Showing posts with label Money. Show all posts
Showing posts with label Money. Show all posts
MONETARY POLICY TOOLS AND THE FEDERAL FUNDS RATE BASIC INFORMATION
Until the financial crisis of 2007–2009, the Fed primarily relied on three monetary policy tools. During the financial crisis, the Fed announced several new policy tools. In the fall of 2010, two of these new policy tools were still active.We first consider the Fed’s three traditional policy tools:
1. Open market operations. Open market operations are the Fed’s purchases and sales of securities in financial markets. Traditionally, the Fed concentrated on purchases and sales of Treasury bills, with the aim of influencing the level of bank reserves and short-term interest rates. During the financial crisis, the Fed began purchasing a wider variety of securities to affect long-term interest rates and to support the flow of credit in the financial system.
2. Discount policy. Discount policy includes setting the discount rate and the terms of discount lending. When Congress passed the Federal Reserve Act in 1913, it expected that discount policy would be the Fed’s primary monetary policy tool. The discount window is the means by which the Fed makes discount loans to banks, and serves as the channel to meet banks’ short-term liquidity needs.
3. Reserve requirements. The Fed mandates that banks hold a certain fraction of their checkable deposits as vault cash or deposits with the Fed. These reserve requirements are the last of the Fed’s three traditional monetary policy tools. The required reserve ratio is a determinant of the money multiplier in the money supply process.
During the financial crisis, the Fed introduced two new policy tools connected with bank reserve accounts that were still active in the fall of 2010:
1. Interest on reserve balances. In October 2008, the Fed introduced a new tool when it began for the first time to pay interest on banks’ required reserve and excess reserve deposits. Reserve requirements impose an implicit tax on banks because banks could otherwise receive interest on the funds by lending them out or by investing them.
The Fed reduces the size of this tax by paying interest on reserve balances. The Fed also gains a greater ability to influence banks’ reserve balances. By raising the interest rate it pays, the Fed can increase banks’ holdings of reserves, potentially restraining banks’ ability to extend loans and increase the money supply. By reducing the interest rate, the Fed can have the opposite effect.
2. Term deposit facility. In April 2010, the Fed announced that it would offer banks the opportunity to purchase term deposits, which are similar to the certificates of deposit that banks offer to households and firms. The Fed offers term deposits to banks in periodic auctions. The interest rates are determined by the auctions and have been slightly above the interest rate the Fed offers on reserve balances.
For example, in October 2010, the interest rate on the Fed’s auction of $5 billion in 28-day term deposits was 0.27%, which was higher than the interest rate of 0.25% the Fed was paying on reserve deposits. The term deposit facility gives the Fed another tool in managing bank reserve holdings. The more funds banks place in term deposits, the less they will have available to expand loans and the money supply.
MAJOR WORLD CURRENCIES (MONEY) BASIC INFORMATION AND TUTORIALS
The U.S. Dollar
The United States dollar is the world's main currency. All currencies are generally quoted in U.S. dollar terms. Under conditions of international economic and political unrest, the U.S. dollar is the main safe-haven currency which was proven particularly well during the Southeast Asian crisis of 1997-1998.
The U.S. dollar became the leading currency toward the end of the Second World War and was at the center of the Bretton Woods Accord, as the other currencies were virtually pegged against it. The introduction of the euro in 1999 reduced the dollar's importance only marginally. The major currencies traded against the U.S. dollar are the euro, Japanese yen, British pound, and Swiss franc.
The Euro
The euro was designed to become the premier currency in trading by simply being quoted in American terms. Like the U.S. dollar, the euro has a strong international presence stemming from members of the European Monetary Union.
The currency remains plagued by unequal growth, high unemployment, and government resistance to structural changes. The pair was also weighed in 1999 and 2000 by outflows from foreign investors, particularly Japanese, who were forced to liquidate their losing investments in eurodenominated assets.
Moreover, European money managers rebalanced their portfolios and reduced their euro exposure as their needs for hedging currency risk in Europe declined.
The Japanese Yen
The Japanese yen is the third most traded currency in the world; it has a much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the world, practically around the clock.
The natural demand to trade the yen concentrated mostly among the Japanese keiretsu, the economic and financial conglomerates. The yen is much more sensitive to the fortunes of the Nikkei index, the Japanese stock market, and the real estate market.
