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| Learning
Centre |
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 What is
Value investing ?
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| What is a
Cash flow statement ?
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| What is
short selling ? |
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| What are
Repurchase agreements ? |
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| What is
Time value of money ? |
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| What is an
Initial public offering ? |
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| What is a
Futures exchange ? |
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| What are
Commodity markets ? |
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| What is
short selling ? |
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| What is an
Index fund ? |
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What is Value investing ?
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| Value investing is a style of investment strategy
from the so-called "Graham & Dodd" School. Followers of this style, known as
value investors, generally buy companies whose shares appear underpriced by
some forms of fundamental analysis; these may include shares that are trading
at, for example, high dividend yields or low price-to-earning or price-to-book
ratios. The main proponents of value investing, such as Benjamin Graham and
Warren Buffett, have argued that the essence of value investing is buying
stocks at less than their intrinsic value. The discount of the market price to
the intrinsic value is what Benjamin Graham called the "margin of safety". The
intrinsic value is the discounted value of all future distributions. However,
the future distributions and the appropriate discount rate can only be
assumptions. Warren Buffett has taken the value investing concept even further
as his thinking has evolved to where for the last 25 years or so his focus has
been on "finding an outstanding company at a sensible price" rather than
generic companies at a bargain price.
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What is a Cash flow statement ?
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| In financial accounting, a cash flow statement is a
financial statement that shows a company's incoming and outgoing money during a
time period (often monthly or quarterly). The statement shows how changes in
balance sheet and income accounts affected cash and cash equivalents, and
breaks the analysis down according to operating, investing, and financing
activities. As an analytical tool the statement of cash flows is useful in
determining the short-term viability of a company, particularly its ability to
pay bills. International Accounting Standard 7, is the International Accounting
Standard that deals with cash flow statements. People and groups interested in
cash flow statements include accounting personnel, who need to know whether the
organization will be able to cover payroll and other immediate expenses
potential lenders or creditors, who want a clear picture of a company's ability
to repay potential investors, who need to judge whether the company is
financially sound potential employees or contractors, who need to know whether
the company will be able to afford compensation
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What is short selling ?
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In finance, short selling or "shorting" is a way to profit from the decline in
price of a security, such as stock or a bond. Some investors "go long" on an
investment, hoping that price will rise. To profit from the stock price going
down, short sellers can borrow a security and sell it, expecting that it will
decrease in value so that they can buy it back at a lower price and keep the
difference. The short seller owes his broker, who usually in turn has borrowed
the shares from some other investor who is holding his shares long; the broker
itself seldom actually purchases the shares to lend to the short seller.[1] For
example, 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. This practice has the
potential for an unlimited loss. For example, if the shares of XYZ that one
borrowed and sold in fact went up to $25, the short seller would have to buy
back all the shares at $2500, losing $1500. However, the term "short selling"
or "being short" is often used as a blanket term for all those strategies which
allow an investor to gain from the decline in price of a security. Those
strategies include buying options known as puts. A put option consists of the
right to sell an asset at a given price; thus the owner of the option benefits
when the market price of the asset falls. Similarly, a short position in a
futures contract, or to be short a futures contract, means the holder of the
position has the obligation to sell the underlying asset at a later date. In
fact, what is many times labeled short selling is options or futures activity,
since this activity greatly magnifies the gain that results from a securities
price loss. For example, if the next earnings release of XYZ company is going
to show that its profits declined somewhat in some of its divisions, its stock
might decline only 5 percent when that information is released. Someone within
the company who wants to trade in inside information however would probably not
be satisfied with only a 5 percent gain on his short sell and instead would buy
put options or other derivatives or futures to gain possibly 20 or more percent
on the decline in the stock price of XYZ.
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What are Repurchase agreements ?
