapid succession by two or more entities, especially when the price paid is much greater than the ask price, or greater than the first bid in the
case of unsolicited bidding.
In the context of stock trading on a stock exchange, the bid price is the highest price a buyer of a stock is willing to pay for a share of that given stock. The bid price displayed in most quote services is the highest bid price in the market. The ask or offer price on the other hand is the lowest price a seller of a particular stock is willing to sell a share of that given stock. The ask or offer price displayed is the lowest ask/offer price in the
market (Stock market).
Index
Bond market:
Let's understand the Concept...
The bond market (also known as the credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion, of which the size of the outstanding U.S. bond market
debt was $31.2 trillion according to BIS (or alternatively $34.3 trillion according to SIFMA).
Nearly all of the $822 billion average daily trading volume in the U.S. bond market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small
number of bonds, primarily corporate, are listed on exchanges.
References to the "bond market" usually refer to the government bond market, because of its size, liquidity, lack of credit risk and, therefore, sensitivity to interest rates. Because of the inverse relationship between
bond valuation and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve.
Index
Bond option - Embedded options:
Let's understand the Concept...
The term "bond option" is also used for option-like features of some bonds. These are an inherent part of the bond, rather than a separately traded product. These options are not mutually exclusive, so a bond may
several options embedded. Bonds of this type include:
* Callable bond allows the issuer to buy back the bond at a predetermined price at certain time in future. The holder of such a bond has, in effect, sold a call option to the issuer. Callable bonds cannot be called for the first few years of their life. This period is
known as the lock out period.* Puttable bond allows the holder to demand early redemption at a predetermined price at certain time in future. The holder of such a bond has, in effect, purchased a put option
on the bond.* Convertible bond allows the holder to demand conversion of bonds into the stock of the
issuer at a predetermined price at certain time period in future.* Extendible bond allows the holder to extend the bond maturity date by a number of
years.* Exchangeable bond allows the holder to demand conversion of bonds into the stock of a different company, usually a public subsidiary of the issuer, at a predetermined price at
certain time period in future.
Bonds with embedded option can be valued using the lattice-based approach, as above, but additionally allowing that the option's effect is incorporated at each node in the tree, impacting either the bond price or
the option price as specified. These bonds are also sometimes valued using Black–Scholes. Here, the bond is priced as a "straight bond" (i.e. as if it had no embedded features) and the option is valued using the Black Scholes formula. The option value is then added to the straight bond price if the optionality rests with the
buyer of the bond; it is subtracted if the seller of the bond (i.e. the issuer) may choose to exercise.
Index
Bond option:
* European bond option is an option to buy or sell a bond at a certain date in future for a predetermined price.
Trade Date: 1 March 2003Maturity Date: 6 March 2006
Option Buyer: Bank AUnderlying asset: FNMA Bond
Spot Price: $101Strike Price: $102
Let's understand the Concept...
In finance, a bond option is an OTC-traded financial instrument that facilitates an option to buy or sell a particular bond at a certain date for a particular price.
Types -
* American bond option is an option to buy or sell a bond on or before a certain date in future for a predetermined price.
Example -
On the Trade Date, Bank A enters into an option with Bank B to buy certain FNMA Bonds from Bank B for the Strike Price mentioned. Bank A pays a premium to Bank B which is the premium percentage multiplied by the
face value of the bonds.
At the maturity of the option, Bank A either exercises the option and buys the bonds from Bank B at the predetermined strike price, or chooses not to exercise the option. In either case, Bank A has lost the premium
to Bank B.
Index
Let's understand the Concept...
Book building:
'The process by which an underwriter attempts to determine at what price to offer an IPO based on demand from institutional investors.'
An underwriter "builds a book" by accepting orders from fund managers indicating the number of shares they desire and the price they are willing to pay.
Book building refers to the process of generating, capturing and recording investor demand for shares during an IPO (or other securities during their issuance process) in order to support efficient price discovery. Usually,
the issuer appoints a major investment bank to act as a major securities underwriter or book runner. The “book” is the off-market collation of investor demand by the book runner and is confidential to the
bookrunner, issuer and underwriter. Where shares are acquired, or transferred via a bookbuild, the transfer occurs off-market and the transfer is not gauranteed by an exchange’s clearing house. Where an underwriter
has been appointed, the underwriter bears the risk of non-payment by an acquirer or non-delivery by the seller.
emerging markets as well, including India. Bids may be submitted on-line, but the book is maintained off-market by the bookrunner and bids are confidential to the bookrunner. The price at which new shares are issued is determined after the book is closed at the discretion of the bookrunner in consultation with the
issuer. Generally, bidding is by invitation only to clients of the bookrunner and, if any, lead manager, or co-manager(s). Generally, securities laws require additional disclosure requirements to be met if the issue is to be offered to all investors. Consequently, participation in a book build may be limited to certain classes of
investors. If retail clients are invited to bid, retail bidders are generally required to bid at the final price, which is unknown at the time of the bid, due to the impracticability of collecting multiple price point bids from each
retail client. Although bidding is by invitation, the issuer and bookrunner retain discretion to give some bidders a greater allocation of their bids than other investors. Typically, large institutional bidders receive
preference over smaller retail bidders, by receiving a greater allocation as a proportion of their initial bid. All bookbuilding is conducted ‘off-market’ and most stock exchanges have rules that require that on-market
The key differences between acquiring shares via a bookbuild (conducted off-market) and trading (conducted on-market) are: 1) bids into the book are confidential vs transparent bid and ask prices on a stock exchange;
2) bidding is by invitation only (only clients of the bookrunner and any co-managers may bid); 3) the bookrunner and the issuer determine the price of the shares to be issued and the allocations of shares
between bidders in their absolute discretion; 4) all shares are issued or transferred at the same price whereas on-market acquistions provide for a multiple trading prices.
Book building is essentially a process used by companies raising capital through public offerings—both initial public offers (IPOs) or follow-on public offers (FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at
various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on
the demand generated in the process.
Index
Let's understand the Concept...
Bretton Woods Agreement :
A 1944 agreement made in Bretton Woods, New Hampshire, which helped to establish a fixed exchange rate in terms of gold for major currencies. The International Monetary Fund was also established at this time. The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th Century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent
nation-states.
Preparing to rebuild the international economic system as World War II was still raging, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference. The delegates deliberated upon and signed the
Bretton Woods Agreements during the first three weeks of July 1944.
Previous regimes :
In the 19th and early 20th centuries gold played a key role in international monetary transactions. The gold standard was used to back currencies; the international value of currency was determined by its fixed
relationship to gold; gold was used to settle international accounts. The gold standard maintained fixed exchange rates that were seen as desirable because they reduced the risk of trading with other countries.
Imbalances in international trade were theoretically rectified automatically by the gold standard. A country with a deficit would have depleted gold reserves and would thus have to reduce its money supply. The
resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus the deficit would be rectified. Any country experiencing inflation would lose gold and therefore would have a decrease in
the amount of money available to spend. This decrease in the amount of money would act to reduce the inflationary pressure. Supplementing the use of gold in this period was the British pound. Based on the
dominant British economy, the pound became a reserve, transaction, and intervention currency. But the pound was not up to the challenge of serving as the primary world currency, given the weakness of the British
economy after the Second World War.
The architects of Bretton Woods had conceived of a system wherein exchange rate stability was a prime goal. Yet, in an era of more activist economic policy, governments did not seriously consider permanently fixed rates on the model of the classical gold standard of the nineteenth century. Gold production was not even sufficient to meet the demands of growing international trade and investment. And a sizeable share of the
world's known gold reserves were located in the Soviet Union, which would later emerge as a Cold War rival to the United States and Western Europe.
The only currency strong enough to meet the rising demands for international liquidity was the U.S. dollar. The strength of the U.S. economy, the fixed relationship of the dollar to gold ($35 an ounce), and the
commitment of the U.S. government to convert dollars into gold at that price made the dollar as good as gold. In fact, the dollar was even better than gold: it earned interest and it was more flexible than gold.
Fixed exchange rates :
The Bretton Woods system sought to secure the advantages of the gold standard without its disadvantages. Thus, a compromise was sought between the polar alternatives of either freely floating or irrevocably fixed
rates—an arrangement that might gain the advantages of both without suffering the disadvantages of either while retaining the right to revise currency values on occasion as circumstances warranted.
The rules of Bretton Woods, set forth in the articles of agreement of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), provided for a system of fixed exchange rates. The rules further sought to encourage an open system by committing members to the
convertibility of their respective currencies into other currencies and to free trade.
What emerged was the "pegged rate" currency regime. Members were required to establish a parity of their national currencies in terms of gold (a "peg") and to maintain exchange rates within plus or minus 1% of
parity (a "band") by intervening in their foreign exchange markets (that is, buying or selling foreign money).
The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in
terms of gold and the ability of the IMF to bridge temporary imbalances of payments. In the face of increasing financial strain, the system collapsed in 1971, after the United States unilaterally terminated convertibility of
the dollars to gold. This action caused considerable financial stress in the world economy and created the unique situation whereby the United States dollar became the "reserve currency" for the states which had
signed the agreement.
Index
Let's understand the Concept...
BRIC:
In economics, BRIC (typically rendered as "the BRICs" or "the BRIC countries") is an acronym that refers to the fast-growing developing economies of Brazil, Russia, India, and China. The acronym was first coined and prominently used by Goldman Sachs in 2001. According to a paper published in 2005, Mexico and South Korea are the only other countries comparable to the BRICs, but their economies were excluded initially
because they were considered already more developed.
Goldman Sachs did not argue that the BRICs would organize themselves into an economic bloc, or a formal trading association, as the European Union has done.However, there are strong indications that the "four BRIC
countries have been seeking to form a 'political club' or 'alliance'", and thereby converting "their growing economic power into greater geopolitical clout".On June 16, 2009, the leaders of the BRIC countries held their
first summit in Yekaterinburg, and issued a declaration calling for the establishment of a multipolar world order.
Goldman Sachs argues that the economic potential of Brazil, Russia, India, and China is such that they could become among the four most dominant economies by the year 2050. The thesis was proposed by Jim O'Neill, global economist at Goldman Sachs.These countries encompass over 25% of the world's land coverage and
40% of the world's population and hold a combined GDP (PPP) of 15.435 trillion dollars. On almost every scale, they would be the largest entity on the global stage. These four countries are among the biggest and
fastest growing emerging markets.
Index
Let's understand the Concept...
Buy Side:
The side of Wall Street comprising the investing institutions such as mutual funds, pension funds and insurance firms that tend to buy large portions of securities for money-management purposes. The buy side is the opposite of the sell-side entities, which provide recommendations for upgrades, downgrades, target prices
and opinions to the public market. Together, the buy side and sell side make up both sides of Wall Street.
For example, a buy-side analyst typically works in a non-brokerage firm (i.e. mutual fund or pension fund) and provides research and recommendations exclusively for the benefit of the company's own money managers
(as opposed to individual investors). Unlike sell-side recommendations - which are meant for the public - buy-side recommendations are not available to anyone outside the firm. In fact, if the buy-side analyst stumbles
upon a formula, vision or approach that works, it is kept secret.
Index
Buying back shares:
Let's understand the Concept...
Benefits-
In an efficient market, a company buying back its stock should have no effect at all on its stock price. If the market fairly prices a company's shares at $50/share, and the company buys back 100 shares for $5,000, it
now has $5,000 less cash but there are 100 fewer shares outstanding; the net effect should be that the value per share is unchanged. However, buying back shares does improve certain per-share ratios, such as
price/earnings (earnings per share is increased due to fewer shares outstanding), but since the market risk increases by the same amount, the share value remains unchanged.
If the market is not efficient, the company's shares may be underpriced. In that case a company can benefit its other shareholders by buying back shares. If a company's shares are overpriced, then a company is
actually hurting its remaining shareholders by buying back stock.
Incentives-
One other reason for a company to buy back its own stock is to reward holders of stock options. Call option holders are hurt by dividend payments, since, typically, they are not eligible to receive them. A share
buyback program may increase the value of remaining shares (if the buyback is executed when shares are under-priced); if so, call option holders benefit. A dividend payment short term always decreases the value of shares after the payment, so, on the day shares go ex-dividend, call option holders always lose whereas put
option holders benefit. Finally, if the sellers into a corporate buyback are actually the call option holders themselves, they may directly benefit from temporarily unrealistically favourable pricing.
A company does not benefit by helping call stock options holder so this is not an incentive. A company will not do it for this reason except for the case in which the decision makers for the company have the incentive of
profiting which is indeed illegal.
After buyback-
The company can either retire the shares (however, retired shares are not listed as treasury stock on the company's financial statements) or hold the shares for later resale. Buying back stock reduces the number of outstanding shares. To see this, note that accompanying the decrease in the number of shares outstanding is
a reduction in company assets, in particular, cash assets, which are used to buy back shares.
Index
Let's understand the Concept...
Capital Account Convertibility:
CAC is a monetary policy that centers around the ability to conduct transactions of local financial assets into foreign financial assets freely and at market determined exchange rates. It is sometimes referred to as
Capital Asset Liberation.
In layman's terms, it is basically a policy that allows the easy exchange of local currency (cash) for foreign currency at low rates. This is so local merchants can easily conduct transnational business without needing
foreign currency exchanges to handle small transactions. CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the
creation and liquidation of claims on, or by the rest of the world, on local asset and currency markets.
CAC was first coined as a theory by the Reserve Bank of India in 1997 by the Tarapore Committee, in an effort to find fiscal and economic policies that would enable developing Third World countries transition to globalized market economies. However, it had been practiced, although without formal thought or
organization of policy or restriction, since the very early 90's. Article VIII of the IMF’s Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems
with the concept in regard to outflows of currency.
However, before the formalization of CAC, there were problems with the theory. Free flow of assets was required to work in both directions. Although CAC freely enabled investment in the country, it also enabled quick liquidation and removal of capital assets from the country, both domestic and foreign. It also exposed
domestic creditors to overseas credit risks, fluctuations in fiscal policy, and manipulation.
As a result, there were severe disruptions that helped to contribute to the East Asian crisis of the mid 90's. In Malaysia, for example, there were heavy losses in overseas investments of at least one bank, in the
magnitude of hundreds of millions of dollars. These were not realized and identified until a reform system strengthened regulatory and accounting controls. This led to the Tarapore Committee meeting which
formalized CAC as utilizing a mixture of free asset allocation and stringent controls.
Index
Let's understand the Concept...
Capital budgeting:
- Accounting rate of return- Net present value- Profitability index
- Internal rate of return- Modified internal rate of return
- Equivalent annuity
Capital budgeting (or investment appraisal) is the planning process used to determine whether a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures. Many
formal methods are used in capital budgeting, including the techniques such as
These methods use the incremental cash flows from each potential investment, or project Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be
improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.
Index
Let's understand the Concept...
Capital flight:
Capital flight, in economics, occurs when assets and/or money rapidly flow out of a country, due to an economic event that disturbs investors and causes them to lower their valuation of the assets in that country,
or otherwise to lose confidence in its economic strength. This leads to a disappearance of wealth and is usually accompanied by a sharp drop in the exchange rate of the affected country (depreciation in a variable
exchange rate regime, or a forced devaluation in a fixed exchange rate regime).
This fall is particularly damaging when the capital belongs to the people of the affected country, because not only are the citizens now burdened by the loss of faith in the economy and devaluation of their currency, but
probably also their assets have lost much of their nominal value. This leads to dramatic decreases in the purchasing power of the country's assets and makes it increasingly expensive to import goods.
Index
Let's understand the Concept...
Capital gains tax:
A capital gains tax (CGT) is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of
stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.
For equities, an example of a popular and liquid asset, each national or state legislation, have a large array of fiscal obligations that must be respected regarding capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market. However, these fiscal obligations may vary
from jurisdiction to jurisdiction because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax-free stock
market operations are useful to boost economic growth.
Index
Let's understand the Concept...
Capital stock:
Types of stock :
The capital stock (or just stock) of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to
the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in quantity and value.
Shares -
The stock of a business is divided into shares, the total of which must be stated at the time of business formation. Given the total amount of money invested in the business, a share has a certain declared face
value, commonly known as the par value of a share. The par value is the de minimis (minimum) amount of money that a business may issue and sell shares for in many jurisdictions and it is the value represented as capital in the accounting of the business. In other jurisdictions, however, shares may not have an associated
par value at all. Such stock is often called non-par stock. Shares represent a fraction of ownership in a business. A business may declare different types (classes) of shares, each having distinctive ownership rules,
privileges, or share values.
Ownership of shares is documented by issuance of a stock certificate. A stock certificate is a legal document that specifies the amount of shares owned by the shareholder, and other specifics of the shares, such as the
par value, if any, or the class of the shares.
Stock typically takes the form of shares of either common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock
differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend payments before any dividends can be issued to other shareholders. Convertible
preferred stock is preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date. Shares of such stock are called
"convertible preferred shares" (or "convertible preference shares" in the UK)
New equity issues may have specific legal clauses attached that differentiate them from previous issues of the issuer. Some shares of common stock may be issued without the typical voting rights, for instance, or some shares may have special rights unique to them and issued only to certain parties. Often, new issues that have not been registered with a securities governing body may be restricted from resale for certain
periods of time.
Preferred stock may be hybrid by having the qualities of bonds of fixed returns and common stock voting rights. They also have preference in the payment of dividends over common stock and also have been given
preference at the time of liquidation over common stock. They have other features of accumulation in dividend.
Index
Let's understand the Concept...
Comparison of Cash Method & Accrual Method of accounting:
Cash basis:
Similar definition of cash basis accounting is true for financial accounting purposes.
Accrual basis:
Two primary accounting methods, cash and accrual basis, are used to calculate taxable income for U.S. federal income taxes. According to the Internal Revenue Code, a taxpayer may compute taxable income by:
- The cash receipts and disbursements method; - An accrual method;
- Any other method permitted by the chapter; or
- Any combination of the foregoing methods permitted under regulations prescribed by the Secretary.
As a general rule, a taxpayer must compute taxable income using the same accounting method he uses to compute income in keeping his books. Also, the taxpayer must maintain a consistent method of accounting from year to year. Should he change from the cash basis to the accrual basis (or vice versa), he must notify
and secure the consent of the Secretary.
Cash basis taxpayers include income when it is received, and claim deductions when expenses are paid. A cash basis taxpayer can look to the doctrine of constructive receipt and the doctrine of cash equivalence to
help determine when income is received. Most individuals start as cash basis taxpayers. There are three types of taxpayers that cannot use the cash basis: (1) Corporations; (2) partnerships with at least one C
corporation partner; and (3) tax shelters.
Accrual basis taxpayers include items when they are earned and claim deductions when expenses are incurred. An accrual basis taxpayer looks to the “all-events test” and “earlier-of test” to determine when
income is earned. Under the all-events test, an accrual basis taxpayer generally must include income "for the taxable year when all the events have occurred that fix the right to receive income and the amount of the
income can be determined with reasonable accuracy." Under the "earlier-of test", an accrual basis taxpayer receives income when (1) the required performance occurs, (2) payment therefore is due, or (3) payment
therefore is made, whichever happens earliest.
Similar definition of accrual basis accounting is true for financial accounting purposes, except that revenue can't be recognized until it's earned even if a cash payment has already been received.
Index
Closed-end fund:
Distinguishing features:
Some characteristics that distinguish a closed-end fund from an ordinary open-end mutual fund are that:
1. It is closed to new capital after it begins operating, and2. Its shares (typically) trade on stock exchanges rather than being redeemed directly by the fund.
4. A CEF usually has a premium or discount. An open-end fund sells at its NAV (except for sales charges).
5. A closed-end company can own unlisted securities.
Let's understand the Concept..
A closed-end fund (or closed-ended fund) is a collective investment scheme with a limited number of shares. It is called a closed-end fund (CEF) because new shares are rarely issued once the fund has launched, and
because shares are not normally redeemable[1] for cash or securities until the fund liquidates.
Typically an investor can acquire shares in a closed-end fund by buying shares on a secondary market from a broker, market maker, or other investor as opposed to an open-end fund where all transactions eventually
involve the fund company creating new shares on the fly (in exchange for either cash or securities) or redeeming shares (for cash or securities).
The price of a share in a closed-end fund is determined partially by the value of the investments in the fund, and partially by the premium (or discount) placed on it by the market. The total value of all the securities in
the fund divided by the number of shares in the fund is called the net asset value (NAV) per share. The market price of a fund share is often higher or lower than the per share NAV: when the fund's share price is
higher than per share NAV it is said to be selling at a premium; when it is lower, at a discount to the per share NAV.
In the U.S. legally they are called closed-end companies and form one of four SEC recognized types of investment companies along with mutual funds, exchange-traded funds, and unit investment trusts. Other
examples of closed-ended funds are investment trusts in the UK and listed investment companies in Australia.
3. Its shares can therefore be traded during the market day at any time. An open-end fund can usually be traded only at the closing price at the end of the market day.
Index
Let's understand the Concept...
Collateralized debt obligation:
Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs securities are split into
different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments
(and interest rates) or lower prices to compensate for additional default risk.
In simple terms, think of a CDO as a promise to pay cash flows to investors in a prescribed sequence, based on how much cash flow the CDO collects from the pool of bonds or other assets it owns. If cash collected by
the CDO is insufficient to pay all of its investors, those in the lower layers (tranches) suffer losses first.
CDO can be created as long as global investors are willing to provide the money to purchase the pool of bonds the CDO owns. CDO volume grew significantly between 2000-2006, then declined dramatically in the
wake of the subprime mortgage crisis, which began in 2007. Many of the assets held by these CDO's had been subprime mortgage-backed bonds. Global investors began to stop funding CDO's in 2007, contributing
to the collapse of certain structured investments held by major investment banks and the bankruptcy of several subprime lenders.
A few academics, analysts and investors such as Warren Buffett and the IMF's former chief economist Raghuram Rajan warned that CDOs, other ABSs and other derivatives spread risk and uncertainty about the
value of the underlying assets more widely, rather than reduce risk through diversification. Following the onset of the subprime mortgage crisis in 2007, this view has gained substantial credibility. Credit rating agencies failed to adequately account for large risks (like a nationwide collapse of housing values) when
rating CDOs and other ABSs.
Many CDOs are valued on a mark to market basis and thus experienced substantial write-downs as their market value collapsed during the subprime crisis, with banks writing down the value of their CDO holdings
mainly in the 2007-2008 period.
Index
Let's understand the Concept...
Collateralized fund obligation:
A collateralized fund obligation (CFO) is a form of securitization involving private equity fund or hedge fund assets, similar to collateralized debt obligations. CFOs are a structured form of financing for diversified private
equity portfolios, layering several tranches of debt ahead of the equity holders.
The data made available to the rating agencies for analyzing the underlying private equity assets of CFOs are typically less comprehensive than the data for analyzing the underlying assets of other types of structured
finance securitizations, including corporate bonds and mortgage-backed securities. Leverage levels vary from one transaction to another, although leverage of 50% to 75% of a portfolio's net assets has historically been
common.
The various CFO structures executed in recent years have had a variety of different objectives resulting in a variety of different structures. These differences tend to relate to the amount of equity sold through the
structure as well as to the leverage levels.
Index
Let's understand the Concept...
Collateralized mortgage obligation - Purpose:
The most basic way a mortgage loan can be transformed into a bond suitable for purchase by an investor would simply be to "split it". For example, a $300,000 30 year mortgage with an interest rate of 6.5% could be split into 300 1000 dollar bonds. These bonds would have a 30 year amortization, and an interest rate of 6.00% for example (with the remaining .50% going to the servicing company to send out the monthly bills
and perform servicing work). However, this format of bond has various problems for various investors
* Even though the mortgage is 30 years, the borrower could theoretically pay off the loan earlier than 30 years, and will usually do so when rates have gone down, forcing the investor to have to reinvest his money
at lower interest rates, something he may have not planned for. This is known as prepayment risk.
* A 30 year time frame is a long time for an investor's money to be locked away. Only a small percentage of investors would be interested in locking away their money for this long. Even if the average home owner
refinanced their loan every 10 years, meaning that the average bond would only last 10 years, there is a risk that the borrowers would not refinance, such as during an extending high interest rate period, this is known as extension risk. In addition, the longer time frame of a bond, the more the price moves up and down with the changes of interest rates, causing a greater potential penalty or bonus for an investor selling his bonds
early. This is known as interest rate risk.
* Most normal bonds can be thought of as "interest only loans", where the borrower borrows a fixed amount and then pays interest only before returning the principal at the end of a period. On a normal mortgage, interest and principal are paid each month, causing the amount of interest earned to decrease. This is
undesirable to many investors because they are forced to reinvest the principal.
* On loans not guaranteed by the quasi-governmental agencies Fannie Mae or Freddie Mac, certain investors may not agree with the risk reward tradeoff of the interest rate earned versus the potential loss of principal
due to the borrower not paying.
