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does random walk theory imply that it s impossible to make money in stocks | no according to random walk theory it is impossible to consistently outperform the market over the long term through stock picking or market timing however it is still possible to profit in the stock market by buying and holding a diversified portfolio of stocks such as with an index fund | |
does random walk theory apply only to stocks | no while it is most commonly applied to the stock market it can also be applied to other financial markets such as the bond forex and commodities markets among others | |
is random walk theory correct | random walk theory is widely debated among financial economists and market practitioners while some agree with its basic tenets others have challenged its assumptions and have proposed alternative theories of how and why prices move some have pointed out instances where stock prices do not follow a random walk such as during bubbles or flash crashes in these cases prices may be driven more by emotional factors than by randomness the bottom linerandom walk theory claims that stock prices move randomly and are not influenced by their history because of this it is impossible to use past price action or fundamental analysis to predict future trends or price action if markets are indeed random then markets are efficient reflecting all available information the theory remains popular among economists however it has been criticized by technical and fundamental traders alike for being overly simplistic and discounting real world outperformance achieved by some traders | |
what is a range | range refers to the difference between the low and high prices for a security or index over a specific time it defines the difference between the highest and lowest prices traded for a defined period such as a day a month or a year the range is marked on charts for a single trading period as the high and low points on a candlestick or bar technical analysts closely follow ranges because they re useful in pinpointing entry and exit points for trades investors and traders may also refer to a range of several trading periods as a price range or trading range securities that trade within a definable range may be influenced by many market participants attempting to exercise range bound trading strategies understanding a trading rangea range for an individual trading period is the highest and lowest prices traded within that time the trading range for multiple periods is measured by the highest and lowest prices over a predetermined time frame the relative difference between the high and the low defines the historical volatility of the prices whether on an individual candlestick or over many of them the range depends on the type of security it depends on the sector in which it operates for a stock the range for fixed income instruments is much tighter than that for commodities and equities that are more volatile in price a treasury bond or government security typically has a smaller trading range than a junk bond or convertible security even for fixed income instruments the amount of volatility can vary from one asset to another and from one security to another investors prefer lower volatility so prices becoming significantly more volatile are said to indicate turmoil of some kind in the market many factors affect a security s price and hence its range macroeconomic factors such as the economic cycle and interest rates have a significant bearing on the price of securities over lengthy periods a recession can dramatically widen the price range for most equities as they plunge in price examples of trading rangesmost technology stocks had wide price ranges between 1998 to 2002 as they soared to lofty levels in the first half of that period then slumped in the aftermath of the dotcom bust many to single digit prices 1similarly the 2007 08 financial crisis considerably widened the trading range for equities due to the broad correction that saw most indices plunge more than 50 in price stock ranges have narrowed significantly since the great recession as volatility has reduced during a multi year bull market ranges and volatilityprice volatility is equivalent to risk so a security s trading range is a good indicator of risk a conservative investor prefers securities with smaller price fluctuations compared to securities that are susceptible to significant gyrations such an investor may prefer to invest in more stable sectors like utilities healthcare and telecommunications rather than in more cyclical or high beta sectors like financials technology and commodities high beta sectors may generally have wider ranges than low beta sectors range support and resistancea security s trading range can effectively highlight support and resistance levels the 10 region would be considered an area of strong support if the bottom of a stock s range has been around 10 on several occasions spanning many months or years traders interpret it as a bearish signal if the stock breaks below that level especially on heavy volume conversely a breakout above a price that has marked the top of the range on numerous occasions is considered as a breach of resistance and provides a bullish signal | |
what is a high beta index | a high beta index is made up of volatile stocks they re generally riskier but they can be enticing for investors who are willing to gamble a little to achieve better returns 2 | |
what is a range bound trading strategy | range trading is what the name implies an investor sells and buys within a range of prices one at which a stock is currently trading and the other to which they believe it will rise the investor trades within those price ranges the tactic can be used repeatedly over a set period until the current price of the stock is as high as the investor believes it will go so it s time to get out of it 3 | |
what is a downside to range trading | all trading strategies come with some component of risk and risk increases when market trends are changing from contraction to expansion and back again the success of range trading depends heavily on a trader being able to identify a market s trend during their times of trading 3the bottom linethe success of range trading can depend on how many participants are actively engaged in it at any point in time even if their strategies are different a trading range attempts to pinpoint the element of risk and volatility this type of trading may not be suited for the faint of heart or less experienced traders consider getting your feet wet first by trading in more stable low beta sectors such as healthcare | |
what is the ratchet effect | the ratchet effect is an economic process that is difficult to reverse once it is underway or has already occurred a ratchet is an analogy to a mechanical ratchet which spins one way but not the other in an economic process that tends to only work one way the results or side effects of the process may reinforce the cause by creating or altering incentives and expectations among participants a ratchet effect is closely related to the idea of a positive feedback loop in addition like releasing a mechanical ratchet used to compress a spring the reversal of an economic process that involves a ratchet effect may be rapid forceful and difficult to control understanding the ratchet effectthe ratchet effect in economics refers to escalations in production prices or organizational structures that tend to self perpetuate this occurs because the process involved also changes the underlying conditions that drive the process itself in turn this creates or reinforces the incentives and expectations of the decision makers involved in such a way that sustain or further escalate the process this is very similar to a positive feedback loop which is any pattern that reinforces itself the ratchet effect is named after the mechanical device known as a ratchet which consists of a round gear and pivoting pawl that allows the gear to turn in one direction but not the other in order for example to turn a bolt or to compress a spring in addition to the one way nature of the process a ratchet used to compress a spring can result in a build up of stored energy in the spring that can be suddenly released if the ratchet is disengaged in machines this must be carefully controlled to avoid damage to the system by an uncontrolled release of energy similarly economic processes that involve a ratchet effect may be marked by a build up of countervailing forces over time that can result in a rapid and possibly disruptive reversal of the process if the conditions that produce the ratchet effect are relaxed applications of the ratchet effectthe ratchet effect can be seen in many areas of economics the ratchet effect first came up in alan peacock and jack wiseman s work the growth of public expenditure in the united kingdom peacock and wiseman found that public spending increases like a ratchet following periods of crisis 1similarly governments have difficulty in rolling back huge bureaucratic organizations created initially for temporary needs such as during times of armed conflict or economic crisis this is because the incentives of the bureaucrats who make decisions within government agencies always include their incentive to maintain and improve their positions within the organization and the size and status of the organization itself they then constitute a concentrated interest group that will seek to lobby policymakers and influence pubic opinion to sustain expand and increase the powers of bureaucratic organizations this application of the ratchet effect was further explored by historian robert higgs who described how crises and emergencies are used to expand the powers of government agencies often on an allegedly temporary basis which then become permanent expansions of government power and intervention into the economy once the crisis has passed 2economist sanford ikeda later described how the reversal of this process is often characterized not by incremental ratcheting but by dramatic or revolutionary swings toward smaller less interventionist government that may be accompanied by general turmoil 3the ratchet effect can also impact business activities and investments due to things such as sunk costs relationship specific assets and path dependencies for instance in the auto industry competition drives firms to be constantly creating new features for their vehicles this requires additional investment in new machinery or a different type of skilled worker which increases the cost of labor once an auto company has made these investments and added these features it becomes difficult to scale back production the firm may be unwilling to waste their investment in the physical capital required for the upgrades or the human capital in the form of new workers let s look at another example if a store whose sales have been stagnant for some time adopts some changes such as new managerial strategies staff overhaul or better incentive programs and then earns greater revenues than it had previously the store will find it difficult to justify producing less since firms are always seeking growth and greater profit margins it is hard to scale back production the business version of the ratchet effect can also be similar to that experienced in government bureaucracies where agents in this case managers have an incentive to support a larger more complex array of products services and infrastructure to support the operations they manage similar principles apply to the ratchet effect from the consumer perspective because raised expectations escalate the consumption process if a company has been producing 20 ounces sodas for ten years and then decreases their soda size to 16 ounces consumers may feel duped even if there is a commensurate price decrease the ratchet effect also applies to wages and wage increases laborers will rarely if ever accept a decrease in wages but they may also be dissatisfied with wage increases that they considered insufficient a manager who receives a 10 pay increase one year and a 5 pay increase the next year may feel that the new raise is insufficient even though it still represents a pay raise in labor markets the ratchet effect also presents itself in situations where workers who receive performance pay choose to restrict their output 4 they do this because they are anticipating that the company will respond to higher output levels by raising output requirements or cutting pay this constitutes a multi period principal agent problem in this situation if the workers increase their output they reveal information about their productivity to the principals who will then ratchet up their demands for worker output however the ratchet effect in labor markets is nearly eliminated when competition is introduced this is true regardless of whether market conditions favor firms or workers | |
what is a rate and term refinance | a rate and term refinance is a type of mortgage loan refinancing that results in a lower interest rate or loan term or a combination of both a rate and term refinance does not provide any upfront money to the borrower which is why it s also known as a no cash out refinance conversely with a cash out refinance the home s equity is exchanged for cash adding the cashed out money to the mortgage loan balance the borrower receives cash at the closing in addition to their new loan rate and term refinances often carry lower interest rates than cash out refinances understanding rate and term refinancerate and term refinancing activity is driven primarily by a drop in market interest rates in order to lower monthly mortgage payments in contrast cash out refinance activity is usually driven by increasing home values and by homeowners seeking to tap into their home s equity the potential benefits of rate and term refinancing include securing a lower interest rate and a more favorable term on the mortgage while the principal balance remains the same as a result you could lower your monthly payments you could also choose to establish a new payment schedule to pay off the mortgage more quickly for example if you originally had a 30 year fixed rate mortgage and had been paying it down for 10 years you could refinance the loan at a lower rate but choose a 15 year term you wouldn t benefit from a much lower payment due to the lower rate but you d pay the loan off faster because there are advantages and disadvantages associated with both rate and term and cash out refinancing be sure to compare the rate and term offers from various mortgage lenders from there you can weigh the pros and cons of each before making a final decision requirements for rate and term refinancingfor rate and term refinancing to work lower interest rates must be available to the borrower there are two main reasons why this might not be the case the first is that interest rates in the overall economy can go up during the application process making them no longer available this is one of the many factors influencing interest rates over which borrowers have no control however you do have some control over your consumer debt or credit mortgage lenders will review your credit history and credit score to determine your creditworthiness if your credit has worsened since booking the original mortgage such as if you defaulted on a credit card or paid your mortgage payments late you will probably face a higher interest rate your credit score and history can be more important than mortgage interest rates on the other hand if your credit has improved substantially you might be able to refinance at a lower interest rate cash out refinancing increases the loan amount owed on your mortgage due to the additional credit risk lenders typically charge higher rates for cash out refinances meaning you have a higher monthly payment versus other types of refinances as a result cash out refinancing can increase the risk of foreclosure 1rate and term refinancing vs other optionscash out refinancing takes equity from your home for you to use it works best when the overall value of the property has increased because of rising real estate values however cash out refinancing can also be done if you are well along in the mortgage and have paid in a significant part of its equity a cash out refinancing increases the principal owed on your mortgage this form of refinancing might call for a re appraisal of the home to gauge its new value you might seek such refinancing to gain access to capital from the value of the house money you otherwise might not see until the home was sold a converse option called cash in refinancing involves putting more money toward the settlement of the mortgage to reduce any remaining principal | |
when considering any of these options it is important to calculate all the implications carefully and see how they compare to keeping your current mortgage | examples of rate and term refinancinglet s say you have been paying off a 30 year mortgage for 10 years and interest rates suddenly drop you might want to take advantage of the new rates one option would be to refinance the balance left on the original mortgage at that lower rate for a new 30 year full term the new loan would have lower monthly payments but it would be like starting over at a lower rate it would add 10 years to the total time to pay off the mortgage there were 10 years spent paying the first mortgage and there would be another 30 years for the new one which would equal 40 years in total between the lower interest rates and the longer term monthly payments would be much lower you could also use the rate and term refinancing option to pay the new interest rate and negotiate a 15 year mortgage your monthly payments would be twice as high as for a 30 year term all other things being equal however because interest rates fell your monthly payments may end up being lower than they were for the remaining 20 years of the original mortgage however it s more likely your monthly payments would still be higher because of the shorter term the main advantage is that you would save five years of payments there were 10 years spent paying the original mortgage and there would be 15 years for the new one equaling 25 years in total mortgage lending discrimination is illegal if you think you ve been discriminated against based on race religion sex marital status use of public assistance national origin disability or age there are steps you can take one such step is to file a report to the consumer financial protection bureau or with the u s department of housing and urban development hud | |
