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Who Can Contribute to a Roth IRA?
Most people will be able to contribute to a Roth, but once your income hits certain limits, you may need to find another way. Many people use Roth IRAs to make after-tax retirement contributions that will not be taxable upon withdrawal. If you have earned income under certain income limits, you can fund a Roth for yourself and even for a non-working spouse. Roth IRAs cannot be opened by everyone: the income limits are based on your modified adjusted gross income (MAGI) and marital status. Continue reading...
How is a Roth IRA Different from a Traditional IRA?
The most basic difference is that the Roth contributions are made after-tax while the Traditional IRA contributions are usually deductible from income. Both Roth and Traditional IRAs provide for tax-deferred growth of your assets. However, the contributions you make into your IRA are pretax (or, more accurately, tax-deductible), and contributions you make to your Roth IRA are after-tax. The annual contribution limits for each are usually the same, and, in fact, a person can contribute up to this amount in either of these combined in a given year. Continue reading...
Which is Better for Me: a Roth or Traditional IRA?
The choice between a Roth IRA and a Traditional IRA depends on available discretionary income and financial situation. Both IRAs have the same contribution limits. The Traditional IRA goes in pre-tax (generally), grows tax-deferred, and is taxable as income on withdrawal. The Roth goes in after-tax, grows tax-deferred, and is not taxable upon withdrawal. That’s the primary difference. This will allow you to lower your current taxable income by making Traditional IRA contributions, which may seem more appealing in a number of ways. There’s the effect of immediate gratification that leads investors to favor this way, and the fact that you’re technically paying more (by the amount of taxes you paid on the after-tax Roth) to make the same current contribution to a Roth. Continue reading...
What are Asset-Backed Securities?
An Asset-Backed Security, or ABS, are bonds or notes backed by financial assets. It is an example of “securitization.” The assets within the ABS generally tend to consist of different kinds of debt receivables, such as credit cards, auto loans, home equity loans, and so forth. Banks build portfolios of receivables in making loans and issuing credit, and then in many cases package these loans together and sell them to investors (known as “securitization”). Continue reading...
What is a credit rating?
A credit rating is given to a company or debt issue after a disinterested third party evaluates the strength of the business or cash flow and rates its ability to pay all of its liabilities. Third-party institutions such as Standard & Poor’s (S&P), Moody’s, and Fitch will conduct research in order to give investors an idea of how likely a business, bond issue, or insurance company can pay all of its obligations. Continue reading...
What are Bond Ratings?
The possibility of a company or municipal government defaulting on their bond obligations, usually by going bankrupt, is a real one. For this reason, all bonds are rated according to the financial stability of the issuer. A look at the history of corporate and municipal debt will illuminate the fact that the possibility of the issuer being unable to pay its obligations to bondholders is a very real one. There is an established system of bond ratings that gives a rough estimate of the bond's reliability. Continue reading...
What is an Asset-Backed Security?
Asset-backed securities are bonds or notes that come in several forms, but they typically use the cash flows from debt repayment as the asset that backs them. The assets that back the bonds called asset-backed securities (ABS) can be basically anything with a fairly predictable cash flow, but debt repayment cash flows tend to be used the most. These include credit card debt, home equity loans, auto loans, student loans, and so forth. Continue reading...
What are Mortgage-Backed Securities?
Mortgage-backed securities (MBS) are products that bundle mortgages together and are traded like securities for sale on the markets. Typically investment banks build these products by bundling mortgages with different interest rates and risk premiums, with the hope of the investor gaining a higher yield than can be found from traditional risk-free products, like U.S. Treasuries. Mortgage-backed securities got an infamous name during the 2008 financial crisis, as many of the packaged loans were subprime in nature. Many MBS products lost incredible value during the crisis, particularly following ruling FAS 157, which required banks to mark their value to market. Continue reading...
What is a Credit Crunch?
A credit crunch is when access to liquidity dries up dramatically in rapid fashion, or becomes less accessible due to a spike in borrowing rates. Central banks will often step-in to try and curb the lack of liquidity by offering the markets access to cash at lower than market rates, in the event of a crisis. Perhaps the most famous credit crunch in history occurred in late 2007 and early 2008, when bank balance sheets became highly leveraged overnight due to mark-to-market accounting rules that were applied to the mortgage backed security portfolios on their balance sheets. Continue reading...
What is Freddie Mac?
Freddie Mac is a government-sponsored company which purchases mortgages from banks and securitizes them for sales to investment banks or individuals. Freddie Mac is not a government organization, but was established by a congressional mandate in the 1970’s. It’s proper name is the Federal Home Loan Mortgage Corporation (FHLMC). The company’s purpose is to make mortgage debts into marketable securities by purchasing the mortgage risk and cash flow from banks and dividing into tranches which are sold to or through investment banking institutions. The securitized mortgages are known as Collateralized Mortgage Obligations, or CMO’s. Continue reading...