Salomon Brothers and First Boston created the CMO concept to address these issues. A CMO is essentially a way to create many different kinds of bonds from the same mortgage loan so as to please many different
kinds of investors. For example:
* A group of mortgages could create 4 different classes of bonds. The first group would receive any prepayments before the second group would, and so on. Thus the first group of bonds would be expected to pay off sooner, but would also have a lower interest rate. Thus a 30 year mortgage is transformed into bonds
of various lengths suitable for various investors with various goals.
* A group of mortgages could create 4 different classes of bonds. Any losses would go against the first group, before going against the second group, etc. The first group would have the highest interest rate, while the second would have slightly less, etc. Thus an investor could choose the bond that is right for the risk they want to take (i.e. a conservative bond for an insurance company, a speculative bond for a hedge fund).
* A group of mortgages could be split into principal-only and interest-only bonds. The "principal-only" bonds would sell at a discount, and would thus be zero coupon bonds (e.g., bonds that you buy for $800 each and
which mature at $1,000, without paying any cash interest). These bonds would satisfy investors who are worried that mortgage prepayments would force them to re-invest their money at the exact moment interest rates are lower; countering this, principal only investors in such a scenario would also be getting their money
earlier rather than later, which equates to a higher return on their zero-coupon investment. The "interest-only" bonds would include only the interest payments of the underlying pool of loans. These kinds of bonds
would dramatically change in value based on interest rate movements, e.g., prepayments mean less interest payments, but higher interest rates and lower prepayments means these bonds pay more, and for a longer
time. These characteristics allow investors to choose between interest-only (IO) and principal-only (PO) bonds to better manage their sensitivity to interest rates, and can be used to manage and offset the interest rate-
related price changes in other investments.
Index
Let's understand the Concept...
Collateralized mortgage obligation:
A collateralized mortgage obligation (CMO) is a type of financial debt vehicle that was first created in 1983 by the investment banks Salomon Brothers and First Boston for U.S. mortgage lender Freddie Mac.
Legally, a CMO is a special purpose entity that is wholly separate from the institution(s) that create it. The entity is the legal owner of a set of mortgages, called a pool. Investors in a CMO buy bonds issued by the
CMO, and they receive payments according to a defined set of rules. With regard to terminology, the mortgages themselves are termed collateral, the bonds are tranches while the structure is the set of rules that dictates how money received from the collateral will be distributed. The legal entity, collateral, and
structure are collectively referred to as the deal.
Investors in CMOs include banks, hedge funds, insurance companies, pension funds, mutual funds, government agencies, and most recently central banks. This article focuses primarily on CMO bonds as traded
in the United States of America.
The term collateralized mortgage obligation refers to a specific type of legal entity, but investors also frequently refer to deals issued using other types of entities such as REMICs as CMOs.
Index
Let's understand the Concept...
Commercial paper:
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued (sold) by large banks and corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or
corporation's promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face
value, and carries higher interest repayment rates than bonds.
Typically, the longer the maturity on a note, the higher the interest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates.
Index
Let's understand the Concept...
Commodity market:
Largest commodities exchanges
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.
This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals, electricity) markets but not the ways that services, including those of
governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus
of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets.
The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States,
other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established, there must be very broad consensus on the variations in the product that make it
acceptable for one purpose or another.
The economic impact of the development of commodity markets is hard to overestimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation,
warehousing, and financing, which paved the way to expanded interstate and international trade."
Index
Let's understand the Concept...
Common derivative contract types:
There are three major classes of derivatives:
Examples:The overall derivatives market has five major classes of underlying asset:
# Futures/Forwards are contracts to buy or sell an asset on or before a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized
contract written by a clearing house that operates an exchange where the contract can be bought and sold, whereas a forward contract is a non-standardized contract written by the parties themselves.
# Options are contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the
strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party
has the obligation to carry out the transaction.
# Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies/exchange rates, bonds/interest rates, commodities, stocks or other assets.
More complex derivatives can be created by combining the elements of these basic types. For example, the holder of a swaption has the right, but not the obligation, to enter into a swap on or before a specified future
date.
# Interest rate derivatives (the largest)# Foreign exchange derivatives
# Credit derivatives# Equity derivatives
# Commodity derivatives
Some common examples of these derivatives are:
Index
Let's understand the Concept...
Common stock:
Additional benefits from common stock include earning dividends and capital appreciation.
Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after
preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than preferred shares or bonds over time.
Common stock is usually voting shares, though not always. Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the
company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering.
Index
Let's understand the Concept...
Corporate Action:
A corporate action is an event initiated by a public company that affects the securities (equity or debt) issued by the company. Some corporate actions such as a dividend (for equity securities) or coupon payment (for debt securities (bonds)) may have a direct financial impact on the shareholders or bondholders; another
example is a call (early redemption) of a debt security. Other corporate actions such as stock split may have an indirect impact, as the increased liquidity of shares may cause the price of the stock to rise. Some
corporate actions such as name change have no direct financial impact on the shareholders.
It is the Any event that brings material change to a company and affects its stakeholders. This includes shareholders, both common and preferred, as well as bondholders. These events are generally approved by
the company's board of directors; shareholders are permitted to vote on some events as well. Splits, dividends, mergers, acquisitions and spin-offs are all examples of corporate actions. For example, a company
may decide to split its shares 2:1, leaving shareholders with twice as many shares as they had before. Bondholders are also subject to the effects of corporate actions, which might include calls or the issuance of
new debt. For example, if interest rates fall sharply, a company may call in bonds and pay off existing bondholders, then issue new debt at the current lower interest rates.
In short, A Corporate Action is any pending or completed action taken by an issuing corporation that affects the financial and/or physical status of a security.
Financial Status : An action affecting the financial status of a security is one that influences the original cost, market value, or the income earned on a security.
Example : A corporation declares a cash dividend to be paid to its stockholders. The financial effect on the security would be income earned.
Physical status change : An action affecting the physical status of a security is one that changes the appearance of the actual certificate.
Example-The corporation changes its name. All registered shareholders will be notified of the details related to the change. In the physical environment, the corporation's new name replaces the old name on the
certificate and the corporation reissues the certificate to the shareholders. In the book entry environment, a physical certificate may not exist so the certificate records are updated electronically.
Index
Let's understand the Concept...
Corporate bond:
Corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used
for instruments with a shorter maturity.)
Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of
local authorities and supranational organizations do not fit in either category.
Corporate bonds are often listed on major exchanges (bonds there are called "listed" bonds) and ECNs like Bonds.com and MarketAxess, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized,
dealer-based, over-the-counter markets.
Index
Let's understand the Concept...
Corporate restructuring:
Steps:
Update detailed business plan and considerations
Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Alternate reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout. Restructuring may also be described as corporate restructuring, debt restructuring and financial
restructuring.
Executives involved in restructuring often hire financial and legal advisors to assist in the transaction details and negotiation. It may also be done by a new CEO hired specifically to make the difficult and controversial decisions required to save or reposition the company. It generally involves financing debt, selling portions of
the company to investors, and reorganizing or reducing operations.
The basic nature of restructuring is a zero sum game. Strategic restructuring reduces financial losses, simultaneously reducing tensions between debt and equity holders to facilitate a prompt resolution of a
distressed situation.
Ensure the company has enough liquidity to operate during implementation of a complete restructuring
Produce accurate working capital forecasts Provide open and clear lines of communication with creditors who mostly control the company's ability to
raise financing
A company that has been restructured effectively will theoretically be leaner, more efficient, better organized, and better focused on its core business with a revised strategic and financial plan. If the restructured
company was a leverage acquisition, the parent company will likely resell it at a profit if the restructuring has proven successful.
Index
Let's understand the Concept...
Cost:
Costs are often further described based on their timing or their applicability.
Accounting vs opportunity costs:
In theoretical economics, cost used without qualification often means opportunity cost.
In business, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended
to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the
price also includes a mark-up for profit over the cost of production.
In accounting, costs are the monetary value of expenditures for supplies, services, labour, products, equipment and other items purchased for use by a business or other accounting entity. It is the amount
denoted on invoices as the price and recorded in bookkeeping records as an expense or asset cost basis.
Opportunity cost, also referred to as economic cost is the value of the best alternative that was not chosen in order to pursue the current endeavour—i.e., what could have been accomplished with the resources
expended in the undertaking. It represents opportunities forgone.
Index
Let's understand the Concept...
Credit derivative:
* bankruptcy (the risk that the reference entity will become bankrupt)
* failure to pay (the risk that the reference entity will default on one of its obligations such as a bond or loan)
* obligation default (the risk that the reference entity will default on any of its obligations)
* restructuring (the risk that obligations of the reference entity will be restructured)...
underlying bond, loan or any other financial asset. In this way, the credit risk is on an entity other than the counterparties to the transaction itself. This entity is known as the reference entity and may be a corporate, a sovereign or any other form of legal entity which has incurred debt. Credit derivatives are bilateral contracts
between a buyer and seller under which the seller sells protection against the credit risk of the reference entity. Stated in plain language, a credit derivative is a wager, and the reference entity is the thing being wagered on. Similar to placing a bet at the racetrack, where the person placing the bet does not own the
horse or the track or have anything else to do with the race, the person buying the credit derivative doesn't necessarily own the bond (the reference entity) that is the object of the wager. He or she simply believes that
there is a good chance that the bond or collateralized debt obligation (CDO) in question will default (go to zero value). Originally conceived as a kind of insurance policy for owners of bonds or CDO's, it evolved into a
freestanding investment strategy. The cost might be as low as 1% per year. If the buyer of the derivative believes the underlying bond will go bust within a year (usually an extremely unlikely event) the buyer stands
to reap a 100 fold profit. A small handful of investors anticipated the credit crunch of 2007/8 and made
The parties will select which credit events apply to a transaction and these usually consist of one or more of the following:
* obligation acceleration (the risk that an obligation of the reference entity will be accelerated e.g. a bond will be declared immediately due and payable following a default)
* repudiation/moratorium (the risk that the reference entity or a government will declare a moratorium over the reference entity's obligations)
Where credit protection is bought and sold between bilateral counterparties, this is known as an unfunded credit derivative. If the credit derivative is entered into by a financial institution or a special purpose vehicle (SPV) and payments under the credit derivative are funded using securitization techniques, such that a debt obligation is issued by the financial institution or SPV to support these obligations, this is known as a funded
credit derivative.
Index
Let's understand the Concept...
Currency code:
History:
ISO 4217 is the international standard describing three-letter codes (also known as the currency code) to define the names of currencies established by the International Organization for Standardization (ISO). The ISO 4217 code list is the established norm in banking and business all over the world for defining different
currencies, and in many countries the codes for the more common currencies are so well known publicly, that exchange rates published in newspapers or posted in banks use only these to define the different currencies,
instead of translated currency names or ambiguous currency symbols. ISO 4217 codes are used on airline tickets and international train tickets to remove any ambiguity about the price.
In 1973, the ISO Technical Committee 68 decided to develop codes for the representation of currencies and funds for use in any application of trade, commerce or banking. At the 17th session (February 1978) of the
related UN/ECE Group of Experts agreed that the three-letter alphabetic codes for International Standard ISO 4217, "Codes for the representation of currencies and funds", would be suitable for use in international trade.
Over time, new currencies are created and old currencies are discontinued. Frequently, these changes are due to new governments (through war or a new constitution), treaties between countries standardizing on a
currency, or revaluation of the currency due to excessive inflation. As a result, the list of codes must be updated from time to time. The ISO 4217 maintenance agency (MA), SIX Interbank Clearing, is responsible for
maintaining the list of codes.
Index
Let's understand the Concept...
Currency future:
Uses:
A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date;
Typically, one of the currencies is the US dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange
markets. The trade unit of each contract is then a certain amount of other currency, for instance €125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that. Investors can close out the
contract at any time prior to the contract's delivery date.
Hedging - Investors use these futures contracts to hedge against foreign exchange risk. If an investor will receive a
cashflow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the
cashflow.
For example, Jane is a US-based investor who will receive €1,000,000 on December 1. The current exchange rate implied by the futures is $1.2/€. She can lock in this exchange rate by selling €1,000,000 worth of futures
contracts expiring on December 1. That way, she is guaranteed an exchange rate of $1.2/€ regardless of exchange rate fluctuations in the meantime.
Speculation - Currency futures can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling
exchange rates.
For example, Peter buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10
contracts, his profit is $8,875. As with any future, this is paid to him immediately.
More generally, each change of $0.0001/€ (the minimum Commodity tick size), is a profit or loss of $12.50 per contract.
Index
Let's understand the Concept...
Currency pair:
Syntax and quotation:
A currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. The currency that is used as the reference is called the counter currency or
quote currency and the currency that is quoted in relation is called the base currency or transaction currency.
Currency pairs are written by concatenating the ISO currency codes (ISO 4217) of the base currency and the counter currency, separating them with a slash character. Often the slash character is omitted. A widely
traded currency pair is the relation of the euro against the US dollar, designated as EUR/USD. The quotation EUR/USD 1.2500 means that one euro is exchanged for 1.2500 US dollars.
The most traded currency pairs in the world are called the Majors. They involve the currencies euro, US dollar, Japanese yen, pound sterling, Australian dollar, Canadian dollar, and the Swiss franc.
Currency quotations use the abbreviations for currencies that are prescribed by the International Organization for Standardization (ISO) in standard ISO 4217. The major currencies and their designation in the foreign exchange market are the US dollar (USD), euro (EUR), Japanese yen (JPY), British pound (GBP), Australian
dollar (AUD), Canadian dollar (CAD), and the Swiss franc (CHF).
The quotation EUR/USD 1.2500 means that one euro is exchanged for 1.2500 US dollars. If the quote changes from EUR/USD 1.2500 to 1.2510, the euro has increased in relative value, because either the dollar buying
strength has weakened or the euro has strengthened, or both. On the other hand, if the EUR/USD quote changes from 1.2500 to 1.2490 the euro is relatively weaker than the dollar.
Index
Currency swaps:
Structure:
There are three different ways in which currency swaps can exchange loans:
Let's understand the Concept..
A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. Just like interest rate swaps,
the currency swaps also are motivated by comparative advantage.
A currency swap is a foreign-exchange agreement between two parties to exchange aspects (namely the principal and/or interest payments) of a loan in one currency for equivalent aspects of an equal in net present
value loan in another currency; see Foreign exchange derivative. Currency swaps are motivated by comparative advantage. A currency swap should be distinguished from a central bank liquidity swap.
Currency swaps are over-the-counter derivatives, and are closely related to interest rate swaps. However, unlike interest rate swaps, currency swaps can involve the exchange of the principal.
The most simple currency swap structure is to exchange the principal only with the counterparty, at a rate agreed now, at some specified point in the future. Such an agreement performs a function equivalent to a forward contract or futures. The cost of finding a counterparty (either directly or through an intermediary), and drawing up an agreement with them, makes swaps more expensive than alternative derivatives (and
thus rarely used) as a method to fix shorter term forward exchange rates. However for the longer term future, commonly up to 10 years, where spreads are wider for alternative derivatives, principal-only currency swaps are often used as a cost-effective way to fix forward rates. This type of currency swap is also known as an FX-
swap.
Another currency swap structure is to combine the exchange of loan principal, as above, with an interest rate swap. In such a swap, interest cash flows are not netted before they are paid to the counterparty (as they
would be in a vanilla interest rate swap) because they are denominated in different currencies. As each party effectively borrows on the other's behalf, this type of swap is also known as a back-to-back loan.
Last here, but certainly not least important, is to swap only interest payment cash flows on loans of the same size and term. Again, as this is a currency swap, the exchanged cash flows are in different denominations and
so are not netted. An example of such a swap is the exchange of fixed-rate US Dollar interest payments for floating-rate interest payments in Euro. This type of swap is also known as a cross-currency interest rate
swap, or cross-currency swap.
Index
Let's understand the Concept...
Option:
Contract specifications -
- Whether the option holder has the right to buy (a call option) or the right to sell (a put option) - The quantity and class of the underlying asset(s) (e.g. 100 shares of XYZ Co. B stock)
- The expiration date, or expiry, which is the last date the option can be exercised
In finance, an option is a derivative financial instrument that establishes a contract between two parties concerning the buying or selling of an asset at a reference price during a specified time frame. During this
time frame, the buyer of the option gains the right, but not the obligation, to engage in some specific transaction on the asset, while the seller incurs the obligation to fulfill the transaction if so requested by the
buyer. The price of an option derives from the value of an underlying asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiration of the option.
Other types of options exist, and options can in principle be created for any type of valuable asset.
An option which conveys the right to buy something is called a call; an option which conveys the right to sell is called a put. The price specified at which the underlying may be traded is called the strike price or exercise
price. The process of activating an option and thereby trading the underlying at the agreed-upon price is referred to as exercising it. Most options have an expiration date. If the option is not exercised by the
expiration date, it becomes void and worthless.
An option can usually be sold by its original buyer to another party. Many options are created in standardized form and traded on an anonymous options exchange among the general public, while other over-the-counter
options are customized to the desires of the buyer on an ad hoc basis, usually by an investment bank.
Every financial option is a contract between the two counterparties with the terms of the option specified in a term sheet. Option contracts may be quite complicated; however, at minimum, they usually contain the
following specifications.
- The strike price, also known as the exercise price, which is the price at which the underlying transaction will occur upon exercise
- The settlement terms, for instance whether the writer must deliver the actual asset on exercise, or may simply tender the equivalent cash amount
- The terms by which the option is quoted in the market to convert the quoted price into the actual premium-–the total amount paid by the holder to the writer of the option.
Index
Let's understand the Concept...
Derivative:
Uses -Derivatives are used by investors to:
In finance, a derivative is a financial instrument (or, more simply, an agreement between two parties) that has a value, based on the expected future price movements of the asset to which it is linked—called the
underlying- such as a share or a currency. There are many kinds of derivatives, with the most common being swaps, futures, and options. Derivatives are a form of alternative investment.
A derivative is not a stand-alone asset, since it has no value of its own. However, more common types of derivatives have been traded on markets before their expiration date as if they were assets. Among the
oldest of these are rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.
* Provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative;
* Speculate and make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level);
* Hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out;
* Obtain exposure to the underlying where it is not possible to trade in the underlying (e.g., weather derivatives);
* Create option ability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific price level).
Index
Dividend yield:
Common share dividend yield:
Let's understand the Concept...
The dividend yield or the dividend-price ratio on a company stock is the company's annual dividend payments divided by its market cap, or the dividend per share, divided by the price per share. It is often expressed as a
percentage. Its reciprocal is the Price/Dividend ratio.
There is no stipulated dividend for common stock. Instead, dividends paid to holders of common stock are set by management, usually in relation to the company's earnings. There is no guarantee that future dividends
will match past dividends or even be paid at all. Due to the difficulty in accurately forecasting future dividends, the most commonly-cited figure for dividend yield is the current yield which is calculated using the
following formula:
For example, take a company which paid dividends totaling $1 per share last year and whose shares currently sell for $20. Its dividend yield would be calculated as follows:
Rather than using last year's dividend, some try to estimate what the next year's dividend will be and use this as the basis of a future dividend yield. Such a scheme is used for the calculation of the FTSE UK Dividend+
Index. Estimates of future dividend yields are by definition uncertain.
Index
Documents that can be presented for payment:
Let's understand the Concept...
To receive payment, an exporter or shipper must present the documents required by the letter of credit. Typically instead of presenting goods themselves, a document proving the goods were sent is presented
instead. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin or place. Typical types of documents in such contracts might include.
* Financial Documents Bill of Exchange, Co-accepted Draft
* Commercial Documents Invoice, Packing list* Shipping Documents
Transport Document, Insurance Certificate, Commercial, Official or Legal Documents* Official Documents
License, Embassy legalization, Origin Certificate, Inspection Certificate, Phytosanitary certificate
* Transport Documents Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt,
CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc* Insurance documents
Insurance policy, or Certificate but not a cover note.
Index
Let's understand the Concept...
Dollarization:
Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. The term is not only applied to usage of the United States dollar, but generally to the use
of any foreign currency as the national currency.
Official dollarization has gained prominence as several countries have considered and implemented it as official policy. The major advantage of dollarization is promoting fiscal discipline and thus greater financial
stability and lower inflation.
The biggest economies to have officially dollarized as of June 2002 are Panama (since 1904), Ecuador (since 2000), and El Salvador (since 2001). As of August 2005, the United States dollar, the euro, the New Zealand
dollar, the Swiss franc, the Indian rupee, and the Australian dollar were the only currencies used by other countries for official dollarization. In addition, the Turkish lira, the Israeli shekel, and the Russian ruble are
used by internationally unrecognised but de facto independent states.
Index
Let's understand the Concept...
There are, broadly, two types of trading in the financial markets:
Electronic trading:
Electronic trading, sometimes called etrading, is a method of trading securities (such as stocks, and bonds), foreign currency, and exchange traded derivatives electronically. It uses information technology to bring
together buyers and sellers through electronic media to create a virtual market place. NASDAQ, NYSE Arca and Globex are examples of electronic market places. Exchanges that facilitate electronic trading in the
United States are regulated by either the Securities and Exchange Commission or the Commodity Futures Trading Commission, and are generally called electronic communications networks or ECNs.
Etrading is widely believed to be more reliable than older methods of trade processing, but glitches and cancelled trades do occur.
Historically, stock markets were physical locations where buyers and sellers met and negotiated. With the improvement in communications technology in the late 20th century, the need for a physical location became
less important, as traders could transact from remote locations.
Business-to-business (B2B) trading, often conducted on exchanges, where large investment banks and brokers trade directly with one another, transacting large amounts of securities, and
Business-to-client (B2C) trading, where retail (e.g. individuals buying and selling relatively small amounts of stocks and shares) and institutional clients (e.g. hedge funds, fund managers or insurance companies,
trading far larger amounts of securities) buy and sell from brokers or "dealers", who act as middle-men between the clients and the B2B markets.
Index
Let's understand the Concept...
Equity investments:
An equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains, as the value of the stock
rises. It may also refer to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup company. When the investment is in infant companies, it is referred to as venture capital investing
and is generally understood to be higher risk than investment in listed going-concern situations.
The equities held by private individuals are often held via mutual funds or other forms of collective investment scheme, many of which have quoted prices that are listed in financial newspapers or magazines; the mutual funds are typically managed by prominent fund management firms, such as Schroders, Fidelity
Investments or The Vanguard Group. Such holdings allow individual investors to obtain the diversification of the fund(s) and to obtain the skill of the professional fund managers in charge of the fund(s). An alternative,
which is usually employed by large private investors and pension funds, is to hold shares directly; in the institutional environment many clients who own portfolios have what are called segregated funds, as opposed
to or in addition to the pooled mutual fund alternatives.
A calculation can be made to assess whether an equity is over or underpriced, compared with a long-term government bond. This is called the Yield Gap or Yield Ratio. It is the ratio of the dividend yield of an equity
and that of the long-term bond.
Index
Equity swap:
An equity swap involves a notional principal, a specified tenor and predetermined payment intervals.Equity swaps are typically traded by Delta One trading desks.
Examples -
Let's understand the Concept..
An equity swap is a financial derivative contract (a swap) where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. The two cash flows are usually referred to as "legs" of the swap; one of these "legs" is usually pegged to a floating rate such as LIBOR. This leg is also
commonly referred to as the "floating leg". The other leg of the swap is based on the performance of either a share of stock or a stock market index. This leg is commonly referred to as the "equity leg". Most equity
swaps involve a floating leg vs. an equity leg, although some exist with two equity legs.
Parties may agree to make periodic payments or a single payment at the maturity of the swap ("bullet" swap), the worst case.
Take a simple index swap where Party A swaps £5,000,000 at LIBOR + 0.03% (also called LIBOR + 3 basis points) against £5,000,000 (FTSE to the £5,000,000 notional). In this case Party A will pay (to Party B) a floating interest rate (LIBOR +0.03%) on the £5,000,000 notional and would receive from Party B any
percentage increase in the FTSE equity index applied to the £5,000,000 notional.
In this example, assuming a LIBOR rate of 5.97% p.a. and a swap tenor of precisely 180 days, the floating leg payer/equity receiver (Party A) would owe (5.97%+0.03%)*£5,000,000*180/360 = £150,000 to the equity
payer/floating leg receiver (Party B).
At the same date (after 180 days) if the FTSE had appreciated by 10% from its level at trade commencement, Party B would owe 10%*£5,000,000 = £500,000 to Party A. If, on the other hand, the FTSE at the six-month
mark had fallen by 10% from its level at trade commencement, Party A would owe an additional 10%*£5,000,000 = £500,000 to Party B, since the flow is negative.
For mitigating credit exposure, the trade can be reset, or "marked-to-market" during its life. In that case, appreciation or depreciation since the last reset is paid and the notional is increased by any payment to the
pricing rate payer or decreased by any payment from the floating leg payer.
Index
Let's understand the Concept...
Eurodollar:
Eurodollars are deposits denominated in United States dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. There is nothing "European"
about Eurodollar deposits; a U.S. dollar-denominated deposit in Tokyo or Caracas would likewise be deemed a Eurodollar deposit. Neither is there any connection with the euro currency. The term was originally coined for
U.S. dollars in European banks, but it expanded over the years to its present definition.