what is the difference between a refinance and a cash out refinance | a rate and term refinance is when a mortgage loan is refinanced by replacing the existing mortgage with a new loan usually with a lower interest rate a cash out refinance is when the mortgage loan is replaced by a new loan but the loan balance increases since the home s equity is exchanged for cash | |
what are the benefits of a rate and term refinance | a rate and term refinance can help you take advantage of a drop in mortgage rates lowering your monthly payment or you can choose to shorten the loan s term and pay off the mortgage earlier instead of benefiting from a lower monthly payment | |
what are the risks of a cash out refinance | a cash out refinance increases the mortgage loan balance since it reduces the equity in the home in exchange for cash as a result borrowers who lose their jobs or experience a reduction in income are at a greater risk of default or foreclosure the bottom linerate and term refinancing usually means a lower interest rate and a more favorable loan term however the principal balance remains the same while the monthly payment is often lower if you refinance and opt not to lower your payment you can pay off the mortgage more quickly however it s important to consider the costs and fees of refinancing and whether the monthly amount saved is worth it | |
what is rate of change roc | the rate of change roc is the speed at which a variable changes over a specific period of time roc is often used when speaking about momentum and it can generally be expressed as a ratio between a change in one variable relative to a corresponding change in another graphically the rate of change is represented by the slope of a line the roc is often illustrated by the greek letter delta understanding the rate of change roc the rate of change is used to mathematically describe the percentage change in value over a defined period of time and it represents the momentum of a variable it is used in a variety of mathematical and scientific situations for example finding a change in distance over time it can also be used in finance and investing to describe the change in the value of something over time such as a market index or individual security the rate of change is an important financial concept because it allows investors to spot security momentum and other trends for example a security with high momentum or one that has a positive roc normally outperforms the market in the short term conversely a security is more likely to decline if it has a roc that falls below its moving average or one that has a low or negative roc in this case the rate of change could be seen as a sell signal to investors the rate of change is also a good indicator of market bubbles even though momentum is good and traders look for securities with a positive roc if a broad market etf index or mutual fund has a sharp increase in its roc in the short term it may be a sign that the market is unsustainable if the rate of change of an index or other broad market security is over 50 investors should be wary of a bubble traders also can pay close attention to the speed at which one price changes relative to another for example options traders study the relationship between the rate of change in the price of an option relative to a small change in the price of the underlying asset known as an option s delta options traders use rate of change in various risk metrics known as the greeks the gamma for example is the rate of change of the delta where the delta is how the option s price changes with movements in the underlying | |
how to find the rate of change | the general formula for the rate of change is roc x1 x2 t1 t2 where x1 x2 is the change in variable being measured and t1 t2 is the amount of time it took for the change to happen 1this formula can also be written as | |
where | in finance the calculation for roc can also be computed as a return over time in this instance the formula uses the current value of a stock or index and divides it by the value from an earlier period subtract one and multiply the resulting number by 100 to give it a percentage representation r o c current value previous value 1 100 roc frac text current value text previous value 1 100 roc previous valuecurrent value 1 100the price rate of change indicatorthe rate of change is most often used to measure the change in a security s price over time this is also known as the price rate of change also abbreviated roc the price rate of change can be derived by taking the price of a security at time b minus the price of the same security at time a and dividing that result by the price at time a 2price roc b a a 100 where b price at current time a price at previous time begin aligned text price roc frac b a a times 100 textbf where b text price at current time a text price at previous time end aligned price roc ab a 100where b price at current timea price at previous time the indicator is an unbounded momentum indicator used in technical analysis set against a zero level midpoint when it is positive prices are accelerating upward when negative downward | |
what are other terms for rate of change | the rate of change may go by other terms depending on the context when talking about speed or velocity for instance acceleration deceleration is the rate of change in statistics and regression modeling the rate of change is defined by the slope of the line of best fit for populations the rate of change is called the growth rate in financial markets the rate of change is often referred to as momentum | |
how do you solve rate of change problems | rate of change problems can generally be approached using the formula r d t or rate of change equals the distance traveled divided by the time it takes to do so depending on the context involved in the problem the change in distance can be replaced with a different variable such as the change in value or price | |
how do traders use the price rate of change indicator | the price rate of change roc indicator is used in technical analysis to measure momentum a positive roc can confirm a bullish trend while a negative roc indicates a bearish one when the price is consolidating the roc will hover near zero the bottom linerate of change roc is an important concept that tells us not just that things are changing but how fast things are changing it doesn t measure the magnitude or size of the change instead rate of change shows how quickly or slowly that change is happening over time the rate of change can be used in many mathematical or scientific contexts in finance it is often used by traders to understand changes in price returns and identify the momentum of market trends for example if the rate of change of an index is over 50 this can indicate that the current trend is a bubble rather than a sustainable long term change | |
what is a rate of return ror | a rate of return ror is the net gain or loss of an investment over a specified time period expressed as a percentage of the investment s initial cost when calculating the rate of return you are determining the percentage change from the beginning of the period until the end investopedia ellen lindnerunderstanding a rate of return ror a rate of return ror can be applied to any investment vehicle from real estate to bonds stocks and fine art the ror works with any asset provided the asset is purchased at one point in time and produces cash flow at some point in the future investments are assessed based in part on past rates of return which can be compared against assets of the same type to determine which investments are the most attractive many investors like to pick a required rate of return before making an investment choice the formula for rorthe formula to calculate the rate of return ror is rate of return current value initial value initial value 100 text rate of return frac text current value text initial value text initial value times 100 rate of return initial value current value initial value 100this simple rate of return is sometimes called the basic growth rate or alternatively return on investment roi if you also consider the effect of the time value of money and inflation the real rate of return can also be defined as the net amount of discounted cash flows dcf received on an investment after adjusting for inflation the average annual rate of return for the total stock market between 2013 and 2023 as measured by the growth of the s p 500 index note that actual returns vary widely from year to year and from stock to stock 1ror on stocks and bondsthe rate of return calculations for stocks and bonds is slightly different assume an investor buys a stock for 60 a share owns the stock for five years and earns a total amount of 10 in dividends if the investor sells the stock for 80 their per share gain is 80 60 20 in addition they have earned 10 in dividend income for a total gain of 20 10 30 the rate of return for the stock is thus a 30 gain per share divided by the 60 cost per share or 50 on the other hand consider an investor that pays 1 000 for a 1 000 par value 5 coupon bond the investment earns 50 in interest income per year if the investor sells the bond for 1 100 in premium value and earns 100 in total interest the investor s rate of return is the 100 gain on the sale plus 100 interest income divided by the 1 000 initial cost or 20 real rate of return vs nominal rate of returnthe simple rate of return is considered a nominal rate of return since it does not account for the effect of inflation over time inflation reduces the purchasing power of money and so 335 000 six years from now is not the same as 335 000 today discounting is one way to account for the time value of money once the effect of inflation is taken into account we call that the real rate of return or the inflation adjusted rate of return real rate of return vs compound annual growth rate cagr a closely related concept to the simple rate of return is the compound annual growth rate cagr the cagr is the mean annual rate of return of an investment over a specified period of time longer than one year which means the calculation must factor in growth over multiple periods to calculate compound annual growth rate we divide the value of an investment at the end of the period in question by its value at the beginning of that period raise the result to the power of one divided by the number of holding periods such as years and subtract one from the subsequent result example of rorthe rate of return can be calculated for any investment dealing with any kind of asset let s take the example of purchasing a home as a basic example for understanding how to calculate the ror say that you buy a house for 250 000 for simplicity let s assume you pay 100 cash six years later you decide to sell the house maybe your family is growing and you need to move into a larger place you are able to sell the house for 335 000 after deducting any realtor s fees and taxes the simple rate of return on the purchase and sale of the house is as follows 3 3 5 0 0 0 2 5 0 0 0 0 2 5 0 0 0 0 1 0 0 3 4 frac 335 000 250 000 250 000 times 100 34 250 000 335 000 250 000 100 34 now what if instead you sold the house for less than you paid for it say for 187 500 the same equation can be used to calculate your loss or the negative rate of return on the transaction 1 8 7 5 0 0 2 5 0 0 0 0 2 5 0 0 0 0 1 0 0 2 5 frac 187 500 250 000 250 000 times 100 25 250 000 187 500 250 000 100 25 internal rate of return irr and discounted cash flow dcf the next step in understanding ror over time is to account for the time value of money tvm which the cagr ignores discounted cash flows take the earnings of an investment and discount each of the cash flows based on a discount rate the discount rate represents a minimum rate of return acceptable to the investor or an assumed rate of inflation in addition to investors businesses use discounted cash flows to assess the profitability of their investments assume for example a company is considering the purchase of a new piece of equipment for 10 000 and the firm uses a discount rate of 5 after a 10 000 cash outflow the equipment is used in the operations of the business and increases cash inflows by 2 000 a year for five years the business applies present value table factors to the 10 000 outflow and to the 2 000 inflow each year for five years the 2 000 inflow in year five would be discounted using the discount rate at 5 for five years if the sum of all the adjusted cash inflows and outflows is greater than zero the investment is profitable a positive net cash inflow also means that the rate of return is higher than the 5 discount rate the rate of return using discounted cash flows is also known as the internal rate of return irr the internal rate of return is a discount rate that makes the net present value npv of all cash flows from a particular project or investment equal to zero irr calculations rely on the same formula as npv does and utilizes the time value of money using interest rates the formula for irr is as follows i r r n p v t 1 t c t 1 r t c 0 0 where t total number of time periods t time period c t net cash inflow outflows during a single period t c 0 baseline cash inflow outflows r discount rate begin aligned irr npv sum t 1 t frac c t 1 r t c 0 0 textbf where t text total number of time periods t text time period c t text net cash inflow outflows during a single period t c 0 text baseline cash inflow outflows r text discount rate end aligned irr npv t 1 t 1 r tct c0 0where t total number of time periodst time periodct net cash inflow outflows during a single period tc0 baseline cash inflow outflowsr discount rate | |
what are some alternatives to the rate of return | the internal rate of return irr and the compound annual growth rate cagr are good alternatives to ror irr is the discount rate that makes the net present value of all cash flows equal to zero cagr refers to the annual growth rate of an investment taking into account the effect of compound interest | |
what are some drawbacks of ror | the rate of return disregards some key factors in an investment like the time value of money the timing and size of cash flows and the risk and uncertainty associated with any investment | |
what is considered a good return on an investment | a good return on investment is generally considered to be about 7 per year which is also the average annual return of the s p 500 adjusting for inflation the bottom linethe rate of return ror is a simple to calculate metric that shows the net gain or loss of an investment or project over a set period of time ror is expressed as a percentage of the initial value the internal rate of return irr also measures the performance of investments or projects but while ror shows the total growth since the start of the project irr shows the annual growth rate the compound annual growth rate cagr is another metric that shows the annual growth rate of an investment but this time taking into account the effect of compound interest | |
what is a rating | a rating is an assessment tool assigned by an analyst or rating agency to a stock or bond the rating assigned indicates the stock or bond s level of investment opportunity the three major rating agencies are standard poor s moody s investors service and fitch ratings | |
how a rating works | analysts who work on both the buy side and sell side of the industry research stocks and write opinions on those stocks which will often include a rating such as buy hold or sell meanwhile bonds are rated by the three major bond rating agencies a company can improve its rating score by maintaining as little debt as possible and staying vigilant when sudden changes occur within the company types of ratingsanalysts on the buy side will write opinions for their teams for the purposes of informing portfolio management decisions analysts on the sell side will write opinions to educate others on their research and in an attempt to sell particular stocks on behalf of clients for a stock an analyst may assign a buy hold or sell rating and an explanation of why they recommend this action for the stock | |
when it comes to major wall street banks and institutions they all use different terminology and classifications morgan stanley for example uses the terms overweight equal weight and underweight the timeline for its ratings is 12 to 18 months 1 credit suisse uses the terms outperform neutral and underperform which is based on a 12 month time period 2 all of these terms are variations of the buy hold and sell ratings | in august 2023 fitch ratings dropped the credit rating of the united states from aaa to aa citing a steady deterioration in standards of governance within congress over raising the country s debt ceiling these bouts of brinkmanship raised the prospects that the u s might eventually default on some debts increasing the risk for international lenders the other two major agencies did not change their evaluation of the country s credit risk 3for a bond a rating agency will assess the bond s relative safety based upon the issuing entity s fundamental financial picture which scrutinizes the issuer s ability to repay the principal and make interest payments the ratings for moody s and s p from highest to lowest in the investment grade category are aaa aaa aa1 aa aa2 aa aa3 aa a1 a a2 a a3 a baa1 bbb baa2 bbb and baa3 bbb 45standard poor s is the provider of the s p 500 index as well as a leading data source and index provider of independent credit ratings s p 500 index is a widely utilized gauge for determining the overall condition of the u s stock market 6moody s is a provider of international financial research on government and commercial issued bonds moody s utilizes a rating system to judge a borrower s creditworthiness this rating scale goes starts at aaa being of the highest quality and goes to c being of the lowest quality 4fitch ratings is also a credit rating agency that is international this agency bases its ratings on factors such as how sensitive a company is to internal changes and the kind of debt the company holds 7 fitch is used by investors as a guide to what investments will not default and will in turn lead to a solid return the ratings assigned by the various rating agencies are based primarily upon the insurer s or issuer s creditworthiness this rating can therefore be interpreted as a direct measure of the probability of default however credit stability and priority of payment are also factored into the rating | |
