Are Collateralized Debt Obligations Risky Investments?

A collateralized debt obligation (CDO) is a security backed by a pool of assets, such as mortgages, credit card debt, or other types of loans. The issuer of a CDO assembles different types of debt instruments and sells ownership stakes in the CDO to investors. Because the underlying assets are diverse, CDOs offer investors exposure to a wide range of risks. For this reason, some market observers believe that CDOs are risky investments. Others contend that for conservative investors, properly structured CDOs can be an attractive way to gain diversified exposure to the debt market.

Collateralized debt obligations are a collection of secured debts, which is where the “collateral” part comes in. With secured debts, borrowers are required to put up an asset as collateral. If they default, that asset can be seized.

They are typically taken on by institutional investors like pension funds, insurance companies, banks, investment managers and other financial institutions.

Different types of CDOs may be known by different names, based on the type of loans packaged in the CDO. For example, a CDO of mortgage loans is known as a “mortgage-backed security” (MBS), while other collections of debt like credit cards, student loans and corporate debt are known as “asset-backed securities.”

The advantage of CDOs is that, when the economy is strong, these high-risk investments can turn out better returns compared to other fixed-income products in their portfolio. For institutional investors like pension funds, insurance companies and hedge funds, that translates into higher profits.

Since CDOs aren’t tangible assets, their value is determined through a computer model. As those have become more complex, so has evaluating risk. Read more

What are your thoughts on collateralized debt obligations? Are they risky investments? Let us know in the comments below!

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Writing Off Bad Debts

Companies offer credit sales, allowing customers to pay for products and services later. Companies record sales made on credit as accounts receivable. Later, they account for any repayments from customers as a reduction in that account. Sometimes, however, customers may also fail to repay their suppliers. In those cases, companies must write off bad debts.

What is a Bad Debt?

Bad debt is an expense that represents receivable amounts no longer collectible. As mentioned, companies record these amounts when customers fail to repay their owed amounts. Several reasons may exist for their failure to reimburse the company. For example, some customers may be going through bankruptcy or experiencing financial issues.

A bad debt represents an amount that a company deems as irrecoverable. This amount relates to the sales made to customers at an earlier date. For most companies offering credit terms, bad debts are inevitable. These amounts fall under the general administrative expenses reported in the income statement. Writing off bad debts helps represent a true and fair picture of accounts receivable balances.

What is the accounting for Bad Debts?

Companies report bad debts in the financial statements under two methods. The first of these includes the direct write-off method. Under this approach, companies write off bad debts directly against the related receivable account. Usually, companies estimate these bad debts through the corresponding transaction. This method of writing off bad debts is more accurate.

The other approach to reporting bad debts is the allowance method. It does not include a specific bad debt or account. Instead, it estimates the bad debt expense at the end of each accounting period. On top of that, it does not reduce the accounts receivable balance directly.

What are the journal entries for Bad Debts?

The journal entries for bad debts depend on the approach that companies use. As mentioned, these include the direct write-off and allowance methods.

Direct write-off method

Under the direct write-off method, companies report bad debts for specific receivable accounts. This approach involves recording an expense for the irrecoverable amount. On the other hand, it also reduces the receivable balance for the customer account. The journal entries for writing off bad debts under this approach are below.

Dr	Bad debts
Cr	Accounts receivable

Allowance method

Under the allowance method, companies estimate doubtful debts based on past experiences. Usually, this approach involves creating an expense of those amounts. On the other hand, it also requires companies to record a provision for those amounts. The journal entries for writing off doubtful debts under the allowance method are below.

Dr	Doubtful debts
Cr	Allowance for doubtful debts

Example

A company, Green Co., provides credit sales to customers. During a financial year, the company sells goods worth $100,000. However, the company believes $5,000 of this balance to be irrecoverable. On top of that, Green Co. also estimates $3,000 to be doubtful. Therefore, the company must record these debts as bad and doubtful, respectively.

For the bad debts, Green Co. uses the following journal entries.

Dr	Bad debts	$5,000
Cr	Accounts receivable	$5,000

For the doubtful debts, Green Co. uses the following double-entries.

Dr	Doubtful debts	$3,000
Cr	Allowance for doubtful debts	$3,000

Conclusion

Bad debts are an expense in the income statement that relates to amounts owed by customers. When a customer fails to repay, the debt becomes irrecoverable. For that amount, the company must write off the bad debts. Similarly, companies must also estimate doubtful debts and record them in the income statement.

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Decentralized Finance (DeFi) Will Continue to Grow

Decentralized Finance (DeFi) Will Continue to Grow

DeFi, which stands for Decentralized Finance, is a growing sector in the world of finance. It refers to financial applications that are built on top of blockchain technology, and it offers a number of advantages over traditional finance. DeFi is still in its early days, but it is quickly gaining traction and there is no doubt that it will continue to grow in the years ahead.

Decentralised Finance (DeFi) will continue to grow driven by innovations in automated market-making and other liquidity-providing solutions leading to attractive yields on cryptocurrencies, according to Swapnil Pawar, Founder at blockchain startup ASQI told Financial Express Online. Moreover, with the emergence of platforms like Olympus decentralized autonomous organization (DAO) and subsequent forks like Wonderland, a new DeFi commonly known DeFi 2.0 is likely to gain momentum.  Read more

In a decentralized finance world, counterparties can create products and instruments without the need for a third party. While this may sound like a positive development, it has led to the creation of complex and innovative derivatives products that are difficult to understand and trade.

“Complex derivative products and innovative financial instruments are being created daily. Early participants are being rewarded with returns in the 1000s of percentage Moreover, with the DeFi 2.0, institutions can no longer ignore the returns and would look for safe methods to participate in the wild west of crypto,”

The growth of new technologies in the finance world is a testament to how dramatically the industry has changed over time. One area that this change has been felt most keenly is with Decentralized Finance, which brings new opportunities for investment but also more risks if they’re not properly understood and managed.

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Selection Bias: How It Affects Our Lives

Human psychological bias affects us in many different ways. We have recently discussed how recency bias influences our trading. In this post, we’re going to talk about selection bias.

Selection bias occurs when a statistical sample is not representative of the entire population. This situation arises, for example, when a study is based on a small number of people, and/or the subjects are not truly randomized. It can also happen when the researchers subconsciously project their own beliefs onto the experiment design, thus leading to inaccurate results. In trading and portfolio management, the selection bias often manifests itself in the form of cherry-picking, i.e. the tendency for the portfolio managers to present results using samples that validate their views.

A recent article [1] examined the selection bias in a larger context. Specifically, it studied how the success narratives affect people’s decision making,

In this paper, we complement and build upon these previous efforts by focusing on the extent to which popular and widely-read success narratives containing plainly biased examples affect people’s decision-making in terms of what choices they make, how confident they are in those choices, and the justifications they provide around them. In our experiment, we observed a strikingly large difference in participants’ decisions depending on which condition they were assigned to: while 87% of people shown examples of successful graduates bet that graduates are more likely to succeed, only 32% of people shown examples of successful dropouts bet on graduates, a difference of 55 percentage points. Far from discounting the small sets of examples they acknowledged as biased, participants were substantially swayed by them. This strong effect on beliefs is caused by a weak manipulation that involves no outright deception.

Briefly, our decision making can be manipulated without difficulty. In fact, the authors pointed out that even with factual accurate data, its selective presentation can still lead us to a wrong conclusion,

There are many examples of the selective presentation of factually accurate data in polarizing domains like climate science, gun control, immigration, police violence, and social insurance programs. Given the size of the effect that we found with a manipulation that would clearly pass a conventional fact check, our results suggest that more attention should be paid to the prevalence and impact of presenting biased selections of factually accurate examples.

We believe that with the increasing influence of social media, selection bias will have a bigger impact on our decision making. Therefore it’s more important than ever to conduct investment research that is based on statistically valid samples and techniques.

References

[1] G. Lifchits, A. Anderson, DG. Goldstein, JM. Hofman, DJ. Watts, Success stories cause false beliefs about success, Judgment and Decision Making, Vol. 16, No. 6, November 2021, pp. 1439–1463

Originally Published Here: Selection Bias: How It Affects Our Lives

Time-Weighted Rate of Return

In order for us to have a clear idea of our compound growth rate, we must first understand the Time-Weighted Rate Of Return (TWR). Remember, compound growth is simply paying yourself a percentage of your earnings and then reinvesting those earnings to generate a larger return.

In this article, we will be digging deep into the Time-Weighted Rate Of Return or TWR. We will be looking at what it is, how does it work, and why it is important for your investment portfolio. So, let's get started.