More generally, the "euro" prefix can be used to indicate any currency held in a country where it is not the official currency: for example, euroyen or even euroeuro.
Index
Examples of treasuries:
Treasury -
Ministry of finance -
Both -
Let's understand the Concept..
In the United Kingdom, Her Majesty's Treasury is overseen by the Chancellor of the Exchequer. The traditional honorary title of First Lord of the Treasury is held by the Prime Minister. Her Majesty's Revenue and Customs
administers the taxation system.
In the United States, the Treasurer reports to an executive-appointed Secretary of the Treasury. The IRS is the revenue agency of the US Department of Treasury.
In many other countries, the treasury is called the "ministry of finance" and the head is known as the finance minister. Examples include New Zealand, Canada, Malaysia, Singapore, Bangladesh, India and Japan. In some
other countries, a "treasury" will exist alongside a separate "Ministry of Finance", with divided functions (Ukraine).
In the Australian federal government a treasurer and a finance minister co-exist. The Department of the Treasury is responsible for drafting the government budget, economic policy (except monetary policy), some
market regulation and revenue policy (which is administed by the Australian Taxation Office). The Finance Minister, who manages the Department of Finance and Deregulation is responsible for budget management,
government expenditure and market deregulation.
The government of Poland includes the Ministry of Finance as well as the Ministry of State Treasury. It was the same in Italy before the creation of the united Ministry of Economy.
Index
Let's understand the Concept...
Exchange (organized market):
Exchanges can be subdivided:
An exchange (or bourse) is a highly organized market where (especially) tradable securities, commodities, foreign exchange, futures, and options contracts are sold and bought. Exchanges bring together brokers and
dealers who buy and sell these objects. These various financial instruments can typically be sold either through the exchange, typically with the benefit of a clearinghouse to cover defaults, or over-the-counter,
where there is typically less protection against counterparty risk from clearinghouses although OTC clearinghouses have become more common over the years, with regulators placing pressure on the OTC
markets to clear and display trades openly.
* by objects sold: - stock exchange or securities exchange
- commodities exchange - foreign exchange market - is rare today in the form of a specialized institution
* by type of trade: - classical exchange - for spot trades
- futures exchange or futures and options exchange - for derivatives
Index
Let's understand the Concept...
Exchange rate - Quotations :
An exchange system quotation is given by stating the number of units of "quote currency" (price currency, payment currency) that can be exchanged for one unit of "base currency" (unit currency, transaction
currency). For example, in a quotation that says the EUR/USD exchange rate is 1.2290 (1.2290 USD per EUR, also known as EUR/USD), the quote currency is USD and the base currency is EUR.
Market convention from the early 1980s to 2006 was that most currency pairs were quoted to 4 decimal places for spot transactions and up to 6 decimal places for forward outrights or swaps. (The fourth decimal place is usually referred to as a "pip"). An exception to this was exchange rates with a value of less than
1.000 which were usually quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a value greater than around 20 were usually quoted to 3 decimal places and currencies with a value
greater than 80 were quoted to 2 decimal places. Currencies over 5000 were usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR : 0.765432 - EURUSD : 1.5877 - GBPBEF : 58.234 -
EURJPY : 165.29). In other words, quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5 decimal places.
In 2005 Barclays Capital broke with convention by offering spot exchange rates with 5 or 6 decimal places on their electronic dealing platform. The contraction of spreads (the difference between the bid and offer rates)
arguably necessitated finer pricing and gave the banks the ability to try and win transaction on multibank trading platforms where all banks may otherwise have been quoting the same price. A number of other banks
have now followed this.
While official quotations are given with the full number, for example 1.4320, many investors and analysts drop the integer for convenience and use only the fractional part, such as 4320. These are used frequently
where a move in price is being described, for example 4320 to 4290 as opposed to 1.4320 to 1.4290.
Index
Let's understand the Concept...
Exchange rate:
* Direct quotation: 1 foreign currency unit = x home currency units* Indirect quotation: 1 home currency unit = x foreign currency units
In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specify how much one currency is worth in terms of the other. It is the value of a foreign nation’s
currency in terms of the home nation’s currency. For example an exchange rate of 91 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 91 is worth the same as USD 1. The foreign exchange market
is one of the largest markets in the world. By some estimates, about 3.2 trillion USD worth of currency changes hands every day.
The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
Quotes using a country's home currency as the price currency (e.g., EUR 0.735342 = USD 1.00 in the euro zone) are known as direct quotation or price quotation (from that country's perspective) and are used by most
countries.
Quotes using a country's home currency as the unit currency (e.g., EUR 1.00 = USD 1.35991 in the euro zone) are known as indirect quotation or quantity quotation and are used in British newspapers and are also
common in Australia, New Zealand and the eurozone.
Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating, or becoming more valuable) then the exchange rate number decreases. Conversely if the foreign currency is strengthening, the
exchange rate number increases and the home currency is depreciating.
Index
Let's understand the Concept...
Exchange-traded derivative contracts (ETD):
Exchange-traded derivative contracts (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade
standardized contracts that have been defined by the exchange. A derivatives exchange acts as an intermediary to all related transactions, and takes Initial margin from both sides of the trade to act as a
guarantee.
The world's largest derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the
Chicago Board of Trade and the 2008 acquisition of the New York Mercantile Exchange). According to BIS, the combined turnover in the world's derivatives exchanges totaled USD 344 trillion during Q4 2005. Some types of derivative instruments also may trade on traditional exchanges. For instance, hybrid instruments such as convertible bonds and/or convertible preferred may be listed on stock or bond exchanges. Also, warrants (or "rights") may be listed on equity exchanges. Performance Rights, Cash xPRTs and various other instruments
that essentially consist of a complex set of options bundled into a simple package are routinely listed on equity exchanges. Like other derivatives, these publicly traded derivatives provide investors access to
risk/reward and volatility characteristics that, while related to an underlying commodity, nonetheless are distinctive.
Index
Let's understand the Concept...
External Commercial Borrowing:
An Indian enterprise borrowing in foreign exchange has to comply with the external commercial borrowings (ECB) policy announced by the regulator, the Reserve Bank of India (RBI). ECBs encompass commercial bank
loans, buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and fixed rate bonds, credit from official export credit agencies, foreign currency convertible bonds and commercial borrowings from the private sector lending arms of multilateral financial institutions—for instance, the
International Finance Corporation and the Asian Development Bank. The ECB policy is monitored and updated by RBI on a regular basis, according to the macroeconomic conditions and foreign exchange liquidity
situation.
The Indian economy has seen phenomenal growth over the last few years. The economic boom was initiated by the information technology sector and followed by the resurgence in the manufacturing and services industries. While the boom was accompanied by substantial foreign direct investment, Indian enterprises
have also accessed significant amounts of foreign debt. The cost of borrowing being higher in India compared with the international market, Indian companies started using the ECB route frequently. As an anti-inflationary
measure, RBI amended the ECB policy, making it more restrictive.
Over the course of last year, the subprime crisis in the US has snowballed into an international economic crisis. As the impact of this crisis was gradually felt across the globe, it has also affected India. Bankers
globally have adopted a far more cautious approach to lending. The cost of funds has risen globally as more and more financial institutions are grappling with losses and write-offs. Lenders globally have complained that
the standard benchmark rates, for example the London Interbank Offered Rate, do not represent the actual cost of funds. In order to address this, lenders have explored the possibility of invoking terms in the loan
agreement that allow the interest rate to be increased to reflect the actual cost of funds.
Such a change in the interest rate can be initiated using a “market disruption event” clause. While this is a common clause in the standard Loan Market Association standard loan agreements, a market disruption
event would typically be invoked when there is an actual disaster, such as a critical breakdown of computer systems, natural disasters, and so on. This clause appears to be the only comfort to many troubled lenders
across the globe. A market disruption event would allow the lender to calculate the rate of interest for a specific loan that represents its actual cost of funds.
ECBs have suffered in view of the adverse economic conditions coupled with the regulatory hurdles. The challenge for India lies in the regulator—RBI—ensuring that the ECB policy remains proactive and reflects the
economic reality. Simultaneously, banks and financial institutions should endeavour to continue lending to reputed firms that have a good credit history.
Index
Let's understand the Concept...
Features of primary markets:
* In a primary issue, the securities are issued by the company directly to investors.* The company receives the money and issues new security certificates to the investors.
* The primary market performs the crucial function of facilitating capital formation in the economy.
Methods of issuing securities in the primary market are:
* Initial public offering;* Rights issue (for existing companies);
* Preferential issue.
* This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).
* Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.
* The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be * raising capital for converting
private capital into public capital; this is known as "going public."* The financial assets sold can only be redeemed by the original holder.
Index
Let's understand the Concept...
Financial crisis of 2007–2010:
Global contagion:
The financial crisis of 2007–2010 has been called by leading economists the worst financial crisis since the Great Depression of the 1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. Many causes have been proposed, with varying weight assigned by experts. Both market-based and regulatory solutions have been implemented or are under consideration, while significant risks remain for the world economy over the 2010–2011 periods. Although this economic period has at times been referred to as "the Great Recession," this same phrase has been used to refer to
every recession of the several preceding decades.
The collapse of a global housing bubble, which peaked in the U.S. in 2006, caused the values of securities tied to real estate pricing to plummet thereafter, damaging financial institutions globally. Questions regarding
bank solvency, declines in credit availability, and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009. Economies worldwide
slowed during this period as credit tightened and international trade declined. Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st century financial markets.
Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion, and institutional bailouts.
The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and large reductions in the market value of equities and
commodities.
Both MBS and CDO were purchased by corporate and institutional investors globally. Derivatives such as credit default swaps also increased the linkage between large financial institutions. Moreover, the de-
leveraging of financial institutions, as assets were sold to pay back obligations that could not be refinanced in frozen credit markets, further accelerated the liquidity crisis and caused a decrease in international trade.
World political leaders, national ministers of finance and central bank directors coordinated their efforts to reduce fears, but the crisis continued. At the end of October 2008 a currency crisis developed, with investors transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc,
leading many emergent economies to seek aid from the International Monetary Fund.
Index
Let's understand the Concept...
Financial engineering can also refer to:- Mathematical Finance- Computational finance- Financial reinsurance
Financial engineering:
Financial engineering is a multidisciplinary field involving financial theory, the methods of financing, using tools of mathematics, computation and the practice of programming to achieve the desired end results.
The financial engineering methodologies usually apply social theories, engineering methodologies and quantitative methods to finance. It is normally used in the securities, banking, and financial management and
consulting industries, or as quantitative analysts in corporate treasury and finance departments of general manufacturing and service firms.
Index
They are traded across a wide range of currencies, including the G12 country currencies and many others.
Some representative financial futures contracts are:United States
90-day Eurodollar (IMM)1 mo LIBOR (IMM)
Fed Funds 30 day (CBOT) Europe
3 mo Euribor (Euronext.liffe)90-day Sterling LIBOR (Euronext.liffe)
Euro Sfr (Euronext.liffe) Asia
3 mo Euroyen (TIF)90-day Bank Bill (SFE)
- IMM is the International Money Market of the Chicago Mercantile Exchange- CBOT is the Chicago Board of Trade
- OCOM is the Tokyo Commodity Exchange- SFE is the Sydney futures exchange
* There are four contracts per year: March, June, September, December (plus serial months)* They are listed on a 10 year cycle. Other markets only extend about 2–4 years.
* Last Trading Day is the second London business day preceding the third Wednesday of the contract month
* Delivery Day is cash settlement on the third Wednesday.* The minimum fluctuation (Commodity tick size) is half a basis point or 0.005%.
Financial futures are extensively used in the hedging of interest rate swaps.
Let's understand the Concept...
Financial future:
A financial future is a futures contract on a short term interest rate (STIR). Contracts vary, but are often defined on an interest rate index such as 3-month sterling or US dollar LIBOR.
where
As an example, consider the definition of the International Money Market (IMM) eurodollar interest rate future, the most widely and deeply traded financial futures contract.
* Payment is the difference between the price paid for the contract (in ticks) multiplied by the "tick value" of the contract which is $12.50 per tick.
* Before the Last Trading Day the contract trades at market prices. The Final Settlement Price is the British Bankers Association (BBA) percentage rate for Three–Month Eurodollar Interbank Time Deposits, rounded to
the nearest 1/10000th of a percentage point at 11:00 London time on that day, subtracted from 100. (Expressing financial futures prices as 100 minus the implied interest rate was originally intended to make the contract price behave similarly to a Bond price in that an increase in price corresponds to a decrease in yield).
Index
Let's understand the Concept...
Financial instrument:
Matrix Table-
A financial instrument is either cash; evidence of an ownership interest in an entity; or a contractual right to receive, or deliver, cash or another financial instrument.
Categorization-
Financial instruments can be categorized by form depending on whether they are cash instruments or derivative instruments :
* Cash instruments are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and
deposits, where both borrower and lender have to agree on a transfer.
* Derivative instruments are financial instruments which derive their value from the value and characteristics of one or more underlying assets. They can be divided into exchange-traded derivatives and
over-the-counter (OTC) derivatives
Alternatively, financial instruments can be categorized by "asset class" depending on whether they are equity based (reflecting ownership of the issuing entity) or debt based (reflecting a loan the investor has made to
the issuing entity). If it is debt, it can be further categorised into short term (less than one year) or long term.
Foreign Exchange instruments and transactions are neither debt nor equity based and belong in their own category.
Combining the above methods for categorization, the main instruments can be organized into a matrix as follows:
Index
Financial market:
In finance, financial markets facilitate:
* The raising of capital (in the capital markets)* The transfer of risk (in the derivatives markets)
* International trade (in the currency markets)- and are used to match those who want capital to those who have it.
Let's understand the Concept...
In economics, a financial market is a mechanism that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible
items of value at low transaction costs and at prices that reflect the efficient-market hypothesis.
Both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded) exist. Markets work by placing many interested buyers and sellers in one "place", thus
making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy in contrast either to a command
economy or to a non-market economy such as a gift economy.
Typically a borrower issues a receipt to the lender promising to pay back the capital. These receipts are securities which may be freely bought or sold. In return for lending money to the borrower, the lender will
expect some compensation in the form of interest or dividends.
Index
Let's understand the Concept...
Fixed income - Terminology:
While a bond is simply a promise to pay interest on borrowed money, there is some important terminology used by the fixed-income industry:
* The issuer is the entity (company or govt.) who borrows an amount of money (issuing the bond) and pays the interest.
* The principal of a bond - also known as maturity value, face value, par value - is the amount that the issuer borrows which must be repaid to the lender
* The coupon (of a bond) is the interest that the issuer must pay.
* The maturity is the end of the bond, the date that the issuer must return the principal.
* The issue is another term for the bond itself.
* The indenture is the contract that states all of the terms of the bond.
Index
Fixed income:
Fixed income refers to any type of investment that yields a regular (or fixed) return.
Let's understand the Concept...
For example, if you lend money to a borrower and the borrower has to pay interest once a month, you have been issued a fixed-income security. Governments issue government bonds in their own currency and
sovereign bonds in foreign currencies. Local governments issue municipal bonds to finance themselves. Debt issued by government-backed agencies is called an agency bond. Companies can issue a corporate bond or get money from a bank through a corporate loan ("preferred stock" is also sometimes considered to be fixed income). Securitized bank lending (e.g. credit card debt, car loans or mortgages) can be structured into other types of fixed income products such as ABS - asset-backed securities which can be traded on exchanges just
like corporate and government bonds.
The term fixed income is also applied to a person's income that does not vary with each period. This can include income derived from fixed-income investments such as bonds and preferred stocks or pensions that guarantee a fixed income. When pensioners or retirees are dependent on their pension as their dominant source of income, the term "fixed income" can also carry the implication that they have relatively limited
discretionary income or have little financial freedom to make large expenditures.
Fixed-income securities can be contrasted with variable return securities such as stocks. In order for a company to grow as a business, it often must raise money; to finance an acquisition, buy equipment or land
or invest in new product development. Investors will only give money to the company if they believe that they will be given something in return commensurate with the risk profile of the company. The company can either
pledge a part of itself, by giving equity in the company (stock), or the company can give a promise to pay regular interest and repay principal on the loan (bond, bank loan, or preferred stock).
Index
Let's understand the Concept...
Floating rate note:
Issuers -
Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs
have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for
that day and adding the spread. A typical coupon would look like 3 months USD LIBOR +0.20%.
In the U.S., government sponsored enterprises (GSEs) such as the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)
are important issuers. In Europe the main issuers are banks.
Index
Let's understand the Concept...
Foreign direct investment:
US International Direct Investment Flows:
Debates about the benefits of FDI for low-income countries:
Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic
globalization. Maps below show net inflows of foreign direct investment as a percentage of gross domestic product (GDP). The largest flows of foreign investment occur between the industrialized countries (North
America, Western Europe and Japan). But flows to non-industrialized countries are increasing sharply.
Some countries have put restrictions on FDI in certain sectors. India, with its restriction on FDI in the retail sector is a good example. In a country like India, the “walmartization” of the country could have significant
negative effects on the overall economy by reducing the number of people employed in the retail sector (currently the second largest employment sector nationally) and depressing the income of people involved in
the agriculture sector (currently the largest employment sector nationally).
Index
Let's understand the Concept...
Foreign exchange controls:
Common foreign exchange controls include:* Banning the use of foreign currency within the country
* Banning locals from possessing foreign currency* Restricting currency exchange to government-approved exchangers
* Fixed exchange rates
Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents.
* Restrictions on the amount of currency that may be imported or exported
Countries with foreign exchange controls are also known as "Article 14 countries," after the provision in the International Monetary Fund agreement allowing exchange controls for transitional economies. Such controls
used to be common in most countries, particularly poorer ones, until the 1990s when free trade and globalization started a trend towards economic liberalization. Today, countries which still impose exchange
controls are the exception rather than the rule.
Index
Let's understand the Concept...
Foreign exchange market:
The foreign exchange market is unique because of its -
* huge trading volume, leading to high liquidity* geographical dispersion
* the variety of factors that affect exchange rates* the low margins of relative profit compared with other markets of fixed income
The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of
trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.
The primary purpose of the foreign exchange market is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to
import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and
lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries.
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries
gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday
* the use of leverage to enhance profit margins with respect to account size
Index
Let's understand the Concept...
Foreign Institutional Investor:
Pension Funds Mutual Funds
Investment Trust Insurance or reinsurance companies
Endowment Funds University Funds
Foundations or Charitable Trusts or Charitable Societies who propose to invest on their own behalf, and
Asset Management Companies Nominee Companies
Institutional Portfolio Managers Trustees
Power of Attorney Holders Bank
FEMA norms includes maintenance of highly rated bonds(collateral) with security exchange.
One who propose to invest their proprietary funds or on behalf of "broad based" funds or of foreign corporates and individuals and belong to any of the under given categories can be registered for FII.
Foreign Institutional Investor (FII) is used to denote an investor - mostly of the form of an institution or entity, which invests money in the financial markets of a country different from the one where in the institution or
entity was originally incorporated.
FII is An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and
mutual funds.FII investment is frequently referred to as hot money for the reason that it can leave the country at the same
speed at which it comes in.
The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities and Exchange Board of India to
participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies.
In countries like India, statutory agencies like SEBI have prescribed norms to register FIIs and also to regulate such investments flowing in through FIIs. In 2008, FIIs represented the largest institution investment
category, with an estimated US$ 751.14 billion.
Index
Forex swap:
A forex swap consists of two legs:* a spot foreign exchange transaction, and* a forward foreign exchange transaction.
These two legs are executed simultaneously for the same quantity, and therefore offset each other.
It is also common to trade forward-forward, where both transactions are for (different) forward dates.
Uses -
By far and away the most common use of FX swaps is for institutions to fund their foreign exchange balances.
Let's understand the Concept..
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).
Structure -
Once a foreign exchange transaction settles, the holder is left with a positive (or long) position in one currency, and a negative (or short) position in another. In order to collect or pay any overnight interest due on these foreign balances, at the end of every day institutions will close out any foreign balances and re-institute
them for the following day. To do this they typically use tom-next swaps, buying (selling) a foreign amount settling tomorrow, and selling (buying) it back settling the day after.
The interest collected or paid every night is referred to as the cost of carry. As currency traders know roughly how much holding a currency position will make or cost on a daily basis, specific trades are put on based on
this; these are referred to as carry trades.
Index
Let's understand the Concept...
Forward contract:
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a forward contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the
forward price at the time the contract is entered into.
The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time of trade is not the time where the securities
themselves are exchanged.
The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the
forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party.
Forwards, like other derivative securities, can be used to hedge risk (typically currency or exchange rate risk), as a means of speculation, or to allow a party to take advantage of a quality of the underlying instrument
which is time-sensitive.
A closely related contract is a futures contract; they differ in certain respects. Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets.
Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures - such that the parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded OTC, forward contracts specification
can be customized and may include mark-to-market and daily margining. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the
party at gain.
Index
Forward rate agreement:
Let's understand the Concept..
In finance, a forward rate agreement (FRA) is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an
obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract. It is paid on the effective date. The reference rate is fixed one or two days
before the effective date, dependent on the market convention for the particular currency. FRAs are over-the counter derivatives. A FRA differs from a swap in that a payment is only made once at maturity.
Many banks and large corporations will use FRAs to hedge future interest rate exposure. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates. Other parties that use Forward Rate Agreements are speculators purely looking to make bets on future directional
changes in interest rates.
Index
Let's understand the Concept...
Fund Accounting :
Fund Accounting is an accounting system often used by nonprofit organizations and by the public sector. According to StartHereGoPlaces, fund accounting is a "method of accounting and presentation whereby
assets and liabilities are grouped according to the purpose for which they are to be used."
Fund accounting serves any nonprofit organization or the public sector. These organizations have a need for special reporting to financial statements users that show how money is spent, rather than how much profit
was earned. Profit oriented businesses only have one set of self-balancing accounts or general ledger. On the other hand, nonprofits can have more than one general ledger depending on their needs. A business manager
in charge of such an entity must be able to produce reports that can detail expenditures and revenues for multiple funds, and reports that summarize the financial activities of the entire entity across all funds. For
example, if a school system receives a grant from the state to support a new special education initiative, and receives federal funds to support a school lunch program, and even receives an annuity to award to teachers for research projects — at any given time, the school system must be able to extract the financial activities
attributed to these programs and report on them.
Given that funds are essentially having more than one general ledger, the accounts can be designed by the special use of account numbers, each set of numbers therein represent a specific fund. Alternatively, they can
be designed by using certain recording and reporting capabilities and features of the accounting software being used. For this reason, many nonprofit organizations and the public sector will often use off-the-shelf or custom-designed accounting software that is flexible enough to accommodate the needs of special reporting.
The use of fund accounting has often been a topic of debate in the accounting profession who question its usefulness, particularly in the standard-setting process. However, it is the unique nature in which nonprofit
organizations and the public sector operate that has made fund accounting a useful system for financial reporting to meet the needs of financial statement users. To that end, the accounting profession
has recognized this need and continues to support the use of fund accounting by providing extensive standards and principles in this area.
Index
Let's understand the Concept...
Futures contract - Margin :
To minimize credit risk to the exchange, traders must post a margin or a performance bond, typically 5%-15% of the contract's value.
To minimize counterparty risk to traders, trades executed on regulated futures exchanges are guaranteed by a clearing house. The clearing house becomes the buyer to each seller, and the seller to each buyer, so that in the event of a counterparty default the clearer assumes the risk of loss. This enables traders to transact
without performing due diligence on their counterparty.
Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position.
Clearing margin are financial safeguards to ensure that companies or corporations perform on their customers' open futures and options contracts. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are
required to deposit with brokers.
Customer margin Within the futures industry, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. Futures Commission Merchants are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and
contract value. Also referred to as performance bond margin.
Initial margin is the equity required to initiate a futures position. This is a type of performance bond. The maximum exposure is not limited to the amount of the initial margin, however the initial margin requirement is calculated based on the maximum estimated change in contract value within a trading day. Initial margin is set by the
exchange.
Maintenance margin A set minimum margin per outstanding futures contract that a customer must maintain in his margin account.
Margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time. The low margin requirements
of futures results in substantial leverage of the investment. However, the exchanges require a minimum amount that varies depending on the contract and the trader. The
broker may set the requirement higher, but may not set it lower. A trader, of course, can set it above that, if he doesn't want to be subject to margin calls.
Performance bond margin The amount of money deposited by both a buyer and seller of a futures contract or an options seller to ensure performance of the term of the contract. Margin in commodities is not a payment of equity or down payment on the commodity
itself, but rather it is a security deposit.
Return on margin (ROM) is often used to judge performance because it represents the gain or loss compared to the exchange’s perceived risk as reflected in required margin. ROM may be calculated (realized return) / (initial margin). The Annualized ROM is equal to (ROM+1)(year/trade_duration)-1. For example if a trader earns 10% on margin in two months, that
would be about 77% annualized.
