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Finance Basics
Finance Basics
Over-the-counter derivatives are private contracts that are traded between two parties
without going through an exchange or other intermediaries. Therefore, over-the-counter
derivatives could be negotiated and customized to suit the exact risk and return needed by
each party. Although this type of derivative offers flexibility, it poses credit risk because there
is no clearing corporation.
Forward Contracts
A forward contract is a customized contract between two parties to buy or sell an asset at a specified
price on a future date. A forward contract can be used for hedging or speculation, although its non-
standardized nature makes it particularly apt for hedging. Unlike standard futures contracts, a
forward contract can be customized to any commodity, amount and delivery date. A forward contract
settlement can occur on a cash or delivery basis. Forward contracts do not trade on a centralized
exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature
makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher
degree of default risk. As a result, forward contracts are not as easily available to the retail
investor as futures contracts.
Future Contracts
Futures contracts are one of the most common types of derivatives. A futures contract (or
simply futures, colloquially) is an agreement between two parties for the sale of an asset at an
agreed upon price. One would generally use a futures contract to hedge against risk during a
particular period of time. For example, suppose that on July 31, 2014 Diana owned ten thousand
shares of Wal-Mart (WMT) stock, which were then valued at $73.58 per share. Fearing that the
value of her shares would decline, Diana decided that she wanted to arrange a futures contract to
protect the value of her stock. Jerry, a speculator predicting a rise in the value of Wal-Mart stock,
agrees to a futures contract with Diana, dictating that in one year’s time Jerry will buy Diana’s ten
thousand Wal-Mart shares at their current value of $73.58.
Option derivatives
An option is a financial derivative that represents a contract sold by one party (the option writer)
to another party (the option holder). The contract offers the buyer the right, but not the
obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the
strike price) during a certain period of time or on a specific date (exercise date).
What is a 'Money Market Fund'
The money market is where financial instruments with high liquidity and very short
maturities are traded.
A money market fund's purpose is to provide investors with a safe place to invest easily
accessible, cash-equivalent assets. It is a type of mutual fund characterized as a low-risk, low-
return investment. Since money market funds have relatively low returns, investors such as
those participating in employer-sponsored retirement plans, might not want to use money
market funds as a long-term investment option because they will not see the capital
appreciation they require to meet their financial goals.
One of the main advantages of mutual funds is they give small investors access to
professionally managed, diversified portfolios of equities, bonds and other securities. Each
shareholder, therefore, participates proportionally in the gain or loss of the fund. Mutual
funds invest in a wide amount of securities, and performance is usually tracked as the change
in the total market cap of the fund, derived by aggregating performance of the underlying
investments.
Fixed income is a type of investing or budgeting style for which real return rates or periodic
income is received at regular intervals and at reasonably predictable levels. Fixed-income
investors are typically retired individuals who rely on their investments to provide a regular,
stable income stream. This demographic tends to invest heavily in fixed-income investments
because of the reliable returns they offer.
Net assets value is a term used to describe the value of an entity’s assets less the value of its
liabilities.
(Assets-Liabilities)/outstanding shares=NAV
Assets (securities, cash, receivables)
NAV calculation determines how much the investor gets when they withdraw some of their
investments.
How we can get from the total fund NAV to my share of the fund depends on how the fund is
structured. If the fund established as a partnership, Partnership accounting allocate gains
and losses to my account. In the any day net asset value of my account can be as retained. If
fund is set up as a company or as a trust that time we will calculate NAV per a share.
NAV help to determine how much to pay investors when they withdraw from the fund. And to
know how many shares to issue to new investors. It is also used to report fund performance.
What is 'Leverage'
If the cost of a vehicle is $20,000 and a buyer hands over $2,000 in cash and $18,000 in
borrowed money in exchange for the vehicle, the buyer’s cash outlay is only 10% of the
vehicle’s purchase price. Using borrowed money to pay 90% of the cost enables the buyer to
obtain a significantly more expensive vehicle than what could have been purchased using
only available personal cash. From an investment perspective, this buyer was levered 10 to
one (10:1). That is to say, the ratio of personal cash to borrowed cash is $1 in personal cash for
every $10 spent.
What is a 'Fund'?
Fund is a source of money that will be allocated to a specific purpose. A fund can be
established for any purpose whatsoever, whether it is a city government setting aside money
to build a new civic center, a college setting aside money to award a scholarship, or an
insurance company setting aside money to pay its customers' claims.
Individuals, businesses and governments all use funds to set aside money. Individuals might
establish an emergency fund or rainy-day fund to pay for unforeseen expenses, or a trust fund
to set aside money for a specific person.
Individual and institutional investors can also place money in different types of funds with the
goal of earning money. Examples include mutual funds, which gather money from numerous
investors and invest it in a diversified portfolio of assets, and hedge funds, which invest the
assets of high-net-worth individuals in a way that is designed to earn above-market returns.
Governments use funds, such as special revenue funds, to pay for specific public expenses.
What is finance?
Finance is a broad term that describes two related activities: the study of how money is
managed and the actual process of acquiring needed funds. Because individuals, businesses
and government entities all need funding to operate, the field is often separated into three
sub-categories: personal finance, corporate finance and public finance.