What Is Time-Weighted Rate Of Return

In finance, there are a few metrics that have been used to measure the performance of your investment portfolio. One of those rates is the TWR which stands for "Time-Weighted Rate Of Return." The TWR helps to measure the growth of your investment portfolio. It basically breaks up your investment portfolio into different intervals based on your deposits or withdrawals. The TWR also eliminates the distorting effects in growth rates created by the inflows and outflows of money. So it can also be used for comparing the returns of investment managers and various investment portfolios.

The importance of Time-Weighted Rate Of Return

It is hard to calculate the rate of returns from an investment portfolio where there are multiple deposits and withdrawals. This is because when you add these transactions to your investment portfolio, there will be a significant change in the investment value and performance of your portfolio. This change is due to compounding which can be witnessed in both upward and downward movements in the value of your investments.

On the other hand, multiple investments and redemptions can distort the rate of returns over a period of time. It can be difficult to know how much each transaction has contributed to the total return.

So for these reasons, we need a metric that helps us eliminate or adjust for the inflows and outflows of money. That's where the TWR comes in. It helps us get a more accurate picture of the rate of returns for our portfolio.

How does Time-Weighted Rate Of Return work

TWR basically calculates the rate of return for your investment portfolio based on changes in cash flow. It is the calculation of the investment returns that managers generate over a specific time period that is geometrically connected or compounded. Here is the formula for calculating TWR or Time-Weighted Rate Of Return

TWR = [(1+HP1) x (1+HP2) x (1+HPn)] – 1

In this formula

1. n = the number of sub-periods
2. HP = (End Value - (Beginning Value + Cash Flow)) / (Beginning Value + Cash Flow)
3. HPn = Return for sub-period n

Conclusion

In conclusion, the TWR or Time-Weighted Rate Of Return is a metric that helps us get a better picture of our investment portfolio returns. In other words, it helps get rid of the distortion in growth rates due to inflows and outflows of money. This makes it easier for us to analyze how well we have been performing as investors.

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Could There Be a Bitcoin Crash Next Year?

Could There Be a #Bitcoin Crash Next Year?#BTC #SPYhttps://t.co/tU4VpwLJKV

— Harbourfront Technologies (@DerivValuation) December 28, 2021

2021 was a meteoric year for crypto, with bitcoin looking to end the year almost 70% up from its January starting value, the first big crypto company (Coinbase) going public in April, and the launch of the first SEC-approved bitcoin futures ETF in October. This year experienced a lot of volatility in the crypto space, but overall, crypto assets are worth an astounding $2 trillion as the year draws to a close; looking ahead to next year, analysts anticipate some major movement for bitcoin, reports CNBC.

Bitcoin is best known for its volatility and the allure of the gains that it can provide. However, several analysts believe that the surge seen this year could be erased in a potentially massive crash next year, as has been the historical case for the most popular cryptocurrency. In 2018, bitcoin once reached a high of almost $20,000, only to crash down to around $3,000 within the space of a few months.

“Without question, Bitcoin’s price chart appears to track many historical asset bubbles and busts and is carrying a ‘this time it’s different’ narrative just like other bubbles,” said Todd Lowenstein, chief equity strategist of Union Bank’s private banking arm.

Carol Alexander, professor of finance at Sussex University, goes a step further, expecting bitcoin to fall as low as $10,000 next year, completely erasing any gains from this year on the bearish sentiment that bitcoin doesn’t have fundamental value.

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Sales Discount: Accounting, Journal Entry, Example, Debit or Credit

Companies attract customers through their products and services. In addition to those, companies also provide other packages or incentives. These incentives come through the provision of credit terms and incentives. On top of these, companies also offer discounts that promote more sales. Usually, companies provide two forms of discounts, namely sales and trade discounts.

What is a Sales Discount?

A sales discount is a reduction in the amount owed by a customer. This discount does not relate to a company's operations, products, or services. Instead, they depend on the credit terms that companies offer. Sales discounts allow customers to pay a lower price for goods and services. However, this reduction is only valid if they pay promptly.

Another name used for sales discounts is cash discounts. These discounts allow companies to collect their receivables earlier. However, it depends on customers to utilize these discounts. Sales discounts usually fix a date or time for customers to repay. If they fail to reimburse the company until then, they will not receive the reduction in payment. Sales discounts are also crucial for cash and liquidity management.

How do Sales Discounts work?

When companies sell products or services, they may collect cash when the transaction occurs. However, some companies also offer credit terms, allowing customers to pay later. This strategy is crucial in allowing customers to purchase more products or services. However, companies may face an issue when collecting the owed amount. Usually, companies seek to receive these amounts as soon as possible.

It is where sales discounts can be helpful. With these discounts, companies offer customers the chance to reduce the owed amount. However, they also set an expiry time for it, which is before the credit term expires. It allows companies to collect cash earlier, providing more investment opportunities. On the other hand, the customer pays a lower price for the goods.

What is the accounting treatment of Sales Discount?

As mentioned, companies usually offer two types of discounts. A trade discount is a reduction in the price of goods or services. Accounting standards do not require an accounting treatment for those discounts. However, sales discounts are different. With these, companies must record the sold items at the agreed price.

The recording of sales has the same journal entries as traditional sales. However, the accounting for sales discount applies when customers avail the reduction in the owed amount. In that case, the company must record an expense for the reduced amount. Usually, companies use the following journal entries for sales discounts.

Dr	Discount allowed
Cr	Accounts receivable

Example

A company, Red Co., sells goods worth $1,000 to a customer on credit. The company records these sales as follows.

Dr	Accounts receivable	$1,000
Cr	Sales	$1,000

Red Co. requires the customer to repay within 30 days. However, the company also offers a sales discount of 10% if the customer pays within the next ten days. The customer avails of the sale discount and reimburses Red Co. within eight days. Red Co. receives a total of $900 from the customer. Therefore, the company will record the sales discount with the following journal entries.

Dr	Discount allowed	$100
Dr	Cash	$900
Cr	Accounts receivable	$1,000

Conclusion

A sales discount is a reduction of the money owed by a customer. This discount applies to products and services after the sales occur. Usually, it involves allowing customers to repay the company at an earlier date. Companies must record this discount as an expense in the accounts. Sales discounts help with cash management and can reduce bad debts.

Originally Published Here: Sales Discount: Accounting, Journal Entry, Example, Debit or Credit

Transaction Costs

Everyone is familiar with the term 'costs'. In business, there are all sorts of costs - from the cost of goods sold and the cost of marketing and sales to the cost of employee benefits and the cost of occupancy. But what about transaction costs?

Transaction costs are a unique type of cost that businesses incur whenever they exchange goods or services. Business owners need to be aware of these costs and take them into account when making decisions about exchanging goods or services. In this article, we'll take a look at transaction costs are some examples, and the different types of costs that fall under this category.

Definition of Transaction Cost

Transaction costs are an economic term that refers to the cost of participating in a market. It is a type of fee that is paid in order to engage in a transaction. Simply put, it is a payment that banks and brokers charge for their participation in a transaction. Even when you buy real estate or insurance and take assistance from an agent, you have to pay commission to him/her. That can also be considered as a transaction cost.

Examples of Transaction Cost

The following are examples of transaction costs

• Brokers' fees for buying or selling stocks on the stock market. A broker is an intermediary who helps you purchase, sell and manage your investment portfolio. The fee you pay the broker will be considered as a transaction cost.
• The average transaction cost for a mutual fund in the USA is around 1.45%. It is divided into many categories such as management fees, 12b-1 fees, and operating expenses.
• The cost of exchanging one currency for another is known as the foreign exchange rate or Forex rate. When you convert your British pounds into Euros, for example, you will be charged a fee by the bank. This fee is considered a transaction cost.

Different types of Transaction Costs

There are basically three different types of transaction costs that you might come across.

1. Search and Information Costs

These types of costs are associated with finding and obtaining information about a certain company or security. It may also include the cost of notarizing documents as well as the cost of getting opinions from experts such as legal counsel, tax consultants, and investment advisors.

2. Bargaining Costs

This includes all those expenses you incur while seeking to negotiate a deal including hiring legal representation if necessary. It also includes the costs associated with evaluating each competing bid.

3. Policing and Administration Costs

These types of costs are related to ensuring that all the rules and regulations are followed during the transactions like making sure there is no fraud involved, preventing embezzlement or theft. If you're buying a property on your own, you might need to hire a lawyer or an inspector. These types of costs fall into the category of policing and administration costs.