The attempt of the Bank of Japan to deflate the double bubble in these two markets had a negative effect on the Japanese yen, although the impact was short-lived
The British Pound
Until the end of World War II, the pound was the currency of reference. Its nickname, cable, is derived from the telex machine, which was used to trade it in its heyday. The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other currencies.
The two-year bout with the Exchange Rate Mechanism, between 1990 and 1992, had a soothing effect on the British pound, as it generally had to follow the deutsche mark's fluctuations, but the crisis conditions that precipitated the pound's withdrawal from the ERM had a psychological effect on the currency.
Prior to the introduction of the euro, both the pound benefited from any doubts about the currency convergence. After the introduction of the euro, Bank of England is attempting to bring the high U.K. rates closer to the lower rates in the euro zone. The pound could join the euro in the early 2000s, provided that the U.K. referendum is positive.
The Swiss Franc
The Swiss franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries.
Although the Swiss economy is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength and quality of the Swiss economy and finance. Switzerland has a very close economic relationship with Germany, and thus to the euro zone.
Therefore, in terms of political uncertainty in the East, the Swiss franc is favored generally over the euro. Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity. As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.
MONEY MANAGEMENT DEFINITION BASIC INFORMATION AND TUTORIALS
WHAT IS MONEY MANAGEMENT?
I n my opinion, money management is the most significant part of any trading system. Many professionals, and most amateurs, do not understand how important it is. In fact, I recently attended a seminar for stock brokers that detailed a particular method of investing that they could use to help their clients.
While the seminar as a whole was terrific, the topic of money management, as I’ve defined it here, was not even covered. One speaker did talk about money management, but I could not fit what he was talking about into this discussion at all. At the end of ,his talk, I asked him, “What do you mean by money management?”
His response was, “That’s a very good question. I think it’s how one makes trading decisions.” Since money management is the difference between poor performance and great performance - the difference between going broke and being a successful professional - it’s important that I define it right now. Please take note.
The concept is critical because the question of “how much” determines your loss potential and your profit potential. In addition, you need to spread your opportunity around into a number of different investments or products. Equalizing your exposure over the various trades or investments in your portfolio gives each one an equal chance of making you money.
I was intrigued when I read Jack Schwager’s Market Wizards in which he interviews some of the world’s top traders and investors. Practically all of them talked about the importance of money management.
Here are a few sample quotes:
“Risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half” - Bruce Kovner
“Never risk more than 1% of your total equity in any one trade. By risking I %, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical. ” - Lamy Hite
“You have to minimize your losses and tv to preserve capital for those very few instances where you can make a lot in a very short period of time. what you can’t afford to do is throw away your capital on suboptimal trades. ” - Richard Dennis
Professional gamblers play low expectancy, or even negative expectancy, games. They simply use skill and/or knowledge to get a slight edge. These people understand very clearly that money management is the key to their success. Money management for gamblers tends to fall into two types of systems - martingale and antimartingale systems.
Martingale systems increase winnings during a losing streak. For example, suppose you were playing red and black at the roulette wheel. Here you are paid a dollar for every dollar you risk, but your odds of winning are less than 50% on each trial. However, with the martingale system you think you have a chance of making money through money management.
The assumption is that after a string of losses you will eventually win. And the assumption is true - you will win eventually. Consequently, you start with a bet of one dollar and double the bet after every loss. When the ball falls on the color you bet, you will make a dollar frbm the entire sequence of wagers.
The logic is sound. Eventually, you will win and make a dollar. But two factors work against you when you use a martingale system. First, long losing streaks are possible, especially since the odds are less than 50% in your favor.
For example, one is likely to have a streak of 10 losses in a row in a 1,000 trials. In fact, a streak of 15 or 16 losses in a row is quite probable. By the time you have reached ten in a row, you would be betting $2,048 in order to come out a dollar ahead. If you lose on the eleventh throw, you would have lost $4,095. Your reward to- risk ratio is now 1 to 4095.
Second, the casinos place betting limits. At a table where the minimum bet was a dollar, they would never allow you to bet much over $50 or $100. As a result, martingale betting systems, where you risk more when you lose, just do not work.
Antimartingale systems, where you increase your risk when you win, do work. Smart gamblers know to increase their bets, within certain limits, when they are winning. And the same is true for trading
or investing. Money management systems that work call for you to increase your position size when you make money. That holds for gambling and for trading and for investing.
