Cross-Sectional Momentum in the Commodity Market

Momentum trading is often divided into 2 categories: time-series momentum and cross-sectional momentum. Time-series based trading strategies generate trading signals based on the asset’s past returns. A typical time-series trading strategy usually involves buying assets with positive trend signals and selling those with negative trend signals. In contrast, cross-sectional trading strategies generate trading signals based on the relative performance of assets. A typical cross-sectional trading strategy involves buying assets with the highest-ranked trend signals and selling those with the lowest-ranked trend signals. So basically this is a relative value strategy.

Reference [1] examined trend trading in the commodity market from the cross-sectional momentum perspective. The authors conducted a study on a portfolio of 35 commodity futures. They pointed out,

In this paper, we provide a trend factor that exploits the short-, intermediate-, and long-run moving averages of settlement prices in commodity futures markets. It outperforms the momentum benchmark significantly. During our sample period January 2004–December 2020, the trend factor generates statistically and economically large returns while the average return of the momentum factor is insignificant. The trend factor also has less downside risk than the momentum factor. The returns of the trend factor cannot be explained by existing multifactor models. The trend factor also generates a significant and positive risk premium.

In short, cross-sectional momentum exists in the commodity market and it is possible to construct a profitable trend trading strategy. The authors went on to identify the underlying risk/PnL driver of the thus developed trading strategy,

…the trend factor is correlated with funding liquidity measured by the TED spread. Overall, our results indicate that past prices contain important information on the expected returns in commodity futures markets.

In other words, the underlying PnL driver is the TED spread which represents the funding liquidity.

References

[1] Han, Yufeng and Kong, Lingfei, A Trend Factor in Commodity Futures Markets: Any Economic Gains From Using Information Over Investment Horizons? (October 31, 2021). Available at SSRN: https://ssrn.com/abstract=3953845

Article Source Here: Cross-Sectional Momentum in the Commodity Market

Basis Points and Basis Point Values

When it comes to bonds, mortgages, and other interest-rate-sensitive instruments, most people refer to the change in interest rates as basis points or bps for short. For example, you might hear someone say that a bond yield increased by 12 bps. The actual meaning is that the new yield is 0.12% higher than the old one. BPS is used to describe changes in interest rates on fixed income instruments because it is the decimal form of the change.

In this article, we are going to look at what is Basis Point and how to calculate it.

What is a Basis Point

A basis point is a unit in measurement used to quantify change. To calculate the basis points from any given percent change, you simply need to multiply the change by 100 to obtain the value in basis points.

Now when it comes to bonds and mortgages, most people refer to the change in the interest rate as basis points or bps for short. So, bps is used to describe changes in interest rates on fixed income instruments because it is the decimal form of the change.

Example of Basis Points

Question: What is the change in yield in basis point of a bond trading at par that has a yield increase from 6% to 6.10%?

Answer: Using the calculation method mentioned above, we multiply the change (0.10%) by 100 and obtain 10 BPS.

Another Example

Question: What is the change in yield of a bond trading at 103 that has a yield decrease from 5.02% to 4.98%?

Answer: -0.04 multiplied by 100 = -4 BPS

So, as you can see it simply requires multiplying the change by 100 to get your answer.

Why use basis points

BPS is widely used for quoting changes in financial assets, especially bonds and interest rates. This is because the basic point is a decimal form of change that makes it easy to understand the relative change in numbers, compared to percentages, which can be confusing and misleading in certain cases.

It gives you a better idea of a security's or an instrument's volatility. BPS is a unit that is used to measure the change in various fixed-income instruments which have different values for each one, just like interest rates. It does not matter if you are dealing with bonds, mortgages, or other interest-rate-sensitive instruments, BPS measures the increase or decrease from the previous value.

How to Calculate Basis Point Value of a Bond or Mortgage

In order to calculate the basis point value of a bond or mortgage, you need to know how much they are worth currently. Then you have to find out how much their value changes after the shift in interest rates. Once you have done this you divide the change in the instrument’s value by the basis points and you’ll get the basis point value

Benefits of using basis points and basis point values

• It is beneficial because it makes transaction costs easier to understand.
• It makes it easy to compare bonds with different prices and yields
• It is easier to compare bond yields with those on other securities such as mortgages.

