A credit rating assesses the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.
A credit bureau (U.S.), or credit reference agency (UK) is a company that collects information from various sources and provides consumer credit information on individual consumers for a variety of uses. This helps lenders assess credit worthiness, the ability to pay back a loan, and can affect the interest rate and other terms of a loan.
Most consumer welfare advocates advise individuals to review their credit reports at least once per year, in order to ensure that the reports are accurate. Consumers can do so at no cost. They are entitled to a free annual credit report from each of the three nationwide consumer reporting agencies, Equifax, Experian and TransUnion.
Tuesday, September 30, 2008
What is LIBOR
Libor stands for the London interbank offered rate. It is the interest rate banks charge each other to make overnight loans. Most loans that eventually find their way to you begin at the top with the 16 banks that set Libor. And because banks are increasingly nervous about each others’ financial situation, last night something incredible happened: Libor surged the most ever. It rose more than 4% to 6.88%.
Think about that. The most basic interest rate banks charge each other more than tripled.
If banks are going to charge each other nearly 7% for a one-day loan, it says two things. First, they are scared and not willing to lend money unless they are compensated for the risk. Second, credit is likely to tighten up at your level for cars and other loans.
The move in Libor is equivalent to the interest rate on your credit card soaring from 15% to 45%. You may be willing to put that dinner or pair of Levi’s on the card at 15%, but you will be much less likely to use that credit if you have to pay 45% interest. Banks think and act the same way.
Most consumer loans, including how many ARMs will reset, are tied to Libor in the long run. Interest rates trickle down. Libor can be dull to talk about, but the impact on you is anything but.
Think about that. The most basic interest rate banks charge each other more than tripled.
If banks are going to charge each other nearly 7% for a one-day loan, it says two things. First, they are scared and not willing to lend money unless they are compensated for the risk. Second, credit is likely to tighten up at your level for cars and other loans.
The move in Libor is equivalent to the interest rate on your credit card soaring from 15% to 45%. You may be willing to put that dinner or pair of Levi’s on the card at 15%, but you will be much less likely to use that credit if you have to pay 45% interest. Banks think and act the same way.
Most consumer loans, including how many ARMs will reset, are tied to Libor in the long run. Interest rates trickle down. Libor can be dull to talk about, but the impact on you is anything but.
Exchange Traded and Over the Counter
Exchange Traded and Over the Counter
Exchange Traded
A stock exchange, share market or bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends.
Over the Counter
Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via corporate-owned facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.
Exchange Traded
A stock exchange, share market or bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends.
Over the Counter
Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via corporate-owned facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.
Forward and Future Contract
Forward Contract is an agreement between two parties to buy or sell an asset at a specified point of time in the future. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes.
Futures Contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.
Difference between Forward and Future Contracts
While futures and forward contracts are both contracts to deliver an asset on a future date at a prearranged price, they are different in two main respects:
Futures are exchange-traded, while forwards are traded over-the-counter. Thus futures are standardized and face an exchange, while forwards are customized and face a non-exchange counterparty. Futures are margined, while forwards are not.
Thus futures have significantly less credit risk, and have different funding.
Futures Contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.
Difference between Forward and Future Contracts
While futures and forward contracts are both contracts to deliver an asset on a future date at a prearranged price, they are different in two main respects:
Futures are exchange-traded, while forwards are traded over-the-counter. Thus futures are standardized and face an exchange, while forwards are customized and face a non-exchange counterparty. Futures are margined, while forwards are not.
Thus futures have significantly less credit risk, and have different funding.
Options
Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security, or in a futures contract. In other words, the holder does not have to exercise this right, unlike a forward or future.
This tutorial from investopedia gives a clear picture about options.
The primary types of financial options are:
Exchange traded options (also called "listed options") are a class of exchange traded derivatives. Exchange traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the credit of the exchange. Since the contracts are standardized, accurate pricing models are often available.
Exchange traded options include:
stock options, commodity options, bond options and other interest rate options index (equity) options, and options on futures contracts
Over-the-counter options (OTC options, also called "dealer options") are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. In general, at least one of the counterparties to an OTC option is a well-capitalized institution.
Option types commonly traded over the counter include:
interest rate options currency cross rate options, and options on swaps or swaptions.
This tutorial from investopedia gives a clear picture about options.
The primary types of financial options are:
Exchange traded options (also called "listed options") are a class of exchange traded derivatives. Exchange traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the credit of the exchange. Since the contracts are standardized, accurate pricing models are often available.
Exchange traded options include:
stock options, commodity options, bond options and other interest rate options index (equity) options, and options on futures contracts
Over-the-counter options (OTC options, also called "dealer options") are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. In general, at least one of the counterparties to an OTC option is a well-capitalized institution.
Option types commonly traded over the counter include:
interest rate options currency cross rate options, and options on swaps or swaptions.
Derivatives
Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The main types of derivatives are futures, forwards, options, and swaps.
Monday, September 29, 2008
Hedging
In finance, a hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. Hedging is a strategy designed to minimize exposure to an unwanted business risk, particularly in inflationary economies, while still allowing the business to profit from an investment activity.
Friday, September 26, 2008
Listed Company going Bankrupt - What does it mean to investors?
If a large corporation goes bankrupt or taken over by the government (example AIG taken over from Federal Reserve) it means shareholders' equity in that company was wiped out.
It exactly means your investment in that company is gone.
It exactly means your investment in that company is gone.
Home Equity
Home Equity is the value of a homeowner's unencumbered (Property that is not subject to any creditor claims or liens) interest in their property, i.e. the difference between the home's fair market value and the unpaid balance of the mortgage and any outstanding debt over the home. Equity increases as the mortgage is paid or as the property enjoys appreciation. This is sometimes called real property value in economics.
Arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.