Conclusion

As you can see, there are a variety of different costs that fall under the category of transaction costs. Business owners need to be aware of these costs and factor them into their decisions whenever they're exchanging goods or services. By understanding transaction costs, you can make wiser choices and save yourself some money in the process.

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Cost of Goods Sold: Accounting, Income Statement

The income statement details a company's financial performance. This statement includes revenues and expenditures. Based on those items, it calculates several types of profits. However, it must categorize expenses into several categories depending on their nature. One of these classifications includes the cost of goods sold.

What is the Cost of Goods Sold?

The cost of goods sold (COGS) is an item that appears on the income statement. It includes all expenses related to manufacturing or purchasing goods. In essence, it consists of all the direct costs incurred in the process. COGS includes material and labour costs and other factory overheads. This cost also directly relates to the revenues generated during a period.

The cost of goods sold allows companies to calculate the gross profit. These profits include earnings from selling products only. Since it ignores indirect costs, the cost of goods sold indicates the expenses related to production or purchase. In some cases, companies may also refer to the cost of goods sold as the cost of sales. It is also directly proportional to the activity level during a specific period.

How does the Cost of Goods Sold work?

Companies combine expenses under one heading in the income statement based on their nature. These items help calculate different types of profits. The cost of goods sold accumulates direct expenses relating to the production process. In some cases, companies may sell manufactured goods purchased from other companies. The cost of goods sold covers the purchase expenses in those situations.

Usually, the cost of goods sold includes variable costs related to activity levels. For example, they will cover direct material and direct labour expenses. Apart from these, the cost of goods sold may also consist of fixed costs. For instance, factory overheads, holding costs, etc., fall into this category. However, it excludes selling and administrative expenses.

What is the accounting for the Cost of Goods Sold?

The accounting for the cost of goods sold is straightforward. Companies record expenses into their general ledgers. Usually, each account within the financial system has a type. Consequently, each expense account will become a part of a different heading in the income statement. Companies categorize direct expenses as the cost of goods sold.

Therefore, any amounts in those accounts will constitute the cost of goods sold in the income statement. The accounting process for those expenses will remain the same. Based on the classification, companies will present them under different headings. Through this process, companies separate expenses relating to the cost of goods.

Is the Cost of Goods Sold an income statement item or a balance sheet item?

As mentioned above, the cost of goods sold primarily relates to the income statement. Usually, it is the second line item on that statement. Since it includes expenses, it is crucial in calculating profits. Therefore, it becomes a part of the income statement. In contrast, the cost of goods sold does not appear on the balance sheet directly.

However, the cost of goods sold relates to the balance sheet indirectly. It requires opening and closing inventories, which come from the balance sheet. These items can increase or decrease the cost of sales reported in the income statement. Similarly, the cost of goods sold also impacts retained earnings in the balance sheet.

Conclusion

The cost of goods sold includes all direct costs related to producing or purchasing products. It appears on the income statement as an expense. Usually, companies account for the cost of sales by categorizing expenses into the cost of goods sold category. It is primarily a part of the income statement. However, the cost of goods sold can also indirectly impact the balance sheet.

Originally Published Here: Cost of Goods Sold: Accounting, Income Statement

The Yield Curve and Inflation

Inflation is the scourge of the modern economy. In order for us to make wise decisions about where to allocate our precious resources, we need to have a good understanding of what inflation is and how it works.

On the other hand, there are a number of economic indicators that, when used properly, can help investors gain an insight into how the economy is going to behave in the future. The yield curve is one such indicator. In this article, we'll explore the relationship between the yield curve and inflation.

What is the Yield Curve?

Yield Curves are known as the lines that plot yields (interest rates) of bonds having the same credit quality but with differing maturities. The yield curve is meant to show investors the relationship between risk and return, and help them decide upon an optimal portfolio allocation based on their risk appetite and time horizon. An inverted yield curve occurs when long-term yields fall below short-term rates and signify a strong economic downturn.

How does Yield Curve work?

The yield curve works best when it comes to predicting deflationary or inflationary trends in an economy. It works as a benchmark to other debts in the market such as lending rates, and mortgage rates. It is also used to predict the changes in the economic landscape and growth.

What is Inflation?

Inflation is simply a rise in the prices of goods and services in an economy. This can be caused by a number of factors such as an increase in the money supply, higher taxes, or tariffs. Most economists agree that a little bit of inflation is good for an economy as it encourages people to spend money and helps businesses to grow. However, too much inflation becomes detrimental to economic growth as it makes goods and services expensive for consumers.

How does Inflation work?

Inflation works by decreasing the purchasing power of money. When prices for goods and services increase, people need more money to purchase the same amount of stuff. This can cause a lot of problems for people as they may not be able to afford the things that they need. In extreme cases, it can even lead to hyperinflation, which is a term used to describe an extremely high rate of inflation.

What can Yield Curve tell us about Inflation?

The yield curve can be used to tell us a lot about inflation. For example, if the yield curve is inverted, it usually means that there is an impending recession and that prices for goods and services are going to start increasing at a rapid rate. On the other hand, if the yield curve is steep, it usually means that there is a lot of economic activity in an economy, which usually leads to inflation.

How can Yield Curve be used to predict Inflation?

Investors can use the yield curve to help them make decisions about inflation. If an inverted yield curve is observed, it indicates that the economy is not doing well and there are low chances of price hikes for goods and services. Since the inverted yield curve is a signal of recession, investors should avoid purchasing stocks as they are likely to fall as an economy goes into a recession.

On the other hand, if the yield curve is steep, investors should consider putting their money in stocks as inflationary trends are likely to be observed. This usually means good business prospects for companies and that the prices for goods and services are likely to rise.

Conclusion

The yield curve is a powerful economic indicator that can be used to predict inflation. By understanding how the yield curve works, investors can make informed decisions about their investment portfolio and brace themselves for potential price hikes in the future.

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Advantages and Disadvantages of Corporation

A corporation is a legal entity established by individuals or shareholders in order to generate profits. In other words, it’s an impersonal entity that possesses an existence that is separate from its owners. A corporation can own assets, borrow money, enter into contracts, hire employees, and much more. It is managed by a board of directors who are elected by shareholders. The shareholders of a corporation own a percentage of the company based on the number of shares they hold. When it comes to decision making, shareholders vote based on the number of shares they own. The basic structure of a corporation consists of shareholders, board of directors, officers, and employees.

A corporation has limited liability, meaning the owners are protected against debts and lawsuits filed against the company. For example, if a corporation is sued for defaulting on a loan, the shareholders are not personally responsible for the debt.

Advantages of Corporation

• Personal Liability Protection

A corporation is a separate legal entity, meaning the owners are protected from the debts and liabilities of the corporation. If the company goes bankrupt, the creditors cannot pursue the owners’ personal assets. In effect, the owners of a corporation can conduct business without risking their personal assets.

• Access to Capital

A corporation can raise substantial amounts through the sale of stock. This access to capital is a luxury that most entities such as sole proprietorship or partnership do not have.

• Business Security and Perpetuity

The existence of a corporation is not dependent upon its owners. That means it will continue to exist beyond the deaths of the owners, directors, managers, and officers. A corporation can only come to an end when the board of directors and owners decide to end the corporation.

• Easy Transfer of Ownership

The ownership of a corporation is easily transferable through the sale of shares. In the case of a private entity, it is comparatively difficult to transfer ownership.

• Tax Advantages

Although some corporations are subject to double taxation, the owners can receive tax-free benefits such as deductions for retirement plans, health insurance premiums, savings on self-employment taxes, and more.

Disadvantages of A Corporation

• Lengthy application process

The process of incorporating a business is often a long one due to the extensive paperwork involved. The owners have to acquire many permits from different regulatory authorities.

• Double tax

Corporations pay taxes at the corporate level and the individual level. In other words, the corporation’s business income gets taxed and the dividends paid out to shareholders get taxed as well.

• Lack of Business Confidentiality

Corporations are legally required to provide shareholders with an annual report showing sales volume, profits, debts, and other information. These reports are available to the general public, meaning the shareholders lose the confidentiality of their business.

• Conflict of Interest

It’s possible for the board of directors and the executives running the corporation to have a conflict of interest in the business. They may make certain decisions in which they have an interest and end up impacting the profitability of the business.

Conclusion

The choice of business structure to use depends on your type of business and how you want it to operate. Consider these advantages and disadvantages carefully before deciding to incorporate your business.

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How Interest Rates Will Affect Stock Markets

The stock markets are unlikely to continue their bull run of the past year in 2022 with investors eying other opportunities as interest rates rise, according to Wharton finance professor Itay Goldstein. Federal Reserve officials last week projected at least three quarter-percentage-point rate increases next year, signaling their concern over rising inflation. The Fed also stated that it would reduce its asset purchases next year as part of a tighter monetary policy...