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Repurchase agreements (RPs or Repos) are financial instruments used in the
money markets and capital markets. A more accurate and descriptive term is Sale
and Repurchase Agreement, since what occurs is that the cash receiver (aka repo
seller) sells securities now, in return for cash, to the cash provider (aka
repo buyer), and agrees to repurchase those securities from the cash provider
for a greater sum of cash at some later date, that greater sum being all of the
cash lent and some extra cash (constituting the implicit interest rate, known
as the repo rate). There is little that prevents any security from being
employed in a repo; so, Treasury or Government bills, corporate and Treasury /
Government bonds, and stocks / shares, may all be used as securities involved
in a repo. A reverse repo is simply a repurchase agreement as described from
the cash provider's not the repurchasing party, but the reverse i.e. the party
from whom the security is repurchased. Hence, the cash receiver executing the
transaction would describe it as a 'repo', while the cash provider in the same
transaction would describe themselves as executing a 'reverse repo'. So 'repo'
and 'reverse repo' are exactly the same kind of transaction, just described
from opposite viewpoints. A repo is economically similar to a secured loan,
with the lender of money receiving securities as collateral to protect against
default. However, the legal title to the securities clearly passes from the
seller to the investor. The cash provider is referred to as an "investor" or
"buyer"; the provider of the collateral (i.e. the security) is the "seller".
Coupons (installment payments that are payable to the owner of the securities)
which are paid while the repo buyer (aka cash lender i.e. cash provider) owns
the securities are, in fact, usually passed directly onto the repo seller (i.e.
cash receiver) which might seem counterintuitive, as the ownership of the
collateral technically rests with the cash provider during the repo agreement.
It is possible to instead pass on the coupon by altering the cash paid at the
end of the agreement, though this is more typical of Sell/Buy Backs. Although
the underlying nature of the transaction is that of a loan, the terminology
differs from that used when talking of loans due to the fact that the cash
receiver does actually repurchase the legal ownership of the securities from
the cash provider 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. Although repos are typically
short-term, it is not unusual to see repos with a maturity as long as two
years.
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What is Time value of money ?
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The time value of money is the premise that an investor prefers to receive a
payment of a fixed amount of money today, rather than an equal amount in the
future, all else being equal. In other words, the present value of a certain
amount a of money is greater than the present value of the right to receive the
same amount of money time t in the future. This is because the amount a could
be deposited in an interest-bearing bank account (or otherwise invested) from
now to time t and yield interest. Consequently, lenders acting at arm's length
demand interest payments for use of their financial capital. Additional
motivations for demanding interest are to compensate for the risk of borrower
default and the risk of inflation, as well as other, more technical
considerations. All of the standard calculations are based on the most basic
formula, the present value of a future sum, "discounted" to a present value.
For example, a sum of FV to be received in one year is discounted (at the
appropriate rate of R) to give a sum of PV at present. Some standard
calculations based on the time value of money are: Present Value (PV) of an
amount that will be received in the future. Future Value (FV) of an amount
invested (such as in a deposit account) now at a given rate of interest.
Present Value of an Annuity (PVA) is the present value of a stream of
(equally-sized) future payments, such as a mortgage. Future Value of an Annuity
(FVA) is the future value of a stream of payments (annuity), assuming the
payments are invested at a given rate of interest. Present Value of a
Perpetuity is the value of a regular stream of payments that lasts "forever",
or at least indefinitely.
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What is an Initial public offering ?
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An initial public offering (IPO) is the first sale of a corporation's common
shares to investors on a public stock exchange. The main purpose of an IPO is
to raise capital for the corporation. While IPOs are effective at raising
capital, being listed on a stock exchange imposes heavy regulatory compliance
and reporting requirements. The term only refers to the first public issuance
of a company's shares. If a company later sells newly issued shares again to
the market, it is called a "Seasoned Equity Offering". When a shareholder sells
shares, it is called a "secondary offering" and the shareholder, not the
company who originally issued the shares, retains the proceeds of the offering.
These terms are often confused. In distinguishing them, it is important to
remember that only a company, which issues shares can make a "primary
offering". Secondary offerings occur on the "secondary market", where
shareholders (not the issuing company) buy and sell shares from and to each
other.
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What is a Futures exchange ?
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A futures exchange is an exchange which provides a marketplace where one can
buy and sell specific quantities of a commodity or financial instrument at a
specified price with delivery set at a specified time in the future.
