Some 401(k)s give participants the ability to make after-tax contributions, which raises the question of which fits better into a person’s retirement plan. One advantage to Roth 401(k)s is that they do not have income limits which may have barred certain high earners from contributing to a Roth IRA in the past. Down the road in retirement, it may be advantageous for someone with significant savings to be able to take some withdrawals that do not increase his or her income tax bracket. Continue reading...
Discounted Cash Flow (DCF) uses an estimated future cash flow amount and a Discount Rate to determine the Present Value (PV). An investor or business executive might project an estimated future cash flow for a business based on recent growth rates, industry information, futurism, estimated inflation, etc. The most common future cash flow to use is free cash flow, which takes out capital expenditures. Continue reading...
Discount Broker is a financial organization that places trades at a discount to a full service broker, and also often will serve as a custodian for assets. With the onset of online trading platforms, the discount brokerage industry has seen plenty of growth over the last few years. In many cases, however, a discount broker will not offer any investment advice - hence the discounted price for trading services. An investor that wants a lot of personalized service should probably consider a full service broker over a discount broker, since a discount broker literally only focuses on trade execution and will not provide additional services, like research and advice. Continue reading...
The Discount Rate can actually have multiple meanings, but the most prevalent one is in regards to the minimum interest rate the Federal Reserve will charge for lending to commercial banks. The Federal Reserve sets the discount rate in an effort to discourage or encourage commercial banks to borrow, depending on the economic conditions. The discount rate also refers to the rate used to calculate the present value of future cash flows, as part of Discounted Cash Flow (DCF) analysis. Continue reading...
The Federal Discount Rate is the interest rate that the Federal Reserve charges banks for borrowing money. This is usually done overnight to satisfy reserve requirements on short notice. It is different than the Federal Funds Rate, which is the rate that banks charge each other. The 12 regional Federal Reserve Banks determine their Federal Discount Rate in board meetings every 14 days. It is the interest that will be charged to member banks to borrow directly from the Fed, which they do at times in order to make sure they have enough capital reserves to satisfy regulations. Continue reading...
The Time Value of Money is a theme for discourse and calculations related to the effect of interest on money over time, and the interrelation between Present Value and Future Value. The Time in the equation of Rate of Return x Time x Present Value = Future Value has a value and an effect on the Future Value (or the Present Value depending on what you're solving for). The Time Value of Money is, at it's simplest, something which nearly everyone has seen but hasn't heard called by that name: turn this amount of money into that amount of money by letting it grow in the market for a length of time. Continue reading...
The Dividend Discount Model (DDM) is a method for valuing a stock, that looks at expected future dividend payouts and adjusts to present value. If the calculated value is less than the current trading price, the security is thought to be undervalued. The DDM is helpful as a tool but should not solely be used in valuation calculations. Perhaps its biggest flaw is that future dividends have to be projected and assumed, which is a far-from-certain practice. Continue reading...
The price in today's dollars for an asset which will appreciate or depreciate to an amount which may be known at a specific date in the future. One simple example of Present Value is the amount that needs to be invested in order to grow to a specific amount later, if the rate of return and length of time are known. So if someone wanted to have $50,000 to buy a boat in 5 years, and they could get 5% on a guaranteed investment, they would need a lump sum investment of about $39,000 to get them there. Continue reading...
Par value is the nominal value of a security (such as a stock or a bond) that is typically indicated on the certificate of ownership. Par value is most often associated with bonds, and refers to the amount that will be returned to the investor at the bond’s maturity. Par value of bonds is generally $100 or $1,000. Bonds traded on the open market are not generally bought and sold at par value, as they typically trade at a premium or a discount to par. Bond prices are influenced by interest rates, and have an inverse relationship with them. Continue reading...
Lenders have a different par rate for different types of borrowers, which is the base around which they have the ability to negotiate deals. The par rate will be based on the prevailing interest rate environment, with factors changing it slightly for different potential borrowers and the risk associated with them based on creditworthiness. Par rate is the fair market value of a loan for a person with certain risk characteristics, from a lending institution of certain size and qualities. The par rate is the reference point around which a borrower and a lender will strike a deal, even though this is often unknown to the borrower. If the lender, which might be a bank loan officer or a mortgage broker, gives the borrower a break on the front-end cost of the loan, the borrower might have some interest tacked on to the par rate to make up for it. Continue reading...