Conclusion

BASIS POINT is a unit of measurement used to quantify change. It is widely used for quoting changes in financial assets, especially bonds and interest rates. It gives you a better idea of a security's or an instrument's volatility. It is very easy to calculate the basis point. All you have to do is to multiple the change in percent by 100.

Article Source Here: Basis Points and Basis Point Values

Net Sales Vs. Gross Sales

Net sales and gross sales are important financial metrics for businesses to track. Both metrics provide valuable insight into a business’s performance, thereby painting a picture of where a business is going.

If you’re not sure what these metrics are and how they differ from each other, you’re in the right place.

In this article, we will explain the basics of net sales and gross sales to help you understand the distinction between the two.

What Are Net Sales?

Net sales refers to a business’s total sales revenue generated over a specified period of time after subtracting allowances, discounts, and sales returns. In other words, net sales is a business’s gross sales minus the cost of allowances, discounts, and sales returns.

How To Calculate Net Sales

The formula for net sales is:

Net Sales= Gross Sales –Sales Returns-Allowances-Discounts

Let’s define the terms that constitute the net sales formula.

• Gross Sales-This is the amount of sales a business generates over a specified period of time, unadjusted for sales returns, allowances, and discounts.
• Allowances-These are grants given to customers on account of damaged goods, defective goods, wrong goods sent, and other reasons other than discounting.
• Sales Returns- These are product items that are returned in exchange for a partial or full refund. Sold items can be returned due to late shipping, defective products, incorrect product specifications, wrong items shipped, excess quantity shipped, etc.
• Discounts-These are rewards a business extends to customer’s invoices when certain conditions are met. For example, if you offer your customers a 30-day invoice period, you can extend a 5% discount if they make payment within 15 or 20 days.

An Example of the Net Sales Formula

Suppose a book store sold 10,000 books over the financial year, with book retailing for $15. However, they gave out allowances worth $10,000 and discounts of $7,000 and had sales returns worth $10,000.

Using the net sales formula, the net sales for this bookstore is:

Net Sales= (10,000 x $15) - $10,000 - $7,000 - $10,0000 = $123,000

Benefits of Knowing Your Net Sales

Net sales helps businesses to get a better idea of their performance and financial health. Businesses can also use this metric to measure deductions, discounts, and returns for purposes of making the necessary adjustments towards profitability.

What Are Gross Sales?

Gross sales refers to the total sales a business makes within a specified period of time without accounting for any deductions. That is, the total number of units sold multiplied by sales price per unit. Knowing your gross sales helps you to track your sales volume. However, this metric is not a good measure for decision making.

Benefits of Knowing Your Gross Sales

Gross sales gives insight into the total amount of revenue a business generates during a certain period of time. Using gross sales, you can measure how well your sales team is doing and how they can take their sales game to the next level.

Conclusion

Gross sales and net sales are important metrics to track in order to make informed decisions.

Article Source Here: Net Sales Vs. Gross Sales

Brokers and Dealers in Securities

Brokers and dealers are two key figures in the security market. However, both have their distinct functions and relevance to the security market.

Practically, there is no security market without a broker. A broker provides a technical base for transactions. On the flip side, a dealer trades securities for his(her) own profit. Let's take a detailed look at the two figures and see how they differ.

Who is a Broker?

In the security market, a broker acts as an intermediary between a seller and a buyer, facilitating transactions. A broker (either be an individual or a corporate entity) trades on behalf of another for a commission. Put another way, he(she) executes a trade on behalf of stock traders, based on their instructions, and receives a fee as compensation.

This fee can be fixed or a particular percentage of the amount used for a transaction, it all depends on the agreement between the broker and their client.

However, aside from mediation - connecting buyers and sellers of securities, brokers offer their clients some other key benefits which include:

• Provide support for clients via helpful information regarding trading; trading strategies and mechanisms, activities of other market participants, notifications about quotes, etc. In other words, brokers can help to facilitate learning and success in security trading.
• Provide a platform for transactions.
• Stores and protects clients' data.
• Lend securities to clients for margin transactions.

Who is a Dealer?

In the security market, a dealer buys and sells securities for their profit. Dealers diligently follow market moves, ready and willing to take advantage of every opportunity to buy securities.

Generally, the sole target of a dealer is to make a profit for themselves from the spread between the bid and ask prices. By doing so, dealers contribute to the liquidity of the security market.