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| History of futures exchanges |
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Though the origins of futures trading can supposedly be traced to Ancient Greek
or Phoenician times, the history of modern futures trading begins in Chicago,
United States in the early 1800s. Chicago is located at the base of the Great
Lakes, close to the farmlands and cattle country of the U.S. Midwest, making it
a natural center for transportation, distribution and trading of agricultural
produce. Gluts and shortages of these products caused chaotic fluctuations in
price. This led to the development of a market enabling grain merchants,
processors, and agriculture companies to trade in "to arrive" or "cash forward"
contracts to insulate them from the risk of adverse price change and enable
them to hedge. Forward contracts were standard at the time. However, most
forward contracts weren't honored by both the buyer and the seller. For
instance, if the buyer of a corn forward contract made an agreement to buy
corn, and at the time of delivery the price of corn was dramatically lower than
when the two originally contracted, either the buyer or the seller would back
out. Additionally, the forward contracts market was very illiquid and an
exchange was needed that would bring together a market to find potential buyers
and sellers of a commodity instead of making people bear the burden of finding
a buyer or seller. In 1848, the Chicago Board of Trade (CBOT)--the world's
first futures exchange--was formed. Trading was originally in forward
contracts; the first contract (on corn) was written on March 13, 1851. In 1865,
standardized futures contracts were introduced. The Chicago Produce Exchange
was established in 1874 and renamed the Chicago Mercantile Exchange (CME) in
1898. In 1972 the International Monetary Market (IMM), a division of the CME,
was formed to offer futures contracts in foreign currencies: British pound,
Canadian dollar, German mark, Japanese yen, Mexican peso, and Swiss franc. In
1881, a regional market was founded in Minneapolis, Minnesota and in 1883
introduced futures for the first time. Trading continuously since then, today
the Minneapolis Grain Exchange (MGEX) is the only exchange for hard red spring
wheat futures and options.[1] Later in the 1970s saw the development of the
financial futures contracts, which allowed trading in the future value of
interest rates. These (in particular the 90-day Eurodollar contract introduced
in 1981) had an enormous impact on the development of the interest rate swap
market. Today, the futures markets have far outgrown their agricultural
origins. With the addition of the New York Mercantile Exchange (NYMEX) the
trading and hedging of financial products using futures dwarfs the traditional
commodity markets, and plays a major role in the global financial system,
trading over 1.5 trillion U.S. dollars per day in 2005. The recent history of
these exchanges (Aug 2006) finds the Chicago Exchange trading more than 70% of
its Futures contracts on its "Globex" trading platform and this trend is rising
daily. It counts for over 45.5 Billion dollars of nominal trade (over 1 million
contracts) every single day in "electronic trading" as opposed to open outcry
trading of Futures, Options and Derivatives. And that is only one of the worlds
current Futures Exchanges, albeit the largest one at this writing. In June of
2001, ICE acquired the International Petroleum Exchange (IPE), now ICE Futures,
which operated Europe's leading open-outcry energy futures exchange. Since
2003, ICE has partnered with the Chicago Climate Exchange (CCX) to host its
electronic marketplace. In April of 2005, the entire ICE portfolio of energy
futures became fully electronic. In 2006, the New York Stock Exchange teamed up
with the London Exchanges "Euronext" electronic exchange to form the first
trans-continental Futures and Options Exchange. These two developments as well
as the sharp growth of internet Futures trading platforms developed by a number
of trading companies clearly points to a race to total internet trading of
Futures and Options in the coming years.
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| What are Commodity markets ? |
| 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. |
| History |
| 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 over-estimate. 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." |
| Early history of commodity markets |
| Historically, dating from ancient Sumerian use of
sheep or goats, or other peoples using pigs, rare seashells, or other items as
commodity money, people have sought ways to standardize and trade contracts in
the delivery of such items, to render trade itself more smooth and predictable.
Commodity money and commodity markets in a crude early form are believed to
have originated in Sumer where small baked clay tokens in the shape of sheep or
goats were used in trade. Sealed in clay vessels with a certain number of such
tokens, with that number written on the outside, they represented a promise to
deliver that number. This made them a form of commodity money - more than an
"I.O.U." but less than a guarantee by a nation-state or bank. However, they
were also known to contain promises of time and date of delivery - this made
them like a modern futures contract. Regardless of the details, it was only
possible to verify the number of tokens inside by shaking the vessel or by
breaking it, at which point the number or terms written on the outside became
subject to doubt. Eventually the tokens disappeared, but the contracts remained
on flat tablets. This represented the first system of commodity accounting.