what does speculative mean in bond ratings | a bond is considered speculative if it has a rating of bbb or lower from standard and poor s or a rating of baa3 or lower from moody s these ratings indicate a relatively high degree of credit risk and borrowers must pay higher interest rates to accomodate the higher risk | |
what happens when a credit rating drops | a lower credit rating means that credit agencies believe the borrower is becoming more risky either due to a higher level of debt falling income or other causes that make the borrower less able to pay their obligations these borrowers will need to pay higher interest rates to make up for the increased risk to lenders the bottom lineratings are used to assess the quality of an investment such as a stock or bond analysts issue ratings for different instruments based on the risks and opportunities associated with a particular investment there are several different ratings agencies with their own systems for evaluating risk and opportunity | |
what is ratio analysis | ratio analysis is a method of examining a company s balance sheet and income statement to learn about its liquidity operational efficiency and profitability it doesn t involve one single metric instead it is a way of analyzing a variety of financial data about a company ratio analysis is a cornerstone of fundamental equity analysis there are many different ratios that investors and other business experts can analyze to make predictions about a company s financial stability and potential future growth these can be used to evaluate either how a company s performance has changed over time or how it compares to other businesses in its industry investopedia theresa chiechi | |
how ratio analysis works | investors and analysts use ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements for example comparing the price per share to earnings per share allows investors to find the price to earnings p e ratio a key metric for determining the value of a company s stock the ratios of these different financial metrics from a company can be used to every figure needed to calculate the ratios used in ratio analysis is found on a company s financial statements a ratio is the relation between two amounts showing the number of times one value contains or is contained within the other ratios are comparison points for companies and are not generally used in isolation instead they are compared either to past ratios for the same company or to the same ratio from other companies for example if the average p e ratio of all companies in the s p 500 index is 20 and the majority of companies have p es between 15 and 25 a stock with a p e ratio of seven is probably undervalued in contrast one with a p e ratio of 50 likely is overvalued the former may trend upwards in the future while the latter may trend downwards until each aligns with its intrinsic value ratio analysis is often used by investors but it can also be used by the company itself to evaluate how strategic changes have impacted sales growth and performance limitations of ratio analysisratio analysis can help investors understand a company s current performance and likely future growth however companies can make small changes that make their stock and company ratios more attractive without changing any underlying financial fundamentals to counter this limitation investors also need to understand the variables behind ratios what information they do and do not communicate and how they are susceptible to manipulation ratios also can t be used in isolation instead they should be used in combination with other ratios or financial metrics to give a fuller picture of both a company s financial state and how it compares to other companies in the same industry types of ratios for ratio analysisthe financial ratios available can be broadly grouped into six types based on the kind of data they provide using ratios in each category will give you a comprehensive view of the company from different angles and help you spot potential red flags liquidity ratios measure a company s ability to pay off short term debts as they become due using the company s current or quick assets liquidity ratios include also called financial leverage ratios solvency ratios compare a company s debt levels with its assets equity and earnings these are used to evaluate the likelihood of a company staying afloat over the long haul by paying off both long term debt and the interest on that debt examples of solvency ratios include these ratios convey how well a company can generate profits from its operations examples of profitability ratios are also called activity ratios efficiency ratios evaluate how efficiently a company uses its assets and liabilities to generate sales and maximize profits key efficiency ratios include coverage ratios measure a company s ability to make the interest payments and other obligations associated with its debts examples include market prospect ratios are the most commonly used ratios in fundamental analysis investors use these metrics to predict earnings and future performance these ratios include most ratio analysis is only used for internal decision making though some benchmarks are set externally discussed below ratio analysis is often not a required aspect of budgeting or planning application of ratio analysisusing ratio analysis will give you multiple figures and values to compare however those values will mean very little in isolation instead the values derived from these ratios should be compared to other data to determine whether a company s financial health is strong weak improving or deteriorating comparing how the same ratio changes over time provides a picture of how a company has performed during that period what risks might exist in the future and what growth trajectory growth it is likely to follow to perform ratio analysis over time select a single financial ratio then calculate that ratio at set intervals for example at the beginning of every quarter then analyze how the ratio has changed over time whether it is improving the rate at which it is changing and whether the company wanted the ratio to change over time | |
when performing ratio analysis over time be mindful of seasonality and how temporary fluctuations may impact month over month ratio calculations | comparative ratio analysis can be used to understand how a company s performance compares to similar companies in the same industry for example a company with a 10 gross profit margin may be in good financial shape if other companies in the same sector have gross profit margins of 5 however if the majority of competitors achieve gross profit margins of 25 that s a sign that the original company may be in financial trouble | |
when using ratio analysis to compare different companies be sure to | different industries have different ratio expectations a debt equity ratio that might be normal for a utility company that can obtain low cost debt might be deemed unsustainably high for a technology company that relies more heavily on private investor funding companies may set internal targets for their financial ratios the goal may be to hold current levels steady or to strive for operational growth for example a company s existing current ratio may be 1 1 if the company wants to become more liquid it may set the internal target of having a current ratio of 1 2 by the end of the fiscal year benchmarks are also frequently implemented by external parties such as lenders lending institutions often set requirements for financial health as part of covenants in loan document s terms and conditions an example of a benchmark set by a lender is often the debt service coverage ratio which measures a company s cash flow against its debt balances if a company doesn t maintain certain levels for these ratios the loan may be recalled or the interest rate attached to that loan may increase examples of ratio analysis in useratio analysis can predict a company s future performance for better or worse when a company generally boasts solid ratios in all areas any sudden hint of weakness in one area may spark a significant stock sell off for example net profit margin often referred to simply as profit margin or the bottom line is a ratio that investors use to compare the profitability of companies within the same sector it s calculated by dividing a company s net income by its revenues and is often used instead of dissecting financial statements to compare how profitable companies are if company abc and company def are in the same sector with profit margins of 50 and 10 respectively an investor comparing the two companies will conclude that abc converted 50 of its revenues into profits while def only converted 10 this can be combined with additional ratios to learn more about the companies in question if abc has a p e ratio of 100 and def has a p e ratio of 10 that means investors are willing to pay 100 per 1 of earnings abc generates and only 10 per 1 of earnings def generates | |
what are the types of ratio analysis | financial ratio analysis is often broken into six different types profitability solvency liquidity turnover coverage and market prospects ratios other non financial metrics may be scattered across various departments and industries for example a marketing department may use a conversion click ratio to analyze customer capture | |
what are the uses of ratio analysis | ratio analysis serves three main uses first ratio analysis can be performed to track changes within a company s financial health over time and predict future performance second ratio analysis can be performed to compare results between competitors third ratio analysis can be performed to strive for specific internally set or externally set benchmarks | |
why is ratio analysis important | ratio analysis can be used to understand the financial and operational health of a company static numbers on their own may not fully explain how a company is performing consider a business that made 1 billion in revenue last quarter though this seems ideal the company might have had a negative gross profit margin a decrease in liquidity ratio metrics and lower earnings compared to equity than in prior periods this means the company is performing below its competitors in spite of its high revenue | |
what is an example of ratio analysis | consider the inventory turnover ratio that measures how quickly a company converts inventory to a sale a company can track its inventory turnover over a full calendar year to see how quickly it converted goods to cash each month then a company can explore the reasons certain months lagged or why certain months exceeded expectations the bottom linethere is often an overwhelming amount of data and information useful for a company to make decisions to make better use of their information a company may compare several numbers together this process called ratio analysis allows a company to gain better insights to how it is performing over time against competition and against internal goals ratio analysis is usually rooted heavily with financial metrics though ratio analysis can be performed with non financial data | |
what is rational behavior | rational behavior refers to a decision making process that is based on making choices that result in the optimal level of benefit or utility for an individual the assumption of rational behavior implies that people would rather take actions that benefit them versus actions that are neutral or harm them most classical economic theories are based on the assumption that all individuals taking part in an activity are behaving rationally understanding rational behaviorrational behavior is the cornerstone of rational choice theory a theory of economics that assumes that individuals always make decisions that provide them with the highest amount of personal utility these decisions provide people with the greatest benefit or satisfaction given the choices available rational behavior may not involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional or non monetary for example while it is likely more financially beneficial for an executive to stay on at a company rather than retire early it is still considered rational behavior for her to seek an early retirement if she feels the benefits of retired life outweigh the utility from the paycheck she receives the optimal benefit for an individual may involve non monetary returns further a person s willingness to take on risk or conversely their aversion to risk may be considered rational depending on their goals and circumstances for example an investor may choose to take on more risk in his own retirement account than in an account designated for his children s college education both would be considered rational choices for this investor behavioral economicsbehavioral economics is a method of economic analysis that considers psychological insights to explain human behavior as it relates to economic decision making according to rational choice theory the rational person has self control and is unmoved by emotional factors however behavioral economics acknowledges that people are emotional and easily distracted and therefore their behavior does not always follow the predictions of economic models psychological factors and emotions influence the actions of individuals and can lead them to make decisions that may not appear to be entirely rational behavioral economics seeks to explain why people make certain decisions about how much to pay for a cup of coffee whether or not to pursue a college education or a healthy lifestyle and how much to save for retirement among other decisions that most people have to make at some point in their life investors may also make decisions primarily based on emotions for example investing in a company for which the investor has positive feelings even if financial models suggest the investment is not wise example of rational behaviorfor example an individual may choose to invest in the stock of an organic produce operation rather than a conventional produce operation if they have strong beliefs in the value of organic produce they may choose to do this regardless of the present value of the organic operation compared with that of the conventional operation and despite the fact that the conventional operation would earn a higher return | |