What does FDIC Insured mean?
The Federal Deposit Insurance Corporation (FDIC) is a government entity created by the Glass-Steagall Act of 1933, and its purpose is to protect savers from losing their deposits in banking institutions if the bank becomes insolvent. FDIC insurance only covers certain types of assets, up to certain limits for each person, and only at member banks. FDIC insurance will “make whole” any deposit amount up to $250,000 per person if the banking institution that held the funds declares insolvency. Most banks are members of the FDIC program, which was established by the Federal government in the 1930s. Continue reading...
What is Securitization?
Securitization is to turn an asset which would otherwise not be a liquid, tradable security, into one. Simply put, securitization turns assets into securities. The most common example when discussing securitization is mortgage-backed securities, in which the cash flow of interest and principal payments on mortgage loans has been pooled, cut up, and distributed for sale in the form of marketable securities which can be held by an everyday investor. The bank or institution who sold the mortgage-backed securities receives cash which they can loan out to more home-buyers. Continue reading...
What is an Investment Bank?
An investment bank is a financial institution that typically specializes in large, complex transactions, such as underwriting an Initial Public Offering (IPO), mergers and acquisitions, direct investment into start-up firms, or advising large institutional clients on investments/transactions. In short, investment banks help create the bridge between large enterprises and the investor. In that sense, IPOs are one way to accomplish this, but they also help businesses secure financing in other ways, such as through bond issues or derivative products. Continue reading...
What is a Bank Guarantee?
When a lending institution offers a Bank Guarantee, they are reducing the risk involved in a transaction by guaranteeing payment to the seller. Bank Guarantees often come into play with deals made internationally, where the participants in the deal prefer to have some assurances before they do business. The guarantee acts as insurance to protect the parties involved in transactions where they are not fully able to assess the strength and reliability of the other, such as when small companies bid for projects or when bids for a job come-in from around the world. Continue reading...
What is Investment Banking?
Investment banking activity is different than traditional banking. Investment banks often serve as intermediaries that underwrite a new issue of stock and help to distribute it. They also trade in their own accounts, run hedge funds, and generally invest and speculate in ways that most institutions can’t. Investment banks can assist with new issues of stocks and bonds, purchasing large blocks of them to distribute at a premium. Continue reading...
What are Bank Deposits?
Deposits are cash, checks, and electronic transfers that banking customers put into their personal or corporate bank accounts. Deposits will increase the balance, or pay off a debt, within a bank account. Deposits may not show up on an account balance until they have cleared from the institution or account from which the check is written or the electronic transfer was requested. The types of accounts that can receive bank deposits include but are not limited to checking, savings, and money market accounts. Bank Certificates of Deposit (CDs) can be purchased with an initial deposit that satisfied minimum amount. Deposits are considered liabilities on the balance sheet of the bank, since they are obligated to pay that money out when a customer requests it. Continue reading...
What is a Bank Draft?
The truest definition of a Bank Draft is a check written with the certification of a customer’s bank. Bank Drafts are checks also known as Bank Checks and Cashier’s Checks. They have already been cleared at the writing institution and they provide an extra endorsement that the payment is good. Regular personal checks do not need to be co-signed or verified before they are used as payment, whether or not there is enough money in an account to cover it. Continue reading...
What is Bank Credit?
Bank Credit is the amount of loaned capital that an individual or business is capable of getting from a bank at a given time. This amount will be based on a series of evaluative metrics such as the total amount of assets an individual has, home equity, income, liquid net worth, work history, credit rating, and so forth. An individual can only borrow so much at a time, and, using these variables, a banker can essentially estimate how much credit could be extended that a given individual at that time. Continue reading...
What is the Glass-Steagall Act?
The Glass-Steagall Act was passed in 1933 to place a dividing wall between commercial banking and investment banking. It was in an effort to protect consumers and the economy from the risks of speculative investment banking. JP Morgan and other large institutions were targeted. The act was partially repealed and replaced in 1999 by the Gramm-Leach-Bliley Act. After 2008, some opined that the repeal of the original act contributed to the financial crises, and they instituted the Volcker Rule, which reinstated part of the original Glass-Steagall act. Continue reading...
A-/A3 — credit rating
A- — S&P / Fitch A3 — Moody’s Rating institutions assign various levels of credit ratings to signify the chance of default; the A-/A3 rating is considered Investment Grade, but it is getting closer to the Junk Bond range. If a company or debt issue has a rating of A-/A3, it means that S&P and Fitch have given it an A- and Moody’s has given it an A3 rating. They have their own symbology for their ratings system but these are at the same level on both scales: these ratings are at the 6th or 7th degree from the top possible ratings, which is AAA/Aaa. Continue reading...