Let's Understand The Concept

No Topics
1 Active management
2 Ask price
3 Balance of payments
4 BankReconciliation
5 Basic Rule Of Accounts
6 Bid Price
7 Bond market
8 Bond option
9 Bond option - Embedded options
10 Book building
11 Bretton Woods Agreement
12 BRIC
13 Buy Side
14 Buying back shares
15 Capital Account Convertibility
16 Capital budgeting
17 Capital flight
18 Capital gains tax
19 Capital stock
20 Closed-end fund
21 Collateralized debt obligation
22 Collateralized fund obligation
23 Collateralized mortgage obligation
24 Collateralized mortgage obligation - Purpose
25 Commercial paper
26 Commodity market
27 Common derivative contract types
28 Common stock
29 Comparison of Cash Method & Accrual Method of accounting
30 Competence and capital
31 Corporate Action
32 Corporate bond
33 Corporate restructuring
34 Cost
Index
35 Country Market Caps
36 Credit derivative
37 Currency code
38 Currency future
39 Currency pair
40 Currency swaps
41 Derivative
42 Derivative Option
43 Dividend yield
44 Documents that can be presented for payment
45 Dollarization
46 Electronic trading
47 Equity investments
48 Equity swap
49 Eurodollar
50 Examples of treasuries
51 Exchange (organized market)
52 Exchange rate
53 Exchange rate - Quotations
54 Exchange-traded derivative contracts (ETD)
55 External Commercial Borrowing
56 Features of primary markets
57 Financial crisis of 20072010
58 Financial engineering
59 Financial future
60 Financial instrument
61 Financial market
62 Financial Market Index
63 Fixed income
64 Fixed income - Terminology
65 Floating rate note
66 Foreign direct investment
67 Foreign exchange controls
68 Foreign exchange market
69 Foreign Institutional Investor
70 Forex swap
71 Forward contract
72 Forward rate agreement
73 Fund Accounting
74 Futures contract
75 Futures contract - Margin
76 Futures contract - Standardization
77 Global financial system - Institutions
78 Globalization
79 Government bond
80 Government-sponsored enterprise
81 Great Depression
82 Hedge - Agricultural commodity price hedging
83 Hedge (finance)
84 Hedge Accounting
85 Hedge Fund
86 Hedging a stock price
87 How a forward contract works?
88 How a market maker makes money?
89 Inflation
90 Inflation 1
91 Inflation-indexed bond
92 Institutional investor
93 Institutional vs. Retail
94 Interest rate derivative
95 Interest rate future
96 Interest rate swaps
97 International finance
98 International Trade Payment methods
99 Investment
100 Investment banking
101 Investment banking - Organizational structure
102 Investment banking - Organizational structure - Back Office
103 Investment banking - Organizational structure - Front office
104 Investment banking - Organizational structure - Middle office
105 Investment management
106 Investment strategy
107 Investment vs. Speculation
108 InvestmentPortfolio
109 Investor sentiment
110 IOU
111 ISO 9362 - BIC
112 Knowledge capital
113 Late-2000s recession
114 Latest news from International Capital Market
115 Letter of credit
116 Loan servicing
117 Major stock exchanges of the world
118 Market maker
119 Maturity
120 MortgageBank
121 Mortgage-backed security
122 Mortgage-backed security - Types
123 Mortgage-backed security - Uses
124 Open-end fund
125 Over-the-counter
126 Over-the-counter (OTC) derivatives
127 Passive management
128 Pension fund
129 Perpetual bond
130 Preferred stock
131 Price discovery
132 Primary Market
133 Primary market trend
134 Promissory note
135 Purchasing power
136 Raising the capital
137 Repurchase agreement
138 Return of capital
139 S & P 500
140 Secondary Market
141 Secondary market offering
142 Securitization
143 Sell side
144 Settlement - physical versus cash-settled futures
145 Shadow banking system
146 Share repurchase
147 Share repurchase - Purpose
148 Short Selling
149 Short-Term Investment Fund (STIF)
150 Society for Worldwide Interbank Financial Telecommunication
151 Speculation
152 Spot market
153 Stakeholder (corporate)
154 Stock exchange
155 Subprime lending
156 Subprime lending - Student loans
157 Subprime mortgage crisis
158 Subprime mortgage crisis - Causes
159 Subprime mortgage crisis - Responses
160 Supply Side vs. Demand Side
161 Swap
162 Swap market
163 Swaption
164 Sweeps
165 Tariff
166 The basic trades of traded stock options (American style)
167 The role of stock exchanges
168 TIPS and STRIPS
169 Trading - Options
170 Trading curbs
171 Treasury
172 Treasury management
173 Treasury stock
174 Types of Corporate action
175 Types of financial markets
176 Types of hedging
177 Underwriting
178 United States of America
179 Wealth Management
180 Who trades futures
181 World Bank
182 World Bank 1
183 World currency
184 Yield to maturity
185 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:
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 -
The ask price is the lowest price a seller of a commodity is willing to accept for that commodity.