what is rational choice theory | rational choice theory states that individuals use rational calculations to make choices and achieve outcomes that are aligned with their own personal objectives these results are also associated with maximizing an individual s self interest using rational choice theory is expected to result in outcomes that provide people with the greatest benefit and satisfaction given the limited options they have available understanding rational choice theorymany mainstream economic assumptions and theories are based on rational choice theory rational choice theory is associated with the concepts of rational actors self interest and the invisible hand rational choice theory is based on the assumption of involvement from rational actors rational actors are the individuals in an economy who make rational choices based on calculations and the information that is available to them rational actors form the basis of rational choice theory rational choice theory assumes that individuals or rational actors try to actively maximize their advantage in any situation and therefore consistently try to minimize their losses economists may use this assumption of rationality as part of broader studies seeking to understand certain behaviors of society as a whole self interest and the invisible handadam smith was one of the first economists to develop the underlying principles of the rational choice theory smith elaborated on his studies of self interest and the invisible hand theory in his book an inquiry into the nature and causes of the wealth of nations which was published in 1776 1the invisible hand itself is a metaphor for the unseen forces that influence a free market economy first and foremost the invisible hand theory assumes self interest both this theory and further developments in the rational choice theory refute any negative misconceptions associated with self interest instead these concepts suggest that rational actors acting with their own self interest in mind can actually create benefits for the economy at large according to the invisible hand theory individuals driven by self interest and rationality will make decisions that lead to positive benefits for the whole economy through the freedom of production as well as consumption the best interests of society are fulfilled the constant interplay of individual pressures on market supply and demand causes the natural movement of prices and the flow of trade economists who believe in the invisible hand theory lobby for less government intervention and more free market exchange opportunities 2advantages and disadvantages of rational choice theorythere are many economists who dispute the veracity of the rational choice theory and the invisible hand theory dissenters have pointed out that individuals do not always make rational utility maximizing decisions the field of behavioral economics is a more recent intervention into the problem of explaining the economic decision making processes of individuals and institutions behavioral economics attempts to explain from a psychological perspective why individual actors sometimes make irrational decisions and why and how their behavior does not always follow the predictions of economic models critics of rational choice theory say that of course in an ideal world people would always make optimal decisions that provide them with the greatest benefit and satisfaction however we don t live in a perfect world in reality people are often moved by emotions and external factors the nobel laureate herbert simon who rejected the assumption of perfect rationality in mainstream economics proposed the theory of bounded rationality instead this theory says that people are not always able to obtain all the information they would need to make the best possible decision simon argued that knowledge of all alternatives or all consequences that follow from each alternative is realistically impossible for most decisions that humans make 3similarly the economist richard thaler pointed out further limitations of the assumption that humans operate as rational actors thaler s idea of mental accounting shows how people place greater value on some dollars than others even though all dollars have the same value 4 they might drive to another store to save 10 on a 20 purchase but they would not drive to another store to save 10 on a 1 000 purchase like all theories one of the benefits of rational choice theory is that it can be helpful in explaining individual and collective behaviors all theories attempt to give meaning to the things we observe in the world rational choice theory can explain why people groups and society as a whole make certain choices based on specific costs and rewards rational choice theory also helps to explain behavior that seems irrational because a central premise of rational choice theory is that all behavior is rational any action can be scrutinized for its underlying rational motivations helpful in explaining individual and collective behaviorsall theories attempt to give meaning to the things we observe in the worldcan help to explain behavior that seems irrationalindividuals do not always make rational decisionsin reality people are often moved by external factors that are not rational such as emotionsindividuals do not have perfect access to the information they would need to make the most rational decision every timepeople value some dollars more than othersexamples of rational choice theoryaccording to rational choice theory rational investors are those investors that will quickly buy any stocks that are priced too low and short sell any stocks that are priced too high an example of a rational consumer would be a person choosing between two cars car b is cheaper than car a so the consumer purchases car b while rational choice theory is logical and easy to understand it is often contradicted in the real world for example political factions that were in favor of the brexit vote held on june 23 2016 used promotional campaigns that were based on emotion rather than rational analysis 5 these campaigns led to the semi shocking and unexpected result of the vote the united kingdom officially decided to leave the european union the financial markets then responded in kind with shock wildly increasing short term volatility as measured by the cboe volatility index vix 6rational behavior may not involve receiving the most monetary or material benefit the benefit of a particular choice could be purely emotional or non monetary for example while it is likely more financially beneficial for an executive to stay on at a company rather than take time off to care for their new newborn child it is still considered rational behavior for them to take time off if they feel that the benefits of the time spent with their child outweigh the utility from the paycheck they receive | |
what is rational choice theory | the key premise of rational choice theory is that people don t randomly select products off the shelf rather they use a logical decision making process that takes into account the costs and benefits of various options weighing the options against each other who founded rational choice theory adam smith who proposed the idea of an invisible hand moving free market economies in the mid 1770s is usually credited as the father of rational choice theory smith discusses the invisible hand theory in his book an inquiry into the nature and causes of the wealth of nations which was published in 1776 21 | |
what are the main goals of rational choice theory | the main goal of rational choice theory is to explain why individuals and larger groups make certain choices based on specific costs and rewards according to rational choice theory individuals use their self interests to make choices that will provide them with the greatest benefit people weigh their options and make the choice they think will serve them best | |
what is rational choice theory in international relations | states intergovernmental organizations nongovernmental organizations and multinational corporations are all made up of human beings in order to understand the actions of these entities we must understand the behavior of the humans running them rational choice theory helps to explain how leaders and other important decision makers of organizations and institutions make decisions rational choice theory can also attempt to predict the future actions of these actors | |
what are the strengths of rational choice theory | one of the strengths of rational choice theory is the versatility of its application it can be applied to many different disciplines and areas of study it also makes reasonable assumptions and compelling logic the theory also encourages individuals to make sound economic decisions by making sound economic decisions it is possible for an individual to acquire more tools that will allow them to further maximize their preferences in the future the bottom linethe majority of classical economic theories are based on the assumptions of rational choice theory individuals make choices that result in the optimal level of benefit or utility for them further people would rather take actions that benefit them versus actions that are neutral or harm them although many criticisms of rational choice theory exist because people are emotional and easily distracted and therefore their behavior does not always follow the predictions of economic models it is still widely applied across different academic disciplines and fields of study | |
what is rational expectations theory | the rational expectations theory is a concept and modeling technique that is used widely in macroeconomics the theory posits that individuals base their decisions on three primary factors their human rationality the information available to them and their past experiences the theory suggests that people s current expectations of the economy are themselves able to influence what the future state of the economy will become this precept contrasts with the idea that government policy influences financial and economic decisions understanding rational expectations theorythe rational expectations theory is the dominant assumption model used in business cycles and finance as a cornerstone of the efficient market hypothesis emh economists often use the doctrine of rational expectations to explain anticipated inflation rates or any other economic state for example if past inflation rates were higher than expected then people might consider this along with other indicators to mean that future inflation also might exceed expectations using the idea of expectations in economic theory is not new in the 1930s the famous british economist john maynard keynes assigned people s expectations about the future which he called waves of optimism and pessimism a central role in determining the business cycle however the actual theory of rational expectations was proposed by john f muth in his seminal paper rational expectations and the theory of price movements published in 1961 in the journal econometrica muth used the term to describe numerous scenarios in which an outcome depends partly on what people expect will happen the theory did not catch on until the 1970s with robert e lucas jr and the neoclassical revolution in economics 1the influence of expectations and outcomesexpectations and outcomes influence each other there is continual feedback flow from past outcomes to current expectations in recurrent situations the way the future unfolds from the past tends to be stable and people adjust their forecasts to conform to this stable pattern this doctrine is motivated by the thinking that led abraham lincoln to assert you can fool some of the people all of the time and all of the people some of the time but you cannot fool all of the people all of the time from the perspective of rational expectations theory lincoln s statement is on target the theory does not deny that people often make forecasting errors but it does suggest that errors will not recur persistently because people make decisions based on the available information at hand combined with their past experiences most of the time their decisions will be correct if their decisions are correct then the same expectations for the future will occur if their decision was incorrect then they will adjust their behavior based on past mistakes rational expectations theory does it work economics relies heavily on models and theories many of which are interrelated for example rational expectations have a critical relationship with another fundamental idea in economics the concept of equilibrium the validity of economic theories do they work as they should in predicting future states is always arguable an example of this is the ongoing debate about existing models failure to predict or untangle the causes of the 2007 2008 financial crisis because myriad factors are involved in economic models it is never a simple question of working or not working models are subjective approximations of reality that are designed to explain observed phenomena a model s predictions must be tempered by the randomness of the underlying data it seeks to explain and the theories that drive its equations | |
what is rationalization | rationalization is the reorganization of a company in order to increase its operating efficiency this sort of reorganization may lead to an expansion or reduction in company size a change of policy or an alteration of strategy pertaining to particular products offered similar to a reorganization a rationalization is more widespread encompassing strategy as well as structural changes rationalization is necessary for a company to increase revenue decrease costs and improve its bottom line rationalization may also refer to the process of becoming calculable for example the introduction of certain financial models or financial technologies rationalizes markets and makes them more efficient the introduction of the black scholes model for options pricing for instance helped to rationalize the options markets in chicago in the late 1970s understanding rationalizationin the business world rationalization is a process that most organizations consider that s because it s aimed at improving efficiency getting rid of waste standardizing processes and ultimately boosting the bottom line depending on the company and strategy rationalization can result in the expansion or reduction in the size of the firm it can also lead to structural changes specifically the process of rationalization may involve corporate actions including sales or closures of underperforming business segments the expansion of outperforming segments a complete restructuring of the company s financial structure and a streamlining or modernizing of manufacturing or other operations in a large number of cases asset rationalization results in the loss of hundreds of jobs examining a company s application portfolio is important to attain more efficient operations and cost integrations reducing stranded costs left by a seller and streamlining the portfolio to best serve the business the need for rationalizationthere are several reasons that a particular organization might need to go through the process of rationalization they include the need to the process of rationalizing is especially common during recessions and after corporate actions such as a merger acquisition or new ceo hire types of rationalizationthe following subheads are examples of rationalization product rationalization is an important part of managing a product s life cycle if products are not rationalized their numbers continue to increase adding complexity and increased support costs to the company s bottom line according to the 80 20 rule the bulk of a company s revenue and profit 80 comes from a fraction of its products 20 therefore when rationalizing a product line executives need to consider various factors the portfolio effect describes how a product s addition or removal affects the rest of the company s products sales may go to other products or be lost completely although rationalization may reduce complexity in the supply chain as well as redundancy in both the portfolio and support costs the costs can be difficult to quantify the portion of sales that will not transfer to other products needs to be estimated and compensated for by new products entering the portfolio or the sales growth of existing products in addition when products leave the portfolio fixed costs typically remain the same the costs must be spread across the remaining product line increasing unit costs production volume must be transferred to new or more profitable products to ensure that the business remains solvent also customer migration becomes an issue as sales and operations managers must create and carry out migration plans this is especially important with customers buying multiple products who may leave a company that is no longer providing one stop shopping engaging in applications rationalization especially during mergers and acquisitions helps companies reduce costs operate more efficiently and focus on supporting deal objectives legal and regulatory issues systems and process integration and business continuity most businesses accumulate a vast information technology application portfolio over time especially when companies grow and do not fully integrate operations and assets with each transaction many applications do not support the company s objectives after each merger or acquisition and need revision to support the new business rationalization of marketsin terms of market structure financial models theories and technologies that embody these concepts have the force to rationalize markets to make them calculable and more efficient in terms of the efficient market hypothesis emh as more information of various types is able to be processed by information technologies transmitted and disseminated using communications technology and incorporated into the market microstructure prices become more efficient and the market appears more rational the increased use of mathematical formulas and financial models also helps with the rationalization of markets as they become dissociated with human emotion and fallibility advantages and disadvantages of rationalizationrationalization helps companies standardize business processes in order to become more efficient and boost productivity it lets management introduce modern techniques and systems allowing workers to improve their efficiency levels in turn rationalization can lead to better working conditions and higher pay for the workforce ultimately leading to a higher standard of living in society additionally rationalization can translate into both reduced prices and a higher standard of products for consumers on the other hand rationalization often focuses too much on efficiency at the expense of human capital the emphasis on modernization and standardization often has negative consequences such as mass layoffs a loss of initiative from the workforce a significantly increased workload for the workers that remain and a worse off work environment moreover the process of rationalization is costly requires consistent monitoring and provides no guarantee of improved returns helps companies become more efficient and boost productivityallows management to implement modernized techniques and systemslowers market volatilitycan provide the workforce with better working conditions and higher paytranslates into a higher standard of living in societycan lead to lower prices and better products for consumersemphasizes efficiency at the expense of human capitaloften involves large layoffscan lead to a significantly increased workload for the workers that remainloss of initiative from workers due to the mechanization of processescostly and requires consistent monitoringno guarantee of improved returns | |
what is asset rationalization | asset rationalization is the process of reorganizing a company s assets in order to increase operating efficiencies and ultimately improve its bottom line | |
what are the dangers of rationalization | dangers of rationalization include focusing too much on optimization at the expense of human capital the possibility of negative cultural changes and allocating capital in an ultimately inefficient manner | |
what is rationalization in economics | in economics rationalization is the process of changing a preexisting workflow into one that s more goal oriented and based on a specific set of rules the bottom linerationalization is the reorganization of a company to increase its operating efficiency it may lead to an expansion or reduction in company size a change of policy or an alteration of strategy pertaining to particular products offered | |