Goldstein said the steep rise in stock prices this year pointed to a dearth of investment opportunities. “People don’t have many places to put their money,” he noted. “The interest rates that they can get on risk-free investments are low, so they continue to look for investment opportunities and they put their money in the stock market. They put their money in real estate. They start looking for all sorts of other investment opportunities [such as] cryptocurrencies and NFTs (non-fungible tokens, which are digital assets that represent real-world assets). Across the board, prices are high, and people are just looking for more and more investment opportunities.”

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Goldstein said concerns over inflation will continue to fuel volatility in the stock markets in the year ahead. “Some of the uncertainties about inflation are playing into what we see in the market,” he said. “We’re going to continue to see a bumpy ride, but with a pretty high level of risk given the high levels of prices overall.”

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Market Cycle: Definition, Indicators, Stages, Psychology

What is Market Cycle

It is not a secret that every financial market including the stock market faces a lot of ups and downs. It can be seen in past years that these ups and downs are coming with frequent regularity, roughly about every 2-3 years. A lot of people might think that this is just another coincidence but some financial experts recognize these phenomena as the cyclical nature of the stock market. These periods or cycles are known as the market cycle. In this article, we will learn more about the various aspects of the stock market cycle.

Definition of Market Cycle

Market Cycles or Stock Market Cycles is a term that refers to certain patterns and trends that occur in the overall movement of the market. It is said that these patterns and trends repeat themselves over time. During these cycles some stocks or financial assets outperform others, and some become overvalued or undervalued. Some financial assets outperform others because their business models are ideal for the current state of the market.

Simply put, the Market Cycle is the period between the high and low points of the market.

Types of Market Cycle

There are four different types of Market Cycles

1. Accumulation Phase: This is the phase where the market is bottomed and investors start to buy their assets.
2. Markup Phase: This is the phase where the market is becoming more stabilized and thus more investors are entering the market. Prices of stocks keep increasing in this phase.
3. Distribution Phase: This is the phase where the market reaches its peak. Investors start to sell their assets and the prices of stocks start to decline.
4. Downtrend Phase: This is the phase where the market becomes unstable and investors are selling their assets at a loss. The prices of stocks keep falling in this phase.

Indicators of Market Cycle

There are a few indicators that can help you determine where the market is in its cycle.

1. Price Trends: One of the most common indicators of the market cycle is price trends. You can look at the historical prices of stocks or other financial assets to see if there are any patterns.
2. Volume: Another indicator is volume which is the number of shares or contracts that are traded in a given time period. You can look at the volume to see if there is any increase or decrease during certain phases of the market cycle.
3. Sentiment: You can also look at the sentiment of the market to determine where it is in its cycle. There are a few indicators such as the put/call ratio, short interest, etc.
4. Demand: You can also look at the demand for stocks to determine where the market is in its cycle. Demand is high during certain phases of the market cycle and low during other phases.

Analysis of Market Cycle

The market cycle can be analyzed to determine where it is in its current phase. When the market goes into the Downtrend phase, it means that it is at its low point after which there will be an increase in prices or stock value.

The accumulation phase comes after the downtrend phase when prices are low. During the accumulation phase, there is a lot of buying activity in the market and it can be considered to be stable or almost reaching its peak.

The markup phase usually occurs after the accumulation phase. This is where the market starts to become more stable and prices start to increase. Buying and selling activities are starting to rise during this phase.

The distribution phase is considered as the peak point of the market cycle where the stock prices reach their peak. Most investors start to sell their assets at this point, and the market becomes unstable. And it leads again to the Downtrend phrase, And the cycle starts again.

Conclusion

The market cycle is a recurring pattern of phases that the market goes through. There are four different types of the market cycle, and each type has its own indicators. You can use these indicators to determine where the market is in its current phase. The market can be analyzed to determine which phase it is in and what to expect in the future.

Post Source Here: Market Cycle: Definition, Indicators, Stages, Psychology

Memorandum in Accounting

When entering an item into the financial systems, companies must have a supporting document. In most cases, this document will differ based on the type of transaction. Once entered, companies cannot remove the entry. However, they can still reverse the impact through other journal entries. Nonetheless, the transaction will require a supporting document.

What is a Memorandum in Accounting?

A memorandum in accounting is a source document that includes a short message. This message provides the base for an accounting journal entry. Through a memo, companies can enter a transaction in the accounting system. This transaction ends up on the general ledger. When tracking that transaction, the memorandum helps understand its source.

A memorandum is a written note or document. The primary objective of this document is to provide clarity about the financial transaction. Sometimes, it can also serve as a reminder to adjust the accounts. This term may also refer to a memorandum entry in accounting. This entry does not include any amounts. However, it consists of a short message that becomes a part of the general journal and general ledger.

What are the types of Memorandum in Accounting?

A memorandum in accounting may come in three types. These include debit, credit, and general memos. Usually, the first two are more common and involve an amount. However, the general memorandum is also crucial in the accounting process. A description of each of these types is as below.

Debit memorandum

A debit memorandum is a source document used to inform customers about a decrease in their balance. However, that applies to banks only. In accounting, it refers to an entry that serves as a notice to customers about their owed amount. Usually, it also includes a source document sent to the customer. Companies adjust the balance in the customer's account through a debit memo.

With a debit memo, companies increase the receivable balance from a customer. Usually, they use it to include items missed in an invoice. The primary objective of the debit memo is to adjust a billing error, usually under-billing. For example, a company sends a $200 invoice for $300 worth of goods to a customer. A debit memo will increase that invoice amount by $100.

Credit memorandum

A credit memorandum also applies to banking. In that case, it notifies a customer of an increase in their checking account balance. However, a credit memorandum in accounting is different. In that case, it serves as an adjustment to an invoice. It is similar to a debit memorandum in that regard. However, it decreases the invoice amount instead of increasing it.

A credit memorandum is the opposite of a debit memorandum. When companies overbill a customer, they use this memo to reduce it. It also applies to sales returns where customers return goods. For example, a company sends a $200 invoice to a customer. However, the customer returns those goods later. Therefore, the company will issue a credit memorandum for $200 to the customer.

General memorandum

A general memorandum differs significantly from the above two types. It is a document used for internal purposes only. In essence, a general memo is used for partial or incomplete transactions. It includes a short message that companies enter into the general ledger. Another name used for it is memorandum entry.

Conclusion

A memorandum in accounting is a document that includes a short message. This document serves as a source for various transactions. Usually, companies use debit or credit memorandums which adjust customer balances. However, they may also create general memos, which serve as an explanation for transactions.

Article Source Here: Memorandum in Accounting

5x Leveraged Exchange Traded Fund

A leveraged exchange-traded fund (ETF) is a financial instrument that offers the return of an underlying index multiplied by a given leverage factor. The fund usually uses borrowed money, futures, swaps, and other derivatives to amplify the daily price movements of the underlying index. Investing in these exchange-traded funds involves a high level of risk and may not be suitable for all investors. They can lose all of their money, as we have seen during the recent market selloffs of 2018 and 2020,

In February 2018, for example, a sudden and unexpected rise in market volatility resulted in short VIX ETFs to lose more than 90% of their value in a matter of days (some of which were forced to liquidate altogether due to losses incurred). Or take a look at what happened to oil ETFs during the COVID recession. The ProShares Ultra Bloomberg Crude Oil ETF (UCO), which doubles the exposure to crude oil prices, lost 98% of its value from January 2020 to April 2020 and needed to complete a 1:25 reverse split in order to merely stay alive. Even when volatility rises modestly, these leveraged funds can easily fall by 10-20% or more.

Another disadvantage of leveraged ETFs is that their return will not match that of the benchmark index with the leverage factor taken into account. In other words, if the underlying index goes up over time, investors will not get the return of the index times the leverage. The reason is that the mathematics of compounding prevents the funds from exactly replicating the underlying index.

Despite all of this, asset managers keep issuing more exotic ETFs. Recently, Leverage Shares issued an ETF that is designed to offer 5 times the daily return on the Nasdaq 100 index.

Leverage Shares, which could be considered the European version of Direxion, which offers dozens of leveraged and inverse exchange-traded products (among others, of course), brought an unprecedented product to the market this week - the Leverage Shares 5x Long US Tech 100 ETP. As the name suggests, it's designed to offer 5 times the daily return on the Nasdaq 100 index. This product, which is an exchange-traded note and not an exchange-traded fund, will be linked to the Invesco QQQ Trust (QQQ). Read more.

