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The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service. Entities with absolute advantages can produce a product or service using a smaller number of inputs and/or using a more efficient process than another party producing the same product or service. I: Here are some examples of how absolute advantage works:
-The United States produces 700 million gallons of wine per year, while Italy produces 4 billion gallons of wine per year. Italy has an absolute advantage because it produces many more gallons of wine (the output) in the same amount of time (the input) as the United States.
-Jane can knit a sweater in 10 hours, while Kate can knit a sweater in 8 hours. Kate has an absolute advantage over Jane, because it takes her fewer hours (the input) to produce a sweater (the output).
An entity can have an absolute advantage in more than one good or service. Absolute advantage also explains why it makes sense for countries, individuals and businesses to trade with one another. Because each has advantages in producing certain products and services, they can both benefit from trade. For example, if Jane can produce a painting in 5 hours while Kate needs 9 hours to produce a comparable painting, Jane has an absolute advantage over Kate in painting. Remember Kate has an absolute advantage over Jane in knitting sweaters. If both Jane and Kate specialize in the products they have an absolute advantage in and buy the products they don't have an absolute advantage in from the other entity, they will both be better off.
A type of option in which the payoff is structured to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money. The success of a binary option is thus based on a yes/no proposition, hence "binary". A binary option automatically exercises, meaning the option holder does not have the choice to buy or sell the underlying asset. I: Investors may find binary options attractive because of their apparent simplicity, especially since the investor must essentially only guess whether something specific will or will not happen. For example, a binary option may be as simple as whether the share price of ABC Company will be above $25 on November 22nd at 10:45 am. If ABC's share price is $27 at the appointed time, the option automatically exercises and the option holder gets a preset amount of cash.
Binary options are significantly different from vanilla options. They are occasionally traded on platforms regulated by the SEC and other regulatory agencies, but are most likely traded over the Internet on platforms existing outside of regulations. Because these platforms operate outside of regulations, investors are at greater risk of fraud. For example, a binary options trading platform may require the investor to deposit a sum of money to purchase the option. If the option expires out-of-the-money, meaning the investor chose the wrong proposition, the trading platform may take the entire sum of deposited money with no refund provided.
A company's average payable period. Days payable outstanding tells how long it takes a company to pay its invoices from trade creditors, such as suppliers. DPO is typically looked at either quarterly or yearly.
The formula to calculate DPO is written as: ending accounts payable / (cost of sales/number of days). These numbers are found on the balance sheet and the income statement. I: Companies must strike a delicate balance with DPO. The longer they take to pay their creditors, the more money the company has on hand, which is good for working capital and free cash flow. But if the company takes too long to pay its creditors, the creditors will be unhappy. They may refuse to extend credit in the future, or they may offer less favorable terms. Also, because some creditors give companies a discount for timely payments, the company may be paying more than it needs to for its supplies. If cash is tight, however, the cost of increasing DPO may be less than the cost of foregoing that cash earlier and having to borrow the shortfall to continue operations.
Most companies' DPO is about 30, meaning that it takes them about a month to pay their vendors. DPO can vary by industry, and a company can compare its DPO to the industry average to see if it is paying its vendors too quickly or too slowly. If the industry standard is 45 days and the company has been paying its invoices in 15 days, it may want to stretch out its payment period to improve cash flow, as long as doing so won't mean losing a discount, getting hit with a price increase or harming the relationship with the vendor. DPO can vary significantly from year to year, company to company and industry to industry based on how well or how poorly the company, the industry and the overall economy are performing.
A person or firm in the business of buying and selling securities for their own account, whether through a broker or otherwise. A dealer is defined by the fact that it acts as principal in trading for its own account, as opposed to a broker who acts as an agent in executing orders on behalf of its clients. A dealer is also distinct from a trader in that buying and selling securities is part of its regular business, while a trader buys and sells securities for his or her own account but not on a business basis. I: While "dealer" is a separate registration category in the U.S., in Canada the term is used as the shortened version of "investment dealer," which is the equivalent of a broker-dealer in the U.S.