what is rationing | rationing is the practice of controlling the distribution of a good or service in order to cope with scarcity rationing is a mandate of the government at the local or federal level it can be undertaken in response to adverse weather conditions trade or import export restrictions or in more extreme cases during a recession or a war | |
how rationing works | rationing involves the controlled distribution of a scarce good or service an individual might be allotted a certain amount of food per week for example or households might be allowed to water their lawns only on certain days according to the law of supply and demand when the available supply of a good or service falls below the quantity demanded the equilibrium price rises often to unaffordable levels rationing can artificially depress the price by putting constraints on demand alternatively price ceilings can be imposed they risk the need for rationing in order to maintain a certain level of supply in any case rationing generally results in shortages rationing examplethe 1973 arab oil embargo caused gasoline supplies in the u s to plummet pushing up prices the federal government responded by rationing domestic oil supplies to states which in turn implemented systems to ration their limited stocks in some states cars with license plates ending in odd numbers were only allowed to fill up on odd numbered dates for example while cars with even numbered plates were only allowed to fill up on even numbered days these responses kept gas prices from spiking further but led to long lines faced with the choice of allowing the prices of basic necessities to rise inexorably or imposing rations governments typically choose the latter policymakers in such circumstances must choose among policies that are all difficult and risk some negative impact special considerationsclassical economic theory suggests that when demand exceeds supply prices rise and high prices in turn curtail demand and encourage new entrants to the market increasing supply and bringing prices back down to reasonable levels if the reality were this simple rationing would be both counterproductive because it creates shortages and unnecessary since the market will act to re stabilize itself the problem is that for some goods and services food fuel and medical care demand is inelastic that is it does not fall in proportion to increases in price moreover the entry of new suppliers to rebalance markets may not be possible if the shortage is the result of a crop failure war natural disaster siege or embargo while not ideal rationing is often undertaken by governments that would otherwise be facing an even bigger economic crisis rationing to combat shortagesmany capitalist economies have temporarily resorted to rationing in order to cope with wartime or disaster related shortages the u s and britain issued ration books during world war ii for example limiting the quantities of tires gasoline sugar meat butter and other goods that could be purchased in communist countries by contrast rationing was in many cases a permanent or semi permanent feature of daily life in cuba in 2019 a ration book entitled an individual to small amounts of rice beans eggs sugar coffee and cooking oil for the equivalent of a few cents in the united states since that is not enough to survive cubans must purchase additional supplies on the open market where the price of rice is around 20 times higher additionally there are limits on the number of higher quality items cubans can purchase on the open market such as chicken cuba has implemented rationing as a way of mitigating the impact of an economic crisis citizens are entitled to small amounts of basic food for almost no charge while everything else is pricey and supplies are limited risks of rationingrationing provides governments with a way to constrain demand regulate supply and cap prices but it does not totally neutralize the laws of supply and demand black markets often spring up when rationing is in effect these allow people to trade rationed goods they may not want for ones they do black markets also allow people to sell goods and services for prices that are more in line with demand undermining the intent of rationing and price controls but sometimes alleviating shortages | |
what are raw materials | raw materials are materials or substances used in the primary production or manufacturing of goods raw materials are commodities that are bought and sold on commodities exchanges worldwide businesses buy and sell raw materials in the factor market because raw materials are factors of production investopedia nez riazunderstanding raw materialsraw materials are used in a multitude of products and can take many different forms raw materials are the input goods or inventory that a company needs to manufacture its products for example the steel used to manufacture vehicles would be a raw material for an automobile manufacturer for manufacturing companies raw materials inventory requires detailed budgeting and a special framework for accounting on the balance sheet and income statement raw materials are often related to natural resources for this reason manufacturing companies may be at the disposal of mother nature regarding the availability to secure raw materials in the same light manufacturing companies may not want to directly invest in extracting the raw materials for example consider how a company that relies on oil or plastics often does not own the drilling rig that extracts the raw materials from the group examples of raw materials include steel oil corn grain gasoline lumber forest resources plastic natural gas coal and minerals accounting for raw materialsmanufacturing companies take special steps to account for raw materials inventory this includes three distinct inventory classifications on their balance sheet compared to just one for non manufacturers the current assets portion of the balance sheet represents the assets that are likely to be used up in less than one year and include all inventory including raw materials inventory should be valued at its comprehensive cost this means its value includes shipping storage and preparation the typical journal entries in an accrual accounting system for the initial purchases of raw materials inventory include a credit to cash and a debit to inventory debiting inventory increases current assets and crediting cash will reduce cash assets by the inventory amount | |
when a company uses raw materials inventory in production it transfers them from the raw materials inventory to the work in process inventory when a company completes its work in process items it adds the finished items to the finished goods inventory making them ready for sale | direct vs indirect raw materialsin some cases raw materials may be divided into two categories direct and indirect whether a raw material is direct or indirect will influence where it is reported on the balance sheet and how it is expensed on the income statement direct raw materials are materials that companies directly use in the manufacturing of a finished product such as wood for a chair direct raw materials are placed in current assets and are expensed on the income statement within cost of goods sold manufacturing companies must also take added steps over non manufacturing companies to create more detailed expense reporting on costs of goods sold direct raw materials are typically considered variable costs since the amount used depends on the quantities being produced a manufacturer calculates the amount of direct raw materials it needs for specific periods to ensure there are no shortages by closely tracking the amount of direct raw materials bought and used an entity can reduce unnecessary inventory stock potentially lower ordering costs and reduce the risk of material obsolescence raw materials may degrade in storage or become unusable in a product for various reasons in this case the company declares them obsolete if this occurs the company expenses the inventory as a debit to write offs and credits the obsolete inventory to decrease assets indirect raw materials are not part of the final product but are instead used comprehensively in the production process indirect raw materials will be recorded as long term assets they can fall under several categories within long term assets including selling general and administrative sg a or property plant and equipment pp e long term assets usually follow a depreciation schedule that allows them to be expensed over time and matched with revenue they help produce for indirect raw materials depreciation timing will usually be shorter than other long term assets like a building expensed over several years companies may make an entirely independent budget specific for raw materials when preparing its annual manufacturing or production budget types of raw materialsraw materials can be classified in several ways but one common classification is the nature of how the good is extracted these types include raw materials are often segregated into these three categories as each type often entails very different investments to procure the raw materials for example the operations of a farm are substantially different from an oil drilling rig companies that require both raw materials must be mindful of how to most efficiently source the materials example of raw materialsconsider a company manufactures tables and chairs below are the materials used in production since the wood padding and fabric can be directly tied to the production of the tables and chairs they are considered direct raw materials when calculating the cost on a per unit basis the direct raw materials could be traced to each unit the glue nails and worker equipment would likely be considered indirect materials since the quantities used would not be significant nor would they be directly tied to each unit produced these types of costs would likely be allocated to a product via manufacturing overhead | |
what are raw materials in food | raw materials in food can be standalone items like meats milk fruits and vegetables they can also refer to the ingredients that go into a food item or recipe for instance milk is a raw material used in the production of cheese and yogurt | |
is water a raw material | yes water can be thought of as a raw material that is used in a wide range of products and production processes from beverages to agriculture to industrial uses | |
what is the difference between inventory and raw materials | in many cases raw materials are a type of inventory it represents goods on a balance sheet that have not yet been converted to work in progress or a finished product companies often buy acquire or extract raw materials for use then report raw materials as an asset then as the company uses raw materials in the production of finished goods it converts the raw materials into products it can sell to consumers | |
how do companies get raw materials | companies are often very strategic in how they obtain raw materials for many it makes most financial sense to work closely with a reliable third party that collects and distributes the raw materials in other cases it may be more efficient for companies to establish production facilities that directly collect the raw materials the former path incurs ongoing operating expenses while the latter path results in arguably less operating costs but greater upfront capital investment the bottom lineraw materials are the inputs used in the production process to create finished products that are ready to sell to consumers this makes raw materials a vital piece of the global economy and international trade having natural resources that can serve as raw materials can boost exports and help a country grow its gdp businesses and investors can engage in raw trading markets through commodities markets | |
what is reaganomics | reaganomics refers to the economic policies of ronald reagan the 40th u s president serving from 1981 1989 his economic policies called for widespread tax cuts decreased social spending increased military spending and the deregulation of domestic markets these policies were introduced in response to a prolonged period of economic stagflation that began under president gerald ford in 1976 understanding reaganomicsthe term reaganomics was used by both supporters and detractors of reagan s policies based on the principles of supply side economics and the trickle down theory reaganomics proposed that decreases in taxes especially for corporations stimulate economic growth if the expenses of corporations are reduced the savings then trickle down to the rest of the economy spurring overall growth reagan believed that by reducing the tax burden on individuals and corporations they would be incentivized to invest innovate and generate economic growth this approach was rooted in the belief that a strong private sector would ultimately benefit all levels of society reagan also pursued deregulation across various industries believing that reducing government intervention would spur competition innovation and efficiency objectives of reaganomicsas reagan began his first term the country suffered through several years of stagflation where high inflation was accompanied by high unemployment to fight high inflation the federal reserve board increased the short term interest rate reaching a peak in 1981 reagan proposed a four pronged economic policy intended to reduce inflation and stimulate economic and job growth measures introduced by reaganomicsa proponent of supply side economics reagan regarded government intervention as a damper on economic growth that reduced economic incentives and distorted market signals to spur the free market he introduced several measures to reduce government interference to curtail government intervention reagan cut or reduced funding to multiple domestic welfare programs including social security medicaid food stamps education and job training programs in a deeply controversial move he also ordered the social security administration to tighten enforcement on disabled recipients ending benefits for more than a million recipients though reagan ordered government spending cuts to domestic programs he increased defense spending by 35 to achieve peace through strength in his opposition to communism and the soviet union 1in the first year of his presidency reagan lowered taxes significantly income taxes on the top marginal tax bracket dropped from 70 to 50 in 1982 along with sharp cuts to corporate and estate taxes in 1986 gdp stood at 3 5 but the unemployment rate was at a high of 6 6 reagan cut the tax rate to 38 5 in 1987 and unemployment fell to 5 7 2the goal of these reforms was not only to reduce tax burdens but also to simplify the tax code some of reagan s reforms eliminated write offs exceptions and other loopholes for favored businesses they also changed the way companies accounted for expenditures which encouraged them to invest in equipment reagan removed price controls on oil and gas reduced restrictions on the financial services industry and relaxed the enforcement of the clean air act the department of the interior also opened large areas of public land for oil drilling 3in 1982 congress passed the garn st germain depository institutions act for savings and loan banks to deal with rising inflation and interest rates by further deregulating deposit rates as president reagan encouraged the federal reserve to tighten the money supply as federal reserve chairman paul volcker had steadily raised the federal funds rate to 20 by 1980 and these high interest rates helped end double digit inflation 4 the reaganomics monetary policy was developed to complement the federal reserve s policy of raising interest rates to reduce borrowing and spending some of the deregulation and monetary reforms associated with ronald reagan were initiated under president carter to the extent that these policies were consistent with reagan s laissez faire worldview they are generally included with reaganomics advantages and disadvantages of reaganomicsadvocates of president reagan s policies cite from december 1982 to june 1990 reaganomics created over 21 million jobs more jobs than have been added since wrote arthur laffer whose work heavily influenced reagan s tax cuts the top marginal tax rate on individual income was slashed from 70 to 28 and the corporate tax rate was reduced from 48 to 34 inflation was reduced to 4 and the unemployment rate fell below 6 5between 1982 and 2000 the dow jones industrial average djia grew nearly 14 fold and the economy added 40 million new jobs however nobel laureate paul krugman downplayed the success of reagan s policies yes there was a boom in the mid 1980s as the economy recovered from a severe recession krugman wrote in the new york times but while the rich got much richer there was little sustained economic improvement for most americans by the late 1980s middle class incomes were barely higher than they had been a decade before and the poverty rate had risen 6although reagan reduced the economic regulation that began under president jimmy carter and eliminated price controls on oil and natural gas long distance telephone services and cable television critics argue that the deregulation of the financial services industry during the reagan administration played a part in the savings and loan crisis as well as the financial collapse of 2008 the inflation level decreased significantlyindividual corporate and investment taxes were reducedderegulation encouraged a more open and free marketpublic and social programs were curtailedboth the national deficit and national debt increasedthe divide increased between the wealthy and middle and lower classes | |
what did reaganomics do | reaganomics reduced taxes on individuals and businesses as well as cutting federal regulations and domestic social programs | |