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
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
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
20072010, plans to address global imbalances are now high on the agenda of policy makers for
Index
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:
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:
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:
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
* 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
* 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 BlackScholes. 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:
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-
* European bond option is an option to buy or sell a bond at a certain date in future for a
predetermined price.
* 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 -
Trade Date: 1 March 2003
Maturity Date: 6 March 2006
Option Buyer: Bank A
Underlying asset: FNMA Bond
Spot Price: $101
Strike Price: $102
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
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 exchanges 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.
Book building is a common practice in developed countries and has recently been making inroads
into 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 trading be halted during the bookbuilding
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
Book building is essentially a process used by companies raising capital through public
offeringsboth 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
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
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
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 ratesan 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 valueplus or
minus one percentin 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
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
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:
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
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
IMFs 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
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
Capital budgeting:
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
- Accounting rate of return
- Net present value
- Profitability index
- Internal rate of return
- Modified internal rate of return
- Equivalent annuity
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
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
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
Capital 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
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.
Types of stock :
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
Comparison of Cash Method & Accrual Method of accounting:
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 combinationof 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:
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.
Similar definition of cash basis accounting is true for financial accounting purposes.
Accrual basis:
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
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
Let's understand the Concept..
Closed-end fund:
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.
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, and
2. Its shares (typically) trade on stock exchanges rather than being redeemed directly by the fund.
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.
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.
Index
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
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
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
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
* 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
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
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'
Index
Commodity market:
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.
Largest commodities exchanges
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
Common derivative contract types:
There are three major classes of derivatives:
# 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.
Examples:
The overall derivatives market has five major classes of underlying asset:
#Interest rate derivatives (the largest)
#Foreign exchange derivatives
#Credit derivatives
#Equity derivatives
#Commodity derivatives
Some common examples of these derivatives are:
Index
Common stock:
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.
Additional benefits from common stock include earning dividends and capital appreciation.
Index
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
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
Corporate restructuring:
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
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.
Steps:
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
Update detailed business plan and considerations
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
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.
Costs are often further described based on their timing or their applicability.
Accounting vs opportunity costs:
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 endeavouri.e., what could have been accomplished with
the resources expended in the undertaking. It represents opportunities forgone.
In theoretical economics, cost used without qualification often means opportunity cost.
Index
Credit derivative:
In finance, a credit derivative is a securitized derivative whose value is derived from the credit risk
on an 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 billions placing "bets" via this method.
The parties will select which credit events apply to a transaction and these usually consist of one
or more of the following:
* 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)
* 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)
* restructuring (the risk that obligations of the reference entity will be restructured)...
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
Currency code:
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.
History:
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
Currency future:
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.
Uses:
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
Currency pair:
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
Syntax and quotation:
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
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
Index
Currency swaps:
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.
Structure:
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.
There are three different ways in which currency swaps can exchange loans:
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
Option:
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.
Contract specifications -
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.