Apart from buying and selling securities, a dealer also makes markets in securities, underwrites securities and provides investment services to investors. Most dealers also act as brokers, and are therefore known as broker-dealers. Broker-dealers range in size from small independent houses to subsidiaries of the largest banks.
The Securities and Exchange Commission (SEC) requires that all brokers and dealers generally register with it, and also be members of the Financial Industry Regulatory Authority (FINRA). The SEC requires that individuals who engage in the following activities may need to register as a dealer:
Someone who holds himself/herself out as being willing to buy and sell a specific security on a continuous basis, i.e. is making a market in that security;
A person who runs a matched book of repurchase agreements; or
An individual who issues or originates securities that he or she also buys and sells.
The SEC requires dealers to perform certain duties in their dealings with clients. These duties include prompt order execution, disclosure of material information and conflicts of interest to investors, and charging prices that are reasonable in the prevailing market.
In recent years, the profitability of dealers has been challenged by a number of factors, including the heightened regulatory environment (which has increased compliance costs), increasing technology requirements to keep up with rapidly changing markets, and industry consolidation.
A financial market mechanism wherein multiple dealers post prices at which they will buy or sell a specific security of instrument. In a dealer market, a dealer - who is designated as a "market maker" - provides liquidity and transparency by electronically displaying the prices at which it is willing to make a market in a security, indicating both the price at which it will buy the security (the "bid" price) and the price at which it will sell the security (the "offer" price). Bonds and foreign exchange trade primarily in dealer markets, while stock trading on the Nasdaq is a prime example of an equity dealer market. I: A market maker in a dealer market stakes its own capital to provide liquidity to investors. The primary mode of risk control for the market maker is therefore the use of the bid-ask spread, which represents a tangible cost to investors.
For example, if Dealer A has ample inventory of WiseWidget Co. stock - which is quoted in the market by other market makers at $10 / $10.05 - and wishes to offload some of its holdings, it can post its bid-ask quote as $9.98 / $10.03. Rational investors looking to buy WiseWidget Co. would then take Dealer A's offer price of $10.03, since it is 2 cents cheaper than the $10.05 price at which it is offered by other market makers. Conversely, investors looking to sell WiseWidget Co. stock would have little incentive to "hit the bid" of $9.98 posted by Dealer A, since it is 2 cents less than the $10 price that other dealers are willing to pay for the stock.
A dealer market differs from an auction market primarily in this multiple market maker aspect. In an auction market, a single specialist in a centralized location (think of the trading floor on the New York Stock Exchange, for instance) facilitates trading and liquidity by matching buyers and sellers for a specific security.
An uncommon type of takeover in which the acquirer becomes a subsidiary of the acquired or targeted company, with business after the takeover conducted in the name of the acquired company. A backflip takeover gets its name from the fact that it runs counter to the norm of a conventional acquisition, where the acquirer is the surviving entity and the acquired company becomes a subsidiary of the acquirer.
While the acquired company's assets are subsumed into the acquiring company, control of the combined entity is generally in the hands of the acquirer. I: While companies may consider a backflip takeover for a number of valid reasons, a common motive for such a structure is much stronger brand recognition and goodwill for the target company than the acquirer in their major markets.
Often, the acquirer may be struggling with problems of its own. For instance, the acquirer may be a hitherto sizeable and successful company that has had its image tarnished by one or more negative issues such as a large product recall, well-publicized product deficiencies, accounting fraud and so on. These issues may significantly impede its future business prospects, leading it to consider other options for its long-term survival and success. One of these options is to acquire a rival company that has complementary businesses and sound prospects, but which needs significantly more financial and operational resources to expand than it could raise on its own.
For example, DullCo is a large company that has fallen on relatively hard times because the massive recall of one of its biggest-selling products has hurt its finances and caused large-scale customer defections. Management decides that its brand has suffered irreparable damage, and decides to use its financial resources - which are still substantial - to acquire smaller and fast-growing rival Hotshot Inc. DullCo's management also decides that business after the completed takeover will be conducted under the Hotshot name, which will be the surviving entity, with DullCo becoming a Hotshot subsidiary.