what were the goals of reaganomics | reaganomics sought to reduce the cost of doing business by reducing tax burdens relaxing regulations and price controls and cutting domestic spending programs reagan also sought to reduce inflation by tightening the money supply | |
what were the major parts of reaganomics | the four main pillars of reaganomics were tax cuts deregulation cuts to domestic social spending and reducing inflation did reagan ever say trickle down while there is no record of president reagan using the phrase trickle down his economic philosophy was closely aligned with the idea that business friendly policies would ultimately benefit the entire economy by reducing taxes on the wealthy reagan hoped the benefits would trickle down in the form of increased employment and business activity | |
does trickle down economics really work | while economists remain divided into various elements of reaganomics the suggestion that wealth would trickle down has so far remained unrealized on the contrary economic studies have found that tax cuts such as those enacted by reagan tend to increase economic inequality rather than reduce it 7the bottom linereaganomics was regarded as a common sense approach to the perception of stagflation and over regulation that prevailed at the end of the carter presidency by reducing government spending and taxes and making it easier to do business president reagan hoped to incentivize economic activity and reduce dependence on the government these policies garnered reduced inflation lower unemployment and an entrepreneurial revolution that later became synonymous with the 1980s however detractors of reagan s policies claim that federal deficits grew and the increased wealth gap increased the divide between the rich and the poor | |
what is a real asset | real assets are physical assets that have an intrinsic worth due to their substance and properties real assets include precious metals commodities real estate land equipment and natural resources they are appropriate for inclusion in most diversified portfolios because of their relatively low correlation with financial assets such as stocks and bonds investopedia ellen lindnerunderstanding real assetsassets are categorized as either real financial or intangible all assets can be said to be of economic value to a corporation or an individual if it has a value that can be exchanged for cash the item is considered an asset intangible assets are valuable property that is not physical in nature such assets include patents copyrights brand recognition trademarks and intellectual property for a business perhaps the most important intangible asset is a positive brand identity financial assets are a liquid property that derive value from a contractual right or ownership claim stocks bonds mutual funds bank deposits investment accounts and good old cash are all examples of financial assets they can have a physical form like a dollar bill or a bond certificate or be nonphysical like a money market account or mutual fund in contrast a real asset also known as a non security has a tangible form and its value derives from its physical qualities it can be a natural substance like gold or oil or a man made one like machinery or buildings special considerationsfinancial and real assets are sometimes collectively referred to as tangible assets for tax purposes the internal revenue service irs requires businesses to report intangible assets differently than tangible assets but it groups real and financial assets under the tangible asset umbrella most businesses own a range of assets which typically fall into real financial or intangible categories real assets like financial assets are considered tangible assets for example imagine xyz company owns a fleet of cars a factory and a great deal of equipment these are real assets however the company also owns several trademarks and copyrights which are its intangible assets finally the company owns shares of stock in a sister company and these are its financial assets real assets vs financial assetsalthough they are lumped together as tangible assets real assets are a separate and distinct asset class from financial assets unlike real assets which have intrinsic value financial assets derive their value from a contractual claim on an underlying asset that may be real or intangible for example commodities and property are real assets but commodity futures exchange traded funds etfs and real estate investment trusts reits constitute financial assets whose value depends on the underlying real assets it is in those types of assets that overlap and confusion over asset categorization can occur etfs for example can invest in companies that are involved in the use sale or mining of real assets or more directly linked etfs can aim to track the price movement of a specific real asset or basket of real assets physically backed etfs include some of the most popular etfs in the world based on volumes such as state street s spdr gold shares gld and ishares silver trust slv both invest in precious metals and seek to mirror the performance of those metal technically speaking though these etfs are financial assets while the actual gold or silver bullion they own is the real asset advantages and disadvantages of real assetsreal assets tend to be more stable than financial assets inflation shifts in currency values and other macroeconomic factors affect real assets less than financial assets real assets are particularly well suited investments during inflationary times because of their tendency to outperform financial assets during such periods in a 2017 report asset management firm brookfield cited a global value of real asset equities totaling 5 6 trillion of this total 57 consisted of natural resources 23 was real estate and 20 was in infrastructure in the firm s 2017 report on real assets as a diversification mechanism brookfield noted that long lived real assets tend to increase in value as replacement costs and operational efficiency rise over time further the found that cash flow from real assets like real estate energy servicing and infrastructure projects can provide predictable and steady income streams for investors real assets however have lower liquidity than financial assets as they take longer to sell and have higher transaction fees in general also real assets have higher carrying and storage costs than financial assets for example physical gold bullion often has to be stored in third party facilities which charge monthly rental fees and insurance portfolio diversificationinflation hedgeincome streamilliquiditystorage fees transport costs | |
what is the real economic growth rate | the real economic growth rate or real gdp growth rate measures economic growth as expressed by gross domestic product gdp from one period to another adjusted for inflation or deflation in other words it reveals changes in the value of all goods and services produced by an economy the economic output of a country while accounting for price fluctuations understanding the real economic growth ratethe real economic growth rate is expressed as a percentage that shows the rate of change in a country s gdp typically from one year to the next another economic growth measure is the gross national product gnp which is sometimes preferred if a nation s economy is substantially dependent on foreign earnings the real gdp growth rate is a more useful measure than the nominal gdp growth rate because it considers the effect of inflation on economic data the real economic growth rate is a constant dollar figure avoiding the distortion from periods of extreme inflation or deflation to give a more consistent measure calculating the real economic growth rategdp is the sum of consumer spending business spending government spending and total exports minus total imports the calculation for factoring in inflation to arrive at the real gdp figure is as follows the base year is a designated year updated periodically by the government and used as a comparison point for economic data such as the gdp the calculation for the real gdp growth rate is based on real gdp as follows real economic growth can also be calculated by backing inflation out of nominal gdp nominal economic growth is inclusive of inflation while real economic growth is not this calculation is done by factoring in a gdp deflator a gdp deflator is the quotient of nominal gdp divided by real gdp divided by 100 so this method is only useful in determining real gdp if the gdp deflator is already known at the end of 2010 real gdp in the united states was 17 trillion at the end of q1 2024 real gdp was measured at 22 8 trillion 1 | |
how the real economic growth rate is used | a country s real economic growth rate is helpful to policymakers when making fiscal policy or monetary policy decisions these decisions might be applied to spur economic growth or control inflation real economic growth rate figures serve two purposes economic growth rates are also useful for businesses and investors an organization or company looking to expand into new markets may leverage gdp data to better understand growth opportunities in certain countries alternatively an investor seeking to diversify into emerging markets may be suited to use gdp to understand geographical areas that may receive the greatest growth governments use economic growth metrics to shape public policy and budgets while policymakers use real gdp when determining interest rates tax rates and trade policies special considerationsthe gdp growth rate changes during the four phases of the business cycle peak contraction trough and expansion in an expanding economy the gdp growth rate will be positive because businesses are growing and creating jobs for greater productivity a period of contraction will follow when businesses hold off on investing and hiring which will result in consumers having less money to spend if the growth rate turns negative the country will be in recession gdp is calculated as the sum of public consumption domestic investment government spending and net imports it is possible for a country to experience negative growth in one area but still experience net real economic growth some specific transactions are excluded from both nominal and real gdp real economic growth only reports the sale of final products goods in production i e a vehicle that is partially assembled are not counted real economic growth also excludes the sale of used goods the sale of goods produced outside of the united states financial transactions i e stocks and bonds and volunteer services | |
how do you calculate the real economic growth rate | there are two ways to calculate the real economic growth rate real gdp can be calculated by taking the difference between the most recent year s real gdp and the prior year s real gdp then divide this difference by the prior year s real gdp alternatively real gdp can be determined if nominal gdp and the prevailing inflation rate are known real gdp is calculated as nominal gdp less inflation | |
what is the real gdp growth rate | the annualized real gdp growth rate for the united states in the first quarter of 2024 was 1 4 2 | |
what is the difference between nominal gdp and real gdp | nominal gdp measures a nation s annual production of goods and services using actual market prices or values real gdp measures goods and services by adjusting for inflation both measurements are useful for evaluating a nation s financial health though real gdp is generally a more accurate representation of underlying economic activity | |
why is real gdp important | real gdp is informative of the size of the economy and the performance of recent economic activity the real growth rate is often used as a performance indicator as it often provides better guidance on economic conditions due to actual activity as opposed to growth due to inflated prices the bottom linethe real gdp growth rate measures economic growth by measuring gdp from one period to the next taking into consideration inflation it is an indicator of the health of an economy and helps policymakers adjust fiscal and monetary policy in order to achieve economic objectives | |
what is the real effective exchange rate reer | the real effective exchange rate reer is the weighted average of a country s currency in relation to an index or basket of other major currencies the weights are determined by comparing the relative trade balance of a country s currency against that of each country in the index an increase in a nation s reer is an indication that its exports are becoming more expensive and its imports are becoming cheaper it is losing its trade competitiveness investopedia laura porter | |
how to calculate the real effective exchange rate reer | a nation s currency may be considered undervalued overvalued or in equilibrium with those of other nations that it trades with a state of equilibrium means that demand and supply are equally balanced and prices will remain stable a country s reer measures how well that equilibrium is being held reer is determined by taking the average of the bilateral exchange rates between one nation and its trading partners and then weighting it to take into account the trade allocation of each partner the bank for international settlements website provides updated effective exchange rate indices on a daily and monthly basis 1reer cern cern cern 100where cer country exchange rate begin aligned text reer text cer n times text cer n times text cer n times100 textbf where text cer country exchange rate end aligned reer cern cern cern 100where cer country exchange rate breaking down the formula some calculations use bilateral exchange rates while other models use real exchange rates the latter adjusts the exchange rate for inflation regardless of the way in which reer is calculated it is an average that indicates when a currency is overvalued in relation to one trading partner or undervalued in relation to another partner | |
what does the real effective exchange rate reer tell you | a country s reer is an important measure when assessing its trade capabilities reer can be used to measure the equilibrium value of a country s currency identify the underlying factors of a country s trade flow and analyze the impact that other factors such as competition and technological changes have on a country and ultimately on the trade weighted index for example if the u s dollar exchange rate weakens against the euro u s exports to europe will become cheaper european businesses or consumers buying u s goods need to convert their euros to dollars to buy our exports if the dollar is weaker than the euro it means europeans can get more dollars for each euro as a result u s goods get cheaper due solely to the exchange rate between the euro and the u s dollar the u s has a substantial trading relationship with europe because of this the euro to u s dollar exchange would have a larger weighting in the index a big move in the euro exchange rate would impact the reer more than if another currency with a smaller weighting strengthened or weakened against the dollar example of real effective exchange rate reer let s say the u s had a foreign trading relationship with only three parties the eurozone great britain and australia that means the u s dollar has a trading relationship with the euro the british pound and the australian dollar in this hypothetical example the u s does 70 of its trading with the eurozone 20 with great britain and 10 with australia the basket of currencies in this case would also hold the same percentages with the euro at 70 the british pound at 20 and the australian dollar at 20 a move in the euro would have a greater impact on the basket than a move in the australian dollar if one of the exchange rates moved significantly but the weighted average of the basket didn t change it could mean that the other currencies moved in the opposite direction offsetting the move of the first currency reer vs spot exchange ratea spot exchange rate is the current price to exchange one currency for another for delivery on the earliest possible value date the value date is the effective date for a financial transaction involving an asset that fluctuates in price although the spot exchange rate is for delivery on the earliest date the standard settlement date for most spot transactions is two business days after the transaction date the spot exchange rate therefore is a current market price the reer is an indicator of the value of a currency in relation to its trading partners limitations of the real effective exchange rate reer factors besides trade can impact the reer the real effective exchange rate doesn t take into account price changes tariffs or other factors that may affect trade between nations if prices are higher in one country compared with another the trade might decrease in the country with higher prices impacting its reer the weighting used in the reer calculation then has to be adjusted to reflect any changes in trade in addition the central bank of each nation adjusts its monetary policy which can lower or raise interest rates in the home country the flow of money could increase to countries with higher rates as investors chase yield thus strengthening the currency exchange rate the reer would be impacted but it would have little to do with trade and more to do with the interest rate markets economists use reer to evaluate a country s trade flow and analyze the impact that factors such as competition and technological changes are having on a country and its economy | |
what is the real effective change rate | the real effective exchange rate is a measure of the relative strength of a nation s currency in comparison with those of the nations it trades with it is used to judge whether the nation s currency is undervalued or overvalued or ideally fairly valued | |
how do you calculate real effective exchange rate | first weigh each nation s exchange rate to reflect its share of the home country s foreign trade multiply all of the weighted exchange rates then multiply the total by 100 that is its reer or skip the mathematics and go to the bank for international settlements website for its updated effective exchange rate indices | |