The purpose of money management is to tell you how many units (shares or contracts) you are going to put on, given the size of your account. For example, a money management decision might be that you don’t have enough money to put on any positions because the risk is too big. It allows you to determine your reward and risk characteristics by determining how many units you risk on a given trade and in each trade in a portfolio.
It also helps you equalize your trade exposure in the elements in your portfolio. Some people believe that they are “managing their money” by having a “money management stop.” Such a stop would be one in which you get out of your position when you lose a predetermined amount of money - say $1000.
However, this kind of stop does not tell you “‘how much” or ‘how many,” so it really has nothing to do with money management. Controlling risk by determining the amount of loss if you are stopped out is not the same as controlling risk through a money management model that determines the size of your position.
There are numerous money management strategies that you can use. In the remainder of this update, you’ll learn different money management strategies that work well. Some are probably much more suited to your style of trading or investing than others. Some work best with stock accounts, while others are designed for a futures account.
All of them are anti-martingale strategies in that your position size goes up as your account size grows. The material is somewhat complex. However, I’ve avoided the use of difficult mathematical expressions and given clear examples of each strategy. As a result, you simply need to read the material carefully and go over it until you understand it.
I n my opinion, money management is the most significant part of any trading system. Many professionals, and most amateurs, do not understand how important it is. In fact, I recently attended a seminar for stock brokers that detailed a particular method of investing that they could use to help their clients.
While the seminar as a whole was terrific, the topic of money management, as I’ve defined it here, was not even covered. One speaker did talk about money management, but I could not fit what he was talking about into this discussion at all. At the end of ,his talk, I asked him, “What do you mean by money management?”
His response was, “That’s a very good question. I think it’s how one makes trading decisions.” Since money management is the difference between poor performance and great performance - the difference between going broke and being a successful professional - it’s important that I define it right now. Please take note.
The concept is critical because the question of “how much” determines your loss potential and your profit potential. In addition, you need to spread your opportunity around into a number of different investments or products. Equalizing your exposure over the various trades or investments in your portfolio gives each one an equal chance of making you money.
I was intrigued when I read Jack Schwager’s Market Wizards in which he interviews some of the world’s top traders and investors. Practically all of them talked about the importance of money management.
Here are a few sample quotes:
“Risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half” - Bruce Kovner
“Never risk more than 1% of your total equity in any one trade. By risking I %, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical. ” - Lamy Hite
“You have to minimize your losses and tv to preserve capital for those very few instances where you can make a lot in a very short period of time. what you can’t afford to do is throw away your capital on suboptimal trades. ” - Richard Dennis
Professional gamblers play low expectancy, or even negative expectancy, games. They simply use skill and/or knowledge to get a slight edge. These people understand very clearly that money management is the key to their success. Money management for gamblers tends to fall into two types of systems - martingale and antimartingale systems.
Martingale systems increase winnings during a losing streak. For example, suppose you were playing red and black at the roulette wheel. Here you are paid a dollar for every dollar you risk, but your odds of winning are less than 50% on each trial. However, with the martingale system you think you have a chance of making money through money management.
The assumption is that after a string of losses you will eventually win. And the assumption is true - you will win eventually. Consequently, you start with a bet of one dollar and double the bet after every loss. When the ball falls on the color you bet, you will make a dollar frbm the entire sequence of wagers.
The logic is sound. Eventually, you will win and make a dollar. But two factors work against you when you use a martingale system. First, long losing streaks are possible, especially since the odds are less than 50% in your favor.
For example, one is likely to have a streak of 10 losses in a row in a 1,000 trials. In fact, a streak of 15 or 16 losses in a row is quite probable. By the time you have reached ten in a row, you would be betting $2,048 in order to come out a dollar ahead. If you lose on the eleventh throw, you would have lost $4,095. Your reward to- risk ratio is now 1 to 4095.
Second, the casinos place betting limits. At a table where the minimum bet was a dollar, they would never allow you to bet much over $50 or $100. As a result, martingale betting systems, where you risk more when you lose, just do not work.
Antimartingale systems, where you increase your risk when you win, do work. Smart gamblers know to increase their bets, within certain limits, when they are winning. And the same is true for trading
or investing. Money management systems that work call for you to increase your position size when you make money. That holds for gambling and for trading and for investing.