An adjunct account increases the valuation of a liability account. An adjunct account is commonly used when accounting for a bond issue sold at a premium. The par value of the bonds sold is included in one line as a credit to Bonds Payable, and the increased premium in placed in another line as a credit to Premium on Bonds payable. The technical term for the account into which a discounted bond’s discount is placed is a Contra Account. Continue reading...
Future Value is the hypothetical value of an investment at a specific date in the future. The future value (FV) of an investment or business is a calculation used in several types of planning and accounting. In a Time Value of Money (TVM) calculation, the Future Value is often the starting point, and the interest rate that will be earned in the meantime is called Discount Rate, and is discounted by the number of years of periods back to the present time. This allows investors to see the Present Value (PV), which is a lesser, discounted amount from the future value, and gives us the premise for the Time Value of Money, which is that “a dollar today is worth more than a dollar tomorrow.” Continue reading...
The Federal Reserve extends credit in the form of short-term loans to member banks. Banks avoid taking loans from the Fed if they can, because it is viewed as a sign of instability. The Federal Discount Rate applies to loans taken from what is known as the discount window at the Fed, and it tends to be a higher rate than what is charged between two banks. The Federal Reserve will extend credit only to banking institutions that are members of the Federal Reserve system. Continue reading...
The Gordon Growth Model is also known as the dividend discount model (DDM). It is a model for pricing a stock that was developed by professor Myron J. Gordon in the 1960s. The model uses a stock’s present value relative to the present value of its future dividends to provide an intrinsic value for the stock. The model is a shaky one at best, especially given that companies these days often change the course of dividend payments, and many (particularly in the tech world) don’t pay any dividends at all. Continue reading...
Real rate of return is a notion that takes factors such as inflation and taxation into account before reporting a realized rate of interest on an investment. Economic theorist Irving Fisher first popularized the idea that there is a difference between a nominal interest rate and a real interest rate. Consider a bond that pays a steady coupon rate of 2% for the next 10 years. If inflation is more than 2%, the real rate of return on that investment is negative. If the investor got taxed on the nominal gains, the real rate of return is pushed further into negative territory. Continue reading...
Dividend growth rate is the annual increase in the scale of dividend payments to stockholders. Good dividend growth is a sign of a company with solid earnings. Dividend growth rate is also referred to as dividend appreciation, and it can be computed fairly easily using historical data. Simply put, the dividend rate is the amount of dividend paid in a year divided by the share price when the dividend is paid. Continue reading...
The abnormal earnings valuation method is one in which the future cash flows of a business are given significant weight in a valuation, especially when there are not many hard assets to use for valuation purposes. If a company is rich in human capital or has significant cash flows, whether or not it has many hard asset or book value, the Abnormal Earnings Valuation Model can be the most useful method for arriving at an accurate valuation of a business and its stock. Continue reading...
Intrinsic Value is the value of a security which is “built into it.” Both options and stocks have it, but it is different for each. Options and stocks have intrinsic value. For options, the intrinsic value is easy to compute, if the option is in-the-money. It is the difference between the strike price of the option and the market price of the underlying security. If an option is out-of-the-money it has no intrinsic value. Continue reading...
Gains and losses are only "real" when shares are sold or withdrawals are made, but up until that point the gains were more of a notional amount, and are said to be "unrealized." A more salient way to understand unrealized gains is to look at the opposite: unrealized losses. If a person makes an investment of $1,000 and the value of the shares drops sharply the next week, has the person lost any money? The answer of course is no, not unless he sells the shares and takes the lower market price for them. Continue reading...
An accurate historical return calculation for an investment should be done with the dividends in mind, such as assuming all dividends were reinvested, which is the most common way they are used. Accurate historical information concerning prices and return should take the stock splits, dividends, and so-on into account. In a lesser-known context, dividend adjustment means a payment of accrued but yet-unpaid dividend amounts to the bearer of convertible preferred stock at the time that he or she converts them to shares of common stock. Continue reading...