Index
Let's understand the Concept...
Futures contracts ensure their liquidity by being highly standardized, usually by specifying:
# The type of settlement, either cash settlement or physical settlement.
# The currency in which the futures contract is quoted.
# The delivery month.# The last trading date.
# Other details such as the commodity tick, the minimum permissible price fluctuation.
Futures contract - Standardization :
# The underlying asset or instrument. This could be anything from a barrel of crude oil to a short term interest rate.
# The amount and units of the underlying asset per contract. This can be the notional amount of bonds, a fixed number of barrels of oil, units of foreign currency, the notional amount of the deposit over which the
short term interest rate is traded, etc.
# The grade of the deliverable. In the case of bonds, this specifies which bonds can be delivered. In the case of physical commodities, this specifies not only the quality of the underlying goods but also the manner and location of delivery. For example, the NYMEX Light Sweet Crude Oil contract specifies the acceptable sulphur
content and API specific gravity, as well as the pricing point -- the location where delivery must be made.
Index
Let's understand the Concept...
Futures contract:
In finance, a futures contract is a standardized contract between two parties to buy or sell a specified asset (eg.oranges, oil, gold) of standardized quantity and quality at a specified future date at a price agreed today
(the futures price). The contracts are traded on a futures exchange. Futures contracts are not "direct" securities like stocks, bonds, rights or warrants. They are still securities, however, though they are a type of
derivative contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.
The price is determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract.
In many cases, the underlying asset to a futures contract may not be traditional "commodities" at all – that is, for financial futures, the underlying asset or item can be currencies, securities or financial instruments and
intangible assets or referenced items such as stock indexes and interest rates.
The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on
the exchange.
A closely related contract is a forward contract; they differ in certain respects. Future contracts are very similar to forward contracts, except they are exchange-traded and defined on standardized assets. Unlike
forwards, futures typically have interim partial settlements or "true-ups" in margin requirements. For typical forwards, the net gain or loss accrued over the life of the contract is realized on the delivery date.
Index
Global financial system - Institutions:
The most prominent international institutions are the IMF, the World Bank and the WTO:
* Commercial banks* Hedge funds and Private Equity
* Pension funds* Insurance companies
* Mutual funds
Examples are:* Commonwealth of Independent States (CIS)
* Eurozone* Mercosur
Let's understand the Concept...
International institutions -
* The International Monetary Fund keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount
of money a country provides to the fund relative to the size of its role in the international trading system.
* The World Bank aims to provide funding, take up credit risk or offer favourable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles.
* The World Trade Organization settles trade disputes and negotiates international trade agreements in its rounds of talks (currently the Doha Round).
Also important is the Bank for International Settlements, the intergovernmental organisation for central banks worldwide. It has two subsidiary bodies that are important actors in the global financial system in their own
right - the Basel Committee on Banking Supervision, and the Financial Stability Board.
In the private sector, an important organisation is the Institute of International Finance, which includes most of the world's largest commercial banks and investment banks.
Government institutions -
Governments act in various ways as actors in the GFS , primarily through their finance ministries: they pass the laws and regulations for financial markets, and set the tax burden for private players, e.g., banks, funds
and exchanges. They also participate actively through discretionary spending. They are closely tied (though in most countries independent of) to central banks that issue government debt, set interest rates and deposit
requirements, and intervene in the foreign exchange market.
Private participants -Players active in the stock-, bond-, foreign exchange-, derivatives- and commodities-markets, and investment
banking, including:
* Sovereign wealth funds
Regional institutions -
* North American Free Trade Agreement (NAFTA)
Index
Let's understand the Concept...
Globalization:
Effects of globalization:
Globalization (or globalisation) describes an ongoing process by which regional economies, societies and cultures have become integrated through globe-spanning networks of exchange. The term is sometimes used
to refer specifically to economic globalization: the integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, and the spread of technology. However, globalization is usually recognized as being driven by a combination of economic, technological, sociocultural, political and biological factors. The term can also refer to the transnational dissemination of
ideas, languages, or popular culture.
Globalization, since World War II, is largely the result of planning by politicians to break down borders hampering trade to increase prosperity and interdependence thereby decreasing the chance of future war.
Their work led to the Bretton Woods conference, an agreement by the world's leading politicians to lay down the framework for international commerce and finance, and the founding of several international institutions
intended to oversee the processes of globalization.
Since World War II, barriers to international trade have been considerably lowered through international agreements - GATT. Particular initiatives carried out as a result of GATT and the World Trade Organization
(WTO), for which GATT is the foundation, have included:
Promotion of free trade Elimination of tariffs; creation of free trade zones with small or no tariffs
Reduced transportation costs, especially resulting from development of containerization for ocean shipping
Reduction or elimination of capital controls Reduction, elimination, or harmonization of subsidies for local businesses
Creation of subsidies for global corporations Harmonization of intellectual property laws across the majority of states, with more restrictions
Supranational recognition of intellectual property restrictions (e.g. patents granted by China would be recognized in the United States)
Financial - emergence of worldwide financial markets and better access to external financing for borrowers. As these worldwide structures grew more quickly than any transnational regulatory regime, the instability of the global financial infrastructure dramatically increased, as evidenced by the financial crises of late 2008.
Economic - realization of a global common market, based on the freedom of exchange of goods and capital. The interconnectedness of these markets, however meant that an economic collapse in any one given
country could not be contained.
Index
Let's understand the Concept...
Government bond:
A bond is a debt investment in which an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company. A government bond is a bond issued by a national
government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. The first ever government bond was issued by the
English government in 1693 to raise money to fund a war against France.
Government bonds are usually referred to as risk-free bonds, because the government can raise taxes to redeem the bond at maturity. Some counter examples do exist where a government has defaulted on its
domestic currency debt, such as Russia in 1998 (the "ruble crisis"), though this is very rare. As an example, in the US, Treasury securities are denominated in US dollars. In this instance, the term "risk-free" means free of
credit risk. However, other risks still exist, such as currency risk for foreign investors (for example non-US investors of US Treasury securities would have received lower returns in 2004 because the value of the US
dollar declined against most other currencies). Secondly, there is inflation risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected.
Many governments issue inflation-indexed bonds, which should protect investors against inflation risk.
Index
Let's understand the Concept...
Government-sponsored enterprise:
The government-sponsored enterprises (GSEs) are a group of financial services corporations created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. The desired effect of the GSEs
is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors: agriculture, home finance and education. Congress created the first GSE in 1916 with the creation of the Farm Credit
System; it initiated GSEs in the home finance segment of the economy with the creation of the Federal Home Loan Banks in 1932; and it targeted education when it chartered Sallie Mae in 1972 (although Congress allowed Sallie Mae to relinquish its government sponsorship and become a fully private institution via
legislation in 1995). The residential mortgage borrowing segment is by far the largest of the borrowing segments in which the GSEs operate. GSEs hold or pool approximately $5trillion worth of mortgages.
Index
Great Depression :
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and
lasted until the late 1930s or early 1940s. It was the longest, most widespread, and deepest depression of the 20th century. In the 21st century, the Great Depression is commonly used as an example of how far the
world's economy can decline. The depression originated in the U.S., starting with the fall in stock prices that began around September 4, 1929 and became worldwide news with the stock market crash of October 29,
1929 (known as Black Tuesday). From there, it quickly spread to almost every country in the world.
The Great Depression had devastating effects in virtually every country, rich and poor. Personal income, tax revenue, profits and prices dropped while international trade plunged by ½ to ⅔. Unemployment in the U.S. rose to 25%, and in some countries rose as high as 33%. Cities all around the world were hit hard, especially those dependent on heavy industry. Construction was virtually halted in many countries. Farming and rural
areas suffered as crop prices fell by approximately 60%. Facing plummeting demand with few alternate sources of jobs, areas dependent on primary sector industries such as cash cropping, mining and logging
suffered the most. Some economies started to recover by the mid-1930s. However, in many countries the negative effects of the Great Depression lasted until the start of World War II.
By mid-1930, interest rates had dropped to low levels. But expected deflation and the continuing reluctance of people to borrow meant that consumer spending and investment were depressed. By May 1930,
automobile sales had declined to below the levels of 1928. Prices in general began to decline, although wages held steady in 1930; but then a deflationary spiral started in 1931. Conditions were worse in farming areas,
where commodity prices plunged, and in mining and logging areas, where unemployment was high and there were few other jobs. The decline in the US economy was the factor that pulled down most other countries at
first, then internal weaknesses or strengths in each country made conditions worse or better.
Index
Hedge - Agricultural commodity price hedging :
Let's understand the Concept...
A typical hedger might be a commercial farmer. The market values of wheat and other crops fluctuate constantly as supply and demand for them vary, with occasional large moves in either direction. Based on
current prices and forecast levels at harvest time, the farmer might decide that planting wheat is a good idea one season, but the forecast prices are only that — forecasts. Once the farmer plants wheat, he is committed to it for an entire growing season. If the actual price of wheat rises greatly between planting and harvest, the farmer stands to make a lot of unexpected money, but if the actual price drops by harvest time, he could be
ruined.
If the farmer sells a number of wheat futures contracts equivalent to his crop size at planting time, he effectively locks in the price of wheat at that time: the contract is an agreement to deliver a certain number of bushels of wheat to a specified place on a certain date in the future for a certain fixed price. The farmer
has hedged his exposure to wheat prices; he no longer cares whether the current price rises or falls, because he is guaranteed a price by the contract. He no longer needs to worry about being ruined by a low wheat price at harvest time, but he also gives up the chance at making extra money from a high wheat price at
harvest times.
Index
Hedge (finance):
Let's understand the Concept...
In finance, a hedge is a position established in one market in an attempt to offset exposure to price changes or fluctuations in some opposite position with the goal of minimizing exposure to an unwanted financial or other risks. There are many ways in which risks can be eliminated, including insurance, forward contracts,
swaps, options, many types of over-the-counter and derivative products, and perhaps most popularly, futures contracts. Public futures markets were established in the 19th century to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for
hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.
Index
Let's understand the Concept...
Hedge Accounting:
Why is hedge accounting necessary?
A method of accounting where entries for the ownership of a security and the opposing hedge are treated as one. Hedge accounting attempts to reduce the volatility created by the repeated adjustment of a financial
instrument's value, known as marking to market. This reduced volatility is done by combining the instrument and the hedge as one entry, which offsets the opposing movements.
The point of hedging a position is to reduce the volatility of the overall portfolio. Hedge accounting has the same effect except that it's used on financial statements. For example, when accounting for complex financial instruments, such as derivatives, the value is adjusted by marking to market; this creates large swings in the profit and loss account. Hedge accounting treats the reciprocal hedge and the derivative as one entry so that
the large swings are balanced out.
Many financial institutions and corporate businesses (entities) use derivative financial instruments to hedge their exposure to different risks (for example interest rate risk, foreign exchange risk, commodity risk, etc).
Accounting for derivative financial instruments under International Accounting Standards is covered by IAS39 (Financial Instrument: Recognition and Measurement).
IAS39 requires that all derivatives are marked-to-market with changes in the mark-to-market being taken to the profit and loss account. For many entities this would result in a significant amount of profit and loss
volatility arising from the use of derivatives.An entity can mitigate the profit and loss effect arising from derivatives used for hedging, through an optional
part of IAS39 relating to hedge accounting.
Index
Let's understand the Concept...
Hedge Fund:
It is an aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of
generating high returns (either in an absolute sense or over a specified market benchmark). A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and
trading activities than traditional long-only investment funds, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of
investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. Some people consider the fund created in 1949 by
Alfred Winslow Jones to be the first hedge fund.
As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term "hedge fund" has also
come to be applied to certain funds that, as well as (or instead of) hedging certain risks, use short selling and other "hedging" methods as a trading strategy to generate a return on their capital.
The net asset value of a hedge fund can run into many billions of dollars, and the gross assets of the fund will usually be higher still due to leverage. Hedge funds dominate certain specialty markets such as trading within
derivatives with high-yield ratings and distressed debt.
Index
Hedging a stock price -
The first day the trader's portfolio is:* Long 1,000 shares of Company A at $1 each* Short 500 shares of Company B at $2 each
(Notice that the trader has sold short the same value of shares)
* Long 1,000 shares of Company A at $1.10 each: $100 gain* Short 500 shares of Company B at $2.10 each: $50 loss
(In a short position, the investor loses money when the price goes up.)
Value of long position (Company A):* Day 1: $1,000* Day 2: $1,100
Value of short position (Company B):* Day 1: −$1,000* Day 2: −$1,050
* Day 3: −$525 => ($1,000 − $525) = $475 profit
Let's understand the Concept...
A stock trader believes that the stock price of Company A will rise over the next month, due to the company's new and efficient method of producing widgets. He wants to buy Company A shares to profit from their
expected price increase. But Company A is part of the highly volatile widget industry. If the trader simply bought the shares based on his belief that the Company A shares were under priced, the trade would be a
speculation.
Since the trader is interested in the company, rather than the industry, he wants to hedge out the industry risk by short selling an equal value (number of shares × price) of the shares of Company A's direct
competitor, Company B.
If the trader was able to short sell an asset whose price had a mathematically defined relation with Company A's stock price (for example a call option on Company A shares), the trade might be essentially riskless. But in
this case, the risk is lessened but not removed.
On the second day, a favorable news story about the widgets industry is published and the value of all widgets stock goes up. Company A, however, because it is a stronger company, increases by 10%, while
Company B increases by just 5%:
The trader might regret the hedge on day two, since it reduced the profits on the Company A position. But on the third day, an unfavorable news story is published about the health effects of widgets, and all widgets
stocks crash: 50% is wiped off the value of the widgets industry in the course of a few hours. Nevertheless, since Company A is the better company, it suffers less than Company B:
* Day 3: $550 => ($1,000 − $550) = $450 loss
Without the hedge, the trader would have lost $450 (or $900 if the trader took the $1,000 he has used in short selling Company B's shares to buy Company A's shares as well). But the hedge – the short sale of
Company B – gives a profit of $475, for a net profit of $25 during a dramatic market collapse.
Index
How a forward contract works ...
Suppose that Bob wants to buy a house a year from now. At the same time, suppose that Andy currently owns a $100,000 house that he wishes to sell a year from now. Both parties could enter into a forward contract
with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Andy and Bob have entered into a forward contract. Bob,
because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the short forward contract.
At the end of one year, suppose that the current market valuation of Andy's house is $110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one needs only to recognize that Bob can buy from Andy for $104,000 and immediately sell to the market
for $110,000. Bob has made the difference in profit. In contrast, Andy has made a potential loss of $6,000, and an actual profit of $4,000.
The similar situation works among currency forwards, where one party opens a forward contract to buy or sell a currency (ex. a contract to buy Canadian dollars) to expire/settle at a future date, as they do not wish to be exposed to exchange rate/currency risk over a period of time. As the exchange rate between U.S. dollars and Canadian dollars fluctuates between the trade date and the earlier of the date at which the contract is closed or the expiration date, one party gains and the counterparty loses as one currency strengthens against the other. Sometimes, the buy forward is opened because the investor will actually need Canadian dollars at a
future date such as to pay a debt owed that is denominated in Canadian dollars. Other times, the party opening a forward does so, not because they need Canadian dollars nor because they are hedging currency risk, but because they are speculating on the currency, expecting the exchange rate to move favorably to
generate a gain on closing the contract.
In a currency forward, the notional amounts of currencies are specified (ex: a contract to buy $100 million Canadian dollars equivalent to, say $114.4 million USD at the current rate—these two amounts are called the
notional amount(s)). While the notional amount or reference amount may be a large number, the cost or margin requirement to command or open such a contract is considerably less than that amount, which refers
to the leverage created, which is typical in derivative contracts.
Index
Let's understand the Concept...
How a market maker makes money:
A market maker makes money by buying stock at a lower price than the price at which they sell it. Note that because a market maker can take short positions, purchase and sale may be either way round - a market
maker may sell stock and then buy it back later at a lower price. Therefore a market maker can make money in both rising or falling markets, as long as they correctly predict which way a stock's price will move.
Stock market makers also receive liquidity rebates from ECNs for each share that is sold to or purchased from each posted bid or offer. Conversely, a trader who takes liquidity from a bid or offer posted on an ECN is
charged a fee for removing that liquidity.
Index
Let's understand the Concept...
Index:
In Market capitalization weighted index method, index is calculated with the help of following formula.
A market index is very important for its use.1. as a barometer for market behavior.
2. as a benchmark portfolio performance.3. as an underlying in derivatives instruments like index futures, and
4. in passive fund management by index funds.
It is a statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the
percentage change is more important than the actual numeric value.
Stock and bond market indexes are used to construct index mutual funds and exchange-traded funds (ETFs) whose portfolios mirror the components of the index.
The Standard & Poor's 500 is one of the world's best known indexes, and is the most commonly used benchmark for the stock market. Other prominent indexes include the DJ Wilshire 5000 (total stock market),
the MSCI EAFE (foreign stocks in Europe, Australasia, Far East) and the Lehman Brothers Aggregate Bond Index (total bond market).
Because, technically, you can't actually invest in an index, index mutual funds and exchange-traded funds (based on indexes) allow investors to invest in securities representing broad market segments and/or the
total market.
Current market capitalization INDEX = ---------------------------------------------- * Base value
Base market capitalization
Index
Let's understand the Concept...
Inflation:
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently,
inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
Inflation can have adverse effects on an economy. For example, uncertainty about future inflation may discourage investment and saving. High inflation may lead to shortages of goods if consumers begin hoarding
out of concern that prices will increase in the future.
Origin of Inflation :
Inflation originally referred to the debasement of the currency. When gold was used as currency, gold coins could be collected by the government (e.g. the king or the ruler of the region), melted down, mixed with other metals such as silver, copper or lead, and reissued at the same nominal value. By diluting the gold with other metals, the government could increase the total number of coins issued without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits
from an increase in seigniorage ( It is the net revenue derived from the issuing of currency). This practice would increase the money supply but at the same time lower the relative value of each coin. As the relative
value of the coins decrease, consumers would need more coins to exchange for the same goods and services. These goods and services would experience a price increase as the value of each coin is reduced.
By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or resource costs of the good, a change in the price of money which then was
usually a fluctuation in metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private bank note currency printed during the American Civil War, the term "inflation" started
to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable bank notes outstripped the quantity of metal available for their redemption. The term inflation then referred to the
devaluation of the currency, and not to a rise in the price of goods.
This relationship between the over-supply of bank notes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate to what effect a currency devaluation (later termed monetary inflation) has on the price of goods
(later termed price inflation, and eventually just inflation).
Index
Inflation:
Let's understand the Concept..
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services.
Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the
inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time,
uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and
encouraging investment in non-monetary capital projects.
Today, most mainstream economists favor a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust
more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through
the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.
Index
Let's understand the Concept...
Inflation-indexed bond:
Structure -
For some bonds, such as the Series I Savings Bonds (U.S.), the interest rate is adjusted according to inflation.
Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown
dramatically since the British government began issuing inflation-linked Gilts in 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the international debt market. The inflation-linked market primarily consists of sovereign bonds, with privately issued inflation-linked bonds
constituting a small portion of the market.
Inflation-indexed bonds pay a periodic coupon that is equal to the product of the inflation index and the nominal coupon rate. The relationship between coupon payments, breakeven inflation and real interest rates is given by the Fisher equation. A rise in coupon payments is a result of an increase in inflation expectations,
real rates, or both.
For other bonds, such as in the case of TIPS, the underlying principal of the bond changes, which results in a higher interest payment when multiplied by the same rate. For example, if the annual coupon of the bond
was 5% and the underlying principal of the bond were 100 units, the annual payment would be 5 units. If the inflation index increased by 10%, the principal of the bond would increase to 110 units. The coupon rate
would remain at 5%, resulting in an interest payment of 110 x 5% = 5.5 units.
Index
Let's understand the Concept...
Institutional investor:
Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets. They can also include operating companies which decide to invest
its profits to some degree in these types of assets.
Types of typical investors include banks, insurance companies, retirement or pension funds, hedge funds, investment advisors and mutual funds. Their role in the economy is to act as highly specialized investors on behalf of others. For instance, an ordinary person will have a pension from his employer. The employer gives that person's pension contributions to a fund. The fund will buy shares in a company, or some other financial product. Funds are useful because they will hold a broad portfolio of investments in many companies. This
spreads risk, so if one company fails, it will be only a small part of the whole fund's investment.
Institutional investors will have a lot of influence in the management of corporations because they will be entitled to exercise the voting rights in a company. They can actively engage in corporate governance.
Furthermore, because institutional investors have the freedom to buy and sell shares, they can play a large part in which companies stay solvent, and which go under. Influencing the conduct of listed companies, and
providing them with capital are all part of the job of investment management.
Index
Let's understand the Concept...
Institutional vs. Retail:
Institutional investor-
Retail investor-
An institutional investor is an investor, such as a bank, insurance company, retirement fund, hedge fund, or mutual fund, that is financially sophisticated and makes large investments, often held in very large portfolios
of investments. Because of their sophistication, institutional investors may often participate in private placements of securities, in which certain aspects of the securities laws may be inapplicable.
A retail investor is an individual investor possessing shares of a given security. Retail investors can be further divided into two categories of share ownership.
1. A Beneficial Shareholder is a retail investor who holds shares of their securities in the account of a bank or broker, also known as “in Street Name.” The broker is in possession of the securities on behalf of the
underlying shareholder.
2. A Registered Shareholder is a retail investor who holds shares of their securities directly through the issuer or its transfer agent. Many registered shareholders have physical copies of their stock certificates.
Index
Let's understand the Concept...
Interest rate derivative:
An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a notional amount of money at a given interest rate. These structures are popular for investors with customized
cashflow needs or specific views on the interest rate movements (such as volatility movements or simple directional movements) and are therefore usually traded OTC.
The interest rate derivatives market is the largest derivatives market in the world. The Bank for International Settlements estimates that the notional amount outstanding in June 2009 were US$437 trillion for OTC
interest rate contracts, and US$342 trillion for OTC interest rate swaps. According to the International Swaps and Derivatives Association, 80% of the world's top 500 companies as of April 2003 used interest rate derivatives to control their cashflows. This compares with 75% for foreign exchange options, 25% for
commodity options and 10% for stock options.
Modeling of interest rate derivatives is usually done on a time-dependent multi-dimensional Lattice ("tree") built for the underlying risk drivers, usually domestic or foreign short rates and Forex rates; see Short-rate
model. Specialised simulation models are also often used.
Index
Let's understand the Concept...
Interest rate future:
Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures.
Uses:
An interest rate futures is a financial derivative (a futures contract) with an interest-bearing instrument as the underlying asset.
The global market for exchange-traded interest rate futures is notionally valued by the Bank for International Settlements at $5,794,200 million in 2005.
Interest rate futures are used to hedge against the risk of that interest rates will move in an adverse direction, causing a cost to the company.
For example, borrowers face the risk of interest rates rising. Futures use the inverse relationship between interest rates and bond prices to hedge against the risk of rising interest rates. A borrower will enter to sell a
future today. Then if interest rates rise in the future, the value of the future will fall (as it is linked to the underlying asset, bond prices), and hence a profit can be made when closing out of the future (i.e buying the
future).
Treasury futures are contracts sold on the Globex market for March, June, September and December contracts. As pressure to raise interest rates rises, futures contracts will reflect that speculation as a decline
in price. Price and yield will always be in an inversely correlated relationship.
Index
Interest rate swaps :
Let's understand the Concept..
The most common type of swap is a “plain Vanilla” interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this
exchange is to take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets while other companies have a comparative advantage in floating rate markets. When
companies want to borrow they look for cheap borrowing i.e. from the market where they have comparative advantage. However this may lead to a company borrowing fixed when it wants floating or borrowing floating
when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.
For example, party B makes periodic interest payments to party A based on a variable interest rate of LIBOR +70 basis points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. The
payments are calculated over the notional amount. The first rate is called variable, because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR. In reality, the
actual rate received by A and B is slightly lower due to a bank taking a spread.
Index
Let's understand the Concept...
International finance:
International finance is the branch of economics that studies the dynamics of exchange rates, foreign investment, and how these affect international trade. It also studies international projects, international
investments and capital flows, and trade deficits. It includes the study of futures, options and currency swaps. Together with international trade theory, international finance is also a branch of international economics.
Some of the theories which are important in international finance include the Mundell-Fleming model, the optimum currency area (OCA) theory, as well as the purchasing power parity (PPP) theory. Moreover, whereas
international trade theory makes use of mostly microeconomic methods and theories, international finance theory makes use of predominantly intermediate and advanced macroeconomic methods and concepts.
Absolute purchasing power parity (APPP) states that the random exchange rate is equal to the ratio of the domestic price level to the international price level. APPP: Random Exchange Rate = Price Level
Domestic/Price Level Foreign. The price levels can be determined by the Laspeyres Indices, which are the sumations of the price vector times the quantity vector. There are five factors which cause APPP to fail: taxes,
homogeneity, demand for characteristics, politics, and uncertainty.