what is the difference between real exchange rate and real effective exchange rate | the real exchange rate is the current price businesses and consumers will pay to buy a foreign product using their home currencies for example if the current u s exchange rate between the u s and britain was 138 u s dollars for one pound an american consumer would need 1 38 to buy one pound worth of goods | |
what is the difference between neer and reer | the nominal effective exchange rate neer and the real effective exchange rate reer are both indicators of a nation s competitiveness in relation to its trading partners neer is the average rate at which one nation s currency is valued in comparison with a basket of other currencies weighted for the percentage of trade that each currency represents to that nation the neer can be adjusted to compensate for the inflation rate in the home country that adjusted number is the reer | |
what does a high reer mean | an increase in a nation s reer means businesses and consumers have to pay more for the products they export while their own people are paying less for the products that it imports it is losing its trade competitiveness 2 | |
what is real estate | real estate is defined as the land and any permanent structures like a home or improvements attached to the land whether natural or man made real estate is a form of real property it differs from personal property which is not permanently attached to the land such as vehicles boats jewelry furniture and farm equipment understanding real estatethe terms land real estate and real property are often used interchangeably but there are distinctions land refers to the earth s surface down to the center of the earth and upward to the airspace above including the trees minerals and water the physical characteristics of land include its immobility indestructibility and uniqueness where each parcel of land differs geographically real estate encompasses the land plus any permanent man made additions such as houses and other buildings any additions or changes to the land that affects the property s value are called an improvement once land is improved the total capital and labor used to build the improvement represent a sizable fixed investment though a building can be razed improvements like drainage electricity water and sewer systems tend to be permanent real property includes the land and additions to the land plus the rights inherent to its ownership and usage a real estate agent is a licensed professional who arranges real estate transactions matching buyers and sellers and acting as their representatives in negotiations | |
what are types of real estate | residential real estate any property used for residential purposes examples include single family homes condos cooperatives duplexes townhouses and multifamily residences commercial real estate any property used exclusively for business purposes such as apartment complexes gas stations grocery stores hospitals hotels offices parking facilities restaurants shopping centers stores and theaters industrial real estate any property used for manufacturing production distribution storage and research and development land includes undeveloped property vacant land and agricultural lands such as farms orchards ranches and timberland special purpose property used by the public such as cemeteries government buildings libraries parks places of worship and schools the economics of real estatereal estate is a critical driver of economic growth in the u s and housing starts the number of new residential construction projects in any given month released by the u s census bureau is a key economic indicator the report includes building permits housing starts and housing completions data for single family homes homes with 2 4 units and multifamily buildings with five or more units such as apartment complexes1investors and analysts keep a close eye on housing starts because the numbers can provide a general sense of economic direction moreover the types of new housing starts can give clues about how the economy is developing if housing starts indicate fewer single family and more multifamily starts it could signal an impending supply shortage for single family homes driving up home prices the following chart shows 20 years of housing starts from jan 1 2000 to feb 1 2020 2 | |
how to invest in real estate | some of the most common ways to invest in real estate include homeownership investment or rental properties and house flipping one type of real estate investor is a real estate wholesaler who contracts a home with a seller then finds an interested party to buy it real estate wholesalers generally find and contract distressed properties but don t do any renovations or additions the earnings from investment in real estate are garnered from revenue from rent or leases and appreciation of the real estate s value according to attom which oversees the nation s premier property database the year end 2021 u s home sales report shows that home sellers nationwide realized a profit of 94 092 a 45 3 return on investment up 45 from 64 931 in 2020 and up 71 from 55 000 two years ago 3real estate is dramatically affected by its location and factors such as employment rates the local economy crime rates transportation facilities school quality municipal services and property taxes can affect the value of the real estate offers steady incomeoffers capital appreciationdiversifies portfoliocan be bought with leverage | |
is usually illiquid | influenced by highly local factorsrequires big initial capital outlaymay require active management and expertiseinvesting in real estate indirectly is done through a real estate investment trust reit a company that holds a portfolio of income producing real estate there are several types of reits including equity mortgage and hybrid reits and are classified based on how their shares are bought and sold such as publicly traded reits public non traded reits and private reits the most popular way to invest in a reit is to buy shares that are publicly traded on an exchange the shares trade like any other security traded on an exchange such as stocks and makes reits very liquid and transparent income from reits is earned through dividend payments and appreciation of the shares in addition to individual reits investors can trade in real estate mutual funds and real estate exchange traded funds etfs another option for investing in real estate is via mortgage backed securities mbs such as through the vanguard mortgage backed securities etf vmbs made up of federal agency backed mbs that have minimum pools of 1 billion and minimum maturity of one year 4 or the ishares mbs etf mbb which focuses on fixed rate mortgage securities and tracks the bloomberg u s mbs index its holdings include bonds issued or guaranteed by government sponsored enterprises such as fannie mae and freddie mac 5liquiditydiversificationsteady dividendsrisk adjusted returnslow growth low capital appreciationnot tax advantagedsubject to market riskhigh feesmortgage lending discrimination is illegal if you think you ve been discriminated against based on race religion sex marital status use of public assistance national origin disability or age there are steps you can take 6 one such step is to file a report to the consumer financial protection bureau or with the u s department of housing and urban development hud | |
what are the best ways to finance a real estate investment | real estate is commonly purchased with cash or financed with a mortgage through a private or commercial lender | |
what is real estate development | real estate development or property development includes activities that range from renovating existing buildings to the purchase of raw land and the sale of developed land or parcels to others | |
what careers are common in the real estate industry | common careers found in the real estate industry include leasing agent foreclosure specialist title examiner home inspector real estate appraiser real estate agent and mortgage broker | |
a real estate agent is a licensed professional who arranges property transactions connects buyers and sellers and represents them in negotiations real estate agents are usually paid through a commission a percentage of the property s sale price so their income depends on the size and number of deals they close in almost every state a real estate agent must work for or be affiliated with a real estate broker someone who is more experienced has taken additional coursework and is licensed 1 | yurle villegas investopedia | |
what a real estate agent does | real estate agents usually specialize in either commercial or residential real estate in either case their duties largely depend on whether they work for the buyer or the seller agents who work for the seller known as listing agents advise clients on how to price the property and prepare it for sale they commonly supply tips on last minute improvements to boost prices or encourage faster offers seller agents market the property through listing services their network of professionals and others and advertisements agents who work for the buyer search for available properties that match the buyer s price range and wish list these agents usually look at past sales data for comparable properties to help prospective buyers create a bid that is at least realistic 2from there the agents act as go betweens for the principal parties conveying offers counteroffers and other questions back and forth essentially negotiating on the client s behalf once a bid is accepted agents on both sides have work ahead helping their clients through the paperwork communicating on their behalf advising on inspections and moving and generally shepherding the deal through to closing | |
when you re engaged in a real estate transaction you should be clear about which party a real estate agent represents the buyer the seller or both parties 3 the party that the real estate agents represent and have a fiduciary responsibility to can significantly affect how they act during the transaction state laws regulate whether an agent can represent both parties in a real estate transaction technically known as dual agency 4 agents must disclose whom they represent so that buyers and sellers are aware of any conflicts of interest 4 | dual agency in which one person represents both the buyer and seller in a real estate transaction is illegal in eight states alaska colorado florida kansas maryland texas vermont and wyoming real estate agent compensationtraditionally agents were paid a percentage of the property s sale price through commission the more the house sells for the more money the agent makes 2 however payment arrangements for real estate agents are changing with online listings allowing consumers to do much of the shopping on their own without help from an agent 5some brokerages charge a lower commission for more expensive properties and some handle the entire transaction for a flat fee that ends up lower than a regular commission other companies offer an la carte price structure that lets sellers pay only for certain parts of the sale process such as adding the property to a multiple listing service or helping with an open house 5you hear people use the terms real estate agent real estate broker and realtor interchangeably while there is overlap among them there are key differences to know real estate agent vs real estate brokerthe distinctions between a real estate agent and a real estate broker vary across states 4 generally speaking anyone who earns a basic real estate license which involves taking a certain number of accredited courses and passing an exam is a real estate agent a salesperson qualified to help consumers buy or sell property 1a real estate broker is a step up the professional ladder brokers have additional training and education and have a broker s license most states also require that brokers have a certain amount of recent experience as active real estate agents brokers handle the technical aspects of the real estate transaction 4 a client signs a contract with a brokerage not an individual agent in many states brokers additional certification authorizes them to handle other legal and financial aspects of a deal such as handling the earnest money deposit and establishing the escrow account 1brokers normally own a firm or a franchise they can be on their own but must obtain an additional license to hire agents or other brokers to work for them meanwhile a real estate agent ordinarily cannot work alone but must operate with a real estate broker the exceptions are in states such as colorado and new mexico which mandate that every real estate professional be licensed as a broker 67 more typically agents work for brokers and split commissions with them on march 15 2024 the national association of realtors settled a class action lawsuit brought by home sellers who alleged that the association had inflated the commissions paid to its realtors as part of the proposed 418 settlement the nar agreed to prohibit offers of broker compensation when a property is listed on its multiple listing services mls if approved by the court the new rule is expected to give buyers more room to negotiate on agent commissions 8real estate agent vs realtorevery real estate broker is or has been a real estate agent but not every real estate agent is a broker how do realtors fit into the equation a realtor is a member of the national association of realtors nar a trade association both agents and brokers can be realtors along with property managers appraisers and other real estate industry professionals realtors are expected to be experts in their field and must follow the nar s code of ethics which requires agents to uphold specific duties to clients customers the public and other realtors in addition to nar realtors must belong to a state or local real estate association or board all realtors are real estate agents brokers or in a related profession but not all agents or brokers are realtors there are about three million active real estate licensees in the u s almost 1 6 million nar members and about 106 500 brokerage firms in the u s 910 | |
what does a real estate agent do | a real estate agent juggles various tasks like property appraisals negotiations and administrative duties while also meeting with clients their research typically involves studying market trends property values local zoning laws neighborhood features and marketing strategies they also keep abreast of the latest real estate laws and regulations 2 | |
how do i become a real estate agent | to become a real estate agent you need to complete some steps though these vary by jurisdiction here s what s typical you are above a certain age a legal resident of where you plan to practice have completed the necessary pre license education passed your state s real estate exam have activated your license and finally have joined a real estate brokerage | |
what is a real estate agent s salary | the median annual salary was 49 980 for real estate sales agents and 62 190 for real estate brokers in 2022 according to the u s bureau of labor statistics 11 however salaries for agents can vary significantly depending on experience and location these professionals make money primarily through commissions on property sales which means their income can fluctuate based on the real estate market and the size and number of deals they close it s also the case that many real estate agents do so part time and experience and skill can vary widely and also the pay 12 | |
what is a real estate professional | a real estate professional is someone who works in the real estate industry they can have different titles as an agent broker property manager or someone else involved in real estate 1 | |
what does it take to succeed as a real estate agent | to have success as a real estate agent you need good communication skills the ability to network be adept at technology and have an in depth knowledge of the relevant housing market 5 good real estate agents should also be skilled at setting goals creating a marketing plan maintaining connections with past clients and staying resilient in the face of challenges given the volatility in the industry 2the bottom linea state regulatory board authorizes a real estate agent to represent clients in property transactions generally working under a licensed broker essential skills include communicating and reading other people for client interaction and deal negotiation understanding local market trends having knowledge of real estate law being organized enough to handle many listings at once and having the integrity to build trust and ensure successful transactions many factors can influence the success and earning potential of those working in real estate | |