Why would Hotshot's management want to sell out to a larger, struggling competitor? Probably because Hotshot's executive team believes it can use DullCo's huge resources to expand faster than it could on its own. Hotshot's management is also very likely to bargain for a substantial presence on the Board of Directors and management of the combined entity.
The process of deducing backwards from the end of a problem or scenario to infer a sequence of optimal actions in game theory. Backward induction starts at the final step in a game, and by anticipating what the last player in a two-player game will do at that point, determines what moves likely lead to it. The results inferred from backward induction often do not hold up in real life. Backward induction was first mentioned by game theory inventors John von Neumann and Oskar Morgenstern in 1944. I: There are several problems associated with the results obtained from backward induction. Firstly, it may not reflect how players in a game actually play, as the actual pattern of play may differ from the pattern deduced by backward induction. Secondly, people who play naively or illogically may actually end up obtaining higher payoffs or utilities than the payoffs predicted by backward induction in well-known game theory games such as Centipede and Traveler's Dilemma.
For example, the Centipede Game is an extensive-form game in which two players alternately get a chance to take the larger share of a stash of money from two piles of money (contributed by a third party). Each time the money passes across the table, the quantity doubles. The game concludes as soon as a player takes the stash, with that player getting the larger portion and the other player getting the smaller portion. A total of 99 rounds are played, and if both players always choose to pass (rather than take), they each receive an equal payoff of $50 at the end of the game.
Backward induction predicts that the first player will choose to take on the very first move. However, in experimental studies, only a very small percentage of subjects chose to take on the first move, which is intuitively not surprising given the tiny starting payoff when compared with the much larger payoffs as the game progresses.
A scenario in which a government or profitable company acquires control of a financially unstable company with the goal of returning it to a position of financial strength. In a bailout takeover, the government or strong company takes over the weak company by purchasing its shares, exchanging shares or both. The acquiring entity develops a rehabilitation plan for the weak company, describing how it will be managed and by whom, how shareholders will be protected and how its financial position will be turned around. I: An example of a bailout takeover is NPNC Financial Services' 2008 takeover of National City Corp. National City experienced massive losses because of the subprime mortgage crisis, and PNC used TARP funds to bail it out. PNC purchased about $5.2 billion in National City's stock to acquire it; some people said the purchase price was less than National City's fair market value. PNC became the fifth-largest U.S. bank as a result of the bailout takeover, but numerous National City employees lost their jobs at the bank's headquarters.
Another example of a bailout takeover is the U.S. government's takeover of Chrysler and General Motors in 2008 to prevent the companies' bankruptcy and the subsequent loss of approximately 1 million jobs in the industry. Under the takeover's terms, the government loaned the two companies $17.4 billion and required them to reduce their debt, decrease workers' wages and benefits, and create restructuring plans. The government retained the ability to call the loans if the companies didn't uphold their end of the bargain. The companies later received additional funds from the government, but they were forced through bankruptcy anyway, causing both stockholders and bondholders to lose everything. The bailout was criticized as primarily benefiting labor unions since workers kept their jobs but investors lost everything.
A statement that summarizes an economy's transactions with the rest of the world for a specified time period. The balance of payments, also known as balance of international payments, encompasses all transactions between a country's residents and its nonresidents involving goods, services and income; financial claims on and liabilities to the rest of the world; and transfers such as gifts. The balance of payments classifies these transactions in two accounts - the current account and the capital account. The current account includes transactions in goods, services, investment income and current transfers, while the capital account mainly includes transactions in financial instruments. An economy's balance of payments transactions and international investment position (IIP) together constitute its set of international accounts. I: Despite its name, the "balance of payments" data is not concerned with actual payments made and received by an economy, but rather with transactions. Since many international transactions included in the balance of payments do not involve the payment of money, this figure may differ significantly from net payments made to foreign entities over a period of time.