Finance is study in banking, leverage, credit, capital markets, money, investments along that
how they are used by individuals and companies. Many of the basic concepts in finance come
from micro and macro-economic theories. One of the most known theory is the time value of
money. Which is sensually states that dollar today is worth more than a dollar in the future.
Public finance sectors include government, tax, spending, budgeting, debt issuance policies
that all effects how the government pays for the services it provides to the public.
Corporate finance refers to the financial activities related to running a corporation.
Personal finance applies to individual consumers and save their money for the future and pay
for the basic needs.
What is a 'Margin'
Margin is a loan given by broker to investors and traders who use the borrowed money to
purchase stocks shares and other types of securities and use cash and other assets held in the
broker’s account. Investor or traders use margins to increase their purchasing power.
Thereby maximizing potential gains on winning positions.
Margin is the difference between a product or service's selling price and its cost of production
or to the ratio between a company's revenues and expenses. It also refers to the amount of
equity contributed by an investor as a percentage of the current market
value of securities held in a margin account. Margin is the portion of the interest rate on
an adjustable-rate mortgage added to the adjustment-index rate. (watch the video)
A married couple who earns $108,000 annually after taxes should set aside a readily
accessible minimum of $27,000 to $54,000 to address unexpected financial surprises. The
funds should be highly liquid, remaining in checking or savings accounts. These vehicles
allow quick access to cash for satisfying household expenses during an emergency situation.
A central loss fund is important to protect the interests of policyholders in the event an
insurance company is unable to pay claims. The states' respective insurance commissioners
are responsible for overseeing insurance companies and ensuring that they maintain
adequate collateral to cover expected losses. However, widespread and unanticipated
catastrophes may still arise which result in claims exceeded an insurance company's ability
to pay.
Appropriation
Appropriation is the act of setting aside money for a specific purpose. A company or a
government appropriates funds in order to delegate cash for the necessities of its business
operations. This may occur for any of the functions of a business, including setting aside
funds for employee salaries, research and development, dividends and all other uses of cash.
Balance Sheet
A balance sheet is a financial statement that summarizes a company's assets, liabilities and
shareholders' equity at a specific point in time. These three balance sheet segments give
investors an idea as to what the company owns and owes, as well as the amount invested by
shareholders.
Balance sheet is a statement of net worth. It is broken up into three sections. Assets,
Liabilities, Equity. A=L+E. Let’s say Joe has a pizza restaurant. Joe goes to the bank to get the
small business loan. The bank gives him cash. This time on the balance sheet his liabilities by
the size of loan and assets also increased by same amount of money. Balance sheet remains
in the balance. Let’s say Joe needs a motorbike to deliver the pizzas. And he bought it. His
cash asset decreased. But it is balanced by increase another asset a new motorbike. As Joe
delivered pizza profits are recorded in the balance sheet as a retained earnings in the equity
section of the balance sheet. Every month Joe pays the loan to the bank. And it reduced his
liabilities and it also reduced his cash asset by the same amount.
Over-The-Counter – OTC
Financial statements are traded one of two ways. Either on an exchange such as New York
Stock Exchange or over the counter-OTC. Over-the-counter (OTC) is a security traded in some
context other than on a formal exchange such as the New York Stock
Exchange (NYSE), Toronto Stock Exchange or the NYSE MKT, formerly known as the American
Stock Exchange (AMEX). The phrase "over-the-counter" can be used to refer to stocks that
trade via a dealer network as opposed to on a centralized exchange. It also refers to debt
securities and other financial instruments, such as derivatives, which are traded through a
dealer network.
Investment management
Investment management is a generic term that most commonly refers to the buying and
selling of investments within a portfolio.
Financial statements
Cash Flows
This statement shows changes to the cash account during accounting period.
The CFS allows investors to understand how a company's operations are running,
where its money is coming from, and how it is being spent. The cash flow statement is
distinct from the income statement and balance sheet because it does not include the amount of
future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the
same as net income, which on the income statement and balance sheet, includes cash
sales and sales made on credit.
Cash flow is determined by looking at three components by which cash enters and leaves a
company: core operations, investing and financing,
Operation
Measuring the cash inflows and outflows caused by core business operations, the operations
component of cash flow reflects how much cash is generated from a company's products or
services. Generally, changes made in cash, accounts
receivable, depreciation, inventory and accounts payable are reflected in cash from operations.
Investing
Changes in equipment, assets, or investments relate to cash from investing. Usually, cash
changes from investing are a "cash out" item, because cash is used to buy new equipment,
buildings, or short-term assets such as marketable securities. However, when a company divests
of an asset, the transaction is considered "cash in" for calculating cash from investing.
Investing is considered cash out because cash is used to buy for example new equipment.
Financing
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash
from financing are "cash in" when capital is raised, and they're "cash out" when dividends are
paid. Thus, if a company issues a bond to the public, the company receives cash financing;
however, when interest is paid to bondholders, the company is reducing its cash.
Financing is cash in when capital is raised, and cash out when dividends are paid.