Relative purchasing power parity (RPPP) states that the estimated exchange rate is equal to the inflation rate differential, which is also equal to the interest rate differential, which is also equal to the ratio of the (foward
rate - spot rate)/(spot rate).
Index
International Trade Payment methods:
* Advance payment (most secure for seller) Where the buyer parts with money first and waits for the seller to forward the goods
* Documentary Credit (more secure for seller as well as buyer)
* Documentary collection (more secure for buyer and to a certain extent to seller)
* Direct payment (most secure for buyer)
Where the supplier ships the goods and waits for the buyer to remit the bill proceeds, on open account terms.
Let's understand the Concept...
Subject to ICC's UCP 600, where the bank gives an undertaking (on behalf of buyer and at the request of applicant) to pay the shipper (beneficiary) the value of the goods shipped if certain documents are submitted
and if the stipulated terms and conditions are strictly complied with.
Here the buyer can be confident that the goods he is expecting only will be received since it will be evidenced in the form of certain documents called for meeting the specified terms and conditions while the supplier can
be confident that if he meets the stipulations his payment for the shipment is guaranteed by bank, who is independent of the parties to the contract.
Also called "Cash against Documents". Subject to ICC's URC 525, sight and usance, for delivery of shipping documents against payment or acceptances of draft, where shipment happens first, then the title documents
are sent to the [collecting bank] buyer's bank by seller's bank [remitting bank], for delivering documents against collection of payment/acceptance
Index
Let's understand the Concept...
Investment banking - Organizational structure : Back office:-
* Operations involves data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While some believe that
operations provides the greatest job security and the bleakest career prospects of any division within an investment bank, many banks have outsourced operations. It is,
however, a critical part of the bank. Due to increased competition in finance related careers, college degrees are now mandatory at most Tier 1 investment banks. A finance degree has proved significant in understanding the depth of the deals and transactions
that occur across all the divisions of the bank.
* Technology refers to the information technology department. Every major investment bank has considerable amounts of in-house software, created by the technology team, who
are also responsible for technical support. Technology has changed considerably in the last few years as more sales and trading desks are using electronic trading. Some trades
are initiated by complex algorithms for hedging purposes.
Index
Let's understand the Concept...
Investment banking - Organizational structure : Front office:-Core investment banking activities
* Investment banking:
* Sales and trading:
* Research:
Investment banking (corporate finance) is the traditional aspect of investment banks which also involves helping customers raise funds in capital markets and giving advice on mergers and acquisitions (M&A). This
may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target. Another term for the investment banking division is corporate finance, and its advisory group
is often termed mergers and acquisitions. A pitch book of financial information is generated to market the bank to a potential M&A client; if the pitch is successful, the bank arranges the deal for the client. The
investment banking division (IBD) is generally divided into industry coverage and product coverage groups. Industry coverage groups focus on a specific industry, such as healthcare, industrials, or technology, and
maintain relationships with corporations within the industry to bring in business for a bank. Product coverage groups focus on financial products, such as mergers and acquisitions, leveraged finance, project finance,
asset finance and leasing, structured finance, restructuring, equity, and high-grade debt and generally work and collaborate with industry groups on the more intricate and specialized needs of a client.
emptor basis) and take orders. Sales desks then communicate their clients' orders to the appropriate trading desks, which can price and execute trades, or structure new products that fit a specific need. Structuring has
been a relatively recent activity as derivatives have come into play, with highly technical and numerate employees working on creating complex structured products which typically offer much greater margins and returns than underlying cash securities. In 2010, investment banks came under pressure as a result of selling complex derivatives contracts to local municipalities in Europe and the US. Strategists advise external as well
as internal clients on the strategies that can be adopted in various markets. Ranging from derivatives to specific industries, strategists place companies and industries in a quantitative framework with full
consideration of the macroeconomic scene. This strategy often affects the way the firm will operate in the market, the direction it would like to take in terms of its proprietary and flow positions, the suggestions
salespersons give to clients, as well as the way structures create new products. Banks also undertake risk through proprietary trading, performed by a special set of traders who do not interface with clients and
Research is the division which reviews companies and writes reports about their prospects, often with "buy" or "sell" ratings. While the research division may or may not generate revenue (based on policies at different banks), its resources are used to assist traders in trading, the sales force in suggesting ideas to customers,
and investment bankers by covering their clients. Research also serves outside clients with investment advice (such as institutional investors and high net worth individuals) in the hopes that these clients will execute
suggested trade ideas through the sales and trading division of the bank, and thereby generate revenue for the firm. There is a potential conflict of interest between the investment bank and its analysis, in that
published analysis can affect the bank's profits. Hence in recent years the relationship between investment banking and research has become highly regulated, requiring a Chinese wall between public and private
functions.
Index
Let's understand the Concept...
Investment banking - Organizational structure : Middle office:-
* Risk management involves analyzing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are able to trade in order to prevent "bad" trades having a
detrimental effect on a desk overall. Another key Middle Office role is to ensure that the economic risks are captured accurately (as per agreement of commercial terms with the
counterparty), correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution). In recent years the risk of errors has become known as "operational risk" and the assurance Middle Offices provide now includes measures to address this risk. When this assurance is not in place, market and credit risk analysis can be unreliable and open to deliberate manipulation.
* Corporate treasury is responsible for an investment bank's funding, capital structure management, and liquidity risk monitoring.
* Financial control tracks and analyzes the capital flows of the firm, the Finance division is the principal adviser to senior management on essential areas such as controlling the
firm's global risk exposure and the profitability and structure of the firm's various businesses. In the United States and United Kingdom, a Financial Controller is a senior
position, often reporting to the Chief Financial Officer.
* Corporate strategy, along with risk, treasury, and controllers, also often falls under the finance division.
* Compliance areas are responsible for an investment bank's daily operations compliance with government regulations and internal regulations. Often also considered a
back-office division.
Index
Let's understand the Concept...
Investment banking - Organizational structure:
Main activities
Core investment banking activities
Front office -* Investment banking (corporate finance)
* Sales and trading* Research
Other businesses that an investment bank may be involved in* Global transaction banking* Investment management
* Merchant banking* Commercial banking
Middle office -* Risk management* Corporate treasury* Financial control
* Corporate strategy* Compliance
Back office -* Operations* Technology
An investment bank is split into the so-called front office, middle office, and back office. While large full-service investment banks offer all of the lines of businesses, both sell side and buy side, smaller sell side
investment firms such as boutique investment banks and small broker-dealers focus on investment banking and sales/trading/research, respectively.
Investment banks offer services to both corporations issuing securities and investors buying securities. For corporations, investment bankers offer information on when and how to place their securities in the market. For investors, investment bankers offer protection against unsafe securities. The offering of a few bad issues
can cause serious damage to an investment bank's reputation, and hence loss of business. Therefore, investment bankers play a very important role in issuing new security offerings.
Index
Let's understand the Concept...
Investment banking:
An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank
may also assist companies involved in mergers and acquisitions, and provides ancillary services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity
securities.
Unlike commercial banks and retail banks, investment banks do not take deposits. From 1933 (Glass-Steagal Act) until 1999 (Gramm–Leach–Bliley Act), the United States maintained a separation between investment banking and commercial banks. Other industrialized countries, including G8 countries, have historically not
maintained such a separation.
There are two main lines of business in investment banking. Trading securities for cash or for other securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research,
etc.) is the "sell side", while dealing with pension funds, mutual funds, hedge funds, and the investing public (who consume the products and services of the sell-side in order to maximize their return on investment)
constitutes the "buy side". Many firms have buy and sell side components.
An investment bank can also be split into private and public functions with a Chinese wall which separates the two to prevent information from crossing. The private areas of the bank deal with private insider information that may not be publicly disclosed, while the public areas such as stock analysis deal with public information.
An advisor who provides investment banking services in the United States must be a licensed broker-dealer and subject to Securities & Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA)
regulation.
Index
Let's understand the Concept...
Investment management:
Investment management is the professional management of various securities (shares, bonds and other securities) and assets (e.g., real estate) in order to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private
investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds or exchange-traded funds).
The term asset management is often used to refer to the investment management of collective investments, (not necessarily) while the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services
as wealth management or portfolio management often within the context of so-called "private banking".
The provision of 'investment management services' includes elements of financial statement analysis, asset selection, stock selection, plan implementation and ongoing monitoring of investments. Investment
management is a large and important global industry in its own right responsible for caretaking of trillions of yuan, dollars, euro, pounds and yen. Coming under the remit of financial services many of the world's largest
companies are at least in part investment managers and employ millions of staff and create billions in revenue.
Fund manager (or investment adviser in the United States) refers to both a firm that provides investment management services and an individual who directs fund management decisions.
Index
Let's understand the Concept...
In finance, a portfolio is an appropriate mix or collection of investments held by an institution or an individual.
Many strategies have been developed to form a portfolio.
- equally-weighted portfolio- capitalization-weighted portfolio
- price-weighted portfolio- optimal portfolio (for which the Sharpe ratio is highest)
Investment Portfolio :
Holding a portfolio is a part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio
could include Bank accounts; stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value.
In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which
offers portfolio management services.
Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios of
different asset bundles are compared.
The unique goals and circumstances of the investor must also be considered. Some investors are more risk averse than others.
Mutual funds have developed particular techniques to optimize their portfolio holdings. See fund management for details.
Portfolio formation :
Index
Investment strategy:
Let's understand the Concept...
In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximize expected returns by investing in risky assets, others will
prefer to minimize risk, but most will select a strategy somewhere in between.
Passive strategies are often used to minimize transaction costs, and active strategies such as market timing are an attempt to maximize returns.
One of the better known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods
of volatility or decline. A purely passive variant of this strategy is indexing where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an
index fund or an exchange-traded fund (ETF).
This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail
investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.
Index
Let's understand the Concept...
Investment vs. Speculation:
Identifying speculation can be best done by distinguishing it from investment. According to Ben Graham in Intelligent Investor, the prototypical defensive investor is "...one interested chiefly in safety plus freedom from bother." He admits, however, that "...some speculation is necessary and unavoidable, for in many
common-stock situations, there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone."Many long-term investors, even those who buy and hold for decades, may be
classified as speculators, excepting only the rare few who are primarily motivated by income or safety of principal and not eventually selling at a profit.
Speculators can be increasingly distinguishable by shorter holding times, the use of leverage, by being willing to take short positions as well as long positions. A degree of speculation exists in a wide range of financial decisions, from the purchase of a house to a bet on a horse; this is what modern market economists call
"ubiquitous speculation."
Index
Let's understand the Concept...
Investment:
Investment is the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in the form of interest, income, or appreciation of the value of the instrument. It is related to saving or deferring consumption. Investment is involved in many areas of the economy, such as
business management and finance no matter for households, firms, or governments. An investment involves the choice by an individual or an organization such as a pension fund, after some analysis or thought, to place
or lend money in a vehicle, instrument or asset, such as property, commodity, stock, bond, financial derivatives (e.g. futures or options), or the foreign asset denominated in foreign currency, that has certain
level of risk and provides the possibility of generating returns over a period of time.
Investment comes with the risk of the loss of the principal sum. The investment that has not been thoroughly analyzed can be highly risky with respect to the investment owner because the possibility of losing money is not within the owner's control. The difference between speculation and investment can be subtle. It depends
on the investment owner's mind whether the purpose is for lending the resource to someone else for economic purpose or not.
In finance, investment is the commitment of funds by buying securities or other monetary or paper (financial) assets in the money markets or capital markets, or in fairly liquid real assets, such as gold or collectibles.
Valuation is the method for assessing whether a potential investment is worth its price. Returns on investments will follow the risk-return spectrum.
Types of financial investments include shares, other equity investment, and bonds (including bonds denominated in foreign currencies). These financial assets are then expected to provide income or positive
future cash flows, and may increase or decrease in value giving the investor capital gains or losses.
Trades in contingent claims or derivative securities do not necessarily have future positive expected cash flows, and so are not considered assets, or strictly speaking, securities or investments. Nevertheless, since
their cash flows are closely related to (or derived from) those of specific securities, they are often studied as or treated as investments.
Investments are often made indirectly through intermediaries, such as banks, mutual funds, pension funds, insurance companies, collective investment schemes, and investment clubs. Though their legal and
procedural details differ, an intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary.
Index
Investor sentiment:
Investor sentiment is a contrarian stock market indicator.
Let's understand the Concept...
By definition, the market balances buyers and sellers, so it's impossible to literally have 'more buyers than sellers' or vice versa, although that is a common expression. The market comprises investors and traders. The
investors may own a stock for many years; traders put on a position for several weeks down to seconds.
When a high proportion of investors express a bearish (negative) sentiment, some analysts consider it to be a strong signal that a market bottom may be near. The predictive capability of such a signal is thought to be highest when investor sentiment reaches extreme values. Indicators that measure investor sentiment may
include:
* Investor Intelligence Sentiment Index: If the Bull-Bear spread (% of Bulls - % of Bears) is close to a historic low, it may signal a bottom. Typically, the number of bears surveyed would exceed the number of bulls.
However, if the number of bulls is at an extreme high and the number of bears is at an extreme low, historically, a market top may have occurred or is close to occurring. This contrarian measure is more reliable
for its coincidental timing at market lows than tops.
* American Association of Individual Investors (AAII) sentiment indicator: Many feel that the majority of the decline has already occurred once this indicator gives a reading of minus 15% or below.
* Other sentiment indicators include the Nova-Ursa ratio, the Short Interest/Total Market Float, and the Put/Call ratio.
Index
Let's understand the Concept...
IOU:
California Registered Warrants:
An IOU is usually an informal document acknowledging debt. The term is derived from the opening phrase "I owe unto" and/or the pronunciation of "I owe you". An IOU differs from a promissory note in that an IOU is not a negotiable instrument and does not specify repayment terms such as the time of repayment. IOUs usually
specify the debtor, the amount owed, and sometimes the creditor. IOUs may be signed or carry distinguishing marks or designs to ensure authenticity. In some cases, IOUs may be redeemable for a specific product or
service rather than a quantity of currency.
Also referred to as "IOUs" by the U.S. state of California, the term "Registered Warrants", which specify a future payment date, is meant to differentiate these IOUs from regular, or “normal” payroll warrants which permit the holder to exchange their warrant for cash immediately. For both types of warrants, redeeming
them may be delayed until funds are available. Because of this uncertainty, warrants like IOUs are not negotiable instruments. Registered Warrants were issued in July 2009 due to the inability of the state of
California to meet its financial obligations. They are issued as payment to private businesses, local governments, taxpayers receiving income tax refunds, and owners of unclaimed money
Index
ISO 9362 - BIC:
The latest edition is ISO 9362:2009 (dated 2009-10-01). The SWIFT code is 8 or 11 characters, made up of:
* 4 letters: Institution Code or bank code.* 2 letters: ISO 3166-1 alpha-2 country code
* 3 letters or digits: branch code, optional ('XXX' for primary office)
Where an 8-digit code is given, it may be assumed that it refers to the primary office.
Let's understand the Concept...
ISO 9362 (also known as SWIFT-BIC, BIC code, SWIFT ID or SWIFT code) is a standard format of Business Identifier Codes approved by the International Organization for
Standardization (ISO). It is a unique identification code for both financial and non-financial institutions. These codes are used when transferring money between banks, particularly
for international wire transfers, and also for the exchange of other messages between banks. The codes can sometimes be found on account statements.
The overlapping issue between ISO 9362 and ISO 13616 is discussed in the article International Bank Account Number (also called IBAN).
* 2 letters or digits: location code - if the second character is "0", then it is typically a test BIC as opposed to a BIC used on the live
network. - if the second character is "1", then it denotes a passive participant in the SWIFT network
- if the second character is "2", then it typically indicates a reverse billing BIC, where the recipient pays for the message
- as opposed to the more usual mode whereby the sender pays for the message.
SWIFT Standards, a division of The Society for Worldwide Interbank Financial Telecommunication (SWIFT), handles the registration of these codes. For this reason, Business Identifier Codes (BICs) are often called
SWIFT addresses or codes.
The 2009 update of ISO 9362 broadened the scope to include non-financial institutions, before then BIC was commonly understood to be an acronym for Bank Identifier Code.
There are over 7,500 "live" codes (for partners actively connected to the BIC network) and an estimated 10,000 additional BIC codes which can be used for manual transactions.
Index
Let's understand the Concept...
Knowledge capital:
Knowledge capital is a concept which asserts that ideas have intrinsic value which can be shared and leveraged within and between organizations. Knowledge capital connotes that sharing skills and information
is a means of sharing power. Knowledge capital is the know how that results from the experience, information, knowledge, learning, and skills of the employees or individual of an organization or group. Of all
the factors of production, knowledge capital creates the longest lasting competitive advantage. It may consist entirely of technical information (as in chemical and electronics industries) or may reside in the actual
experience or skills acquired by the individuals (as in construction and steel industries). Knowledge capital is an essential component of human capital.
Index
Late-2000s recession :
Overview :
The late-2000s recession, more often called the Great Recession, was a severe economic recession that began in the United States in December 2007 and ended in June 2009, according to the U.S. National Bureau
of Economic Research (NBER). Most people throughout the world consider it to be ongoing, because heightened degrees of unemployment and economic hardship remain prominent in the everyday experience
of non-rich people. By most conventional definitions in the science of economics, which are quantitatively based on certain economic statistics, the recession has ended, having been over since June 2009. For example, this is the end point defined by the NBER. The Great Recession has affected the entire world economy, with higher detriment in some countries than others. It is a global recession characterized by
various systemic imbalances and was sparked by the outbreak of the financial crisis of 2007–2010. In July 2009, it was announced that a growing number of economists believed that the recession may have ended. However, in the United States, the requisite two consecutive quarters of growth in the GDP did not actually
occur until the end of 2009.
The financial crisis is linked to reckless lending practices by financial institutions and the growing trend of securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had
risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The
precarious financial situation was made more difficult by a sharp increase in oil and food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated
asset prices. With loan losses mounting and the fall of Lehman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined, many large and well
established investment and commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance.
A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the
United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s. Paul Robin Krugman, who won the Nobel Memorial Prize in Economics, once commented on this as seemingly
the beginning of "a second Great Depression." The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated boom in economic demand, are considered a result of the extended period of easily available credit, inadequate regulation and oversight, or increasing inequality.
The recession has renewed interest in Keynesian economic ideas on how to combat recessionary conditions. Fiscal and monetary policies have been significantly eased to stem the recession and financial risks.
Economists advise that the stimulus should be withdrawn as soon as the economies recover enough to "chart a path to sustainable growth".
Index
Latest news from international capital market...
China has overtaken Japan as the world's second biggest economy. Equity market caps for countries, China is getting very close to second biggest as well. Japan's stock market capitalization is currently 7.97% of world market cap. China ranks second at 6.89%. Five years ago, Japan accounted for 10.34% of world market cap, while China accounted for just 1.10%. Back in 2005, China ranked just 17th in terms of market cap, behind
countries like Saudi Arabia, Spain, Switzerland, South Korea, Taiwan, India, and the Netherlands. Now with the world's second biggest economy and third biggest stock market, it's hard to classify China as an emerging
market, but it is indeed still emerging in terms of growth.
Change in percent of world market cap over the last five years China has had the biggest growth in percentage points, while the US has had the biggest fall. Hong Kong, India, and Brazil have seen pretty big
increases in share, while the UK, France, and Japan have all lost the most ground after the US. It will be interesting to see how things look in another five years.
Index
Letter of credit:
Let's understand the Concept...
A standard, commercial letter of credit (LC) is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking.
The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. In such cases the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits applies (UCP 600 being the latest version). They are also used in the land development process to ensure that approved public facilities
(streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended
or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any.
In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial
invoice, bill of lading, and documents proving the shipment was insured against loss or damage in transit.
Index
Let's understand the Concept...
Loan servicing:
There are economical loan servicing products that can also be purchased.
Loan servicing is the process by which a mortgage bank or subservicing firm collects the timely payment of interest and principal from borrowers. The level of service varies depending on the type of loan and the terms
negotiated between the firm and the investor seeking their services.
Mortgage servicing became "far more profitable during the housing boom", and servicers targeted borrowers "less likely to make timely payments" in order to collect more late fees.
Servicers are normally compensated by receiving a percentage of the unpaid balance on the loans they service. The fee rate can be anywhere from one to twenty five basis points depending on the size of the loan,
whether it is secured by commercial or residential real estate, and the level of service required.
The net present value of the flow of payments received from servicing less the expected costs to servicers creates an asset which remains on the balance sheets of servicers. Since in refinancing periods loans are
often quickly prepaid and hence servicing fees cease, the value of these assets is extremely volatile.
Index
Major stock exchanges of the world...
20 Major Stock Exchanges : Year ended 31 December 2009
Source: World Federation of Exchanges - Statistics/Monthly
Index
Let's understand the Concept...
Market maker:
A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid/offer spread, or turn.
In foreign exchange (or FX) trading, where most deals are conducted over-the-counter and are, therefore, completely virtual, the market maker sells to and buys from its clients. Hence, the client's loss and the spread
is the market-maker firm's profit, which gets thus compensated for the effort of providing liquidity in a competitive market. This extra liquidity reduces transaction costs and therefore facilitates trades for the
clients, who would otherwise have to accept a worse price or even not be able to trade at all. Most foreign exchange trading firms are market makers and so are many banks, although not in all currency markets.
Recent developments in the over-the-counter FX market have permitted even buy-side (non bank participants) in becoming virtual market-makers through the advent of high speed/frequency software
applications. These algorithmic engines submit bids and offers outside of prices that are available on other networks or ECN (electronic communication networks) where FX is traded.
Most stock exchanges operate on a matched bargain or order driven basis. In such a system there are no designated or official market makers, but market makers nevertheless exist. When a buyer's bid meets a
seller's offer or vice versa, the stock exchange's matching system will decide that a deal has been executed.
Index
Market trend:
Secular market trend:
Let's understand the Concept...
A market trend is a putative tendency of a financial market to move in a particular direction over time. These trends are classified as secular for long time frames, primary for medium time frames, and secondary lasting short times. Traders identify market trends using technical analysis, a framework which characterizes market trends as a predictable price response of the market at levels of price support and price resistance, varying
over time.
The terms bull market and bear market describe upward and downward market trends, respectively, and can be used to describe either the market as a whole or specific sectors and securities.
A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of sequential primary trends. A secular bear market consists of smaller bull markets and larger bear markets; a secular bull
market consists of larger bull markets and smaller bear markets.
In a secular bull market the prevailing trend is "bullish" or upward moving. The United States stock market was described as being in a secular bull market from about 1983 to 2000 (or 2007), with brief upsets
including the crash of 1987 and the dot-com bust of 2000–2002.
In a secular bear market, the prevailing trend is "bearish" or downward moving. An example of a secular bear market was seen in gold during the period between January 1980 to June 1999, culminating with the Brown
Bottom. During this period the nominal gold price fell from a high of $850/oz ($30/g) to a low of $253/oz ($9/g), and became part of the Great Commodities Depression.
Index
Maturity :
Let's understand the Concept..
In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal (and all remaining interest) is due to be paid.
The term fixed maturity is applicable to any form of financial instrument under which the loan is due to be repaid on a fixed date. This includes fixed interest and variable rate loans or debt instruments, whatever they
are called, and also other forms of security such as redeemable preference shares, provided their terms of issue specify a maturity date. It is similar in meaning to 'redemption date'. However some such instruments
may have no fixed maturity date. Loans with no maturity date continue indefinitely (unless repayment is agreed between the borrower and the lenders at some point) and may be known as 'perpetual stocks'. Some
instruments have a range of possible maturity dates, and such stocks can usually be repaid at any time within that range, as chosen by the borrower.
A serial maturity is when bonds are all issued at the same time but are divided into different classes with different, staggered redemption dates.
In the financial press the term maturity is sometimes used as shorthand for the securities themselves, for instance In the market today, the yields on 10 year maturities increased means that the prices of bonds due
to mature in 10 years time fell, and thus the redemption yield on those bonds increased.
Index
Let's understand the Concept...
Bank Reconciliation:
Bank reconciliation is the process of comparing and matching figures from the accounting records against those shown on a bank statement. The result is that any transactions in the accounting records not found on the bank statement are said to be outstanding. Taking the balance on the bank statement adding the total of
outstanding receipts less the total of the outstanding payments this new value should (match) reconcile to the balance of the accounting records.
Bank reconciliation allows companies or individuals to compare their account records to the bank's records of their account balance in order to uncover any possible discrepancies. Discrepancies could include: cheques
recorded as a lesser amount than what was presented to the bank; money received but not lodged; or payments taken from the bank account without the business's knowledge. A bank reconciliation done
regularly can reduce the number of errors in an accounts system and make it easier to find missing purchases and sales invoices.
Securities Reconciliation:
Similar to the process of verifying that bank accounts are in agreement, Custodian banks who hold securities for clients must also verify that the count of securities held at the bank matches the client's account(s).