Does the "balance of payments" actually balance? In theory, a current account deficit would have to be financed by a net inflow in the capital and financial account, while a current account surplus should correspond to an outflow in the capital and financial account for a net figure of zero. In actual practice, however, the fact that data are compiled from multiple sources gives rise to some degree of measurement error.
Balance of payments and international investment position data are critical in formulating national and international economic policy. Certain aspects of the balance of payments data, such as payment imbalances and foreign direct investment, are key issues that a nation's economic policies seek to address.
Economic policies are often targeted at specific objectives that, in turn, impact the balance of payments. For example, a country may adopt policies specifically designed to attract foreign investment in a particular sector. Another nation may attempt to keep its currency at an artificially depressed level to stimulate exports and build up its currency reserves. The impact of these policies is ultimately captured in the balance of payments data.
Don't stop now! Broaden your knowledge of the balance of payments by reading our article on What Is The Balance Of Payments?
Countries with high productivity growth also experience high wage growth, which leads to higher real exchange rates. The Balassa-Samuelson effect suggests that an increase in wages in the tradable goods sector of an emerging economy will also lead to higher wages in the non-tradable (service) sector of the economy. The accompanying increase in inflation makes inflation rates higher in faster growing economies than it is in slow growing, developed economies.
The effect was proposed by economists Bela Balassa and Paul Samuelson in 1963. I: The Balassa-Samuelson effect suggests that the optimal inflation rate for developing economies is higher than it is for developed countries. Developing economies grow by becoming more productive and using land, labor and capital more efficiently. This results in wage growth in both the tradable good and non-tradable good components of an economy. People consume more goods and services as their wages increase, which in turn pushes up prices.
As emerging economies develop and become more productive they also see increased wages, but they see these increases in both tradable and non-tradable goods sectors of the economy. When wages increase at a slower rate than productivity, countries wind up producing more than they can consume. These countries then have a current-account surplus. When wages grow faster than the productivity rate, workers consumer more goods and the current-account surplus falls.
The effect an appreciating real exchange rate has on an emerging economy depends on whether the country has a fixed exchange rate or floating exchange rate. Fixed exchange rate economies will see an increase in overall prices, while floating exchange rates will see increases in the exchange rate.
An indicator of a company's financial performance which is calculated in the following EBITDA calculation:
EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. I: This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.
EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.
A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it's key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.
Understand th EBITDA with practical examples by reading A Clear Look at EBITDA and EBITDA: Challenging the Calculation
The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.
Calculated as:
When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.
Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. I: Earnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio.
For example, assume that a company has a net income of $25 million. If the company pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).
An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.
For more on EPS read The 5 Different Types Of Earnings Per Share (EPS) and How To Evaluate The Quality Of EPS
The unlawful targeting and theft of a nation's critical economic intelligence. Economic espionage may include the clandestine acquisition or outright theft of invaluable proprietary information in a number of areas including technology, finance and government policy. Economic espionage differs from corporate or industrial espionage in a number of ways - it is likely to be state-sponsored, have motives other than profit or gain (such as closing a technology gap) and be much larger in scale and scope. Recognizing the threat from such activity, the U.S. signed the Economic Espionage Act into law in October 1996. I: According to the FBI, foreign competitors conduct economic espionage in three main ways:
By recruiting insiders working for U.S. companies and research institutions that typically share the same national background.
Using methods such as bribery, cyber-attacks, "dumpster diving" and wiretapping.
Establishing seemingly innocent relationships with U.S. companies to gather economic intelligence including trade secrets.
The FBI recommends that to counter this threat, companies should take a number of steps that include implementing a proactive plan to safeguard trade secrets, securing physical and electronic versions of intellectual property, and training employees.
In November 2011, the U.S. accused China of being the world's "most active and persistent" perpetrator of economic espionage, and also identified Russia as one of the most aggressive collectors of U.S. economic information and technology. The problem's scale was evident in subsequent media reports that said hundreds of leading U.S. companies had been targeted by overseas entities for economic espionage.