Home Equity Loan
Lien
Mortgage
Arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.
Home Equity Loan
Lien
Mortgage
What caused US financial Crisis
Option ARM's and Sub-Prime mortgages played a significant role in the turmoil of US Financial Systems.
Adjustable Rate Mortgage
Adjustable Rate Mortgage (ARM) is a mortgage loan where the interest rate on the note is periodically adjusted based on a variety of indices.[1] Among the most common indices are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR).
Option ARMs were marketed to borrowers via low introductory rates and included various payment options. Those loans often included the option to pay only interest, which caused the borrowers debt to grow with each payment, becoming negative amortization loans.
When housing prices began to fall just at the time rates were adjusting higher on those loans, borrowers began defaulting at alarming rates, leading to big losses for WaMu and others who had extended the credit or purchased securities based on the credits.
Negative amortization an amortization schedule where the loan amount actually increases through not paying the full interest. In other words "whenever the loan payment (loan amount) for any period is less than the interest charged over that period so that the outstanding balance of the loan increases"
Option ARMs were marketed to borrowers via low introductory rates and included various payment options. Those loans often included the option to pay only interest, which caused the borrowers debt to grow with each payment, becoming negative amortization loans.
When housing prices began to fall just at the time rates were adjusting higher on those loans, borrowers began defaulting at alarming rates, leading to big losses for WaMu and others who had extended the credit or purchased securities based on the credits.
Negative amortization an amortization schedule where the loan amount actually increases through not paying the full interest. In other words "whenever the loan payment (loan amount) for any period is less than the interest charged over that period so that the outstanding balance of the loan increases"
Subprime
Subprime crisis that put the US financial companies into turmoil was not so good lending practice, which basically aimed at low income or below average credit score consumers. Many lenders including large financial corporations tried to make more money by making hidden charges and costs for subprime mortgage loans which many consumer who signed didn't know about, leading to about 1.3 million foreclosures of housing property which ultimately resulted in housing decline in US.
Subprime mortgage crisis
Subprime mortgage crisis
Write-off
The term write-off (or write-down) describes a reduction in recognized value. In accounting terminology, it refers to recognition of the reduced or zero value of an asset.
Credit risk
Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of credit (either the principal or interest (coupon) or both)
Friday, September 19, 2008
Trade Finance
Trade Finance is a specific topic within the financial services industry. It's much different, for example, than commercial lending, mortgage lending or insurance. A product is sold and shipped overseas, therefore, it takes longer to get paid. Extra time and energy is required to make sure that buyers are reliable and creditworthy. In addition, foreign buyers - just like domestic buyers - prefer to delay payment until they receive and resell the goods. Due diligence and careful financial management can mean the difference between profit and loss on each transaction.
More on Trade Finance can be found here
An excellent introduction about Trade Finance can be found here.
More on Trade Finance can be found here
An excellent introduction about Trade Finance can be found here.
Letter of Credit (L/C)
Short Selling
In finance, short selling or "shorting" is the practice of selling a financial instrument the seller does not own, in the hope of repurchasing them later at a lower price. This is done in an attempt to profit from an expected decline in price of a security, such as a stock or a bond, in contrast to the ordinary investment practice, where an investor "goes long," purchasing a security in the hope the price will rise.
Link-I and Link-II are helpful for understanding better.
Link-I and Link-II are helpful for understanding better.
Thursday, September 18, 2008
Floating And Fixed Exchange Rates
There are two ways the price of a currency can be determined against another. A fixed exhange rate, or pegged exchange rate and a floating rate. Floating rate is further classified as Free Floating and Managed or dirty float. This link speaks more about exchange rates.
Drawbacks of Pegged System
Drawbacks of Pegged System
Indian Currency - Managed Float - Exchange Rate Regime
Officially, the Indian rupee has a market determined exchange rate. However, the RBI trades actively in the USD/INR currency market to impact effective exchange rates. Thus, the currency regime in place for the Indian rupee with respect to the US dollar is a de facto controlled exchange rate. This is sometimes called a dirty or managed float. Other rates such as the EUR/INR and INR/JPY have volatilities that are typical of floating exchange rates.[2] It should be noted, however, that unlike China, successive administrations (through RBI, the central bank) have not followed a policy of pegging the INR to a specific foreign currency at a particular exchange rate. RBI intervention in currency markets is solely to deliver low volatility in the exchange rates, and not to take a view on the rate or direction of the Indian rupee in relation to other currencies.[3]
RBI also exercises a system of capital controls in addition to the intervention (through active trading) in the currency markets. On the current account, there are no currency conversion restrictions hindering buying or selling foreign exchange (though trade barriers do exist). On the capital account, foreign institutional investors have convertibility to bring money in and out of the country and buy securities (subject to certain quantitative restrictions). Local firms are able to take capital out of the country in order to expand globally. But local households are restricted in their ability to do global diversification. However, owing to an enormous expansion of the current account and the capital account, India is increasingly moving towards de facto full Capital Account convertibility.
RBI also exercises a system of capital controls in addition to the intervention (through active trading) in the currency markets. On the current account, there are no currency conversion restrictions hindering buying or selling foreign exchange (though trade barriers do exist). On the capital account, foreign institutional investors have convertibility to bring money in and out of the country and buy securities (subject to certain quantitative restrictions). Local firms are able to take capital out of the country in order to expand globally. But local households are restricted in their ability to do global diversification. However, owing to an enormous expansion of the current account and the capital account, India is increasingly moving towards de facto full Capital Account convertibility.
Progessive Tax
A progressive tax is a tax imposed so that the tax rate increases as the amount subject to taxation increases. In simple terms, it imposes a greater burden (relative to resources) on the rich than on the poor.
More about progressive tax can be found here.
More about progressive tax can be found here.
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