The purpose of money management is to tell you how many units (shares or contracts) you are going to put on, given the size of your account. For example, a money management decision might be that you don’t have enough money to put on any positions because the risk is too big. It allows you to determine your reward and risk characteristics by determining how many units you risk on a given trade and in each trade in a portfolio.
It also helps you equalize your trade exposure in the elements in your portfolio. Some people believe that they are “managing their money” by having a “money management stop.” Such a stop would be one in which you get out of your position when you lose a predetermined amount of money - say $1000.
However, this kind of stop does not tell you “‘how much” or ‘how many,” so it really has nothing to do with money management. Controlling risk by determining the amount of loss if you are stopped out is not the same as controlling risk through a money management model that determines the size of your position.
There are numerous money management strategies that you can use. In the remainder of this update, you’ll learn different money management strategies that work well. Some are probably much more suited to your style of trading or investing than others. Some work best with stock accounts, while others are designed for a futures account.
All of them are anti-martingale strategies in that your position size goes up as your account size grows. The material is somewhat complex. However, I’ve avoided the use of difficult mathematical expressions and given clear examples of each strategy. As a result, you simply need to read the material carefully and go over it until you understand it.
FINANCIAL ASSETS CATEGORIES BASIC AND TUTORIALS
WHAT ARE THE CATEGORIES OF FINANCIAL ASSETS?
The following are five key categories of assets:
1. Money
2. Stocks
3. Bonds
4. Foreign exchange
5. Securitized loans
We now briefly discuss these five key assets.
Money
Although we typically think of “money” as coins and paper currency, even the narrowest government definition of money includes funds in checking accounts. In fact, economists have a very general definition of money: Money is anything that people are willing to accept in payment for goods and services or to pay off debts.
The money supply is the total quantity of money in the economy. money plays an important role in the economy, and there is some debate concerning the best way to measure it.
Stocks
Stocks, also called equities, are financial securities that represent partial ownership of a corporation.When you buy a share of Microsoft stock, you become a Microsoft shareholder, and you own part of Microsoft, although only a tiny part because Microsoft has issued millions of shares of stock.
When Microsoft sells additional stock, it is doing the same thing that the owner of a small firm does when she takes on a partner: increasing the funds available to the firm, its financial capital, in exchange for increasing the number of the firm’s owners.
As an owner of a share of stock in a corporation, you have a legal claim to a share of the corporation’s assets and to a share of its profits, if there are any. Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends, which are payments corporations typically make every quarter.
Bonds
When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. The interest rate is the cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed. For instance, if you borrow $1,000 from a friend and pay him back $1,100 a year later, the interest rate on the loan was $100/$1,000 = 0.10, or 10%.
Bonds typically pay interest in fixed dollar amounts called coupons. When a bond matures, the seller of the bond repays the principal. For example, if you buy a $1,000 bond issued by IBM that has a coupon of $65 per year and a maturity of 30 years, IBM will pay you $65 per year for the next 30 years, at the end of which IBM will pay you the $1,000 principal.
A bond that matures in one year or less is a short-term bond. A bond that matures in more than one year is a long-term bond. Bonds can be bought and sold in financial markets, so, like stocks, bonds are securities.
Foreign Exchange
Many goods and services purchased in a country are produced outside that country. Similarly, many investors buy financial assets issued by foreign governments and firms. To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency.
For example, consumer electronics giant Best Buy exchanges U.S. dollars for Japanese yen when importing Sony televisions. Foreign exchange refers to units of foreign currency. The most important buyers and sellers of foreign exchange are large banks.
Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets. Banks also engage in foreign currency transactions on behalf of firms that want to import or export goods and services or to invest in physical assets, such as factories, in foreign countries.
Securitized Loans
If you lack the money to pay the full price of a car or house in cash, you can apply for a loan at a bank. Similarly, if a developer wants to build a new office building or shopping mall, the developer can also take out a loan with a bank.
Until about 30 years ago, banks made loans with the intention of making profits by collecting interest payments on a loan until the loan was paid off. It wasn’t possible to sell most loans in financial markets, so loans were financial assets but not securities.
The federal government and some financial firms created markets for many types of loans. Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization.
To take one example, a bank might grant a mortgage, which is a loan a borrower uses to buy a home, and sell it to a government-sponsored enterprise or a financial firm that will bundle the mortgage together with similar mortgages granted by other banks.