There are many different types of security reconcilements, such as between an investment manager and the Custodian bank, Fund Accounting or between the Custodian bank and a depository (such as Euro clear or The
Depository Trust Company)Security reconcilements are usually either positional or transactional in nature. In both cases, the
reconcilement is frequently conducted at the security identifier level, such as CUSIP, ISIN, or SEDOL.In a positional reconcilement, the shares are counted between two parties and compared. If the counts
match, then the position is said to be in balance. If the positions do not match, then it is considered "out of balance", also referred to as a "break".
In a transactional reconcilement, only the changes from transactions are applied to accounts. The reconcilement occurs by matching offsetting transactions between the two sides of the reconcilement. If a
transaction cannot be properly matched with its counterpart, it is left open and referred to as an "exception".
A transactional reconcilement can be more accurate when trying to resolve exceptions. In a positional reconcilement, the only fact known is that the positions do not agree; in a transactional environment, all of the details are available to allow for more granular research. In some locations, reconciliations are
required for regulatory reasons.
Most positions are reconciled daily to reduce risk, though for situations where positions are illiquid or traded less frequently (such at OTC Derivatives), they might be reconciled weekly or monthly.
Index
Let's understand the Concept...
A Mortgage bank specializes in originating and/or servicing mortgage loans.
Mortgage Bank:
A mortgage bank is a state-licensed banking entity that makes mortgage loans directly to consumers. The difference between a mortgage banker and a mortgage broker is that the mortgage banker funds loans with
its own capital.
Generally, a mortgage bank originates a loan and places it on a pre-established warehouse line of credit until the loan can be sold to an investor such as Fannie Mae, or Freddie Mac. The process of selling a loan from the
mortgage bank to another investor is referred to as selling the loan on the secondary market.
Mortgage banks frequently use the secondary market to sell loans because the funds received pay down their warehouse lines of credit which enables the mortgage bank to continue to lend. A mortgage bank is not
regulated as a federal or state bank and does not take deposits from consumers or businesses. A mortgage bank raises some equity which it uses to guarantee the warehouse line and the bulk of the funds are provided
by the warehouse lender.
A mortgage bank can vary in size. Some mortgage banking companies are nationwide. Some may originate a large loan volume exceeding that of a nationwide commercial bank. Many mortgage banks employ specialty
servicers for tasks such as repurchase and fraud discovery work.
Their two primary sources of revenue are from loan origination fees, and loan servicing fees (provided they are a loan servicer). Many Mortgage bankers are opting not to service the loans they originate. By selling
them shortly after they are closed and funded, they are eligible for earning a service released premium. The secondary market investor that buys the loan will earn revenue for the servicing of the loan for each month
the loan is kept by the borrower.
Unlike a federally chartered savings bank, a mortgage bank generally specializes only in making mortgage loans. They do not take deposits from customers. Their funds come primarily from the secondary wholesale
market. Examples of the secondary market lenders most known are Fannie Mae, and Freddie Mac.
A company desiring to enter the mortgage business often chooses to be a mortgage banker vs. a mortgage broker primarily to earn yield spread premiums. Mortgage bankers risk their own capital to fund loans and
therefore do not have to disclose the price at which they sell mortgage to another company. Mortgage brokers, on the other hand, earning the same yield spread premium disclose the additional fee to the
consumer because the yield spread premium becomes an additional fee earned and therefore discloseable under federal and state law.
Index
Let's understand the Concept...
Mortgage-backed security - Types:
Mortgage-backed security sub-types include:
There are a variety of underlying mortgage classifications in the pool:
* Subprime mortgages have weaker credit scores, no verification of income or assets, etc.
Most bonds backed by mortgages are classified as an MBS. This can be confusing, because a security derived from an MBS is also called an MBS. To distinguish the basic MBS bond from other mortgage-backed
instruments the qualifier pass-through is used, in the same way that "vanilla" designates an option with no special features.
* A pass-through mortgage-backed security is the simplest MBS, as described in the sections above. Essentially, it is a securitization of the mortgage payments to the mortgage originators. These can be
subdivided into:
- A residential mortgage-backed security (RMBS) is a pass-through MBS backed by mortgages on residential property.
- A commercial mortgage-backed security (CMBS) is a pass-through MBS backed by mortgages on commercial property.
* A collateralized mortgage obligation (CMO) is a more complex MBS in which the mortgages are ordered into tranches by some quality (such as repayment time), with each
tranche sold as a separate security.
* A stripped mortgage-backed security (SMBS) where each mortgage payment is partly used to pay down the loan's principal and partly used to pay the interest on it. These two components can be separated to create SMBS's, of which there are two
subtypes: - An interest-only stripped mortgage-backed security (IO) is a bond with cash flows backed by the
interest component of property owner's mortgage payments. # A net interest margin security (NIMS) is resecuritized residual interest of a mortgage-backed
security - A principal-only stripped mortgage-backed security (PO) is a bond with cash flows backed by the
principal repayment component of property owner's mortgage payments.
* Prime mortgages are conforming mortgages with prime borrowers, full documentation (such as verification of income and assets), strong credit scores, etc.
* Alt-A mortgages are an ill-defined category, generally prime borrowers but non-conforming in some way, often lower documentation (or in some other way: vacation home, etc.)
* Jumbo mortgages when the size of the loan is bigger than the "conforming loan amount" as set by Fannie Mae.
These types are not limited to Mortgage Backed Securities. Bonds backed by mortgages, but are not MBS can also have these subtypes.
Index
Let's understand the Concept...
Mortgage-backed security - Uses:
Mortgage-backed securities:
1. Transform relatively illiquid, individual financial assets into liquid and tradable capital market instruments.
There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities.
2. Allow mortgage originators to replenish their funds, which can then be used for additional origination activities.
3. Can be used by Wall Street banks to monetize the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance
(typically, a public market transaction).4. Are frequently a more efficient and lower cost source of financing in comparison with other bank and
capital markets financing alternatives.5. Allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt
and equity financing.
6. Allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilise capital more efficiently and achieve compliance with risk-based capital standards.
The high liquidity of most mortgage-backed securities means that an investor wishing to take a position need not deal with the difficulties of theoretical pricing; the price of any bond is essentially quoted at fair value,
with a very narrow bid/offer spread.
Reasons (other than investment or speculation) for entering the market include the desire to hedge against a drop in prepayment rates (a critical business risk for any company specializing in refinancing).
Index
Let's understand the Concept...
Mortgage-backed security:
Also known as a "mortgage-related security" or a "mortgage pass through".
A mortgage-backed security (MBS) is an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans through a process known as securitization. It is a type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in
one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a
regulated and authorized financial institution.
When you invest in a mortgage-backed security you are essentially lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to
worry about whether the customers have the assets to cover the loan. Instead, the bank acts as a middleman between the home buyer and the investment markets.
This type of security is also commonly used to redirect the interest and principal payments from the pool of mortgages to shareholders. These payments can be further broken down into different classes of securities,
depending on the riskiness of different mortgages as they are classified under the MBS.
Index
Open-end fund:
Fees:
These charges may represent profit for the fund manager or go back into the fund.
Let's understand the Concept..
An open-end(ed) fund is a collective investment scheme which can issue and redeem shares at any time. An investor will generally purchase shares in the fund directly from the fund itself rather than from the existing
shareholders. It contrasts with a closed-end fund, which typically issues all the shares it will issue at the outset, with such shares usually being tradeable between investors thereafter.
Open-ended funds are available in most developed countries, though terminology and operating rules vary. U.S. mutual funds, UK unit trusts and OEICs, European SICAVs, hedge funds and exchange-traded funds are all
examples of open-ended funds.
The price at which shares in an open-ended fund are issued or can be redeemed will vary in proportion to the net asset value of the fund, and therefore directly reflects the fund's performance.
There may be a percentage charge levied on the purchase of shares or units. Some of these fees are called an initial charge (UK) or 'front-end load' (US). Some fees are charged by a fund on the sale of these units,
called a 'close-end load,' that may be waved after several years of owning the fund. Some of the fees cover the cost or distributing the fund by paying commission to the adviser or broker that arranged the purchase. These fees are commonly referred to as 12b-1 fees in U.S. Not all fund have initial charges; if there are no
such charges levied, the fund is "no-load" (US).
Index
Let's understand the Concept...
Over-the-counter (OTC) derivatives:
Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate
agreements, and exotic options are almost always traded in this way.
The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly
sophisticated parties, such as hedge funds. Reporting of OTC amounts are difficult because trades can occur in private, without activity being visible on any exchange. According to the Bank for International
Settlements, the total outstanding notional amount is US$684 trillion (as of June 2008). Of this total notional amount, 67% are interest rate contracts, 8% are credit default swaps (CDS), 9% are foreign exchange
contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to
counter-party risk, like an ordinary contract, since each counter-party relies on the other to perform.
Index
Let's understand the Concept...
Over-the-counter:
OTC contracts:
This segment of the OTC market is occasionally referred to as the "Fourth Market."
Over-the-counter (OTC) or off-exchange trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs
via facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.
An over-the-counter contract is a bilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards
and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives Association
agreement.
The NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort,
the exchange's clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts.
Index
Let's understand the Concept...
Passive management:
Passive management (also called passive investing) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any
use of market timing or stock picking would NOT qualify as passive management). The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most
popular method is to mimic the performance of an externally specified index. Retail investors typically do this by buying one or more 'index funds'. By tracking an index, an investment portfolio typically gets good
diversification, low turnover (good for keeping down internal transaction costs), and extremely low management fees. With low management fees, an investor in such a fund would have higher returns than a
similar fund with similar investments buy higher management fees and/or turnover/transaction costs.
Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.
Today, there is a plethora of market indexes in the world, and thousands of different index funds tracking many of them.
One of the largest equity mutual funds, the Vanguard 500, is a passive management fund. The two firms with the largest amounts of money under management, Barclays Global Investors and State Street Corp., primarily
engage in passive management strategies.
Index
Pension fund:
A pension fund is any plan, fund, or scheme which provides retirement income.
Classifications -
Closed pension funds are further sub classified into:
* Single employer pension funds * Multi-employer pension funds
* Related member pension funds * Individual pension funds
Let's understand the Concept...
Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold
about $6 trillion in assets. In January 2008, The Economist reported that Morgan Stanley estimates that pension funds worldwide hold over US$20 trillion in assets, the largest for any category of investor ahead of
mutual funds, insurance companies, currency reserves, sovereign wealth funds, hedge funds, or private equity.
A] Open vs. closed pension fundsOpen pension funds support at least one pension plan with no restriction on membership while closed pension
funds support only pension plans that are limited to certain employees.
B] Public vs. private pension funds
A public pension fund is one that is regulated under public sector law while a private pension fund is regulated under private sector law. In certain countries the distinction between public or government pension
funds and private pension funds may be difficult to assess. in others, the distinction is made sharply in law, with very specific requirements for administration and investment. For example, local governmental bodies in
the United States are subject to laws passed by the states in which those localities exist, and these laws include provisions such as defining classes of permitted investments and a minimum municipal obligation.
Index
Let's understand the Concept...
Perpetual bond:
Perpetual bond, which is also known as a Perpetual or just a Perp, is a bond with no maturity date. Therefore, it may be treated as equity, not as debt. Perpetual bonds pay coupons forever, and the issuer does not have
to redeem them. Their cash flows are, therefore, those of a perpetuity.
Examples of perpetual bonds are consols issued by the UK Government. Most perpetual bonds issued nowadays are deeply subordinated bonds issued by banks. The bonds are counted as Tier 1 capital, and help the banks fulfil their capital requirements. Most of these bonds are callable, but the first call date is never less
than five years from the date of issue—a call protection period.
Index
Let's understand the Concept...
Preferred stock:
Features
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid
instrument. Preferreds are senior (i.e. higher ranking) to common stock, but are subordinate to bonds.
Preferred stock usually carries no voting rights, but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. Preferred stock may have a convertibility feature into
common stock. Terms of the preferred stock are stated in a "Certificate of Designation".
Similar to bonds, preferred stocks are rated by the major credit rating companies. The rating for preferreds is generally lower since preferred dividends do not carry the same guarantees as interest payments from bonds
and they are junior to all creditors.
Preferred stock is a special class of shares that may have any combination of features not possessed by common stock.
The following features are usually associated with preferred stock -
- Preference in dividends.
- Preference in assets in the event of liquidation.
- Convertible into common stock.
- Callable at the option of the corporation.
- Nonvoting.
In general, preferreds have preference to dividends payments. A preference does not assure the payment of dividends, but the company must pay the stated dividend rate prior to paying any dividends on common
stock.
Index
* Buyers and seller (number, size, location, and valuation perceptions)* Market mechanism (bidding and settlement process, liquidity);
* Risk management choices.
Let's understand the Concept...
Price discovery:
The price discovery process is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.
Price discovery is different from valuation. Price discovery process involves buyers and sellers arriving at a transaction price for a specific item at a given time. It involves the following:
* Available information (amount, timeliness, significance and reliability) including futures and other related markets
In a dynamic market, the price discovery takes place continuously. The price will sometimes fall below the duration average and sometimes exceed the average as a result of the noise due to uncertainties.
The price would fluctuate between the support and resistance levels, which are associated with the ends of the expectation spectrum.
Usually, price discovery helps find the exact price for a commodity or a share of a company. The price discovery is used in speculative markets which helps traders, manufacturers, exporters, farmers, oil well
owners, refineries, governments, consumers and speculators.The process involves transfer of the risk to another person who is ready to take the risk assuming that the
demand for the given asset or commodity either goes up or goes down.In a given market condition when farmers cannot demand a specific price the best option would be price
discovery.Price discovery process helps commodities which are consumed world wide and produced world wide.
Governments do not involve majorly in fixing a particular price to buy or sell therefore market forces help to discover appropriate price for an asset.
For example, for crude oil which is consumed world-wide and also produced in different quantities in various nations, fixing the price becomes very difficult for one nation or for one individual. The mechanism of
discovering the price helps oil importing nations as well as oil exporting nations.In another example, farmers have the maximum retail price printed on the farm produce. Hence, the process
of price discovery helps them to know what is the price for their produce.
Index
Let's understand the Concept...
Primary Market : A market that issues new securities on an exchange. Companies, governments and other groups obtain
financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee
its sale directly to investors.
Also known as "new issue market" (NIM).
The primary markets are where investors can get first crack at a new security issuance. The issuing company or group receives cash proceeds from the sale, which is then used to fund operations or expand the
business. Exchanges have varying levels of requirements which must be met before a security can be sold.
Once the initial sale is complete, further trading is said to conduct on the secondary market, which is where the bulk of exchange trading occurs each day. Primary markets can see increased volatility over secondary markets because it is difficult to accurately gauge investor demand for a new security until several days of
trading have occurred.
Initial Public Offering - IPO : An initial public offering (IPO), referred simply as an "offering" or "flotation", is when a company (called the
issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies
looking to become publicly traded.
In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.
An IPO can be a risky investment. For the individual investor it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to
analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.
Index
Primary market trend:
A primary trend has broad support throughout the entire market (most sectors) and lasts for a year or more.
Bull market-
Examples-
Bear market-
Examples-
Let's understand the Concept...
A bull market is associated with increasing investor confidence, and increased investing in anticipation of future price increases (capital gains). A bullish trend in the stock market often begins before the general
economy shows clear signs of recovery.
India's Bombay Stock Exchange Index, SENSEX, was in a bull market trend for about five years from April 2003 to January 2008 as it increased from 2,900 points to 21,000 points. A notable bull market was in the
1990s and most of the 1980s when the U.S. and many other stock markets rose; the end of this time period sees the dot-com bubble.
A bear market is a general decline in the stock market over a period of time. It is a transition from high investor optimism to widespread investor fear and pessimism. According to The Vanguard Group, "While
there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period." It is sometimes referred to as "The Heifer Market" due to the
paradox with the above subject.
A bear market followed the Wall Street Crash of 1929 and erased 89% (from 386 to 40) of the Dow Jones Industrial Average's market capitalization by July 1932, marking the start of the Great Depression. After
regaining nearly 50% of its losses, a longer bear market from 1937 to 1942 occurred in which the market was again cut in half. Another long-term bear market occurred from about 1973 to 1982, encompassing the 1970s
energy crisis and the high unemployment of the early 1980s. Yet another bear market occurred between March 2000 and October 2002. The most recent example occurred between October 2007 and March 2009.
Index
Let's understand the Concept...
Promissory note:
A promissory note, referred to as a note payable in accounting, or commonly as just a "note", is a contract where one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to
the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. They differ from IOUs in that they contain a specific promise to pay, rather than simply acknowledging
that a debt exists.
The terms of a note typically include the principal amount, the interest rate if any, the parties, the date, the terms of repayment (which could include interest) and the maturity date. Sometimes, provisions are included concerning the payee's rights in the event of a default, which may include foreclosure of the maker's assets. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand of the lender. Usually the lender will only give the borrower a few days notice before the payment is due. For loans between individuals, writing and signing a promissory note are often instrumental for tax and record keeping. In the United States, a promissory note that meets certain conditions is a negotiable instrument regulated by article 3 of the Uniform Commercial Code. Negotiable promissory notes are used extensively in combination with mortgages in the financing of real estate transactions. Promissory notes, or commercial papers, are also
issued to provide capital to businesses. However, Promissory Notes act as a source of Finance to the companies creditors.
Index
Let's understand the Concept...
Purchasing power:
Purchasing power is the number of goods/services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater
number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s. Currency can be either a commodity money, like gold or silver, or fiat currency like US dollars. As
Adam Smith noted, having money gives one the ability to "command" others' labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for
money or currency.
If one's money income stays the same, but the price level increases, the purchasing power of that income falls. Inflation does not always imply falling purchasing power of one's money income since it may rise faster than the price level. A higher real income means a higher purchasing power since real income refers to the
income adjusted for inflation.
Index
Raising the capital:
The following table illustrates where financial markets fit in the relationship between lenders and borrowers:
Let's understand the Concept...
To understand financial markets, let us look at what they are used for, i.e. what where firms make the capital to invest
Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend
money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages.
More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by
selling shares to investors and its existing shares can be bought or sold.
Index
Let's understand the Concept...
Repurchase agreement:
A Repurchase agreement, also known as a Repo or Sale and Repurchase Agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price
will be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party who originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of
interest.
A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the
forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan while the
settlement date of the forward contract is the maturity date of the loan.
Structure and terminology -A repo is economically similar to a secured loan, with the buyer (effectively the lender or investor) receiving
securities as collateral to protect against default of the seller - the party who initially sells the securities being effectively the borrower. Almost any security may be employed in a repo, though practically speaking highly liquid securities are preferred because they are more easily disposed of in the event of a default and, more importantly, they can be easily secured in the open market where the buyer has created a short position in
the repo security through a reverse repo and market sale; by the same token, illiquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as "collateral" in a repo transaction. Unlike a secured loan, however, legal title to the securities clearly
passes from the seller to the buyer. Coupons (installment payments that are payable to the owner of the securities) which are paid while the repo buyer owns the securities are, in fact, usually passed directly onto
the repo seller. This might seem counterintuitive, as the ownership of the collateral technically rests with the buyer during the repo agreement. It is possible to instead pass on the coupon by altering the cash paid at the
end of the agreement, though this is more typical of Sell/Buy Backs.
Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking of loans because the seller does actually repurchase the legal ownership of the securities from
the buyer at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in using the "repurchase" terminology, the emphasis is placed upon the current legal ownership of
the collateral securities by the respective parties. That said, one of the most important aspects of repos is that they are legally recognised as a single transaction (especially important in the event of counterparty
insolvency) but do not count as a disposal and a repurchase for tax purposes.
Index
Let's understand the Concept...
Return of capital :
* Private business can distribute any amount of equity that the owners need personally.
Return of capital (ROC) refers to payments back to "capital owners" (shareholders, partners, unitholders) that exceed the growth (net income/taxable income) of a business. It should not be confused with return on capital
which measures a 'rate of return'.
The ROC effectively shrinks the firm's equity in the same way that all distributions do. It is a transfer of value from the company to the owner. In an efficient market, the stock's price will fall by an amount equal to the
distribution. Most public companies pay out only a percentage of their income as dividends. In some industries it is common to pay ROC.
* Real Estate Investment Trusts (REITs) commonly make distributions equal to the sum of their income and the depreciation (capital cost allowance) allowed for in the calculation of that income. The business has the
cash to make the distribution because depreciation is a non-cash charge.
* Oil and gas royalty trusts also make distributions that include ROC equal to the drawdown in the quantity of their reserves. Again, the cash to find the O&G was spent previously, and current operations are generating
excess cash.
* Structured Products (closed ended investment funds) frequently use high distributions, that include returns of capital, as a promotional tool. The retail investors these funds are sold to rarely have the technical
knowledge to distinguish income from ROC.
* Public business may return capital as a means to increase the debt/equity ratio and increase their leverage (risk profile). When the value of real estate holdings (for example) have increased, the owners may realize
some of the increased value immediately by taking a ROC and increasing debt. This may be considered analogous to cash out refinancing of a residential property.
* When companies spin off divisions and issue shares of a new, stand-alone business, this distribution is a return of capital.
Index
Let's understand the Concept...
Secondary market offering:
A follow-on offering (often called secondary public offering or just secondary offering) is an issuance of stock subsequent to the company's initial public offering. A follow-on offering can be either of two types (or a
mixture of both): dilutive and non-dilutive (as rights issue). Furthermore it could be a cash issue or a capital increase in return for stock.
A secondary offering is an offering of securities by a shareholder of the company (as opposed to the company itself, which is a primary offering). For example, Google's initial public offering (IPO) included both a primary
offering (issuance of Google stock by Google) and a secondary offering (sale of Google stock held by shareholders, including the founders).
In the case of the dilutive offering (seasoned equity offering), the company's board of directors agrees to increase the share float for the purpose of selling more equity in the company. This new inflow of cash might be used to pay off some debt or used for needed company expansion. When new shares are created and then
sold by the company, the number of shares outstanding increases and this causes dilution of earnings on a per share basis. Usually the gain of cash inflow from the sale is strategic and is considered positive for the
longer term goals of the company and its shareholders. Some owners of the stock however may not view the event as favorably over a more short term valuation horizon.
The non-dilutive type of follow-on offering is when privately held shares are offered for sale by company directors or other insiders (such as venture capitalists) who may be looking to diversify their holdings.
Because no new shares are created, the offering is not dilutive to existing shareholders, but the proceeds from the sale do not benefit the company in any way. Usually however, the increase in available shares allows
more institutions to take non-trivial positions in the company.
As with an IPO, the investment banks who are serving as underwriters of the follow-on offering will often be offered the use of a greenshoe or over-allotment option by the selling company.
Index
Let's understand the Concept...
Secondary Market :
A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and the NASDAQ are
secondary markets.
The term "secondary market" is also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset where the customer base is the second market.
Secondary markets exist for other securities as well, such as when funds, investment banks, or entities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the cash proceeds
go to an investor rather than to the underlying company/entity directly.
A newly issued IPO will be considered a primary market trade when the shares are first purchased by investors directly from the underwriting investment bank; after that any shares traded will be on the
secondary market, between investors themselves. In the primary market prices are often set beforehand, whereas in the secondary market only basic forces like supply and demand determine the price of the
security.
The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold. With primary issuances of securities or financial instruments, or the primary market, investors purchase these
securities directly from issuers such as corporations issuing shares in an IPO or private placement, or directly from the federal government in the case of treasuries. After the initial issuance, investors can purchase from
other investors in the secondary market.
Index
Let's understand the Concept...
First, mortgage loans are purchased from banks, mortgage companies, and other lenders.
Securitization:
The process of securitization is complicated, and is highly dependent on the jurisdiction upon which the process is conducted.
Secondly, these loans are assembled into collections, or "pools". While a residential mortgage-backed security (RMBS) is secured by single-family or two to four family real estate, a commercial mortgage-backed security
(CMBS) is secured by commercial and multifamily properties, such as apartment buildings, retail or office properties, hotels, schools, industrial properties and other commercial sites. A CMBS is usually structured
differently than an RMBS.
Thirdly, these pools are securitized by assigning the pool to a securitized trust, with a schedule of pooled mortgage loans that identify the underlying mortgages. This securitization is done by government-sponsored
enterprises and private entities which may offer credit enhancement features to mitigate the risk of prepayment and default associated with these mortgages. Since residential mortgages in the United States have the option to pay more than the required monthly payment (curtailment) or to pay off the loan in its
entirety (prepayment), the monthly cash flow of an MBS is not known in advance, and therefore presents risk to MBS investors. These securities are usually sold as bonds, but financial innovation has created a variety of
securities that derive their ultimate value from mortgage pools.
In the United States, most MBS's are issued by Fannie Mae and Freddie Mac, U.S. government-sponsored enterprises. Ginnie Mae, a U.S. government-sponsored enterprise backed by the full faith and credit of the
U.S. government, guarantees its investors receive timely payments. Some private institutions, such as brokerage firms, banks, and homebuilders, also securitize mortgages, known as "private-label" mortgage
securities. The most common securitized trusts are the mortgage-backed securities and participation certificates (PC) of Fannie Mae and Freddie Mac, as well as Real Estate Mortgage Investment Conduits
(REMIC) and the Real Estate Investment Trusts (REIT) of private entities.