Hence, conclusively, a dealer does not facilitate trade nor connect the two parties (sellers and buyers) rather they trade on their own behalf.

Key Differences Between Brokers and Dealers in Securities

• A broker facilitates transactions in the security market by creating a technical base for exchange between sellers and buyers. In contrast, a dealer does not facilitate trading, they carry out trading activities for their own benefit.

However, most dealers also double as brokers and are called broker-dealers.

• A dealer does not receive a commission for trade unlike a broker, he/she trades in their account and therefore is the principal. A broker charges the client a commission for trading on their behalf.
• Brokers trade based on what their clients want, whereas dealers do not take instructions from anyone regarding trades.
• A dealer tends to have more knowledge about securities trading than a broker. Since they trade on their behalf, they will dig into every information necessary for profitable trading. This might give them an edge over brokers who only act according to the instructions of their clients.

Bottom Line

Both brokers and dealers matter in the security market. While a broker enables the transaction of securities, a dealer ensures that the market stays liquid, which is also very vital to the existence of the market.

Originally Published Here: Brokers and Dealers in Securities

Sales Returns: Definition, Journal Entry, Example, Allowances

Companies that manufacture products and services may offer sales returns or allowance policies. These are a normal part of the business that these companies conduct. Usually, customers return goods sold to them for various reasons. For companies, these sales returns are a reduction in sales. First, however, it is crucial to understand what sales returns are.

What are Sales Returns?

Sales returns are goods that customers return to a company for various reasons. Usually, companies provide this facility to customers to increase sales. In essence, a sales return policy allows customers to return goods when they find issues with those goods. In some cases, companies may offer goods in exchange for any returns. However, some others may return the customer's money.

A sales return policy is essential in ensuring customers of the quality of the goods delivered. However, it can lead to a decrease in revenues for companies. Some companies may also offer a sales allowance policy, which is similar to accounting treatment. However, both processes are fundamentally different.

What are the reasons for Sales Returns?

As mentioned, customers may have several reasons to return goods to a company. Some of the primary ones include the following.

• The company sent defective goods.
• The customer received the goods late, or the company failed to deliver them on time.
• The company did not send the right order to the customer.
• The goods do not satisfy the customer’s needs.
• The company delivered a higher quantity than what the customer requested.
• The customer made an unintended order.

What are the journal entries for Sales Returns?

The accounting treatment of sales returns involves recording two journal entries. The first entry requires companies to reduce the customer's account while decreasing revenues. Usually, this decrease in revenues occurs through a contra revenue account. This account does not impact a company's revenues directly. However, it can lead to a reduction in the income statement later.

When companies receive goods returns from customers, they can use the following journal entries to record them.

Dr Sales Returns and Allowances

Cr Customer account

The above double-entry assumes the customer has not paid for the goods yet. If customers have already done so, the company may create a liability for the customer. In that case, the journal entries will be as follows.

Dr Sales Returns and Allowances

Cr Payable to customer

When customers return sales, the company also receives goods back from the customer. Therefore, it must record those goods in the inventory account. It is the second accounting treatment that involves sales returns. For this process, the journal entries will be as below.

Dr Inventory

Cr Cost of goods sold

Example

A company, Red Co., manufactures and sells electronic items. During an accounting period, the company sold $100,000 worth of electronics. Red Co. records these sales using the following journal entries.

Dr Accounts receivables $100,000

Cr Sales $100,000

However, some of the goods that Red Co. sent were faulty. These goods got damaged during the delivery process. As a result, Red Co. received $10,000 worth of electronics back from customers. However, none of the customers had paid for those goods at the time. The company used the following journal entries to record them.

Dr Sales returns and allowances $10,000

Cr Accounts receivables $10,000

Conclusion

Sales returns are goods returned by a customer. There are several reasons why a customer may do so. For example, these may include faulty goods, incorrect orders, shipping delays, etc. The accounting entries for sales returns involve two steps. First, a company must record a decrease in sales through a contra revenue account. The second step is to record the increase in inventory from those goods.

Article Source Here: Sales Returns: Definition, Journal Entry, Example, Allowances

How to Determine Credit Risks of a Startup

There is a very interesting discussion on stackexchange on how to determine the credit risks of a startup.