So there must be a demand for this kind of financial instrument? Let us know what you think.

Originally Published Here: 5x Leveraged Exchange Traded Fund

Time Weighted Average Price

Almost every security trader will rather go for a trading strategy that minimizes risks and increases chances of achieving success. And, the time-weighted average price (TWAP) is one such trade execution strategy.

TWAP reduces the impact of large orders on the security market, making it a perfect choice for high-volume traders. Furthermore, calculating the time-weighted average price uses an easy-to-understand formula. And, in this article, we will help you understand the time-weighted average price better, including how to calculate it.

What is the Time Weighted Average Price?

Time-weighted average price (TWAP) tells you the average price of a security over a predetermined period. TWAP is a relevant tool for effective trading as it offers traders an alternative strategy to executing large orders. Using the TWAP, you can break up a large order into smaller chunks to minimize the impact of large orders on the market.

The ultimate goal is to improve the price of security via executing trades evenly over a specified period. For instance, if you want to purchase 10,000 of a company's shares, applying the TWAP strategy, you could break the trade down, purchasing 1,000 shares every 15 mins.

The Time-weighted average price is not so different from the Volume -weighted average price (VWAP). While the VWAP considers volume in its calculation, TWAP does not. Normally, VWAP is an ideal order execution algorithm, but not when you foresee unfavorable market price momentum.

How to Calculate Time Weighted Average Price

Calculating TWAP does not demand any complex mathematical procedure, you only need to master the formula. You can calculate TWAP by taking the average of the "typical price" - Open, High, Low, and Close price of each bar, and then calculating their averages for ‘n’ number of periods.

The formula for calculating TWAP is:

TP=(Open+Low+Close+High)/4

TWAP=TP1+TP2+...+TPnn

In application, assuming you want TWAP value for 5 periods, then:

• Take the Average of Open, High, Low, and Close values of each 5 bars - a1,a2,a3,a4,a5
• Take an average of a1 to a5. TWAP= (a1+a2+a3………..+a5)/5

However, if you are faced with daily prices with several after-hours movements, you should use the open, high, low, and close when factoring in the typical price. In cases where the open and close are similar, such as intraday prices on liquid stocks, using the open, high, and low is advisable.

When you have gotten the TWAP, it is also important to detect whether the security is overvalued or undervalued. To do this you have to compare the order price. An order price that is below TWAP indicates that the security is undervalued, and if above the TWAP, it is an indicator that the security is overvalued.

Conclusion

The time-weighted average price plays a major role in trading especially when you are dealing with large orders. By breaking down your order into smaller chunks and executing them within a specific period you could reduce the impact of large orders and improve price.

Originally Published Here: Time Weighted Average Price

Bank of Canada’s working group recommends ending CDOR in mid-2024

Publication of the Canadian dollar offered rate (CDOR), Canada's primary interest rate benchmark, should end after June 2024, the working group helping to transition Canadian financial markets to risk-free benchmark interest rates said on Thursday.

The Canadian Alternative Reference Rate working group (CARR) recommends that Refinitiv Benchmark Services (UK) Limited (RBSL), the administrator of CDOR, cease publication of all of the interest rate benchmark's remaining tenors after June 30, 2024

....

The decision to cease using CDOR ultimately lies solely with RBSL. CARR proposes a two-staged approach to the transition from CDOR.

The first stage would run until June 30, 2023, when the working group would expect all new derivative contracts and securities to have transitioned to using CORRA. That date is also when all remaining U.S. dollar Libor tenors are due to cease.

The second stage to June 30, 2024, would provide firms with additional time to transition their loan agreements and deal with potential issues.

Read more

 

Post Source Here: Bank of Canada’s working group recommends ending CDOR in mid-2024

Operational Audit

For most companies, external audits are mandatory. This process involves independent auditors assessing a company's financial statements. Based on that, they conclude whether those statements include material misstatements. However, companies must also examine their internal processes. This process falls under internal auditing. Within that process, companies may conduct operational audits.

What is an Operational Audit?

An operational audit is an internal process of evaluating a company's operations. Usually, it includes assessing all the processes involved in performing operating activities. Unlike external audits, operational audits don't consider financial information only. These audits are more thorough compared to other forms of examination. In essence, operational audits involve examining how companies conduct their operations.

Operational audits require companies to analyze their procedures, processes, and systems. Usually, these audits do not consider a specific area or department. In most cases, operational audits don't focus on financial issues. Instead, they examine a company's management practices. Companies may use external auditors or an internal team to conduct these audits.

The aim of operational audits also differs from other types of audits. With this process, companies seek to identify inefficient processes or operations. Once they do so, they can assess whether those areas need improvement to achieve efficiency. In contrast, external audits examine financial statements and other related information.

How does an Operational Audit work?

Operational audits involve several steps. The first of these includes establishing whether to use external auditors. In most cases, companies use an internal team to conduct these audits. Sometimes, however, they may not have an internal audit department. Therefore, they will obtain the services of an external audit firm. The primary objective of this process is also to ensure the auditors are independent.

The second step in the operational audit process is for auditors to plan it. This process is similar to other audits. However, it focuses on operations and processes. During the planning stage, auditors will also establish their goals and strategies for the audit. These strategies will differ based on the underlying objective of the audit.

Once auditors complete the planning stage, they will conduct the audit. This stage involves examining the processes and procedures involved within operations. In most cases, the primary objective of the audit is to identify any weaknesses in those operations. Once they evaluate the processes, they will assess whether any inefficiencies exist.

Subsequently, auditors will prepare a report that includes their findings during the operational audit. This process is similar to other audits. However, this report focuses on operations and the inefficiencies within them. Similarly, auditors will also present their recommendations on how the company can improve those areas. The last step will involve performing a follow-up on those recommendations.

What are the advantages and disadvantages of an Operational Audit?

Operational audits can be highly beneficial for companies. These audits allow a company to assess its operations and identify any inefficiencies. Similarly, it can help build on the effectiveness of processes and procedures. Operational audits also provide companies with an objective opinion. Furthermore, these audits can also identify any risks and opportunities within operations.

However, operational audits may also involve some disadvantages. The most crucial of these is the costs involved with these audits. Companies must compare those costs with the benefits obtained from these audits. Similarly, operational audits may require companies to make changes to their operations. They can also be time-consuming and affect productivity.

Conclusion

An operational audit is a process auditors use to evaluate a company's operations. Through these audits, companies can identify inefficient activities. Usually, operational audits involve several steps, similar to other audits. However, the primary objective of operational audits differs. These audits also have several advantages and disadvantages, as listed above.

Article Source Here: Operational Audit

Automated Trading: Strategies, Software, Algorithm, Platform

No matter your trading strategy, there are some parameters you must get right to become a profitable trader. Beyond correct analyses and prediction, a good trader must also master good timing, accuracy, and precision. This will help to get trades on time and maximize market movements.

However, it usually takes much time and effort to master these trading fundamentals and integrate them into a trading strategy. Unless you're a full-time trader, you might not have the luxury of time to monitor the market all the time to execute trades. This is where automated trading comes in handy.

Here, let's consider what automated trading means, the strategies you can use for automated trading, and the different systems that can help you implement automated trading.

What is Automated Trading?

Automated Trading is a kind of trading where a computer automatically makes trade decisions based on pre-installed algorithms. The algorithms are defined with predefined instructions to execute the trader's strategy. In a nutshell, automated trading enables traders to automatically execute trades using computer software.

How Does Automated Trading Work?

Every strategy defines certain criteria that must be met under certain rules before a trade is executed. For instance, a trend strategy trader will always wait to confirm that a market movement is a trend before taking a trade.

So, the general idea behind automated trading is to program these rules into a computer and set the necessary parameters. Such parameters include the volume of the trade market price, etc. The software algorithm then executes trades with the parameters when the specified conditions are fulfilled.

Strategies For Automated Trading

As earlier mentioned, the strength of automated trading systems lies in the strategy it is set up to execute. There are different strategies common to automated trading, and each one executes trades based on the modalities of the programmed strategy. Some of the most common automated trading strategies include:

• Trend Based Strategy

This strategy often makes use of technical analysis and indicators like moving averages to identify trends based on existing data. Then, it executes trades based on the prediction of whether or not the trend continues.

• Arbitrage Strategy

This strategy seeks to maximize differences in securities prices in different exchanges. The automated trading system detects and purchases an item for a lower price on one exchange and sells for a higher exchange on another.

The strength of this strategy is the ability of the system to be fast and accurate and maximize high trade volumes for optimal profit even on little price differences.

• Mean Reversion Strategy

People who use this strategy believe that prices must fluctuate but must return to a certain average point after a certain time.