a real estate investment group reig is a business that concentrates much of its efforts and capital on real estate in search of profits real estate investment groups may choose to buy renovate sell or finance properties real estate investment groups commonly buy multiunit properties sell units to investors and take over administration and maintenance of the property reigs either do not elect to be or qualify as a real estate investment trust reit | understanding reigsreigs have several partners or private shareholders these investors provide a pool of capital and a greater ability to invest more broadly reigs focus much of their business on real estate but they are not subject to rules that require them to invest only in properties as such they can structure their business in several ways or take up other opportunities that align with their business strategy thus reigs may engage in property financing flipping properties leasing properties to clients or property management companies for rental income or selling units while maintaining management control in general there are no limits on the activities of a reig though most will market themselves as such to make it easier for investors to identify them the goal of a reig is to have monthly cash flows from investing in real estate reig investinginvesting in real estate is attractive since it offers several ways of gaining returns reigs may buy stakes in apartment buildings rental homes commercial buildings or commercial units they may earn income from mortgage lending rental properties or property management fees reigs often appeal to high net worth investors who want to gain a stake in real estate but do not wish to manage the properties themselves reigs also draw investors who manage single rental properties independently or are interested in flipping houses the reig allows the investor to buy one or more properties through an operating company the operating company collectively manages all the units and takes care of marketing them in exchange the operating company takes a percentage of the monthly rent diversification might help prevent significant losses during economic downturns and soft real estate markets one of the advantages of reigs is the pooled capital they receive as a partnership or corporate entity reig partners typically put up more cash initially than other real estate investments but will often see greater returns the structure of reigsreigs and reits are acronyms too often used interchangeably despite their differences reits established by congress in 1960 create financial statements follow specific tax laws and must provide 90 of their profits as dividends each year reigs meanwhile can have any business structure though the most common are partnerships and corporations a partnership is a business owned by two or more people who share profits losses and debts partners take stakes in the business proportional to their investment under the u s tax code partnerships are not taxed rather the income to partnerships passes to the partners who report the income on k 1 forms 1 partners receiving a k 1 must individually file their partnership income on form 1040 if they are individuals or on form 1120 for a corporation partners in a reig need not take part in managing the business partnership agreements detail the minimum investments fees distributions and partner voting some partnerships have a collaborative structure for investment decisions while others leave the core management of the business to a few executives generally the management team sources and identifies deals before investing partner capital some real estate investment partnerships accept investments from 5 000 to 50 000 while that may not be enough to purchase a unit the partnership might pool money from several investors to fund a shared or co owned property forming a corporation public or private is an option for any business the securities and exchange commission sec governs public corporations while sec regulation d covers private corporations public companies must provide quarterly transparent financial statements any businesses other than sole proprietors can elect to be taxed as a corporation if they meet the requirements incorporating a business allows a company to sell equity shares of the business equity shares comprise a part of the company s total value public equity shares vary in value based on public trading alternatively private shares are valued by their owners an executive management team manages corporations however shares can be structured with different voting rights which gives equity investors some say in the company s overall management crowdfundingonline real estate crowdfunding platforms can operate as a reig these platforms are structured as partnerships and pass through all income to investing partners with reporting on a k 1 the emergence of real estate crowdfunding platforms makes it easier for both accredited and non accredited investors to speculate in real estate the best real estate crowdfunding sites can help you diversify your portfolio and offer opportunities for competitive returns though such investments also carry greater risk than alternatives fundrise is a popular real estate crowdfunding platform that offers people the opportunity to invest in debt capital financing or take equity in real estate properties advantages and disadvantages of reigsreal estate investment groups diversify their investments to maximize profits pooled resources allow for several investments often generating larger returns | |
when run by experienced professionals the group s investments can be diversified well enough to lower risk and react to market volatility reigs also benefit from having few limits on what they can engage in and how they operate | reigs often have formal agreements stipulating when and how members can access their money if you want to withdraw from the group you may not recoup your investment or share of the profits immediately thus greatly limiting your liquidity reigs also can have set fees these fees can be costly especially when profits are slim or when losses occur some groups charge fees annually or more frequently lastly the success of the group depends on the people who make the decisions the risk may greatly outweigh any rewards if managed by unskilled and inexperienced people unrestricted investment opportunitiespooled capital for venturesdiversified portfolio for maximum profitsgroup fees may erode profitsreig agreement may prevent free access to fundsfailure is possible with an unskilled and inexperienced groupreigs vs reitsreigs and reits are both vehicles for investing in real estate but they have different structures and operating methods reits are generally more liquid than reigs because they are traded on major stock exchanges while reigs could require a longer capital commitment since they involve direct investment in physical properties 2another key difference involves their management reigs may offer more direct control over investment decisions while reits are managed by a professional team that makes all investment decisions 3 also reits are highly regulated and must follow sec regulations including disclosing financials and providing 90 of profits as dividends while reigs are subject to fewer regulations 2finally reigs often require a higher minimum investment than reits which can be purchased through single shares you should analyze the performance and trends of respective reigs and reits to better understand these vehicles especially in light of evolving market conditions and the regulatory environment structure reigs are companies that invest in real estate by pooling together capital from several investors operation in a typical reig an investor purchases a property through the group and becomes a part of the group returns and risks investors typically receive income from the property s rental revenue after operational expenses and fees managed by the reig are taken out the risks could be high if the management team is not experienced or the properties do not perform well structure reits are often publicly traded companies that own operate or finance income producing real estate across a range of property sectors operation investors can buy shares in the reit and the reit uses the pooled capital to invest in properties or mortgages returns and risks shares of a reit earn income without having to buy manage or finance property the risks are like those associated with any equity investment including loss of principal and fluctuation of value | |
where can i find reigs | search online for real estate investment groups or connect with investors via social networking sites and interest groups such as linkedin or the national real estate investors association as a beginner it might be beneficial to join a local real estate group to become more closely connected with other investors and to stay informed on regional activities | |
how can i join a reig | you can join a reig or start your own professional networking groups and websites such as linkedin or the national real estate investors association are good starting points joining a group may be as simple as signing an agreement and paying dues | |
how much money do i need to join a reig | the amount of money you need largely depends on the group reigs often have bylaws which each member must follow each group sets its capital requirements and fees which could be due annually or more frequently minimum investments often range from 5 000 to 50 000 | |
a real estate investment group reig is a business that concentrates much of its efforts and capital on real estate in search of profits real estate investment groups may choose to buy renovate sell or finance properties real estate investment groups commonly buy multiunit properties sell units to investors and take over administration and maintenance of the property reigs either do not elect to be or qualify as a real estate investment trust reit | understanding reigsreigs have several partners or private shareholders these investors provide a pool of capital and a greater ability to invest more broadly reigs focus much of their business on real estate but they are not subject to rules that require them to invest only in properties as such they can structure their business in several ways or take up other opportunities that align with their business strategy thus reigs may engage in property financing flipping properties leasing properties to clients or property management companies for rental income or selling units while maintaining management control in general there are no limits on the activities of a reig though most will market themselves as such to make it easier for investors to identify them the goal of a reig is to have monthly cash flows from investing in real estate reig investinginvesting in real estate is attractive since it offers several ways of gaining returns reigs may buy stakes in apartment buildings rental homes commercial buildings or commercial units they may earn income from mortgage lending rental properties or property management fees reigs often appeal to high net worth investors who want to gain a stake in real estate but do not wish to manage the properties themselves reigs also draw investors who manage single rental properties independently or are interested in flipping houses the reig allows the investor to buy one or more properties through an operating company the operating company collectively manages all the units and takes care of marketing them in exchange the operating company takes a percentage of the monthly rent diversification might help prevent significant losses during economic downturns and soft real estate markets one of the advantages of reigs is the pooled capital they receive as a partnership or corporate entity reig partners typically put up more cash initially than other real estate investments but will often see greater returns the structure of reigsreigs and reits are acronyms too often used interchangeably despite their differences reits established by congress in 1960 create financial statements follow specific tax laws and must provide 90 of their profits as dividends each year reigs meanwhile can have any business structure though the most common are partnerships and corporations a partnership is a business owned by two or more people who share profits losses and debts partners take stakes in the business proportional to their investment under the u s tax code partnerships are not taxed rather the income to partnerships passes to the partners who report the income on k 1 forms 1 partners receiving a k 1 must individually file their partnership income on form 1040 if they are individuals or on form 1120 for a corporation partners in a reig need not take part in managing the business partnership agreements detail the minimum investments fees distributions and partner voting some partnerships have a collaborative structure for investment decisions while others leave the core management of the business to a few executives generally the management team sources and identifies deals before investing partner capital some real estate investment partnerships accept investments from 5 000 to 50 000 while that may not be enough to purchase a unit the partnership might pool money from several investors to fund a shared or co owned property forming a corporation public or private is an option for any business the securities and exchange commission sec governs public corporations while sec regulation d covers private corporations public companies must provide quarterly transparent financial statements any businesses other than sole proprietors can elect to be taxed as a corporation if they meet the requirements incorporating a business allows a company to sell equity shares of the business equity shares comprise a part of the company s total value public equity shares vary in value based on public trading alternatively private shares are valued by their owners an executive management team manages corporations however shares can be structured with different voting rights which gives equity investors some say in the company s overall management crowdfundingonline real estate crowdfunding platforms can operate as a reig these platforms are structured as partnerships and pass through all income to investing partners with reporting on a k 1 the emergence of real estate crowdfunding platforms makes it easier for both accredited and non accredited investors to speculate in real estate the best real estate crowdfunding sites can help you diversify your portfolio and offer opportunities for competitive returns though such investments also carry greater risk than alternatives fundrise is a popular real estate crowdfunding platform that offers people the opportunity to invest in debt capital financing or take equity in real estate properties advantages and disadvantages of reigsreal estate investment groups diversify their investments to maximize profits pooled resources allow for several investments often generating larger returns | |
when run by experienced professionals the group s investments can be diversified well enough to lower risk and react to market volatility reigs also benefit from having few limits on what they can engage in and how they operate | reigs often have formal agreements stipulating when and how members can access their money if you want to withdraw from the group you may not recoup your investment or share of the profits immediately thus greatly limiting your liquidity reigs also can have set fees these fees can be costly especially when profits are slim or when losses occur some groups charge fees annually or more frequently lastly the success of the group depends on the people who make the decisions the risk may greatly outweigh any rewards if managed by unskilled and inexperienced people unrestricted investment opportunitiespooled capital for venturesdiversified portfolio for maximum profitsgroup fees may erode profitsreig agreement may prevent free access to fundsfailure is possible with an unskilled and inexperienced groupreigs vs reitsreigs and reits are both vehicles for investing in real estate but they have different structures and operating methods reits are generally more liquid than reigs because they are traded on major stock exchanges while reigs could require a longer capital commitment since they involve direct investment in physical properties 2another key difference involves their management reigs may offer more direct control over investment decisions while reits are managed by a professional team that makes all investment decisions 3 also reits are highly regulated and must follow sec regulations including disclosing financials and providing 90 of profits as dividends while reigs are subject to fewer regulations 2finally reigs often require a higher minimum investment than reits which can be purchased through single shares you should analyze the performance and trends of respective reigs and reits to better understand these vehicles especially in light of evolving market conditions and the regulatory environment structure reigs are companies that invest in real estate by pooling together capital from several investors operation in a typical reig an investor purchases a property through the group and becomes a part of the group returns and risks investors typically receive income from the property s rental revenue after operational expenses and fees managed by the reig are taken out the risks could be high if the management team is not experienced or the properties do not perform well structure reits are often publicly traded companies that own operate or finance income producing real estate across a range of property sectors operation investors can buy shares in the reit and the reit uses the pooled capital to invest in properties or mortgages returns and risks shares of a reit earn income without having to buy manage or finance property the risks are like those associated with any equity investment including loss of principal and fluctuation of value | |
where can i find reigs | search online for real estate investment groups or connect with investors via social networking sites and interest groups such as linkedin or the national real estate investors association as a beginner it might be beneficial to join a local real estate group to become more closely connected with other investors and to stay informed on regional activities | |
how can i join a reig | you can join a reig or start your own professional networking groups and websites such as linkedin or the national real estate investors association are good starting points joining a group may be as simple as signing an agreement and paying dues | |
how much money do i need to join a reig | the amount of money you need largely depends on the group reigs often have bylaws which each member must follow each group sets its capital requirements and fees which could be due annually or more frequently minimum investments often range from 5 000 to 50 000 |
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