- 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 strike price, also known as the exercise price, which is the price at which the underlying
transaction will occur upon exercise
- The expiration date, or expiry, which is the last date the option can be exercised
- 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
Derivative:
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
linkedcalled 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.
Uses -
Derivatives are used by investors to:
*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:
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.
Common share dividend yield:
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:
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
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
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.
There are, broadly, two types of trading in the financial markets:
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
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 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.
An equity swap involves a notional principal, a specified tenor and predetermined payment
Equity swaps are typically traded by Delta One trading desks.
Examples -
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
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
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
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 -
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.
Ministry of finance -
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).
Both -
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
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
Exchange (organized market):
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
Exchanges can be subdivided:
* 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
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
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
Exchange rate:
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 nations currency in terms of the home nations 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.
* Direct quotation: 1 foreign currency unit = x home currency units
* Indirect quotation: 1 home currency unit = x foreign currency units
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
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
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 institutionsfor 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
ECBs have suffered in view of the adverse economic conditions coupled with the regulatory
hurdles. The challenge for India lies in the regulatorRBIensuring 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
Features of primary markets:
* 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).
* 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.
* Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.
* The primary market performs the crucial function of facilitating capital formation in the
* 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.
Methods of issuing securities in the primary market are:
* Initial public offering;
* Rights issue (for existing companies);
* Preferential issue.
Index
Financial crisis of 20072010:
The financial crisis of 20072010 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 20102011 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
Global contagion:
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
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.
Financial engineering can also refer to:
- Mathematical Finance
- Computational finance
- Financial reinsurance
Index
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.
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)
where
- 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
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.
* 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 24 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%.
* 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 ThreeMonth 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).
Financial futures are extensively used in the hedging of interest rate swaps.
Index
Financial instrument:
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
orderivative 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.
Matrix Table-
Combining the above methods for categorization, the main instruments can be organized into a
matrix as follows:
Index
Financial market:
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.
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.
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
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.
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
Floating rate note:
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%.
Issuers -
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
Foreign direct investment:
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.
US International Direct Investment Flows:
Debates about the benefits of FDI for low-income countries:
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
Foreign exchange controls:
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.
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
* 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
Foreign exchange market:
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.
The foreign exchange market is unique because of its -
* huge trading volume, leading to high liquidity
* geographical dispersion
* continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday
until 22:00 GMT Friday
* the variety of factors that affect exchange rates
* the low margins of relative profit compared with other markets of fixed income
* the use of leverage to enhance profit margins with respect to account size
Index
Foreign Institutional Investor:
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
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
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.
FEMA norms includes maintenance of highly rated bonds(collateral) with security exchange.
Index
Forex swap:
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 -
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
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.
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
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:
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
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
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
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 marginA 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 exchanges 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
Futures contract - Standardization :
Futures contracts ensure their liquidity by being highly standardized, usually by specifying:
# The underlying asset or instrument. This could be anything from a barrel of crude oil to a short
term interest rate.
# The type of settlement, either cash settlement or physical settlement.
# 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 currency in which the futures contract is quoted.
# 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.
# The delivery month.
# The last trading date.
# Other details such as the commodity tick, the minimum permissible price fluctuation.
Index
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
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:
International institutions -
The most prominent international institutions are the IMF, the World Bank and the WTO:
* 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:
* Commercial banks
* Hedge funds and Private Equity
* Pension funds
* Insurance companies
* Mutual funds
* Sovereign wealth funds
Regional institutions -
Examples are:
* Commonwealth of Independent States (CIS)
* Eurozone
* Mercosur
* North American Free Trade Agreement (NAFTA)
Index
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
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)
Effects of globalization:
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
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
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
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 to .
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 :
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):
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
Hedge Accounting:
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.
Why is hedge accounting necessary?
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
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 -
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.
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)
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%:
* 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.)
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:
Value of long position (Company A):
* Day 1: $1,000
* Day 2: $1,100
* Day 3: $550 => ($1,000 $550) = $450 loss
Value of short position (Company B):
* Day 1: $1,000
* Day 2: $1,050
* Day 3: $525 => ($1,000 $525) = $475 profit
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 ratethese 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
Index
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
Index:
It is astatistical 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
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.