A type of foreign exchange exposure caused by the effect of unexpected currency fluctuations on a company's future cash flows. Also known as operating exposure, economic exposure can have a substantial impact on a company's market value, since it has far-reaching effects and is long-term in nature.
Unlike transaction exposure and translation exposure (the two other types of currency exposure), economic exposure is difficult to measure precisely and hence challenging to hedge. Economic exposure is also relatively difficult to hedge because it deals with unexpected changes in foreign exchange rates, unlike expected changes in currency rates, which form the basis for corporate budgetary forecasts. I: For example, assume that a large U.S. company that gets about 50% of its revenues from overseas markets has factored in a gradual decline of the U.S. dollar against major global currencies - say 2% per annum - into its operating forecasts for the next few years. If the U.S. dollar appreciates instead of declining gradually in the years ahead, this would represent economic exposure for the company. The dollar's strength means that the 50% of revenues and cash flows the company receives from overseas will be lower when converted back into dollars, which will have a negative effect on its profitability and valuation.
Increasing globalization has made economic exposure a source of greater risk for companies. The degree of economic exposure is directly proportional to currency volatility. Economic exposure increases as foreign exchange volatility rises, and decreases as it falls.
Economic exposure is obviously greater for multinational companies that have numerous subsidiaries overseas and a huge number of transactions involving foreign currencies. However, economic exposure can arise for any company regardless of its size and even if it only operates in domestic markets.
For example, small European manufacturers that only sell in their local markets and do not export their products would be adversely affected by a stronger euro, since it would make imports from other jurisdictions such as Asia and North America cheaper and increase competition in European markets.
Economic exposure can be mitigated either through operational strategies or currency risk mitigation strategies. Operational strategies involve diversification - of production facilities, end-product markets and financing sources, since currency effects may offset each other to some extent if a number of different currencies are involved. Currency risk-mitigation strategies involve matching currency flows, risk-sharing agreements and currency swaps.
A financial payment that may constitute a bribe and that is made with the intention of expediting an administrative process. A facilitating payment is a payment made to a public or government official that acts as incentive for the official to complete some action or process expeditiously, to the benefit of the party making the payment.
In general, a facilitating payment is made to smooth the progress of a service to which the payer is legally entitled, without making such a payment. In some countries, these payments are considered normal, whereas in other countries, facilitating payments are prohibited by law and considered bribes. Also called facilitation payments. I: Generally, facilitating payments are demanded by low-level, low-income officials in exchange for providing a service to which the payer is entitled even without the payment. Certain countries do not consider facilitating payments bribes as long as such payment is not made to earn or maintain business, or to create an unfair or improper advantage over another business. Such countries may believe these payments are simply a part of the cost of doing business. In other countries, including the United Kingdom and Germany, facilitating payments made abroad are considered bribes and are prohibited.
An example of a facilitating payment may be illustrated in the following scenario. Assume a business required a particular license or permit in order to operate. The company is entitled to the license or permit because it has met all the requirements. The business is otherwise poised to open its doors for business, but is legally bound to wait until the license or permit has been issued. The company may make a facilitating payment to an official who can help expedite the licensing or permitting process. In many countries, this payment would be acceptable as long as it does not involve a payment made to a foreign entity. In other countries, this would still be considered a bribe (and thus illegal).
The United Nations Convention against Corruption (UNCAC) prohibits facilitation payments. The legal status of facilitating payments varies by country. The Business Anti-Corruption Portal maintains information regarding different countries' profiles regarding corruption, bribes and facilitating payments.
