The Invisible Hand Glossary and Terms
– An asset is a resource with economic value that is owned or controlled by an individual or corporation. Assets are bought to increase the monetary value of a corporation or individual. The more assets are acquired, the more the company’s value goes up.
– Futures are financial contracts obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets.
Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures.
– A put is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying asset at a set price within a specified time. The buyer of a put option estimates that the underlying asset will drop below the exercise price before the expiration date.
– An option is a financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
Call options give the option to buy at certain price, so the buyer would want the stock to go up.
Put options give the option to sell at a certain price, so the buyer would want the stock to go down.
– An option chain is a form of quoting options prices through a list of all of the options for a given security. An option chain is simply a listing of all the put and call option strike prices along with their premiums for a given maturity period. The majority of online brokers and stock trading platforms display option quotes in the form of an option chain.
– Short selling is a financial technique also known as ‘shorting’ or ‘going short.’ Traditionally, traders invest in stock when it is predicted to go up; however, in short selling, stock traders can use stock with declining values to make money. The practice is risky because the trader is betting against the overall trend of the stock market.
A main trader, known as the “short seller,” would borrow assets from a broker at a small fee. Let’s say that a short seller named Justin borrowed a certain number of assets from a firm. The assets are valued at $600. The short seller would then sell these very same assets to a different trader or organization at the same rate of $600. Since he borrowed the assets from his broker, the short seller must buy the assets back at a later date. For the short seller to make money, the value of the assets must drop before buying them back. Let’s say that short seller predicted that the stock’s value declines and the value of the assets dropped from $600 to $200.
The short seller then buys back the assets at the lower rate of $200. The difference between the original purchase and the final rebuying rate will equal to the profit made by the short seller. After paying the borrowing fee, the short seller made roughly $400.
– A position is the amount of a security, commodity or currency that is owned (a long position) or borrowed and then sold (a short position) by an individual, institution or dealer. A position can be profitable or unprofitable, depending on market movements. The practice of restating the value of a position based on its current value is called mark-to-market.
A position can be speculative or part of a broader business. For example, an investor can buy euros, which is a long position, because he believes the euro will appreciate in value. This is a speculative position. A business might have a natural long position in euros because it exports to Europe and gets paid in euros. The investor who purchased euros will leave that position open until he thinks it is time to close it out to take a profit or limit a loss. The business with the natural long position may enter into an offsetting position, known as a hedge, to protect against market moves before eventually closing it out.
-- Volume is the number of shares or contracts traded in a security or an entire market during a given period of time. For every buyer, there is a seller, and each transaction contributes to the count of total volume. That is, when buyers and sellers agree to make a transaction at a certain price, it is considered one transaction. If only five transactions occur in a day, the volume for the day is five.
Volume is one of the most important measures of strength for traders and technical analysts. Put simply, volume refers to the number of contracts traded. For any trade to occur, the market needs to produce a buyer and a seller. A transaction occurs when buyers and sellers meet and is referred to as the market price. From an auction perspective, when buyers and sellers become particularly active at a certain price, it means there is a lot of volume.
Analysts use bar charts to quickly determine the level of volume. Bars also provide easier identification of trends in volume. When bars are higher than average, it is a sign of high volume or strength at a particular market price. In this way, analysts use volume as a way to confirm a price movement. If volume increases when the price moves up or down, it is considered a price movement with strength.
– In the midst of WWII, the United Nations hosted an international conference in Bretton Woods, New Hampshire to establish an international economic system intended to govern monetary relations among independent nation-states. The conference founded the International Monetary Fund and the World Bank. The chief features of the Bretton Woods system were:
(1) an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar; and
(2) the ability of the IMF to bridge temporary imbalances of payments. The system addressed the lack of cooperation among other countries and prevented competitive devaluation of the currencies as well.
While much of the Bretton Woods system is embedded into today’s global economy (IMF and the World Bank are the most concrete examples of this). President Nixon put an end to the fixed exchange rate system, a staple of Bretton Woods, in 1971.