In Market capitalization weighted index method, index is calculated with the help of following
Current market capitalization
INDEX = ---------------------------------------------- * Base value
Base market capitalization
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.
Index
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:
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
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
Inflation-indexed bond:
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.
Structure -
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 some bonds, such as the Series I Savings Bonds (U.S.), the interest rate is adjusted according
to inflation.
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
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
Institutional vs. Retail:
Institutional 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.
Retail investor-
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
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
Interest rate future:
An interest rate futures is a financial derivative (a futures contract) with an interest-bearing
instrument as the underlying asset.
Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures.
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.
Uses:
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
Index
Interest rate swaps :
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
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
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
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)
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.
* Documentary collection (more secure for buyer and to a certain extent to seller)
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
* 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.
Index
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
* 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
Investment banking - Organizational structure : Front office:-
Core investment banking activities
* Investment banking:
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.
* Sales and trading:
On behalf of the bank and its clients, a large investment bank's primary function is buying and
selling products. In market making, traders will buy and sell financial products with the goal of
making an incremental amount of money on each trade. Sales is the term for the investment
bank's sales force, whose primary job is to call on institutional and high-net-worth investors to
suggest trading ideas (on a caveat 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 through "principal risk"risk
undertaken by a trader after he buys or sells a product to a client and does not hedge his total
exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet.
The necessity for numerical ability in sales and trading has created jobs for physics, mathematics
* Research:
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
Index
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
* 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
Index
Investment banking - Organizational structure:
Main activities
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.
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
Index
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 (GrammLeachBliley 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
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
InvestmentPortfolio:
In finance, a portfolio is an appropriate mix or collection of investments held by an institution or
an individual.
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:
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)
Index
Investment strategy:
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
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
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.
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
* 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
IOU:
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
California Registered Warrants:
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:
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).
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
* 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.
* 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.
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
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
Index
Late-2000s recession :
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 20072010. 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
Overview :
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:
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
Loan servicing:
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.
There are economical loan servicing products that can also be purchased.
Index
Major stock exchanges of the world...
20 Major Stock Exchanges : Year ended 31 December 2009
Source: World Federation of Exchanges - Statistics/Monthly
Index
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
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:
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
Secular market trend:
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 20002002.
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
Index
Maturity :
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
BankReconciliation:
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
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
MortgageBank:
A Mortgage bank specializes in originating and/or servicing mortgage loans.
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
Mortgage-backed security - Types:
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.
Mortgage-backed security sub-types include:
* 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.
There are a variety of underlying mortgage classifications in the pool:
* 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.)
* Subprime mortgages have weaker credit scores, no verification of income or assets, 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
Mortgage-backed security - Uses:
There are many reasons for mortgage originators to finance their activities by issuing mortgage-
backed securities.
Mortgage-backed securities:
1. Transform relatively illiquid, individual financial assets into liquid and tradable capital market
instruments.
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
Mortgage-backed security:
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
Also known as a "mortgage-related security" or a "mortgage pass through".
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:
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
Fees:
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).
These charges may represent profit for the fund manager or go back into the fund.
Index
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
Over-the-counter:
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.
OTC contracts:
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.
This segment of the OTC market is occasionally referred to as the "Fourth Market."
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
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.
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.
Classifications -
A] Open vs. closed pension funds
Open 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.
Closed pension funds are further sub classified into:
* Single employer pension funds
* Multi-employer pension funds
* Related member pension funds
* Individual pension funds
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
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 issuea call protection period.
Index
Preferred stock:
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.
Features
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
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:
* Buyers and seller (number, size, location, and valuation perceptions)
* Market mechanism (bidding and settlement process, liquidity);
* Available information (amount, timeliness, significance and reliability) including futures and
other related markets
* Risk management choices.
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
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
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-
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.
Examples-
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.
Bear market-
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 theres 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.