So, the automated trading systems try to identify these "limits" and execute trades as soon as prices are off these points, waiting to take profit as price returns.

Best Platforms for Automated Trading

Many different trading platforms enable automated trading, with each providing both general and unique features for profitable trading. Below are some of the most popular and most effective.

• MetaTrader 4
• ProRealTime
• AvaTrade
• eToro
• Learn2Trade

Conclusion

If you have developed a working strategy for your digital trading, automated trading systems can help you implement it. That way, you can minimize emotional instability during trades and make profits from trades without having to monitor them all the time.

Article Source Here: Automated Trading: Strategies, Software, Algorithm, Platform

Gold Oil Price Ratio As a Predictor of Stock Market Returns

Analyzing the intermarket relationships between assets can help us identify trends and predict returns. Traditionally, analysts use commodity, currency, and interest-rate data to predict the direction of the stock markets. In this regard, reference [1] brings a fresh new perspective. It utilized price ratios of gold over other assets in order to forecast stock market returns. Specifically, the authors constructed ten gold price ratios: the gold oil ratio, gold silver ratio, gold CPI ratio, gold corn ratio, gold copper ratio, gold Dow Jones Industrial Average ratio, gold yield dividend ratio, gold treasury bond yield ratio, and gold federal fund rate ratio. They then used univariate and bivariate predictive regressions to investigate the forecasting power of the constructed gold price ratios in the stock market. The authors pointed out,

We empirically investigate the predictive ability of ten gold price ratios for US excess stock returns. Gold price ratios are constructed as the natural logarithm of gold to other asset prices. We find that gold price ratios positively predict future stock returns and have higher predictive ability than traditional predictors studied in Welch and Goyal (2008) on average. Among these ratios, the gold oil ratio (GO) is the most powerful return predictor, and the information contained in GO does not overlap with that contained in traditional predictors and other gold price ratios. A one standard deviation increase in GO is associated with a 6.60% increase in the annual excess return for the next month in sample. GO also significantly outperforms the historical mean model out of sample and generates substantial economic gains for a mean variance investor. Therefore, the predictive ability of GO is both statistically and economically significant.

In short, among the constructed gold price ratios, the gold oil ratio is a good predictor of the stock market returns.

This article showed that we can use not only asset prices as independent variables in a predictive model but also combinations of them.

References

[1] T. Fang, Z. Su and L Yin, Gold price ratios and aggregate stock returns, 2021. Available at SSRN: https://ssrn.com/abstract=3950940

Article Source Here: Gold Oil Price Ratio As a Predictor of Stock Market Returns

Equity Reserves

The term reserves describe resources kept or retained for future use. Usually, these resources are not available for immediate utilization. However, they can help in the future if required. This term has various meanings in every field. In accounting, it covers several areas. These include a portion of shareholders' equity, a liability for estimated claims, or a contra asset for bad debts.

The term reserves may also relate to equity reserves, which is prevalent in accounting.

What are Equity Reserves?

Equity reserves are a part of shareholders’ capital in accounting. Usually, these reserves are a part of the financial statements and kept apart for specific purposes. Equity reserves are balances created from shareholders’ contributions. For most companies, they are inaccessible balances unless for defined purposes. Usually, these purposes relate to accounting treatments or regulatory requirements.

In some instances, equity reserves may also refer to a type of bank capital. These reserves represent funds set aside for contingencies, for example, legal action against the bank, losses on assets, etc. On top of that, it also provides a reserve for dividends that a company expects to pay to shareholders. However, they do not include declared dividends. Therefore, there is no liability for a company to make those payments.

Companies may also use these equity reserves as a sinking fund. Usually, these provide finance to retire stock or debt capital instruments in the future. Overall, the definition of equity reserves may differ based on the area to which these reserves relate. In most circumstances, the former accounting definition will apply unless specified otherwise.

What do Equity Reserves include?

As mentioned above, equity reserves primarily include contributions from the shareholders. The two primary types of equity reserves consist of share premium and legal reserve funds. An explanation of what each of these involves is as below.

Share premium

Share premium refers to an account in the balance sheet, a part of a company's equity reserves. This reserve account records the amount received for new share issues above the par value. Usually, share premium relates to the share capital account. Any finance received for shares issued at par will become a part of the share capital account. The excess funds will end up on the share premium account.

Legal reserve funds

Legal reserve funds include balances required by legal legislation. Usually, this account balance is a percentage of the share capital balance. Like the share premium account, any reserves in the legal reserve funds account are also inaccessible. Another name used for it includes legal reserve funds from profits.

Translation reserves

Translation reserves is a type of equity reserve that only comes from the consolidation process. Usually, parent and subsidiary companies that operate in different currencies must translate their operations when consolidating. In some cases, it may create a reserve, which ends up in the translation reserves account.

Remuneration reserves

Companies may also promise their employees or management performance-based incentives or bonuses. For these bonuses, they may create an equity reserves account. This account will include the expected amount that a company expects to pay employees as incentives.

Hedging reserves

Hedging reserves is an account that includes equity reserves generated during the hedging process. This account consists of funds generated when a company takes steps to mitigate volatility in some input costs. Usually, it relates to the hedge accounting process.

Conclusion

The term equity reserves can have different meetings. In accounting, it refers to balances created from shareholders’ contributions. However, it may also represent a type of bank capital. There are several types of equity reserves that companies may have. These include share premium, legal reserve funds, translation reserves, remuneration reserves, and hedging reserves.

Post Source Here: Equity Reserves

Real Option Valuation

Profitability and growth are two essential factors for companies. Several factors determine whether they will achieve this. Usually, the decisions that management makes can impact those factors significantly. The decision-making process must ensure that the company benefits from the underlying choice. During this process, real options can be crucial.

What are Real Options?

The real options approach is a technique used in decision-making. This approach uses the financial options theory for tangible assets. In essence, real options provide managers with the right to select between various choices. However, it does not oblige them to do so. With real options, managers focus on maximizing opportunities for profitability and growth.

Real options can be a critical part of investment appraisals. These options help managers decide the best outcomes for a company. Unlike financial options, which include financial instruments, real options involve tangible assets. Therefore, they apply to most business asset investment opportunities. A critical part of these options is the real option valuation.

What is Real Options Valuation?

Real options valuation involves applying option valuation techniques to investment appraisals. As mentioned, real options include the right to make business decisions. Usually, these decisions consist of expanding, contracting, staging, abandoning, or deferring projects. Real options valuation can help companies make decisions with different outcomes and uncertainty.

Another name used for real option valuation is real option analysis. It involves a technique that prioritizes adaption interventions. Furthermore, it also considers the possibility to adjust them in the future. This process can help companies make decisions while mitigating the risks involved. Companies utilize various techniques within this valuation to achieve optimal results.

How does Real Options Valuation work?

Real options valuation can be significantly beneficial in high-risk decisions. Traditional investment appraisal techniques take a quantitative approach towards valuation. However, real options analysis also focuses on qualitative methods. Similarly, companies can use this approach to evaluate the risks associated with investing in tangible assets. Companies can achieve real options valuation in several ways.

One method to real options valuation is the dynamic programming approach. This approach is similar to the decision-tree analysis. However, it is more complex. With this process, companies can compare the real option valuation to the normal economic calculations. Usually, companies use a cost-benefit analysis within those calculations.

The real option valuation approach can produce two types of results. First, it determines whether it is more beneficial to delay investments to wait for new information. This result only occurs if a project passes a deterministic analysis. The second result involves establishing whether loss-making projects can be profitable in the future.

What are the advantages and disadvantages of Real Options Valuation?

Real options valuation can have several advantages. Firstly, it allows companies to analyze the value of flexibility and learning through quantitative analysis. It also provides a structured approach to visualize the concept of adaptive management. Similarly, it can guide the timing of adaption interventions. Real options valuation also allows companies to use qualitative information in decision-making.

However, real option valuation can also have some disadvantages. Implementing this analysis involves costs. For some companies, these costs may exceed the benefits associated with the process. Similarly, real option valuation requires significant volumes of data and resources. This process also leads to subjective valuations, which may not be ideal.

Conclusion

Real options involve the application of financial options theory to tangible assets. Real options valuation uses option valuation techniques for investment appraisals. In most cases, this approach can be crucial in evaluating high-risk decisions. There are several advantages of real options valuation, some of which are mentioned above.

Originally Published Here: Real Option Valuation

Services Rendered: Definition, Meaning, Accounting, Examples

The accounting for goods sold to customers is straightforward. When a company delivers goods, it records an expense while reducing inventory. Similarly, it accounts for the revenues generated from those goods. For services, however, the process may differ, which falls under services rendered. Before understanding its accounting, though, it is crucial to understand what it is.