What would be the ideal way to develop the IFRS9 ECL model for startup fintech when there is no historical data.

There are 2 answers to this question (as of November 2021)

1. This is more of an educated guess than an actual answer, I may be completely off track - take this at a discount: I would identify and quantify my targeted clientele („EUR <region> retail: x %, EUR <Region> corporates y %...“) and I would then buy default data / credit histories / model parameter from data vendors. Another idea could be to reach out to companies that offer outsourcing for risk models / model estimates, at least during the initial phase of your product.
2. According to the regulations of IFRS 9, the valuation for the ECL is not permitted exclusively on the basis of historical values. (For example, IFRS 9.B5.5.17). The inclusion of macroeconomic data and the economic environment is also desired. Similar companies can also be included in the valuation.

This is in fact a very tough question. We have faced this situation frequently in our consulting practice. To determine the credit risks of a startup, or a private company in general, we usually utilize

• Data of comparable public companies,
• The startup’s recent debts,
• Relevant high yield credit indices,
• A structural credit risk model,
• Combination of the above.

Another possible solution is to develop a predictive model, but again, lack of data will be an issue.

Let us know what you think.

Article Source Here: How to Determine Credit Risks of a Startup

Auction Market: Definition, Examples, Comparison with Dealer Market

One general goal for investing is to own assets that will appreciate over time. As an investor, note that there are different types of markets to consider when you want to execute a trade. The auction market is primarily concerned with executing trades among buyers and sellers.

Having a lot of buyers who are interested in buying a financial instrument will make that asset more valuable. Also, when liquidating the asset to cash, the market gets to set the prices realized for the assets being sold.

In this article, you will get to know what an auction market is, how it works, and differentiate between the auction market and the dealer market.

What is an Auction Market?

An auction market is a trading market where buyers and sellers trade assets. In this market, a trade is executed when the highest price from the buyer matches with the lowest price the seller is willing to accept. It's an environment where a bidding process facilitates competition between buyers and sellers.

How Does an Auction Market Work?

This market strategy is quite different from OTC (over-the-counter) market strategy, where trade is carried out directly between two parties without a broker. The auction market can be done physically and also via the computer. But there's no direct negotiation between the buyers and sellers.

Here, the seller place offers in the desired financial instrument. Also, buyers place multiple bids in the desired financial instrument that is available in the market. Then the trade executes when the highest bid price is matched with the lowest ask price.

In this process, there could either be multiple buyers and multiple sellers or multiple buyers and one seller.

Examples

We'll use the case scenario where there are multiple buyers and multiple sellers to explain further.

Three buyers are interested in buying a share of company ABC with the bid prices of $5.00, $5.03, and $ 5.5 respectively. Whereas, three sellers had offered to sell their shares of company ABC for $5.5, $5.7, and $5. 9 respectively.

In this scenario, the highest bid price of $5.5 will be matched with the lowest sell price of $5.5 and the trade will be executed. However, the rest of the orders will not be executed immediately and the current market price of company ABC will be adjusted to $5.5.

Auction Market vs Dealer Market

Going through the characteristics of the dealer market,  it is quite different from the auction market in various ways.

As explained earlier, an auction market is a competitive market where trade is executed by matching the buyer's highest bid price with that of the lowest sell price. On the other hand, a dealer market is a market where dealers post a fixed price to sell a desired financial instrument. Without involving a third party, trade is executed when an investor accepts the dealer’s fixed price.

In the auction market, there's a single platform where buyers and sellers post the prices they want to buy and sell. However, this process ensures that the financial security is sold at a good price. In the dealer’s market, buyers and sellers get to know the bid price and offer price electronically but the trade is executed through dealers.

The auction market operates an order-driven market where buyers and sellers engage in competitive bidding. On the other hand, dealers get to fix the sell and buy prices. That is to say, the dealer market operates a quote-driven system.

Conclusion

The main focus of the auction market is to connect buyers and sellers. In doing this, brokers stand in place of the individual owners of the securities. It's important to note that, no matter how intense trading might be, each market operates with a set of guiding rules.

Post Source Here: Auction Market: Definition, Examples, Comparison with Dealer Market

Is It Better To Be Lucky Than Good?

