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when you make a new purchase through a dspp regardless of whether you make a one time purchase or sign up to invest monthly typically you will not have any control over the respective trade date when you use a transfer company the transaction may not happen for a number of weeks basically the purchase goes through at whatever the stock price happens to be at that time | on the other hand discount brokers allow you to trade in real time so you always know the price a cardinal precept of investing is to diversify your investments so unless you are enrolled in dozens of dspps across multiple industries and internationally or have most of your investments in index funds mutual funds or exchange traded funds etf you may be inadequately diversified in fact just about any individual stock purchase whether direct or broker transacted runs this same risk you need to diversify dspps on their own typically will not do the trick for the average investor although a dspp s associated fees are low it is rare that a plan would have no fees at all many charge initial setup fees and some charge for each purchase transaction as well as sales fees even very small fees can add up over time especially if you are slowly and automatically adding to your position so as with any investment always read a dspp prospectus carefully to see what fees you might be charged special considerationsall things considered the greatest benefit of dspps for individual investors remains the ability to avoid commissions by not going through brokers for some investing in dspps still is a good option for the small investor who is ready to buy individual shares of a particular company to add to their portfolio and hold for the long term a dspp may be a thrifty way to do so | |
what is a direct tax | a direct tax is a tax that a person or organization pays directly to the entity that imposed it examples include income tax real property tax personal property tax and taxes on assets all of which are paid by an individual taxpayer directly to the government investopedia zoe hansenunderstanding a direct taxdirect taxes in the united states are largely based on the ability to pay principle this economic principle states that those who have more resources or earn a higher income should bear a greater tax burden some critics of progressive or ability to pay taxation see it as a disincentive for individuals to work hard and earn more money because the more a person makes the more taxes they pay direct taxes cannot be passed on to a different person or entity the individual or organization upon which the tax is levied is responsible for paying it 1a direct tax is the opposite of an indirect tax wherein the tax is levied on one entity such as a seller and paid by another such as a sales tax paid by the buyer in a retail setting both kinds of taxes are important revenue sources for governments 1examples of indirect taxes include excise duties on fuel liquor and cigarettes as well as a value added tax vat also referred to as a consumption tax the history of direct taxesthe modern distinction between direct taxes and indirect taxes came about with the ratification of the 16th amendment to the u s constitution in 1913 before the 16th amendment tax law in the united states was written so that direct taxes had to be directly apportioned to a state s population 23 a state with a population that was 75 of the size of another state s for example would only be required to pay direct taxes equal to 75 of the larger state s tax bill this antiquated verbiage created a situation in which the federal government could not impose many direct taxes such as a personal income tax due to apportionment requirements however the advent of the 16th amendment changed the tax code and allowed for the levying of numerous direct and indirect taxes 23examples of direct taxescorporate taxes are a good example of direct taxes if for example a manufacturing company reports 1 million in revenue 500 000 in the cost of goods sold cogs and 100 000 in operating costs its earnings before interest taxes depreciation and amortization ebitda would be 400 000 if the company has no debt depreciation or amortization and has a corporate tax rate of 21 its direct tax would be 84 000 400 000 x 0 21 84 000 an individual s federal income tax is another example of a direct tax if a person makes 100 000 in a year for example and owes the government 20 000 in taxes that 20 000 would be a direct tax there are a number of other direct taxes that are common in the united states such as the property taxes that homeowners are required to pay those are typically collected by local governments and based on the assessed value of the property other types of direct taxes in the u s and elsewhere include use taxes such as vehicle licensing and registration fees estate taxes gift taxes and so called sin taxes on liquor and cigarettes for example | |
what are examples of direct taxes | direct taxes are taxes paid directly to the party that levied them such as the irs common examples include income capital gains or property tax that a taxpayer pays to the government | |
what is the difference between direct tax and indirect tax | direct taxes cannot be shifted to another party and remain your responsibility to pay indirect taxes are the opposite whoever is liable for these taxes can pass on or shift them to another person or group 1 | |