This bundle of mortgages will form the basis of a new security called a mortgage-backed security that will function like a bond. Just as an investor can buy a bond from IBM, the investor can buy a mortgage-backed security from the government agency or financial firm.
The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security.
The bank will receive fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders.
Note that what a saver views as a financial asset a borrower views as a financial liability. A financial liability is a financial claim owed by a person or a firm. For example, if you take out a car loan from a bank, the loan is an asset from the viewpoint of the bank because it represents a promise by you to make a certain payment to the bank every month until the loan is paid off. But the loan is a liability to you, the borrower, because you owe the bank the payments specified in the loan.
The following are five key categories of assets:
1. Money
2. Stocks
3. Bonds
4. Foreign exchange
5. Securitized loans
We now briefly discuss these five key assets.
Money
Although we typically think of “money” as coins and paper currency, even the narrowest government definition of money includes funds in checking accounts. In fact, economists have a very general definition of money: Money is anything that people are willing to accept in payment for goods and services or to pay off debts.
The money supply is the total quantity of money in the economy. money plays an important role in the economy, and there is some debate concerning the best way to measure it.
Stocks
Stocks, also called equities, are financial securities that represent partial ownership of a corporation.When you buy a share of Microsoft stock, you become a Microsoft shareholder, and you own part of Microsoft, although only a tiny part because Microsoft has issued millions of shares of stock.
When Microsoft sells additional stock, it is doing the same thing that the owner of a small firm does when she takes on a partner: increasing the funds available to the firm, its financial capital, in exchange for increasing the number of the firm’s owners.
As an owner of a share of stock in a corporation, you have a legal claim to a share of the corporation’s assets and to a share of its profits, if there are any. Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends, which are payments corporations typically make every quarter.
Bonds
When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. The interest rate is the cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed. For instance, if you borrow $1,000 from a friend and pay him back $1,100 a year later, the interest rate on the loan was $100/$1,000 = 0.10, or 10%.
Bonds typically pay interest in fixed dollar amounts called coupons. When a bond matures, the seller of the bond repays the principal. For example, if you buy a $1,000 bond issued by IBM that has a coupon of $65 per year and a maturity of 30 years, IBM will pay you $65 per year for the next 30 years, at the end of which IBM will pay you the $1,000 principal.
A bond that matures in one year or less is a short-term bond. A bond that matures in more than one year is a long-term bond. Bonds can be bought and sold in financial markets, so, like stocks, bonds are securities.
Foreign Exchange
Many goods and services purchased in a country are produced outside that country. Similarly, many investors buy financial assets issued by foreign governments and firms. To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency.
For example, consumer electronics giant Best Buy exchanges U.S. dollars for Japanese yen when importing Sony televisions. Foreign exchange refers to units of foreign currency. The most important buyers and sellers of foreign exchange are large banks.
Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets. Banks also engage in foreign currency transactions on behalf of firms that want to import or export goods and services or to invest in physical assets, such as factories, in foreign countries.
Securitized Loans
If you lack the money to pay the full price of a car or house in cash, you can apply for a loan at a bank. Similarly, if a developer wants to build a new office building or shopping mall, the developer can also take out a loan with a bank.
Until about 30 years ago, banks made loans with the intention of making profits by collecting interest payments on a loan until the loan was paid off. It wasn’t possible to sell most loans in financial markets, so loans were financial assets but not securities.
The federal government and some financial firms created markets for many types of loans. Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization.
To take one example, a bank might grant a mortgage, which is a loan a borrower uses to buy a home, and sell it to a government-sponsored enterprise or a financial firm that will bundle the mortgage together with similar mortgages granted by other banks.
This bundle of mortgages will form the basis of a new security called a mortgage-backed security that will function like a bond. Just as an investor can buy a bond from IBM, the investor can buy a mortgage-backed security from the government agency or financial firm.
The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security.
The bank will receive fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders.
Note that what a saver views as a financial asset a borrower views as a financial liability. A financial liability is a financial claim owed by a person or a firm. For example, if you take out a car loan from a bank, the loan is an asset from the viewpoint of the bank because it represents a promise by you to make a certain payment to the bank every month until the loan is paid off. But the loan is a liability to you, the borrower, because you owe the bank the payments specified in the loan.
Subscribe to:
Posts (Atom)