In financial markets, the logarithms of asset prices are often modeled as a normal distribution. Elsewhere in life, many things are normally distributed: people's height, education levels, talents, working hours in a day, etc. Success, as measured by wealth, however, is not normally distributed. In fact, it’s heavily skewed and follows the Pareto rule: 20% of the world’s population own 80% of the wealth. Indeed, the world’s 8 richest people have a total wealth equivalent to that of the world’s poorest 3.8 billion people.

Why is that?

In Reference [1], the authors showed that a large part of a person's success can be attributed to luck. They used computer simulation to reach that conclusion,

In this paper, starting from few very simple and reasonable assumptions, we have presented an agent-based model which is able to quantify the role of talent and luck in the success of people's careers. The simulations show that although talent has a Gaussian distribution among agents, the resulting distribution of success/capital after a working life of 40 years, follows a power law which respects the "80-20" Pareto law for the distribution of wealth found in the real world. An important result of the simulations is that the most successful agents are almost never the most talented ones, but those around the average of the Gaussian talent distribution – another stylised fact often reported in the literature. The model shows the importance, very frequently underestimated, of lucky events in determining the final level of individual success. Since rewards and resources are usually given to those that have already reached a high level of success, mistakenly considered as a measure of competence/talent, this result is even a more harmful disincentive, causing a lack of opportunities for the most talented ones. Our results highlight the risks of the paradigm that we call "naive meritocracy", which fails to give honors and rewards to the most competent people, because it underestimates the role of randomness among the determinants of success.

We find the article very interesting. It

• Quantified and formally demonstrated the role of luck in one’s success.
• Proved the adage “luck happens when opportunity meets preparation”. According to the study, in order to become successful, a person has to be moderately talented and lucky events have to happen in his/her life. He/She doesn’t have, however, to be the most talented person.

The article raised the following questions,

• Is “the harder you work, the luckier you get” still true? Does working harder increase the likelihood of lucky events?
• How do we minimize the role of unluck, and increase luck in portfolio management practice?
• How can we do that in business and life in general?

To this effect, the authors also proposed some schemes for improving meritocracy in research funding,

…several different scenarios have been investigated in order to discuss more efficient strategies, which are able to counterbalance the unpredictable role of luck and give more opportunities and resources to the most talented ones - a purpose that should be the main aim of a truly meritocratic approach. Such strategies have also been shown to be the most beneficial for the entire society, since they tend to increase the diversity of ideas and perspectives in research, thus fostering also innovation.

References

[1] A. Pluchino, A.E. Biondoy, A. Rapisardaz, Talent vs Luck: the role of randomness in success and failure, Advances in Complex Systems, Vol. 21, (2018)

Article Source Here: Is It Better To Be Lucky Than Good?

Net Purchases: Definition, Formula, Examples

Companies incur various expenses that are crucial for their operations. One of these includes purchases, which are direct costs. Usually, they involve expenses incurred on purchasing raw materials or products. Companies report these costs in the income statement as a part of the cost of goods sold. However, most companies usually include them as net purchases.

What are Net Purchases?

When companies purchase products for resale or manufacturing, their expenses rise. These expenses also increase the purchase costs reported on the income statement. However, several items exist, which can result in a decrease in this amount. Accounting standards require companies to disclose these items in the income statement. These disclosures fall under net purchases as deductions from gross purchases.

Net purchase is the gross amount of purchase made by a company minus deductions for specific items. For most companies, these deductions include purchase discounts, returns, and allowances. In accounting, a purchase is an expense account, while these accounts form contra expense accounts.

What are the components of Net Purchases?

Net purchases have several components which affect the final figure reported on the income statement. The most significant of these is a company's purchases. As mentioned, it usually includes costs incurred on manufacturing materials or resalable products. Without any deductions, it is known as gross purchases. When converting this figure into net purchases, the following three components are crucial.

Purchase returns

Purchase returns include any items that companies return to the supplier. Companies may return goods to suppliers for various reasons, for example, when they receive damaged items. Since companies have already recorded the purchase expense in the accounts, they cannot reverse it. Instead, they use the purchase returns account to reduce the figure through a contra account.

Purchase Discounts

When companies purchase goods on credit, they may receive a cash discount. This discount involves paying the value of those goods within a specific time period. For example, a supplier may offer its customer a 10% discount if they pay within 15 days with a credit term of 30 days. For the purchaser, this discount reduces the cost of the goods purchased. Therefore, they result in a deduction from the gross purchases.