An index developed and used by CNNMoney to measure the primary emotions that drive investors: fear and greed. The Fear and Greed Index is based on seven indicators:1. Stock Price Momentum - as measured by the S&P 500 versus its 125-day moving average2. Stock Price Strength - based on the number of stocks hitting 52-week highs versus those hitting 52-week lows on the NYSE3. Stock Price Breadth - as measured by trading volumes in rising stocks against declining stocks.4. Put and Call Options - based on the Put/Call ratio5. Junk Bond Demand - as measured by the spread between yields on investment grade bonds and junk bonds6. Market Volatility - as measured by the CBOE Volatility Index or VIX7. Safe Haven Demand - based on the difference in returns for stocks versus Treasuries
Each of these seven indicators is measured on a scale from 0 to 100, with 50 denoting a neutral reading, and a higher reading signaling more greed. The index is then computed by taking an equal-weighted average of the seven indicators. I: The Fear and Greed Index is a contrarian index of sorts, which is based on the premise that excessive fear can result in stocks trading well below their intrinsic values, while unbridled greed can result in stocks being bid up far above what they should be worth.
The index can therefore be used to signal potential turning points in the equity markets. For example, the index sank to a low of 12 on Sept. 17, 2008, when the S&P 500 fell to a three-year low in the aftermath of the Lehman Brothers bankruptcy and the near-demise of insurance giant AIG. It traded over 90 in September 2012 as global equities rallied following the Federal Reserve's third round of quantitative easing (QE3).
The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation. The Federal Open Market Committee (FOMC), which is the Federal Reserve's primary monetary policymaking body, telegraphs its desired target for the federal funds rate through open market operations. Also known as the "fed funds rate". I: The higher the federal funds rate, the more expensive it is to borrow money. Since it is only applicable to very creditworthy institutions for extremely short-term (overnight) loans, the federal funds rate can be viewed as the base rate that determines the level of all other interest rates in the U.S. economy.

Banks and other depository institutions maintain accounts at the Federal Reserve to make payments for themselves or on behalf of their customers. The end-of-the-day balances in these accounts are used to meet the reserve requirements mandated by the Federal Reserve. If a depository institution expects to have a larger end-of-day balance than it needs, it will lend the excess amount to an institution that expects to have a shortfall in its own balance. The federal funds rate thus represents the interest rate charged by the lending institution.

The target for the federal funds rate - which as noted earlier is set by the FOMC - has varied widely over the years in response to prevailing economic conditions. While it was as high as 20% in the inflationary early 1980s, the rate has declined steadily since then. The FOMC has maintained the target range for the federal funds rate at a record low of 0% to 0.25%, from December 2008 onward, to combat the Great Recession of 2008-09 and stimulate the U.S. economy.
The short term interest rate charged by banks on loans extended to broker-dealers. A call loan rate is an interest charged on loans made to broker-dealers who use the funds to make margin loans to their margin account clients. These loans are payable by the broker-dealer on call (i.e. on demand or immediately) upon receiving such request from the lending institution. The call loan rate forms the basis upon which margin loans are priced. The call loan rate can fluctuate daily in response to factors such as market interest rates, funds' supply and demand, and economic conditions. The rate is published in daily publications including the Wall Street Journal and Investor's Business Daily (IBD). Also called broker's call. I: A call loan is a loan given to a broker-dealer that is used to finance client margin accounts. The interest rate on a call loan is calculated daily; this rate is known as the call loan rate, or broker's call. A margin account is a type of brokerage account in which the broker lends the client cash that is used to purchase securities. The loan is collateralized by the securities held in the account, and by cash that the margin account holder is required to have deposited. A margin account enables investors to use leverage; that is, they are able to trade larger positions than they would otherwise be able to. While this has the potential to magnify profits, trading on margin can also result in magnified losses.
Clients must be approved for margin accounts and are required to make a minimum initial deposit, known as the minimum margin, in the account. Once the account is approved and funded, investors can borrow up to 50% of the purchase price of the transaction. If the account value falls below a stated minimum (known as the maintenance margin), the broker will require the account holder to deposit more funds or liquidate position(s) to pay down the loan.