What are Services Rendered?

Services rendered is a term used to describe the conclusion of a service contract between a renderer and the client. In some cases, the process of providing services may involve a continuous or long period. Similarly, service providers may also receive payments in advance for those services. Therefore, it is crucial to separate those collections from any work delivered to the client.

In essence, the term services rendered refers to the act of providing a service to a client. This definition also applies to accounting and how to record those services. Usually, when companies complete the provision of service, they send an invoice to the client. This invoice serves as a base in the accounting for those services rendered.

What is the accounting for Services Rendered?

Like the delivery of goods or products, services rendered has two accounting aspects. The first relates to the recognition of the expenses incurred for those services. Usually, companies account for these as they occur, which is in line with the accruals concept in accounting. The process involves identifying each expenditure and allocating it to the relevant account.

In the case of goods and products, those expenses become a part of the cost of goods sold. For services, however, they contribute to the cost of services. Overall, when companies incur expenses for services rendered, the journal entries will be as follows.

Dr Service expense (Cost of services rendered)

Cr Accounts payable or Cash/Bank

The other aspect involves recognizing revenues for those services rendered. Usually, companies obtain these amounts from the contract with the client. In some cases, companies may also use a fixed rate for every unit of services rendered. Once established, they will send an invoice to the client requesting a payment. Using this invoice, companies can record the services rendered revenues as below.

Dr Accounts receivable

Cr Service revenues

In some cases, the client may also have paid for the services in advance. Companies record those payments as prepayments or advances. Similarly, some clients may pay for those services at the same time as they get rendered. In either of these cases, the essential journal entries for services rendered will remain the same. However, the relevant accounts will differ.

Example

A company, Green Co., provides accounting services to a client. The contract between both parties dictates the client must pay an annual fee of $50,000 for those services. For Green Co., the services rendered expense is $30,000. At each year-end, the company sends an invoice to the client requesting the contractual payments.

For the services rendered expenses, Green Co. records the following journal entries.

Dr Service expense $30,000

Cr Accounts payable $30,000

Similarly, the company records the revenues for the services rendered as follows.

Dr Accounts receivable $50,000

Cr Service revenues $50,000

Conclusion

The term services rendered describes the conclusion of a service from a provider to a client. The accounting for services rendered involves two aspects. Firstly, it records the expenses related to those services. The second aspect includes accounting for the revenues from services rendered. Usually, these figures come from the contract between both parties.

Originally Published Here: Services Rendered: Definition, Meaning, Accounting, Examples

Recency Bias: How It Affects Your Trading

Trading is a difficult endeavor, and the main reason most traders fail is that they don’t have an edge. The expectation value of most trading strategies is zero before commissions and slippage. Taking commissions and slippage into account, trading is a negative-sum game.

Even with a positive expectancy trading system, the random nature of the market will likely make traders abandon their good system. Let’s say, for example, you have a good trading system with a winning rate of 60% and an overall positive expectancy. This means that 40% of your trades will be losers. Suppose that you start trading this system, and your first 4 trades turn out to be losers. Human psychological bias will make you conclude that the system is bad, and therefore you stop trading it.

In behavioral finance, this psychological bias is called recency bias. It affects us more often than most of us can imagine. Let’s go through a concrete example of a fictional trader called John.

• Trader John developed or learned about a good trading system, but he stopped trading it after 2 losses in a row.
• Frustrated, he tried a system he learned from a guru on YouTube, and it worked great a couple of times in a row.
• John started believing that he had found the holy grail and started increasing size.
• The market went against him and he experienced a loss.
• John decided to hold on to the loser because his strategy has 90% probability of success, and he thought that the losers would eventually become winners.
• Another unfavorable move in the market created a massive “paper” loss in his account.
• The next day, he received a phone call from his broker asking him to deposit more money to cover the margin. He didn’t have enough money, so the broker liquidated the position and his account was wiped out. John lost almost all of his trading capital.

Does this story sound familiar?

As we can see, recency bias affects our trading in a negative way. The key to profitable trading is to develop a robust, positive expectancy system, have confidence in it, and stick with it, especially through bad times.

Originally Published Here: Recency Bias: How It Affects Your Trading

Real Option: Definition, Example

Decision-making is crucial to the long-term success of companies and businesses. Usually, these decisions fall under the responsibility and authority of managers. Through the right choices, companies can grow significantly. However, a wrong decision can also hinder progress substantially. The concept of real options also applies to the decision-making process. Therefore, it is crucial to understand what they are.

What is a Real Option?

A real option is the right to make a business decision. However, it does not constitute an obligation to choose that decision. It also represents the decision alternative available for a tangible asset. Through these options, companies can evaluate various choices. Based on that evaluation, they can choose the right one. This way, companies can ensure future growth and expansion.

With the real options concept, companies can examine a range of possibilities. Once they do so, they can make a choice that is the most beneficial. Similarly, these options allow managers to analyze and evaluate business opportunities. Doing so is crucial for long-term profitability. The real options concept applies to investments and projects. Therefore, they are critical in investment appraisal.

Real options get their name from their application to tangible assets. These options do not apply to financial instruments. In essence, real options are an extension of the financial options concept to real assets. These options extrapolate the definition of financial options to non-financial assets. However, real options differ from financial options contracts since they don't involve exchangeable securities.

How do Real Options work?

Real options allow managers to make decisions in several areas. Through these options, managers can choose between various investment opportunities. However, real options do not oblige them to make a choice. Similarly, it provides them with the opportunity to invest at once or wait for better conditions in the future. Real options are also a part of real options value analysis (ROV).

Real options value analysis involves estimating the opportunity costs of various decisions. With this analysis, managers can evaluate whether to continue a project or abandon it. A real options analysis begins with managers reviewing the risks related to a project. Based on that, they develop models for these risks.

A real options analysis allows managers to be more precise with their decisions. They must evaluate several options and choose an outcome that helps with growth and profitability. Usually, the choices within real options may consist of several scenarios. For example, these may include a decision to expand, abandon, contract, wait, etc.

Example

A company, Red Co., considers a project that will provide a positive NPV of $1 million. However, it can expand its operations through those funds. The expansion process would require more time as well. On top of that, it would also require additional funds to finance the project. Red Co. can choose between the project or expanding its operations.

Within real options, Red Co. can evaluate the choices it has. This process involves assessing both projects and how they will impact their operations. Ultimately, the decision will lie with the company's management. In most cases, it will choose the option with the best outcome.

Conclusion

Real options provide companies with the right to make a business decision. These options apply to tangible assets rather than financial instruments. With these options, companies can evaluate various choices. Based on that evaluation, they can select the option with the most beneficial outcomes. Real options also involve real options valuation.

Originally Published Here: Real Option: Definition, Example

General Journal in Accounting

Companies maintain accounts that help prepare financial statements. Usually, these accounts use the books of prime entry to track transactions. These may include various books, each of which has a specific purpose. The information from those books enables companies to record transactions in their general ledgers. One of the books of prime entry includes the general journal.

What is the General Journal in Accounting?

The general journal is a book of prime entry which helps record transactions that don't relate to the other books. These transactions do not qualify for accounting in specialty journals, for example, purchase, sales, or cash journals. Excluding these transactions, the general journal includes only selected types of entries. For example, it may consist of depreciation, amortization, and accrual journal entries.

The general journal involves adjustment entries in most cases. For example, these may relate to year-end updates or modifications. Like the other books, the general journal is essential in the preparation process of financial statements. The information from this book, along with others, helps constitute the entries for the general ledgers. Another name used to describe it is the books of original entry.

Overall, the general journal is a part of a company's accounting records and its financial systems. Most companies maintain specialty journals, including sales, cash, returns, and purchases journals. In some cases, companies may even have more of these journals. The general journal covers any transactions that do not fall into those journals.

How does a General Journal work?

The general journal consists of journal entries that do not fall under any of the specialty journals. In accounting, the term journal entry refers to a record of financial transactions. These entries have two sides, a debit, and a credit. When a transaction occurs, companies record it into their accounting system using journal entries.

The general journal also consists of various journal entries. Usually, it covers financial transactions such as opening balances, year-end adjustments, non-cash items, etc. When these transactions occur, they do not relate to any of the other books of prime entry. However, companies must still record them to include them in the accounting system. This process occurs through the general journal.

In the past, companies maintained a separate book to record these transactions. However, modern accounting systems organize all these books together. Any transactions that occur in these books also enter the general ledger. From there, this information ends up on the trial balance and, ultimately, the financial statements.