Purchase Allowances

Purchase allowances have similar features as purchase discounts. However, it does not entail a prompt or early payment. Instead, it involves the reduction in prices of goods for various reasons. For example, a supplier may offer a company a reduction in price for damaged goods. Purchase allowances are a decrease in the price of goods purchased to avoid purchase returns.

What is the formula for Net Purchases?

The formula for net purchases is straightforward after considering its components. As mentioned, it is the residual amount after deducting returns, discounts, and allowances from gross purchases. Therefore, the net purchases formula is as below.

Net Purchases = Gross Purchases - Purchase Returns - Purchase Discounts - Purchase Allowances

Usually, companies report this figure in the notes to the financial statements. The net purchases amount goes into the income statement.

Example

A company, Blue Co., made total purchases of $100,000 during an accounting period. Of these purchases, the company returns $10,000 worth of goods to suppliers. Blue Co. also received discounts of $6,000 during the year for early payments. Lastly, the company accepted allowances of $4,000 for purchases that included faulty products. Therefore, the company's net purchases will be as follows.

Net Purchases = Gross Purchases - Purchase Returns - Purchase Discounts - Purchase Allowances

Net Purchases = $100,000 - $10,000 - $6,000 - $4,000

Net Purchases = $80,000

Conclusion

Net purchases include a company's gross purchases minus returns, discounts, and allowances. Similarly, three components are crucial to this amount. These include purchase returns, discounts, and allowances. Companies report net purchases in the income statement. However, these deductions appear on the notes to the financial statements.

Article Source Here: Net Purchases: Definition, Formula, Examples

Bid-Ask Spread: Understanding, How to Read, Example, Liquidity

What is the Bid-Ask Spread?

Bid-ask spreads are most commonly found in the market for stocks, futures, and options. A bid-ask spread is a difference between the price that a buyer is willing to pay for an asset and the price at which a seller is willing to sell the same asset.

Bid-ask spreads exist because investors may not immediately agree on a price, so they need time to negotiate. As a result, the price is set at a point where the lowest ask price equals the highest bid price.

In this article, we'll explore what Bid-ask Spread is and how it works.

Definition of Bid-Ask spread

Bid-ask spread is the difference between the price at which you can sell an asset and the price at which you must buy it. An easy way to understand Bid-ask spread is thinking of it as being similar to a commission when buying or selling something in real life.

The Bid-ask spread is used by traders to determine the impact of an order on the market. The wider the spread, the less liquid a security or asset is and the more difficult it is to execute the order.

Why does Bid-Ask exist?

Bid-ask spreads are actually not that hard to understand once you get familiar with how trading works. A bid-ask spread represents the difference between the lowest asking price for a stock and its highest bid price.

To understand the Bid-Ask spreads better, let's take an example of an investor who wants to enter a market order. When placing this kind of order, you'll be selling at whatever price is available in the exchange, which means that you might not get as much as you would like for it.

On the other hand, if you place a limit order to buy at $100 and somebody places an offer to sell the stock under that price then your order is going to be filled. This means that you don't have to buy for a higher price than what you're willing to because someone else is willing to sell under that price.

For simplicity's sake, let's say that the bid-ask spread for Company inc. shares is $4.95 and $5.00. This means that investors can sell the shares at $4.95 and simultaneously buy at $5.00. The difference between these two prices ($0.05) will be given to whoever operates this exchange.

Use of Bid-Ask Spread

The Bid-Ask spread is used mostly to gauge market liquidity and to decide what type of order we should place. For example, if the Bid-Ask spread is tight, then it’s safer to use the market order. On the other hand, if the Bid-Ask spread is wide, then a limit order should be used.

Here are some of the benefits of Bid-ask Spread

• Helps to determine the fair price of an asset
• Used by traders to determine how much impact their orders will have on the market
• Identifies high-volatility assets
• Helps traders to determine a price range for an asset

Conclusion

The bid-ask spread is the difference between the lowest selling price for a share and the highest buying price. As you can see from our example above, traders can either sell at a lower price or buy under a certain price depending on which order they place.

Article Source Here: Bid-Ask Spread: Understanding, How to Read, Example, Liquidity