One of the four types of compound options, this is a call option on an underlying put option. If the option owner exercises the call option, he or she receives a put option, which is an option that gives the owner the right but not the obligation to sell a specific asset at a set price within a defined time period. The value of a call on a put changes in inverse proportion to the stock price, i.e. it decreases as the stock price increases, and increases as the stock price decreases. Also known as a split-fee option. I: A call on a put will have therefore two strike prices and two expiration dates, one for the call option and the other for the underlying put option. As well, there are two option premiums involved; the initial premium is paid upfront for the call option; the additional premium is only paid if the call option is exercised and the option owner receives the put option. The premium in this case would generally be higher than if the option owner had only purchased the underlying put option to begin with.
For example, consider a U.S. company that is bidding on a contract for a European project; if the company's bid is successful, it would receive say 10 million euros upon project completion in one year's time. The company is concerned about the exchange risk posed to it by the weaker euro if it wins the project. Buying a put option on 10 million euros expiring in one year would involve significant expense for a risk that is as yet uncertain (since the company is not sure that it would be awarded the bid). Therefore, one hedging strategy the company could use would be to buy, for example, a two-month call on a one-year put on the euro (contract amount of 10 million euros). The premium in this case would be significantly lower than it would be if it had instead purchased the one-year put option on the 10 million euros outright.
On the two-month expiry date of the call option, the company has two alternatives to consider. If it has won the project contract or is in a winning position, and still desires to hedge its currency risk, it can exercise the call option and obtain the put option on 10 million euros. Note that the put option will now have ten months (i.e. 12 - 2 months) left to expiry. On the other hand, if the company does not win the contract, or no longer wishes to hedge currency risk, it can let the call option expire unexercised and walk away.
A component of a country's balance of payments that covers claims on or liabilities to non-residents, specifically in regard to financial assets. Financial account components include direct investment, portfolio investment and reserve assets, and are broken down by sector. When recorded in a country's balance of payments, claims made by non-residents on the financial assets of residents are considered liabilities, while claims made against non-residents by residents are considered assets. The financial account differs from the capital account in that the capital account deals with transfers of capital assets. Additionally, the financial account can include claims on land. I: The financial account involves financial assets, such as gold, currency, derivatives, special drawing rights, equity and bonds. During a complex transaction that contains both capital assets and financial claims, a country may record part of a transaction in its capital account and the other part in its current account. Additionally, because entries in the financial account are net entries that offset credits with debits, they may not appear in a country's balance of payments, even if transactions are occurring between residents and non-residents.
Easing access to a country's capital is considered part of a broader movement toward economic liberalization, with a more liberalized financial account providing the benefit of opening a country up to capital markets. Reducing restrictions to the financial account does have its risks. The more a country's economy is integrated with other economies around the world, the higher the likelihood that economic troubles abroad may find their way back home. This potential outcome is weighed against the potential benefits: lower funding costs, access to global capital markets and increased efficiency.
A model of optimality taking into consideration not only benefits less costs, but also the interaction between participants. Game theory attempts to look at the relationships between participants in a particular model and predict their optimal decisions. I: One frequently cited example of game theory is the prisoner's dilemma. Suppose there are two brokers accused of fraudulent trading activities: Dave and Henry. Both Dave and Henry are being interrogated separately and do not know what the other is saying. Both brokers want to minimize the amount of time spent in jail and here lies the dilemma. The sentences vary as follows: 1) If Dave pleads not guilty and Henry confesses, Henry will receive the minimum sentence of one year, and Dave will have to stay in jail for the maximum sentence of five years. 2) If nobody makes any implications they will both receive a sentence of two years. 3) If both decide to plead guilty and implicate their partner, they will both receive a sentence of three years. 4) If Henry pleads not guilty and Dave confesses, Dave will receive the minimum sentence of one year, and Henry will have to stay in jail for the maximum five years. Obviously, pleading guilty is the most attractive should the other plead not guilty since the sentence is only one year. However, if the other party also chooses to plead guilty, both will have to serve three years. On the other hand, if both parties plead not guilty, they'd have to serve two years in jail. Consequently, the risk of pleading not guilty is a five-year sentence, should the other choose to confess.