What is the format of General Journal?

There is no specific format or standard that companies must use to maintain the general journal. These records are a part of a company's internal accounting systems. Despite that, the general journal must include essential information about financial transactions. This information must cover the following areas.

• Date of the transaction.
• Debit/credit accounts.
• Debit/credit amounts.
• A reference number.
• A short description or memo describing the transaction.

The above information should cover the fundamental requirements for further processing. However, companies may cover more areas if they choose to do so. In practice, nonetheless, most general journals use a minimal format.

Conclusion

Companies maintain books of prime entry that record financial transactions. Usually, these books include specialty journals and a general journal. All financial transactions enter those journals. In most cases, the specialty journals may cover financial transactions. Any remaining items end up in the general journal. Usually, it includes transactions, such as depreciation, balance adjustments, year-end adjustments, non-cash entries, etc.

Originally Published Here: General Journal in Accounting

How Rising Inflation Affects Your Investments

Inflation is an important indicator of an economy's health, as it indicates how the costs of goods and services are rising. While consumers often look at the prices of individual products as a gauge of their affordability, they have a broader need for a wide range of commodities. These include food grains, metal, fuel, utilities, transportation, entertainment, and labor. Rising prices of commodities are often the main cause of inflation, and they must continue to rise in order to maintain economic growth.

While inflation may be good for the economy, it can pose a threat to investors. Inflation can impact not only your spending but also your savings and investments.  Rising inflation can hurt your savings and investments in many different ways:

1. Forcing tough choices: … People cutting back spending in one area of their life due to unavoidable inflation elsewhere reduces revenue for those companies associated with those less-immediately essential products. That can hurt the stocks associated with those types of companies.
2. More aggressive cost-cutting actions: When companies are faced with higher costs, they start getting aggressive with their cost-cutting actions. That could include things like changing formulas to reduce input and processing costs, reducing staff to cut salary and benefit costs, or stretching out maintenance cycles to reduce downtimes.
3. Higher borrowing costs: If you're in the market for something that you can't pay cash for (such as a house or potentially a car), you will borrow money to complete the transaction. If inflation means the price of that item is higher today than it was in the past, you will likely both pay more and borrow more for that item.
4. A greater need to hold assets in other forms: As a general rule, money you expect to spend from your portfolio within in the next five years does not belong in stocks. If you're a retiree who expects to spend $40,000 per year from your portfolio, that means you'll need $200,000 in lower-risk investments, assuming no inflation.
5. Better risk-adjusted returns elsewhere: Low interest rates have helped bolster the stock market. It stands to reason that if rates rise in response to inflation, the stock market can get hurt as the money forced into stocks by lower rates can find better risk-adjusted returns elsewhere. Read more

Article Source Here: How Rising Inflation Affects Your Investments

Chief Investment Officer: Job Description, Career Path, vs Chief Financial Officer

In a company, firm, or organization, there's a high need for professionals to manage different departments. The management of an organization's investment portfolio should be handled by efficient professionals to ensure proficiency. One of such important positions is the Chief Investment Officer (CIO).

This position is critical because the performance of an organization's investment portfolio largely depends on the efficiency of the CIO. So, In this article, you will get a comprehensive understanding of who a CIO is, their responsibilities, and how they differ from a Chief Financial Officer.

Who is a Chief Investment Officer

A Chief Investment Officer is a director in a company who is in charge of managing its investment portfolio. They take up the responsibility of setting up the company's investment style and strategy.

They work together with a body of team members in the company to develop its long-term and short-term investment plans. Hence, whether or not a company's investment turns out profitable is a direct responsibility of the CIO and his team.

Different kinds of organizations including investment companies, insurance firms, banks, or non-profit organizations with endowments can have a CIO.

Who Qualifies To Be a CIO?

When you’re looking out for personnel to be in charge of this position, ensure to consider these qualities:

• An enhanced knowledge of asset classes and return generation strategies.
• Profound knowledge of different investment products.
• The ability to operate digital and telecommunication systems.
• The ability to be proficient in leadership, written and verbal communication, as well as balance multiple projects.

Duties And Responsibilities of a Chief Investment Officer

The responsibilities of a CIO in an organization include but are not limited to:

#1. Organization of Team Members

A CIO should possess good leadership skills to be able to select, organize and build a strong team. To achieve this, the CIO will conduct interviews to identify potential candidates with the required skills and expertise or at least the potential to acquire them.

#2. Assets Allocation

The CIO analyzes and decides the kind of assets the organization invests in based on the company's investment goals and strategy. They decide on the amount of money to invest in each asset in line with the investment plan.

#3. Recommend And Create Investment Processes

The CIO is responsible for assessing potential investment opportunities. They usually set up an investment assessment system that helps ascertain whether an opportunity is aligned to their strategy and will be profitable or not.

Who is a Chief Financial Officer?

A Chief Financial Officer (CFO) is an executive in an organization, firm, or company that's in charge of managing its financial operations. The CFO is also responsible for planning, analyzing the company's finances, and recommending corrective actions.

CIO vs CFO: Similarities and Differences

The CFO and the CIO are both associated with the finances and investment decisions of an organization. So, they are closely related offices and can easily overlap in their responsibilities.

In fact, in some organizations, the CFO takes the responsibilities of the CIO. But there are some other organizations where investment is a key part of their operations. In such places, the CIO is usually a distinct office, and sometimes, they report to the CFO who is in charge of all finance-related matters.

The notable difference between the CFO and the CIO is that while the CFO oversees the general finance of an organization, the CIO is streamlined to the investment portfolio.

Conclusion

Investment management is a crucial part of the success of any organization. Therefore, understanding the role of the Chief Investment Officer and how it relates to the CFO and other vital operations of an organization is very important.

Originally Published Here: Chief Investment Officer: Job Description, Career Path, vs Chief Financial Officer

Absorption Costing

Companies use various costing methods to establish the unit cost of manufacturing a product. Determining these costs is highly crucial in understanding how a company’s production process works. On top of that, it provides a base for measuring the price to charge for the underlying product. One of the methods that can help in this regard is absorption costing.

What is Absorption Costing?

Absorption costing is a costing method that companies use to determine the cost of a product. This method falls under managerial accounting, which includes establishing those costs. However, absorption costing doesn't only apply to managerial accounting. It is also crucial in establishing costs under financial accounting under different accounting standards.

Absorption costing involves absorbing a company's variable and fixed manufacturing overheads into a product's cost. This approach differs from other methods that only consider variable material and labour costs. Another name for absorption costing is full costing since it includes all the costs associated with manufacturing a product.

Overall, the absorption costing method involves accumulating all costs associated with a production process. Later, it apportions those costs to individual products. These costs then help establish the value of inventory that companies keep. Furthermore, it also allows companies to estimate the cost of goods sold during an accounting period.

What are the components of Absorption Costing?

Absorption costing considers various components when establishing a product’s cost. Some of these include the following.

Direct material

Direct material includes any raw materials that contribute directly to a product. However, it does not involve any items that do not form a part of the finished product. For example, for companies that manufacture furniture, direct material will consist of wood.

Direct labour

Direct labour includes any costs paid to workers in exchange for working on a product. These costs must contribute directly to the finished goods. For example, salaries and wages paid to production line workers form direct labour costs.

Variable manufacturing overheads

Apart from direct labour and direct material, companies may also incur other variable manufacturing overheads. These overheads include expenses necessary to operate a production facility and relate to production volume. Like direct material and labour, these costs also vary with volume.

Fixed manufacturing overheads

Apart from variable manufacturing overheads, absorption costing also considers fixed overheads. These are similar to the above as it includes expenses to run a manufacturing facility. However, these costs do not change with production levels.

What are the advantages and disadvantages of Absorption Costing?

Absorption costing can provide several advantages. One of the most prominent of these includes being compliant with most accounting standards. Similarly, absorption costing considers all production-related costs when evaluating inventory. This way, it allows companies to value their stock more accurately. Absorption costing can also provide better results for smaller companies and dynamic environments.

However, absorption costing can have some disadvantages. Some companies may prefer other methods such as marginal costing since it helps in better decision-making. Similarly, absorption costing can also impact the accurate presentation of profits. Some companies may use this method to manipulate profits and overstate inventory.

Conclusion

Absorption costing is a product costing technique that considers all production-related costs. This method can help in evaluating inventory and establishing the cost of goods sold. Similarly, it is also compatible with accounting standards. Absorption costing requires four components to calculate product costs. This method can have several advantages and disadvantages, as mentioned above.

Originally Published Here: Absorption Costing