– A reserve currency (or ‘anchor currency’) is a currency that governments and institutions hold in significant quantities as part of their foreign exchange reserves. The US dollar is the world’s most dominant reserve currency. A large percentage of commodities, such as gold and oil, are usually priced in the reserve currency in dollars. The world’s dependency on American dollars allows the United States’ government to borrow at lower costs, and American residents can avoid currency exchange rates when making import purchases. However, this forces countries that are dependent on the dollar to spend the equivalent of the dollar with their respective currency.
– Adam Smith described the self-regulating nature of the marketplace as the “invisible hand.” He believed that an individual has the power to make profit without the intervention of the government, and that an individual’s efforts to maximize their own gains may benefit a free market society.
-- A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.
Start-ups and other high-growth companies such as those in the technology or biotechnology sectors rarely offer dividends because all of their profits are reinvested to help sustain higher-than-average growth and expansion. Larger, established companies tend to issue regular dividends as they seek to maximize shareholder wealth in ways aside fromsupernormal growth.
Companies in the following sectors and industries have among the highest historical dividend yields: basic materials, oil and gas, banks and financial, healthcare and pharmaceuticals, utilities, and REITS.
– A balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders.
The balance sheet adheres to the following formula:
The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders' equity on the other – must balance out. This is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).
The balance sheet is a snapshot, representing the state of a company's finances at a moment in time. By itself, it cannot give a sense of the trends that are playing out over a longer period. For this reason, the balance sheet should be compared with those of previous periods. It should also be compared with those of other businesses in the same industry, since different industries have unique approaches to financing.
–A currency basket is a unit of currency derived from the average value of a collection of currencies with varying market value. The best example of a currency basket is the European Currency Unit (the predecessor of the Euro) that the European Community (now a component of the European Union) used to avoid (or minimize) the risk of currency fluctuations.
Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real estate market, allows assets to be bought and sold at stable prices. Cash is the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid.
Accounting liquidity measures the ease with which an individual or company can meet their financial obligations with the liquid assets available to them. There are several ratios that express accounting liquidity.
Cash is considered the standard for liquidity because it can most quickly and easily be converted into other assets. If a person wants a $1,000 refrigerator, cash is the asset that can most easily be used to obtain it. If that person has no cash, but a rare book collection that has been appraised at $1,000, they are unlikely to find someone willing to trade them the refrigerator for their collection. Instead, they will have to sell the collection and use the cash to purchase the refrigerator. That may be fine if the person can wait months or years to make the purchase, but it could present a problem if the person only had a few days. They may have to sell the books at a discount, instead of waiting for a buyer who was willing to pay the full value. Rare books are therefore an illiquid asset.
– Established at the 1944 Bretton Woods conference, the IMF assisted the reconstruction of the international economic system post-WWII. According to the IMF website, the “organization [is composed] of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.”
The IMF plays three major roles in the global monetary system:
1. Promote global monetary and exchange stability;
2. Facilitating the expansion and balanced growth of international trade; and
3. Assisting in the establishment of a multilateral system of payments for current transactions.
The IMF surveys and monitors economic and financial developments, lends funds to countries with balance-of-payment difficulties, and provides technical assistance and training for countries requesting it.
-- Hawala is an alternative remittance channel that exists outside of traditional banking systems. Hawala is a method of transferring money without any actual movement. One definition from Interpol is that Hawala is "money transfer without money movement." Transactions between Hawala brokers are done without promissory notes because the system is heavily based on trust.
Hawaladars, or Hawala dealers, arrange money transfers that are often backed only by trust, family connections or regional relationships. Hawala originated in South Asia during ancient times, and is used throughout the world today, particularly in the Islamic community as an alternative means of conducting funds transfers. Hawala is frequently referred to as underground banking, which is a misnomer because Hawala services often operate openly and legitimately.