However, the Commodity status of living things is always subject to doubt - it
was hard to validate the health or existence of sheep or goats. Excuses for
non-delivery were not unknown, and there are recovered Sumerian letters that
complain of sickly goats, sheep that had already been fleeced, etc. If a
seller's reputation was good, individual "backers" or "bankers" could decide to
take the risk of "clearing" a trade. The observation that trust is always
required between market participants later led to credit money. But until
relatively modern times, communication and credit were primitive. Classical
civilizations built complex global markets trading gold or silver for spices,
cloth, wood and weapons, most of which had standards of quality and timeliness.
Considering the many hazards of climate, piracy, theft and abuse of military
fiat by rulers of kingdoms along the trade routes, it was a major focus of
these civilizations to keep markets open and trading in these scarce
commodities. Reputation and clearing became central concerns, and the states
which could handle them most effectively became very powerful empires, trusted
by many peoples to manage and mediate trade and commerce.
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| What is short selling ? |
| In finance, short selling or "shorting" is a way to
profit from the decline in price of a security, such as stock or a bond. In
contrast, investors who "go long" on an investment hope that the price will
rise. To profit from the stock price going down, short sellers can borrow a
security and sell it, expecting that it will decrease in value so that they can
buy it back at a lower price and keep the difference. The short seller owes his
broker, who usually in turn has borrowed the shares from some other investor
who is holding his shares long; the broker itself seldom actually purchases the
shares to lend to the short seller.[1] For example, 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. This practice has the potential for an unlimited
loss. For example, if the shares of XYZ that one borrowed and sold in fact went
up to $25, the short seller would have to buy back all the shares at $2500,
losing $1500. However, the term "short selling" or "being short" is often used
as a blanket term for all those strategies which allow an investor to gain from
the decline in price of a security. Those strategies include buying options
known as puts. A put option consists of the right to sell an asset at a given
price; thus the owner of the option benefits when the market price of the asset
falls. Similarly, a short position in a futures contract, or to be short a
futures contract, means the holder of the position has the obligation to sell
the underlying asset at a later date. In fact, what is many times labeled short
selling is options or futures activity, since this activity greatly magnifies
the gain that results from a securities price loss. For example, if the next
earnings release of XYZ company is going to show that its profits declined
somewhat in some of its divisions, its stock might decline only 5 percent when
that information is released. Someone within the company who wants to trade in
inside information however would probably not be satisfied with only a 5
percent gain on his short sell and instead would buy put options or other
derivatives or futures to gain possibly 20 or more percent on the decline in
the stock price of XYZ.
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| What is an Index fund ? |
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An index fund or index tracker is a collective investment scheme that aims to
replicate the movements of an index of a specific financial market, or a set of
rules of ownership that are held constant, regardless of market conditions.
Tracking can be achieved by trying to hold all of the securities in the index,
in the same proportions as the index. Other methods include statistically
sampling the market and holding "representative" securities. Many index funds
rely on a computer model with little or no human input in the decision as to
which securities to purchase and is therefore a form of passive management. The
lack of active management (stock picking and market timing) gives the advantage
of lower fees and lower taxes in taxable accounts. However, the fees will
always reduce the return to the investor relative to the index. In addition it
is impossible to precisely mirror the index as the models for sampling and
mirroring, by their nature, cannot be 100% accurate. The difference between the
index performance and the fund performance is known as the 'tracking error' or
'jitter'. Index funds are available from many investment managers. Some common
indices include the S&P 500, the Wilshire 5000, the FTSE 100 and the FTSE
All-Share Index. Less common indexes come from academics like Eugene Fama and
Kenneth French, who created "research indexes" in order to develop asset
pricing models, such as their Three Factor Model. The Fama French Three Factor
model is used by Dimensional Fund Advisors to design their index funds. Robert
Arnott and Professor Jeremy Siegel have also created new competing
fundamentally based indexes based on such criteria as dividends, earnings, book
value, and sales that are being deployed in ETF products.
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