Examples-
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
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
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:
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.
The following table illustrates where financial markets fit in the relationship between lenders and
borrowers:
Index
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
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
Return of capital :
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.
* Private business can distribute any amount of equity that the owners need personally.
* 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
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
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
Securitization:
The process of securitization is complicated, and is highly dependent on the jurisdiction upon
which the process is conducted.
First, mortgage loans are purchased from banks, mortgage companies, and other lenders.
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
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. traders 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
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
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:
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
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 :
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:
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-
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
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
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
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
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
Index
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 9362:1994 BankingBanking telecommunication messagesBank identifier codes
* ISO 10383:2003 Securities and related financial instrumentsCodes for exchanges and market
identification (MIC)
* ISO 13616:2003 IBAN Registry
* ISO 15022:1999 SecuritiesScheme for messages (Data Field Dictionary) (replaces ISO 7775)
* ISO 20022-1:2004 and ISO 20022-2:2007 Financial servicesUNIversal Financial Industry
message scheme
In RFC 3615 urn:swift: was defined as Uniform Resource Names (URNs) for SWIFT FIN
Index
S&P 500:
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
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 moneyincluding funds placed in the world's stock marketsis 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
Spot market:
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:
* an organized market, an exchange or
* "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
Stakeholder (corporate):
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).
The term has been broadened to include anyone who has an interest in a matter.
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
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 -
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
Subprime crisis -
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:
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:
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
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).
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)
* excessive debt (the known income of the individual or family is unlikely to be enough to pay
living expenses + interest + repayment),
* 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
* 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
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, 228 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:
1) Housing prices would not fall dramatically;
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
5) Stronger regulation of the shadow banking system and derivatives markets was not needed.
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 Reserves 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:
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.
Federal Reserve and central banks -
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 00.25% (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 Reserves
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 :
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
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
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 productwhich 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 thn $426.7 trillion in 2009, according to International Swaps and Derivatives
Association (ISDA).
Index
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
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
Swaption:
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.
There are two types of swaption contracts:
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.
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)
- Length of the option period (which usually ends two business days prior to the start date of the
underlying swap),
- The term of the underlying swap,
- Notional amount,
- Amortization, if any
frequency of settlement of payments on the underlying swap
Index
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
Tariff:
A tariff is a tax levied on imported or exported goods.
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.
In the past, tariffs formed a much larger part of government revenue than they do today.
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
The basic trades of traded stock options (American style):
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.
Long call-
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.
Long put-
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.
Short call-
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.
Short put-
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
The role of stock exchanges:
Stock exchanges have multiple roles in the economy. This may include the following:
* 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:
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
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
Trading - Options :
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),
* Counterparties remain anonymous,
* Enforcement of market regulation to ensure fairness and transparency, and
* Maintenance of orderly markets, especially during fast trading conditions.
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:
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.
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
* 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.
Banks may or may not disclose the prices they charge for Treasury Management products.
Index
Treasury stock:
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'
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 -
* Treasury stock does not pay a dividend
* Treasury stock has no voting rights
* 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
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:
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
Index
Types of Corporate action :
Corporate actions are classified as Voluntary, Mandatory and Mandatory with Choice corporate
actions.
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:
- 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.
* 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.
* Futures markets, which provide standardized forward contracts for trading products at some
future date; see also forward market.
* Insurance markets, which facilitate the redistribution of various risks.
* Foreign exchange markets, which facilitate the trading of foreign exchange.
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
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.
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
* Future contracts for interest
This is a list of hedging strategies, grouped by category.
Index
Underwriting:
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.
Risk, exclusivity, and reward-
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
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
Index
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
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
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
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
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
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
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.
The U.S. dollar and the euro:
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:
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-
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).
* 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.
Index
Country Market Caps
Index Country Market Caps
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
Index

Let's Understand The Concept

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Let's Understand The Concept

Hochgeladen von

Copyright:

Verfügbare Formate

No Topics

Das könnte Ihnen auch gefallen