Index
Let's understand the Concept...
Sell side:
Sell side is a term used in the financial services industry. It is a general term that indicates a firm that sells investment services to asset management firms, typically referred to as the buy side, or corporate entities.
These services encompass a broad range of activities, including broking/dealing, investment banking, advisory functions, and investment research.
In the capacity of a broker-dealer, "sell side" refers to firms that take orders from buy side firms and then "work" the orders. This is typically achieved by splitting them into smaller orders which are then sent directly to an exchange or to other firms. Sell side firms are intermediaries whose task is to sell securities to investors
(usually the buy side i.e. investing institutions such as mutual funds, pension funds and insurance firms).
Sell side firms are paid through commissions charged on the sales price of the stock. Sell side firms employ research analysts, traders and salespeople who collectively strive to generate ideas and execute trades for Buy side firms, enticing them to do business. Part of the research analyst's job includes publishing research
reports on public companies, these reports analyze their business and provide recommendations on the purchase or sale of the stock.
One recent trend in the industry has been unbundling of commission rates; simply put, this is the process of separating the cost of trading the stock (e.g. trader’s salaries) from the cost of research (e.g. research analyst
salaries). This process allows Buy side firms to purchase research from the best research firms and trade through the best trading firms, which often are not one and the same.
Index
Settlement - physical versus cash-settled futures:
Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract:
* Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering
position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). The Nymex crude
futures contract uses this method of settlement upon expiration
* Cash settlement - a cash payment is made based on the underlying reference rate, such as a short term interest rate index such as Euribor, or the closing value of a stock market index. The parties settle by paying/receiving the loss/gain related to the contract in cash
when the contract expires. Cash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item - i.e. how would one deliver an index? A futures contract might also opt to settle against an index based on trade in a related spot
market. Ice Brent futures use this method.
Expiry (or Expiration in the U.S.) is the time and the day that a particular delivery month of a futures contract stops trading, as well as the final settlement price for that contract. For many equity index and interest rate
futures contracts (as well as for most equity options), this happens on the third Friday of certain trading months. On this day the t+1 futures contract becomes the t futures contract. For example, for most CME and CBOT contracts, at the expiration of the December contract, the March futures become the nearest contract. This is an exciting time for arbitrage desks, which try to make quick profits during the short period (perhaps
30 minutes) during which the underlying cash price and the futures price sometimes struggle to converge. At this moment the futures and the underlying assets are extremely liquid and any disparity between an index
and an underlying asset is quickly traded by arbitrageurs. At this moment also, the increase in volume is caused by traders rolling over positions to the next contract or, in the case of equity index futures, purchasing
underlying components of those indexes to hedge against current index positions. On the expiry date, a European equity arbitrage trading desk in London or Frankfurt will see positions expire in as many as eight
major markets almost every half an hour.
Index
Shadow banking system:
Let's understand the Concept...
The shadow banking system or the shadow financial system consists of non-depository banks and other financial entities (e.g., investment banks, hedge funds, money market funds and insurers) that grew in size
dramatically after the year 2000 and play an increasingly critical role in lending businesses the money necessary to operate. By June 2008, the U.S. shadow banking system was approximately the same size as the U.S. traditional depository banking system. The equivalent of a bank run occurred within the shadow banking
system during 2007-2008, when investors stopped providing funds to (or through) many entities in the system. Disruption in the shadow banking system is a key component of the ongoing subprime mortgage
crisis.
By definition, shadow institutions do not accept deposits like a depository bank and therefore are not subject to the same regulations. Familiar examples of shadow institutions included Bear Stearns and Lehman
Brothers. Other complex legal entities comprising the system include hedge funds, SIVs, conduits, money funds, monolines, investment banks, and other non-bank financial institutions.
Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an institutional investor like a pension fund may be willing to lend money, while a corporation may be searching for funds to borrow. The shadow banking institution will channel funds from the investor(s) to the corporation,
profiting either from fees or from the difference in interest rates between what it pays the investor(s) and what it receives from the borrower.
Index
Share repurchase - Purpose :
Let's understand the Concept...
Companies making profits typically have two uses for those profits. Firstly, some part of profits are usually repaid to shareholders in the form of dividends. The remainder, termed stockholder's equity, are kept inside
the company and used for investing in the future of the company. If companies can reinvest most of their retained earnings profitably, then they may do so. However, sometimes companies may find that some or all
of their retained earnings cannot be reinvested to produce acceptable returns.
One reason why companies may prefer to keep a substantial portion of earnings rather than distribute them to shareholders, even if they aren't able to reinvest them all profitably, is that it is considered very
embarrassing for companies to be forced to cut dividends. Normally, investors have more adverse reaction in dividend cut than postponing or even abandoning the share buyback program. So, rather than pay out larger
dividends during periods of excess profitability then have to reduce them during leaner times, companies prefer to pay out a conservative portion of their earnings, perhaps half, with the aim of maintaining an
acceptable level of dividend cover.
Aside from paying out free cash flow, repurchases may also be used to signal and/or take advantage of undervaluation. If a firm's manager believes his/her firm's stock is currently trading below its intrinsic value
he/she may consider repurchases. An open market repurchase, whereby no premium is paid on top of current market price, offers a potentially profitable investment for the manager. That is, he may repurchase the
currently undervalued shares, wait for the market to correct the undervaluation whereby prices increases to the intrinsic value of the equity, and re issue them at a profit. Alternatively, he may undertake a fixed price tender offer, whereby a premium is often offered over current market price, sending a strong signal to the market that he believes the firms equity is undervalued, proven by the fact that he is willing to pay above
market price to repurchase the shares.
Share repurchases avoid the accumulation of excessive amounts of cash in the corporation. Companies with strong cash generation and limited needs for capital spending will accumulate cash on the balance sheet,
which makes the company a more attractive target for takeover, since the cash can be used to pay down the debt incurred to carry out the acquisition. Anti-takeover strategies therefore often include maintaining a lean cash position, and at the same time the share repurchases bolster the stock price, making a takeover more
expensive.
Share repurchases are one possible use of leftover retained profits. When a company repurchases its own shares, it reduces the number of shares held by the public. The reduction of the float, or publicly traded
shares, means that even if profits remain the same, the earnings per share increase. So, repurchasing shares, particularly when a company's share price is perceived as undervalued or depressed, may result in a strong
return on investment.
Index
Share repurchase:
Let's understand the Concept...
Stock repurchase (or share buyback) is the reacquisition by a company of its own stock. In some countries, including the U.S. and the UK, a corporation can repurchase its own stock by distributing cash to existing
shareholders in exchange for a fraction of the company's outstanding equity; that is, cash is exchanged for a reduction in the number of shares outstanding. The company either retires the repurchased shares or keeps
them as treasury stock, available for re-issuance.
Under U.S. corporate law there are five primary methods of stock repurchase: open market, private negotiations, repurchase 'put' rights, and two variants of self-tender repurchase: a fixed price tender offer and a Dutch auction. There has been a meteoric rise in the use of share repurchases in the U.S. in the past twenty
years, from $5 billion in 1980 to $349 billion in 2005.
Index
Let's understand the Concept...
Short Selling :
In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying
identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than
the seller received on selling them. Conversely, the short seller will incur a loss if the price of the assets rises. Other costs of shorting may include a fee for borrowing the assets and payment of any dividends paid
on the borrowed assets. "Shorting" and "going short" also refer to entering into any derivative or other contract under which the investor profits from a fall in the value of an asset.
Assume that shares in XYZ Company currently sell for $10 per share. A short seller would borrow 100 shares of XYZ Company, and then immediately sell those shares for a total of $1000. If the price of XYZ shares later
falls to $8 per share, the short seller would then buy 100 shares back for $800, return the shares to their original owner and make a $200 profit (minus borrowing fees). This practice has the potential for losses as well. For example, if the shares of XYZ that one borrowed and sold in fact went up to $25, the short seller
would have to buy back all the shares at $2500, losing $1500.
Going short can be contrasted with the more conventional practice of "going long", whereby an investor profits from any increase in the price of the asset.
Index
Let's understand the Concept...
Short-Term Investment Fund (STIF):
A Short-Term Investment Fund (STIF) is a type of investment fund which invests in money market investments of high quality and low risk. They are commonly used by investors to temporarily store funds while arranging
for their transfer to another investment vehicle that will provide higher returns.
This type of fund aims to protect capital while generating a return that compares favourably with a particular benchmark, such as a Treasury Bill index. These types of fund have low management fees (usually well beneath 1% p.a.) and relatively low rates of return, commensurate with their low-risk investment style.
Short-term investment funds include cash, bank notes, corporate notes, government bills and various safe short-term debt instruments. These types of funds are usually used by investors who are temporarily parking
funds before moving them to another investment that will provide higher returns.
Index
* ISO 9362:1994 Banking—Banking telecommunication messages—Bank identifier codes
* ISO 13616:2003 IBAN Registry* ISO 15022:1999 Securities—Scheme for messages (Data Field Dictionary) (replaces ISO 7775)
* ISO 20022-1:2004 and ISO 20022-2:2007 Financial services—UNIversal Financial Industry message scheme
Let's understand the Concept...
Society for Worldwide Interbank Financial Telecommunication:
The Society for Worldwide Interbank Financial Telecommunication ("SWIFT") operates a worldwide financial messaging network which exchanges messages between banks and other financial institutions. SWIFT also
markets software and services to financial institutions, much of it for use on the SWIFTNet Network, and ISO 9362 bank identifier codes (BICs) are popularly known as "SWIFT codes".
The majority of international interbank messages use the SWIFT network. As of September 2010, SWIFT linked more than 9,000 financial institutions in 209 countries and territories, who were exchanging an
average of over 15 million messages per day. SWIFT transports financial messages in a highly secure way, but does not hold accounts for its members and does not perform any form of clearing or settlement.
SWIFT does not facilitate funds transfer, rather, it sends payment orders, which must be settled via correspondent accounts that the institutions have with each other. Each financial institution, to exchange
banking transactions, must have a banking relationship by either being a bank or affiliating itself with one (or more) so as to enjoy those particular business features.
SWIFT is a cooperative society under Belgian law and it is owned by its member financial institutions. SWIFT has offices around the world. SWIFT headquarters are located in La Hulpe, Belgium, near Brussels. An average
of 2.4 million messages, with aggregate value of $2 trillion, were processed by SWIFT per day in 1995.
Standards -
SWIFT has become the industry standard for syntax in financial messages. Messages formatted to SWIFT standards can be read by, and processed by, many well known financial processing systems, whether or not
the message actually traveled over the SWIFT network. SWIFT cooperates with international organizations for defining standards for message format and content. SWIFT is also registration authority (RA) for the following
ISO standards:
* ISO 10383:2003 Securities and related financial instruments—Codes for exchanges and market identification (MIC)
In RFC 3615 urn:swift: was defined as Uniform Resource Names (URNs) for SWIFT FIN
Index
S&P 500:
Let's understand the Concept...
The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500 are those of large publicly held companies that trade on either of the two largest American stock market exchanges: the New
York Stock Exchange and the NASDAQ.
The index focus is U.S.-based companies although there are a few legacy companies with headquarters in other countries. Any new companies added to the index are U.S. based, and, when a U.S. company shifts its
headquarters overseas, it is replaced by a U.S. company, as happened when Transocean moved from Houston to Switzerland in 2008.
After the Dow Jones Industrial Average, the S&P 500 is the most widely followed index of large-cap American stocks. It is considered a bellwether for the American economy, and is included in the Index of Leading
Indicators. Many mutual funds, exchange-traded funds, and other funds such as pension funds, are designed to track the performance of the S&P 500 index. Hundreds of billions of US dollars have been invested in this
fashion.
The index is the best known of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill. S&P 500 refers not only to the index, but also to the 500 companies that have their common
stock included in the index. The stocks included in the S&P 500 index are also part of the broader S&P 1500 and S&P Global 1200 stock market indices.
Index
Let's understand the Concept...
Speculation:
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum.
Speculation typically involves the lending of money or the purchase of assets, equity or debt but in a manner that has not been given thorough analysis or is deemed to have low margin of safety or a significant risk of the loss of the principal investment. The term, "speculation," which is formally defined as above in Graham
and Dodd's 1934 text, Security Analysis, contrasts with the term "investment," which is a financial operation that, upon thorough analysis, promises safety of principal and a satisfactory return.
In a financial context, the terms "speculation" and "investment" are actually quite specific. For instance, although the word "investment" is typically used, in a general sense, to mean any act of placing money in a financial vehicle with the intent of producing returns over a period of time, most ventured money—including
funds placed in the world's stock markets—is actually not investment, but speculation.
Speculators may rely on an asset appreciating in price due to any of a number of factors that cannot be well enough understood by the speculator to make an investment-quality decision. Some such factors are shifting
consumer tastes, fluctuating economic conditions, buyers' changing perceptions of the worth of a stock security, economic factors associated with market timing, the factors associated with solely chart-based
analysis, and the many influences over the short-term movement of securities.
There are also some financial vehicles that are, by definition, speculation. For instance, trading in certain commodities, such as oil and gold, is, by definition, speculation. Short selling is also, by definition,
speculative.
Financial speculation can involve the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from
fluctuations in its price, irrespective of its underlying value.
Index
Let's understand the Concept...
Spot market:
* an organized market, an exchange or
The spot market or cash market is a public financial market, in which financial instruments are traded and delivered immediately. The spot market can be of both types:
* "over the counter", OTC.
Spot markets can operate wherever the infrastructure exists to conduct the transaction. The spot market for most instruments exists primarily on the Internet.
Exchange - Securities (i.e. commodities) are traded on exchanges using recent market price.
OTC - Over The Counter Non or less standardized contracts, i.e. forwards or swaps, have no publicly known recent price, so set uniquely each time.
Example: Spot Forex
The spot foreign exchange market has a 2 day delivery date, originally due to the time it would take to move cash from one bank to another. Most speculative retail forex trading is done as spot transaction on an online
trading platform.
Index
Let's understand the Concept...
Stakeholder (corporate):
The term has been broadened to include anyone who has an interest in a matter.
A corporate stakeholder is a party that can affect or be affected by the actions of the business as a whole. The stakeholder concept was first used in a 1963 internal memorandum at the Stanford Research institute. It
defined stakeholders as "those groups without whose support the organization would cease to exist." The theory was later developed and championed by R. Edward Freeman in the 1980s. Since then it has gained
wide acceptance in business practice and in theorizing relating to strategic management, corporate governance, business purpose and corporate social responsibility (CSR).
In reality, the term means the exact opposite: a person with no interest in a matter who acts as a neutral party, to "hold the stakes" in a bet between two other persons, or, in law, a person holding an asset claimed by two or more persons, who does not himself claim an interest in it. The current opposite usage reflects a
misapprehension by persons who did not know the term's meaning.
Examples of a company stakeholders -
Index
Let's understand the Concept...
Stock exchange:
A stock exchange is an entity which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well
as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled
investment products and bonds.
To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of increased speed and reduced cost of
transactions. Trade on an exchange is by members only.
The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important
component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation).
There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way
that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.
Index
United States of America -
Subprime crisis -
Let's understand the Concept...
Although there is no single, standard definition, in the United States subprime loans are usually classified as those where the borrower has a FICO score below 640. The term was popularized by the media during the
Subprime mortgage crisis or "credit crunch" of 2007. Those loans which do not meet Fannie Mae or Freddie Mac underwriting guidelines for prime mortgages are called "non-conforming" loans.
A borrower with an outstanding record of repayment on time and in full will get what is called an A-paper loan. Borrowers with less-than-perfect credit 'scores' might be rated as meriting an A-minus, B-paper, C-paper or D-paper loan, with interest payments progressively increased for less reliable payers to allow the company
to 'share the risk' of default equitably among all its borrowers.
The subprime mortgage crisis arose from 'bundling' American subprime and American regular mortgages which were traditionally isolated from, and sold in a separate market from prime loans. These 'bundles' of mixed (prime and subprime) mortgages were the basis Asset-backed securities so the 'probable' rate of return looked superb (since subprime lenders pay higher premiums, and the loans were anyway secured
against saleable real-estate, and so, theoretically 'could not fail'). Many mortgages had a low interest for the first year, and poorer buyers 'swapped' regularly at first, but finally such borrowers began to default in large
numbers. the inflated house-price bubble burst, property valuations plummeted and the real rate of return on investment could not be estimated, and so confidence in these instruments collapsed, and all were
considered to be almost worthless Toxic assets, regardless of their actual composition or performance.
To avoid high initial mortgage payments, many subprime borrowers took out adjustable-rate mortgages (or ARMs) that give them a lower initial interest rate. But with potential annual adjustments of 2% or more per
year, these loans can end up costing much more. So a $500,000 loan at a 4% interest rate for 30 years equates to a payment of about $2,400 a month. But the same loan at 10% for 27 years (after the adjustable
period ends) equates to a payment of $4,220. A 6% increase in the rate caused slightly more than a 75% increase in the payment. This is even more apparent when the lifetime cost of the loan is considered (though
most people will want to refinance their loans periodically). The total cost of the above loan at 4% is $864,000, while the higher rate of 10% would incur a lifetime cost of $1,367,280.
Index
Subprime lending - Student loans:
Let's understand the Concept...
In some countries student loans are considered subprime, perhaps because of school drop-outs. In other countries such loans are underwritten by governments or sponsors. Many student loans are structured in
special ways because of the difficulty of predicting students' future earnings. These structures may be in the form of Soft loans, Income-Sensitive Repayment loans Income-Contingent Repayment loans and so on. Because student loans provide repayment records for credit rating, and may also indicate their earning potential, Student loan default can cause serious problems later in life as an individual wishes to make a
substantial purchase on credit such as purchasing a vehicle or buying a house, since defaulters are likely to be classified as subprime, which means the loan may be refused or more difficult to arrange and certainly
more expensive than for someone with a perfect repayment record.
Index
Subprime lending:
Subprime borrowers have credit ratings that might include:
* limited debt experience (so the lender's assessor simply does not know, and assumes the worst), or
* no possession of property assets that could be used as security (for the lender to sell in case of default)
* a history of late or sometimes missed payments (morose debt) so that the loan period had to be extended,
* failures to pay debts completely (default debt), and
Let's understand the Concept...
In finance, subprime lending (also referred to as near-prime, non-prime, and second-chance lending) means making loans to people who may have difficulty maintaining the repayment schedule.
Proponents of subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market. Professor Harvey S. Rosen of Princeton University explained, "The main
thing that innovations in the mortgage market have done over the past 30 years is to let in the excluded: the young, the discriminated-against, the people without a lot of money in the bank to use for a down payment."
Defining subprime risk -
As people become economically active, records are created relating to their borrowing, earning and lending history. This is called a credit rating, and although covered by privacy laws the information is readily available
to people with a need to know (in some countries, loan applications specifically allow the lender to access such records).
* excessive debt (the known income of the individual or family is unlikely to be enough to pay living expenses + interest + repayment),
* any legal judgements such as "orders to pay" or bankruptcy (sometimes known in Britain as County Court Judgements or CCJs).
Lenders' standards for determining risk categories may also consider the size of the proposed loan, and also take into account the way the loan and the repayment plan is structured, if it is a conventional repayment
loan a mortgage loan, an Endowment mortgage interest only loan, Standard repayment loan, amortized loan, credit card limit or some other arrangement. The originator is also taken into consideration. Because of this, it
was possible for a loan to a borrower with "prime" characteristics (e.g. high credit score, low debt) to be classified as subprime.
Index
Subprime mortgage crisis - Causes
1) Housing prices would not fall dramatically;
5) Stronger regulation of the shadow banking system and derivatives markets was not needed.
Let's understand the Concept...
The crisis can be attributed to a number of factors pervasive in both housing and credit markets, factors which emerged over a number of years. Causes proposed include the inability of homeowners to make their
mortgage payments (due primarily to adjustable-rate mortgages resetting, borrowers overextending, predatory lending, and speculation), overbuilding during the boom period, risky mortgage products, high personal and corporate debt levels, financial products that distributed and perhaps concealed the risk of mortgage default, bad monetary and housing policies, international trade imbalances, and inappropriate
government regulation. Three important catalysts of the subprime crisis were the influx of moneys from the private sector, the banks entering into the mortgage bond market and the predatory lending practices of the
mortgage lenders, specifically the adjustable-rate mortgage, 2–28 loan, that mortgage lenders sold directly or indirectly via mortgage brokers.
During May 2010, Warren Buffett and Paul Volcker separately described questionable assumptions or judgments underlying the U.S. financial and economic system that contributed to the crisis. These
assumptions included:
2) Free and open financial markets supported by sophisticated financial engineering would most effectively support market efficiency and stability, directing funds to the most profitable and productive uses;
3) Concepts embedded in mathematics and physics could be directly adapted to markets, in the form of various financial models used to evaluate credit risk;
4) Economic imbalances, such as large trade deficits and low savings rates indicative of over-consumption, were sustainable; and
The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk
by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and
systemic breaches in accountability and ethics at all levels.
Index
Subprime mortgage crisis - Responses:
Federal Reserve and central banks -
Let's understand the Concept...
Various actions have been taken since the crisis became apparent in August 2007. In September 2008, major instability in world financial markets increased awareness and attention to the crisis. Various agencies and regulators, as well as political officials, began to take additional, more comprehensive steps to handle the
crisis.
To date, various government agencies have committed or spent trillions of dollars in loans, asset purchases, guarantees, and direct spending. For a summary of U.S. government financial commitments and investments
related to the crisis, see CNN – Bailout Scorecard.
The central bank of the USA, the Federal Reserve, in partnership with central banks around the world, has taken several steps to address the crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve's response has followed two tracks: efforts to support market liquidity and
functioning and the pursuit of our macroeconomic objectives through monetary policy."The Fed has:
1. Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. This took place in six steps occurring between 18 September 2007 and 30 April 2008; In December
2008, the Fed further lowered the federal funds rate target to a range of 0–0.25% (25 basis points).
2. Undertaken, along with other central banks, open market operations to ensure member banks remain liquid. These are effectively short-term loans to member banks collateralized by government securities.
Central banks have also lowered the interest rates (called the discount rate in the USA) they charge member banks for short-term loans;
3. Created a variety of lending facilities to enable the Fed to lend directly to banks and non-bank institutions, against specific types of collateral of varying credit quality. These include the Term Auction
Facility (TAF) and Term Asset-Backed Securities Loan Facility (TALF).
4. In November 2008, the Fed announced a $600 billion program to purchase the MBS of the GSE, to help lower mortgage rates.
5. In March 2009, the Federal Open Market Committee decided to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of government-sponsored
enterprise mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase
up to $300 billion of longer-term Treasury securities during 2009.
According to Ben Bernanke, expansion of the Fed balance sheet means the Fed is electronically creating money, necessary "...because our economy is very weak and inflation is very low. When the economy begins
to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation."
Index
Subprime mortgage crisis :
Let's understand the Concept...
The US subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of
securities backing said mortgages.
Approximately 80% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages. After U.S. house sales prices peaked in mid-2006 and began their steep decline forthwith, refinancing became
more difficult. As adjustable-rate mortgages began to reset at higher interest rates, mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by financial firms, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt and other
securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the
world and slowing economic growth in the U.S. and Europe.
Index
Let's understand the Concept...
Supply Side vs. Demand Side:
A market participant may either be coming from the Supply Side, hence supplying excess money (in the form of investments) in favor of the demand side; or coming from the Demand Side, hence demanding excess
money (in the form of borrowed equity) in favor of the Demand Side. This equation originated from Keynesian Advocates. The theory explains that a given market may have excess cash; hence the supplier of funds may lend it; and those in need of cash may borrow the funds as supplied. Hence, the equation: aggregate savings
equals aggregate investments.
The demand side consists of: those in need of cash flows (daily operational needs); those in need of interim financing (bridge financing); those in need of long-term funds for special
projects (capital funds for venture financing).
The supply side consists of: those who have aggregate savings (retirement funds, pension funds, insurance funds) that can be used in favor of demand side. The origin of the savings
(funds) can be local savings or foreign savings. So much pensions or savings can be invested for school buildings; orphanages; (but not earning) or for road network (toll
ways) or port development (capable of earnings).
The earnings goes to owner (Savers or Lenders) and the margin goes to the banks. When the principal and interest are added up, it will reflect the amount paid for the user (borrower) of the funds. Thus, an interest
percentage for the cost of using the funds.
Index
Let's understand the Concept...
Swap market:
Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties. Some types of swaps are also exchanged on futures markets such as the Chicago Mercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board Options Exchange, Intercontinental Exchange and Frankfurt-based Eurex
AG.
