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What does it mean to Accept Risk?
The notion of who bears risk for various sorts of failures, circumstances, or losses is a prevalent one in the financial world, and many institutions make all of their money accepting risks. To accept a risk is to bear the burden of loss or replacement if an event occurs that causes an asset to lose value or disappear. There is a bright side to this, however. There is a real and theoretical “risk premium” due to those who accept a risk. 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 an Accounting Standard?
Accounting standards are the practices which make financial information uniform and normalized between various businesses and accounting firms. Accounting standards constitute what is known as GAAP: Generally Accepted Accounting Principles. These may apply to how revenue is recognized, how assets are classified, acceptable methods of depreciating assets, and so on. Some of these are based on IRS opinions and the jurisprudence of the law, some are just industry best-practices that are widely used. Continue reading...
What is an Investment Banker?
Investment bankers are proficient analysts themselves, but they have subordinate financial analysts that crunch the numbers for them. They are primarily in the business of procuring clients for deals such as IPOs which their investment bank will underwrite. Investment bankers are employees of investment banks whose role is to acquire clients for the bank and to be the liaison between clients and the back office of the investment bank. Continue reading...
What is an Accounting Convention?
An accounting convention is an established an agreed-upon method of documenting specific items on a company’s books. The most widely-used accounting conventions are part of the Generally Accepted Accounting Principals (GAAP), which is the only accounting methodology accepted for quarterly 10-Q filings with the SEC in the United States, and has also become the basis for regulatory accounting practices in other countries. Continue reading...
Why do Companies Opt for ICOs?
Initial Coin Offerings are ways for new cryptocurrency or other technology companies to raise capital and put their coins into circulation. For companies too small to attract the attention of a big investment bank, this may be the best option for “going public.” In initial coin offerings, as opposed to using venture capital and initial public offerings of stock in regulated markets, the new company doesn’t actually give up any of their equity (i.e., control) in the company to third parties. Continue reading...
What is a Mortgage Broker?
Mortgage brokers act as agents for consumers looking for the best deal possible on a home mortgage loan. Lenders at banks may not be able to find the most competitive interest rates out there. Mortgage brokers can help consumers become more educated about the various kinds of loans out there, some of which are subsidized by the government. Mortgage brokers find and place mortgage loans with consumers who need it to buy a house. Continue reading...
What is GAAP?
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 is Cash Collateral?
Cash collateral is liquid cash and cash equivalents designated as collateral for loans and debts of various sorts. One frequently used example of cash collateral is cash used in short selling of securities in a brokerage account. While securities equal to significantly more than the required cash margin can be substituted for cash, the most cost-effective and least risky way to maintain margin requirements is with cash and cash equivalents. Continue reading...
What does Bid Mean?
When you make a ‘buy offer’ on a stock or other security in the financial markets, you are making a Bid. A Bid offer in terms of financial markets is the price offered by an investor or trader for a security. A market maker will try to reconcile Bid offers (the highest prices that buyers are willing to pay) with Ask offers (the lowest price that a seller is willing to accept). Match the Bid and the Ask offers, and you’ve got a trade. Continue reading...
What is a Broker-Dealer?
A broker-dealer is an entity that engages in the trading of securities, and can act as both an agent and a principal. Brokerages, investment banks, commercial banks, and other financial institutions can act as a broker-dealer. Broker-dealers are important to the liquidity of the markets, since they hold inventories of securities for various amounts of time to help facilitate trading, short-selling, and margin accounts. Continue reading...
What is a Market Maker?
A market maker is a broker-dealer firm or a registered individual that will hold a certain number of shares of a security in order to facilitate trading. There could be as many as 50 market makers for one particular security, and they compete for customer order flows by displaying buy and sell quotations for a guaranteed number of shares. The market maker spread refers to the difference between the amount a market maker is willing to pay for a security and the amount that the other party is willing to sell it. Continue reading...
What is Accrual Accounting?
Accrual accounting is the counterpart to cash accounting, and the accrual method puts expenses and revenues on the books as soon as they are contractually agreed-upon. Accrual accounting is required by GAAP conventions for all publicly traded companies who have over $5 million in annual revenues. This method is the counterpart to cash accounting, which may be more useful to smaller businesses. In accrual accounting, the expenses and revenues which are agreed upon are written onto the business’s ledger at the current time, regardless of when payment will actually settle on the transaction. When a sale is made or service is performed, the revenue from the activity is documented, even if no cash is received in the current period. Continue reading...
What is Deflation?
Deflation is an economic term used to describe a trend of broad-based price declines for goods and services. Deflation is generally considered a big negative in the realm of economics. If a country is experiencing deflation, it is usually because demand for goods has fallen substantially, pushing prices down. It can also be tied to falling investment and government spending, both factors that signal weak demand in an economy. Continue reading...
What is Earnings Before Interest, Taxes ,and Depreciation (EBITD)?
Earnings Before Interest, Taxes, and Depreciation (EBITD) is one method of viewing the earnings of a company with some of the typical expenses added back into it. It is not to be confused with its close cousin EBITDA, which also adds amortization back in. Amortization is essentially the same thing as depreciation, but amortization applies to intangibles such as debt principal amounts and intellectual property. Continue reading...
What is Underwriting?
Underwriting is the process through which risks are accepted by an institution. Underwriting is the assessment of risk or the acceptance of risk after such assessment by a company or bank. Underwriters in insurance companies will assess a risk prior to the company accepting the risk; once the risk has been accepted the company bears the burden of covering the potential losses associated with the risk. The company is paid a premium for accepting the risk. Continue reading...
What are the main Accounting Methods?
There are two main kinds of accounting methods: accrual accounting and cash accounting. Depending on who is speaking, accounting “methods” may also extend to the GAAP vs pro-forma distinction. For the most part, accounting methods can be defined based on the year in which the revenues and expenses are put on the books. In cash accounting, only the revenues and expenses which are collected and paid in the current year or period are documented. Continue reading...
What is Abandoned Property?
Most people think of an abandoned car or even a house when abandoned property is mentioned, but it also applies to investment accounts. If physical property such as a car is left for a long enough time in a public space or privately owned space such as a storage building, the property can be deemed abandoned and the person who discovers it can become the new owner. Through a process called escheatment, investment accounts, savings accounts, bank CDs, and employee 401(k) accounts can all become assets of the state if they are determined to be abandoned. Continue reading...
What is a market-maker spread?
The difference between the Bid and Ask prices on a stock or other security are known as the Spread. Designated market makers are traders whose job it is to make a market for securities, by offering to buy or sell shares, and thus creating liquidity, often at the same time. Their money is made on the spread. In highly liquid markets, the spread will shrink. So if everyone is buying and selling the same stock one day, there may be virtually no spread between the Bid and the Ask price, and this is seen as efficient. Continue reading...
What are Accounting Earnings?
Earnings that are reported in a given year may differ for the same company if different accounting methods were used. Earnings are the revenues of the company minus the cost of good sold, expenses, and investment losses. If that seems like something that’s pretty cut-and-dried, and will look the same no matter who is doing the accounting… well, that’s not entirely correct. Earnings can be made to look different if different non-GAAP or pro-forma methods are used. If non-recurring expenses are ignored or amortized in a pro-forma accounting method, then earnings will not match up to the GAAP-based books. Continue reading...