The Bank for International Settlements (BIS) publishes statistics on the notional amounts outstanding in the OTC derivatives market. At the end of 2006, this was USD 415.2 trillion, more than 8.5 times the 2006 gross
world product. However, since the cash flow generated by a swap is equal to an interest rate times that notional amount, the cash flow generated from swaps is a substantial fraction of but much less than the gross world product—which is also a cash-flow measure. The majority of this (USD 292.0 trillion) was due to interest
rate swaps.
The first swaps were negotiated in the early 1980s. Today, swaps are among the most heavily traded financial contracts in the world: the total amount of interest rates and currency swaps outstanding is more
thаn $426.7 trillion in 2009, according to International Swaps and Derivatives Association (ISDA).
Index
Let's understand the Concept...
Swap:
In finance, a swap is a derivative in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of
financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two
counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way
they are calculated. Usually at the time when the contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as an interest rate, foreign exchange rate, equity
price or commodity price.
The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be in cash or collateral.
Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices.
Index
Let's understand the Concept...
Swaption:
There are two types of swaption contracts:
The buyer and seller of the swaption agree on:- The premium (price) of the swaption
- The strike rate (equal to the fixed rate of the underlying swap)
- The term of the underlying swap,- Notional amount,
- Amortization, if any
A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on
interest rate swaps.
A payer swaption gives the owner of the swaption the right to enter into a swap where they pay the fixed leg and receive the floating leg.
A receiver swaption gives the owner of the swaption the right to enter into a swap where they will receive the fixed leg, and pay the floating leg.
- Length of the option period (which usually ends two business days prior to the start date of the underlying swap),
frequency of settlement of payments on the underlying swap
Index
Let's understand the Concept...
Sweeps:
In United States Banking, Eurodollars are a popular option for what are known as "sweeps". By law, banks aren't allowed to pay interest on corporate checking accounts. To accommodate larger businesses, banks
may automatically transfer, or sweep, funds from a corporation's checking account into an overnight investment option to effectively earn interest on those funds. Banks usually allow these funds to be swept
either into money market mutual funds, or alternately they may be used for bank funding by transferring to an offshore branch of a bank.
Index
Let's understand the Concept...
Tariff:
A tariff is a tax levied on imported or exported goods.
In the past, tariffs formed a much larger part of government revenue than they do today.
History:
Tariffs are usually associated with protectionism, the economic policy of restraining trade between nations. For political reasons, tariffs are usually imposed on imported goods, although they may also be imposed on
exported goods.
When shipments of goods arrive at a border crossing or port, customs officers inspect the contents and charge a tax according to the tariff formula. Since the goods cannot continue on their way until the duty is paid, it is the easiest duty to collect, and the cost of collection is small. Traders seeking to evade tariffs are
known as smugglers.
Tax, tariff and trade rules in modern times are usually set together because of their common impact on industrial policy, investment policy, and agricultural policy. A trade bloc is a group of allied countries agreeing
to minimize or eliminate tariffs and other barriers against trade with each other, and possibly to impose protective tariffs on imports from outside the bloc. A customs union has a common external tariff, and,
according to an agreed formula, the participating countries share the revenues from tariffs on goods entering the customs union.
Index
Let's understand the Concept...
The basic trades of traded stock options (American style):
Long call-
Long put-
Short call-
Short put-
These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hedging. An option contract in US markets usually represents 100 shares of the
underlying security.
A trader who believes that a stock's price will increase might buy the right to purchase the stock (a call option) rather than just purchase the stock itself. He would have no obligation to buy the stock, only the right to do so until the expiration date. If the stock price at expiration is above the exercise price by more than the premium (price) paid, he will profit. If the stock price at expiration is lower than the exercise price, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option
instead of shares, because for the same amount of money, he can control (leverage) a much larger number of shares.
A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price (a put option). He will be under no obligation to sell the stock, but has the right to do so until the expiration date. If the stock price at expiration is below the exercise price by more than the premium paid, he will profit. If the stock price at expiration is above the exercise price, he will let the put contract expire worthless and only lose
the premium paid.
A trader who believes that a stock price will decrease, can sell the stock short or instead sell, or "write," a call. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock
price increases over the exercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited.
A trader who believes that a stock price will increase can buy the stock or instead sell a put. The trader selling a put has an obligation to buy the stock from the put buyer at the put buyer's option. If the stock price at
expiration is above the exercise price, the short put position will make a profit in the amount of the premium. If the stock price at expiration is below the exercise price by more than the amount of the premium, the
trader will lose money, with the potential loss being up to the full value of the stock. A benchmark index for the performance of a cash-secured short put option position is the CBOE S&P 500 PutWrite Index (ticker PUT).
Index
Let's understand the Concept...
Stock exchanges have multiple roles in the economy. This may include the following:
The role of stock exchanges:
* Raising capital for businesses - The Stock Exchange provide companies with the facility to raise capital for expansion through selling shares to the investing public.
* Mobilizing savings for investment - When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in idle
deposits with banks, are mobilized and redirected to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and
higher productivity levels of firms.
* Facilitating company growth - Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the
simplest and most common ways for a company to grow by acquisition or fusion.
* Profit sharing - Both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.
* Creating investment opportunities for small investors - As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys
the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.
* Barometer of the economy - At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an
indicator of the general trend in the economy.
* Government capital-raising for development projects - Governments at various levels may decide to borrow money in order to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need to directly tax the citizens in order to finance development,
although by securing such bonds with the full faith and credit of the government instead of with collateral, the result is that the government must tax the citizens or otherwise raise additional funds to make any
regular coupon payments and refund the principal when the bonds mature.
Index
TIPS and STRIPS:
Let's understand the Concept...
TIPS -
Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used
measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation. TIPS are currently offered in 5-year, 10-year and 30-year maturities.
STRIPS-
Separate Trading of Registered Interest and Principal Securities (or STRIPS) are T-Notes, T-Bonds and TIPS whose interest and principal portions of the security have been separated, or "stripped"; these may then be sold separately (in units of $1000 face value) in the
secondary market. The name derives from the days before computerization, when paper bonds were physically traded; traders would literally tear the interest coupons off of paper
securities for separate resale.The government does not directly issue STRIPS; they are formed by investment banks or brokerage firms, but
the government does register STRIPS in its book-entry system. They cannot be bought through TreasuryDirect, but only through a broker.
STRIPS are used by the Treasury and split into individual principal and interest payments, which get resold in the form of zero-coupon bonds. Because they then pay no interest, there is not any interest to re-invest, and
so there is no reinvestment risk with STRIPS.
Index
Let's understand the Concept...
Trading - Options :
* Counterparties remain anonymous,* Enforcement of market regulation to ensure fairness and transparency, and* Maintenance of orderly markets, especially during fast trading conditions.
The most common way to trade options is via standardized options contracts that are listed by various futures and options exchanges. Listings and prices are tracked and can be looked up by ticker symbol. By publishing
continuous, live markets for option prices, an exchange enables independent parties to engage in price discovery and execute transactions. As an intermediary to both sides of the transaction, the benefits the
exchange provides to the transaction include:
* Fulfillment of the contract is backed by the credit of the exchange, which typically has the highest rating (AAA),
Over-the-counter options contracts are not traded on exchanges, but instead between two independent parties. Ordinarily, at least one of the counterparties is a well-capitalized institution. By avoiding an
exchange, users of OTC options can narrowly tailor the terms of the option contract to suit individual business requirements. In addition, OTC option transactions generally do not need to be advertised to the market and face little or no regulatory requirements. However, OTC counterparties must establish credit lines with each
other, and conform to each others clearing and settlement procedures.
With few exceptions, there are no secondary markets for employee stock options. These must either be exercised by the original grantee or allowed to expire worthless.
Index
Treasury management:
Bank Treasuries may have the following departments:
* A Fixed Income or Money Market desk that is devoted to buying and selling interest bearing securities
* A Foreign exchange or "FX" desk that buys and sells currencies
Banks may or may not disclose the prices they charge for Treasury Management products.
Let's understand the Concept..
Treasury management (or treasury operations) includes management of an enterprise's holdings. It includes activities like trading in bonds, currencies, financial derivatives and also encompasses the associated financial
risk management.
All banks have departments devoted to treasury management, as do larger corporations. For non-banking entities, Treasury Management and Cash Management are sometimes used interchangeably. The treasury
operations come under the control of CFO of the concern or the Vice-President / Director of Finance.
* A Capital Markets or Equities desk that deals in shares listed on the stock market.
In addition the Treasury function may also have a Proprietary Trading desk that conducts trading activities for the bank's own account and capital, an Asset liability management or ALM desk that manages the risk of
interest rate mismatch and liquidity; and a Transfer Pricing or Pooling function that prices liquidity for business lines (the liability and asset sales teams) within the bank.
Index
Treasury stock:
* Treasury stock does not pay a dividend* Treasury stock has no voting rights
Let's understand the Concept...
A treasury stock or reacquired stock is stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market ("open market" including insiders' holdings).
Stock repurchases are often used as a tax-efficient method to put cash into shareholders' hands, rather than paying dividends. Sometimes, companies do this when they feel that their stock is undervalued on the open market. Other times, companies do this to provide a "bonus" to incentive compensation plans for employees. Rather than receive cash, recipients receive an asset that might appreciate in value faster than cash saved in
a bank account. Another motive for stock repurchase is to protect the company against a takeover threat.
The United Kingdom equivalent of treasury stock as used in the United States is treasury share. Treasury stocks in the UK refers to government bonds or gilts.
Limitations of treasury stock -
* Total treasury stock can not exceed the maximum proportion of total capitalization specified by law in the relevant country
When shares are repurchased, they may either be canceled or held for reissue. If not canceled, such shares are referred to as treasury shares. Technically, a repurchased share is a company's own share that has been
bought back after having been issued and fully paid.
The possession of treasury shares does not give the company the right to vote, to exercise pre-emptive rights as a shareholder, to receive cash dividends, or to receive assets on company liquidation. Treasury shares are essentially the same as unissued capital and no one advocates classifying unissued share capital as an asset
on the balance sheet, as an asset should have probable future economic benefits. Treasury shares simply reduce ordinary share capital.
Index
Let's understand the Concept...
Trading curbs:
Trading curbs, also known as "circuit breakers," are a trading halt in the cash market and the corresponding trading halt in the derivative markets triggered by the halt in the cash market, all of which are effected based
on substantial movements in a broad market indicator.A trading curb, also known as a circuit breaker, is a point at which a stock market will stop trading for a period
of time in response to substantial drops in value.
On the New York Stock Exchange (NYSE), one type of trading curb is referred to as a "circuit breaker." These limits were put in place after Black Monday in order to reduce market volatility and massive panic sell-offs,
giving traders time to reconsider their transactions.
At the start of each quarter, the NYSE sets three circuit breaker levels at levels of 10%, 20%, and 30% of the average closing price of the Dow Jones Industrial Average for the month preceding the start of the quarter, rounded to the nearest 50-point interval. As of the first quarter of 2009, these levels are 850 points, 1,700
points, and 2,600 points respectively. Depending on the point drop that happens and the time of day when it happens, different actions occur automatically:
Trading curbs on Dow futures contracts traded on the Chicago Board of Trade are based on NYSE levels, with the exception that only the 10% threshold is in effect outside of regular NYSE trading hours, and is relative to
the previous daily settlement price.
Index
Treasury:
Let's understand the Concept..
A treasury is any place where the currency or items of high monetary value (gold, diamonds, etc.) are kept. The term was first used in Classical times to describe the votive buildings erected to house gifts to the gods, such as the Siphnian Treasury in Delphi or many similar buildings erected in Olympia, Greece by competing city-states to impress others during the ancient Olympic Games. In Ancient Greece treasuries were almost
always physically incorporated within religious buildings such as temples, thus making state funds sacrosanct and adding moral constraints to the penal ones to those who would have access to these funds.
The head of a treasury is typically known as a treasurer. This position may not necessarily have the final control over the actions of the treasury, particularly if they are not an elected representative.
Index
Let's understand the Concept...
Corporate actions are classified as Voluntary, Mandatory and Mandatory with Choice corporate actions.
Types of Corporate action :
Mandatory Corporate Action : A mandatory corporate action is an event initiated by the corporation by the board of directors that affects all shareholders. Participation of shareholders is mandatory for these
corporate actions. An example of a mandatory corporate action is cash dividend. All holders are entitled to receive the dividend payments, and a shareholder does not need to do anything to get the dividend. Other examples of mandatory corporate actions include stock splits, mergers, pre-refunding, return of capital,
bonus issue, asset ID change, pari-passu and spinoffs. Strictly speaking the word mandatory is not appropriate because the share holder per se doesn't do anything. In all the cases cited above the
shareholder is just a passive beneficiary of these actions. There is nothing the Share holder has to do or does in a Mandatory Corporate Action.
Voluntary Corporate Action : A voluntary corporate action is an action where the shareholders elect to participate in the action. A response is required by the corporation to process the action. An example of a
voluntary corporate action is a tender offer. A corporation may request share holders to tender their shares at a pre-determined price. The shareholder may or may not participate in the tender offer. Shareholders
send their responses to the corporation's agents, and the corporation will send the proceeds of the action to the shareholders who elect to participate.
Sometimes a voluntary corporate action may give the option of how to get the proceeds of the action. For example in case of a cash/stock dividend option, the shareholder can elect to take the proceeds of the
dividend either as cash or additional shares of the corporation. Other types of Voluntary actions include rights issue, making buyback offers to the share holders while delisting the company from the stock exchange etc.
Mandatory with Choice Corporate Action : This corporate action is a mandatory corporate action where share holders are given a chance to choose among several options. An example is cash/stock dividend option with one of the options as default. Share holders may or may not submit their elections. In case a share holder
does not submit the election, the default option will be applied.
Index
Types of financial markets:
The financial markets can be divided into different subtypes:
* Capital markets which consist of:
* Commodity markets, which facilitate the trading of commodities.* Money markets, which provide short term debt financing and investment.
* Derivatives markets, which provide instruments for the management of financial risk.
* Insurance markets, which facilitate the redistribution of various risks.* Foreign exchange markets, which facilitate the trading of foreign exchange.
Let's understand the Concept...
- Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
- Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
* Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy
existing securities. The transaction in primary market exist between investors and public while secondary market its between investors.
Index
Hedging strategies:
Examples of hedging include:
* Forward exchange contract for currencies* Currency future contracts
* Money Market Operations for currencies* Forward Exchange Contract for interest* Money Market Operations for interest
This is a list of hedging strategies, grouped by category.
Let's understand the Concept...
Types of hedging :
The stock example is a "classic" sort of hedge, known in the industry as a pairs trade due to the trading on a pair of related securities. As investors became more sophisticated, along with the mathematical tools used to
calculate values (known as models), the types of hedges have increased greatly.
* Future contracts for interest
Index
Let's understand the Concept...
Underwriting:
Risk, exclusivity, and reward-
Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd's slip
created for this purpose.
Once the underwriting agreement is struck, the underwriter bears the risk of being able to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably
sold.
If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument.
That is, even though third-party buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter.
In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The
underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement.
Also, if the securities are priced significantly below market price (as is often the custom), the underwriter also curries favor with powerful end customers by granting them an immediate profit perhaps in a quid pro quo. This practice, which is typically justified as the reward for the underwriter for taking on the market risk, is
occasionally criticized as unethical, such as the allegations that Frank Quattrone acted improperly in doling out hot IPO stock during the dot com bubble.
Index
Let's understand the Concept...
Wealth Management:
It is a professional service which is the combination of financial/investment advice, accounting/tax services, and legal/estate planning for one fee.
In general, wealth management is more than just investment advice, as it can encompass all parts of a person's financial life.
Wealth management is an investment advisory discipline that incorporates financial planning, investment portfolio management and a number of aggregated financial services. High net worth individuals, small
business owners and families who desire the assistance of a credentialed financial advisory specialist call upon wealth managers to coordinate retail banking, estate planning, legal resources, tax professionals and investment management. Wealth managers can be independent certified financial planners, MBAs, CFAs or any credentialed professional money manager who works to enhance the income, growth and tax favored treatment of long-term investors. One must already have accumulated a significant amount of wealth for
wealth management strategies to be effective.
Wealth management can be provided by large corporate entities, independent financial advisers or multi-licensed portfolio managers whose services are designed to focus on high-net worth customers. Large banks
and large brokerage houses create segmentation marketing-strategies to sell both proprietary and nonproprietary products and services to investors designated as potential high net-worth customers.
Independent wealth managers use their experience in estate planning, risk management,and their affiliations with tax and legal specialists, to manage the diverse holdings of high net worth clients. Banks and brokerage
firms use advisory talent pools to aggregate these same services.
"The fallout of the events of 2008 has produced a high level of skepticism and distrust among investors, and they will demand greater transparency from their providers to understand what they own, the value of their
investments and associated risks". For this reason wealth managers must be prepared to respond to a greater need by clients to understand, access, and communicate with advisers regarding their current relationship as
well as the products and services that may satisfy future needs. Moreover, advisors must have sufficient information, from objective sources, regarding all products and services owned by their clients to answer inquiries regarding performance and degree of risk-at the client, portfolio and individual security levels.
Index
Who trades futures?
Futures traders are traditionally placed in one of two groups: hedgers, who have an interest in the underlying asset (which could include an intangible such as an index or interest rate) and are seeking to hedge out the risk of price changes; and speculators, who seek to make a profit by predicting market moves and opening a derivative contract related to the asset
"on paper", while they have no practical use for or intent to actually take or make delivery of the underlying asset. In other words, the investor is seeking exposure to the asset in a
long futures or the opposite effect via a short futures contract.
Hedgers typically include producers and consumers of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate.
For example, in traditional commodity markets, farmers often sell futures contracts for the crops and livestock they produce to guarantee a certain price, making it easier for them to plan. Similarly, livestock
producers often purchase futures to cover their feed costs, so that they can plan on a fixed cost for feed. In modern (financial) markets, "producers" of interest rate swaps or equity derivative products will use financial
futures or equity index futures to reduce or remove the risk on the swap.
An example that has both hedge and speculative notions involves a mutual fund or separately managed account whose investment objective is to track the performance of a stock index such as the S&P 500 stock
index. The Portfolio manager often "equitizes" cash inflows in an easy and cost effective manner by investing in (opening long) S&P 500 stock index futures. This gains the portfolio exposure to the index which is
consistent with the fund or account investment objective without having to buy an appropriate proportion of each of the individual 500 stocks just yet. This also preserves balanced diversification, maintains a higher
degree of the percent of assets invested in the market and helps reduce tracking error in the performance of the fund/account. When it is economically feasible (an efficient amount of shares of every individual position
within the fund or account can be purchased), the portfolio manager can close the contract and make purchases of each individual stock.
The social utility of futures markets is considered to be mainly in the transfer of risk, and increased liquidity between traders with different risk and time preferences, from a hedger to a speculator, for example.
Index
Let's understand the Concept...
World Bank:
World Bank is a term used to describe an international financial institution that provides leveraged loans to developing countries for capital programs. The World Bank has a stated goal of reducing poverty.
The World Bank differs from the World Bank Group, in that the World Bank comprises only two institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), whereas the latter incorporates these two in addition to three more: International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and International Centre for Settlement of Investment Disputes (ICSID).
The World Bank is one of two institutions created at the Bretton Woods Conference in 1944. The International Monetary Fund, a related institution is the second. Delegates from many countries attended the Bretton
Woods Conference. The most powerful countries in attendance were the United States and United Kingdom which dominated negotiations. Although both are based in Washington, the World Bank is by custom headed
by an American, while the IMF is led by a European.
Index
Let's understand the Concept...
World Bank :
World Bank is a term used to describe an international financial institution that provides leveraged loans to developing countries for capital programs. The World Bank has a stated goal of reducing poverty. By law, all
of its decisions must be guided by a commitment to promote foreign investment, international trade and facilitate capital investment.
The World Bank differs from the World Bank Group, in that the World Bank comprises only two institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development
Association (IDA), whereas the latter incorporates these two in addition to three more: International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and International Centre for
Settlement of Investment Disputes (ICSID).
History :
World Bank is one of five institutions created at the Bretton Woods Conference in 1944. The International Monetary Fund, a related institution, is the second. Delegates from many countries attended the Bretton
Woods Conference. The most powerful countries in attendance were the United States and United Kingdom which dominated negotiations.
Although both are based in Washington, D.C., the World Bank is by custom headed by an American, while the IMF is led by a European.
Voting power :
In 2010, voting powers at the World Bank were revised to increase the voice of developing countries, notably China. The countries with most voting power are now the United States (15.85%), Japan (6.84%), China
(4.42%), Germany (4.00%), the United Kingdom (3.75%), and France (3.75%). Under the changes, known as 'Voice Reform - Phase 2', other countries that saw significant gains included Brazil, India, South Korea and
Mexico. Most developed countries' voting power was reduced. Russia's voting power was unchanged.
Index
Basic Rule Of Accounts:
Accounts knowledge in brief
All the account heads used in Accounting systems are classified under two types of Accounts i.e. Real Account and Nominal Account.
Real Account : Debit what comes in, Credit what goes out.
Nominal Account : Debit all expenses/losses, Credit all incomes/gains
An account for a building you own (an asset) could be thought of as representing how much the building owes you (or the entity, if you prefer) for future building services (shelter, etc.). In that sense, all accounts, even
those pertaining to inanimate objects, could be thought of in the same way as "persons"
Personal Account : Debit the Receiver/Sundry Debtor, Credit the Giver/Sundry Creditor.
Index
Let's understand the Concept...
The U.S. dollar and the euro:
World currency:
In the foreign exchange market and international finance, a world currency, supranational currency, or global currency refers to a currency in which the vast majority of international transactions take place and which
serves as the world's primary reserve currency. In March 2009, as a result of the global economic crisis, China and Russia have pressed for urgent consideration of a global currency and a UN panel has proposed greatly
expanding the IMF's SDRs or Special Drawing Rights.
Currencies have many forms depending on several properties: type of issuance, type of issuer and type of backing. The particular configuration of those properties leads to different types of money. The pros and cons
of a currency are strongly influenced by the type proposed. Consider, for example, the properties of a complementary currency.
Since the mid-20th century, the de facto world currency has been the United States dollar. According to Robert Gilpin in Global Political Economy: Understanding the International Economic Order (2001):
"Somewhere between 40 and 60 percent of international financial transactions are denominated in dollars. For decades the dollar has also been the world's principal reserve currency; in 1996, the dollar accounted
for approximately two-thirds of the world's foreign exchange reserves"
Many of the world's currencies are pegged against the dollar. Some countries, such as Ecuador, El Salvador, and Panama, have gone even further and eliminated their own currency (see dollarization) in favor of the
United States dollar. The dollar continues to dominate global currency reserves, with 63.9% held in dollars, as compared to 26.5% held in euros (see Reserve Currency).
Since 1999, the dollar's dominance has begun to be eroded by the euro, which represents a larger size economy, and has the prospect of more countries adopting the euro as their national currency. The euro
inherited the status of a major reserve currency from the German Mark (DM), and since then its contribution to official reserves has risen as banks seek to diversify their reserves and trade in the eurozone continues to
expand.
As with the dollar, quite a few of the world's currencies are pegged against the euro. They are usually Eastern European currencies like the Estonian kroon and the Bulgarian lev, plus several west African currencies like the Cape Verdean escudo and the CFA franc. Other European countries, while not being EU members, have
adopted the euro due to currency unions with member states, or by unilaterally superseding their own currencies: Andorra, Monaco, Montenegro, San Marino, and Vatican City.
As of December 2006, the euro surpassed the dollar in the combined value of cash in circulation. The value of euro notes in circulation has risen to more than €610 billion, equivalent to US$800 billion at the exchange
rates at the time (today equivalent to circa US$968 billion).
Index
Yield to maturity:
* If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.* If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
* If a bond's coupon rate is equal to its YTM, then the bond is selling at par.
Let's understand the Concept..
The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the
market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule. Yield to maturity is actually an estimation of future return, as the rate at which
coupon payments can be reinvested when received is unknown. It enables investors to compare the merits of different financial instruments. The YTM is often given in terms of Annual Percentage Rate (A.P.R.), but more usually market convention is followed: in a number of major markets the convention is to quote yields semi-
annually.
The yield is usually quoted without making any allowance for tax paid by the investor on the return, and is then known as "gross redemption yield". It also does not make any allowance for the dealing costs incurred
by the purchaser (or seller).
* If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
Index
Country Market Caps
Country Market Caps Index
Let's understand the Concept...
Zero-coupon bond:
A zero-coupon bond (also called a discount bond or deep discount bond) is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest
payments, or have so-called "coupons," hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its
par (or redemption) value. Examples of zero-coupon bonds include U.S. Treasury bills, U.S. savings bonds, long-term zero-coupon bonds, and any type of coupon bond that has been stripped of its coupons.
In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond
matures.
Some zero coupon bonds are inflation indexed, so the amount of money that will be paid to the bond holder is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority of
zero coupon bonds pay a set amount of money known as the face value of the bond.
Zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Short-
term zero coupon bonds generally have maturities of less than one year and are called bills. The U.S. Treasury bill market is the most active and liquid debt market in the world.
Index