what are some examples of indirect taxes | common examples of indirect taxes include sales tax excise tax value added tax vat and goods and services tax gst often businesses get individual consumers to foot the bill and cover these costs by charging higher prices | |
when surfers scan the vast expanse of the ocean they are looking for the wave whose direction and pull assure them of an exhilarating ride but how do surfers know which building upsurge of water won t amount to much while others that look the same to beginners will pick them up and carry them in the answer lies in reading the direction and strength of the waves much like how traders navigate the financial markets enter the directional movement index dmi which is often a trusted way for technical analysts and traders to do much the same with the pricing currents of the market | the dmi helps traders determine the strength and direction of price trends developed by j welles wilder in 1978 the dmi identifies the direction in which an asset price is moving the dmi does this by comparing earlier highs and lows and drawing two lines a positive directional movement line called di and a negative directional movement line called di a third line the average directional index adx can also gauge the strength of upward or downward trends 1 | |
when di is above di the price has more upward pressure than downward pressure conversely if di is above di the price has more downward pressure this helps traders assess the trend direction crossovers between the lines are also used as signals to buy or sell below we show you how to employ the dmi in trading compare it to other indicators and review some of its limits | formulas for the directional movement index dmi di smoothed dm atr 1 0 0 di smoothed dm atr 1 0 0 dx di di di di 1 0 0 where dm directional movement current high ph ph previous high dm previous low current low smoothed dm t 1 1 4 dm t 1 1 4 dm 1 4 cdm cdm current dm atr average true range begin aligned text di left frac text smoothed dm text atr right times 100 text di left frac text smoothed dm text atr right times 100 text dx left frac mid text di text di mid mid text di text di mid right times 100 textbf where text dm directional movement text current high text ph text ph text previous high text dm text previous low text current low text smoothed dm textstyle sum t 1 14 text dm left frac sum t 1 14 text dm 14 right text cdm text cdm text current dm text atr text average true range end aligned di atr smoothed dm 100 di atr smoothed dm 100dx di di di di 100where dm directional movement current high phph previous high dm previous low current lowsmoothed dm t 114 dm 14 t 114 dm cdmcdm current dmatr average true range calculating the directional movement index | |
what does the directional movement index tell you | the dmi is primarily used to help assess trend direction and provide trade signals crossovers are the main trade signal a long trade is taken when the di crosses above the di and an uptrend could be underway meanwhile a sell signal occurs when the di instead crosses below the di 1 in such cases a short trade may be initiated because a downtrend might be underway while this method may produce some good signals it can also provide misleading ones since a trend might not develop after entry the indicator can also be used as a trend or trade confirmation tool if the di is well above di the trend has strength on the upside and this would help confirm current long trades or new long trade signals based on other entry methods conversely if di is well above di this confirms a strong downtrend or short positions the directional movement index vs the aroon indicatorcalculation the calculation compares consecutive highs and lows to determine the direction of movement and uses a smoothed average to calculate the indicator interpretation traders tend to look at di and di crossovers for buying and selling prospects uses best used in markets with clear trends the dmi is also suitable for confirming trend direction and strength helping to filter our potential false signals in other indicators calculation the calculation focuses on the time elapsed since the high and low points interpretation traders tend to use the aroon indicator to determine the beginning and end of trends as well as potential consolidation phases uses particularly useful for identifying trend reversals and the beginning of new trends the indicator is often more effective in markets where price action involves frequent highs and lows over the period being analyzed while the dmi and the aroon indicator are both technical analysis tools used to identify the direction and strength of a market trend they have distinct methods and ways of interpreting them 1the aroon indicator is a technical analysis tool designed to identify changes and strength in a trend direction developed by tushar chande in 1995 it can be particularly useful for pinpointing the start of a new trend and discerning whether an asset is trending or trading sideways 2while the dmi and aroon indicators aim to identify and analyze trends they do so with different approaches and calculations traders may choose one over the other based on their trading style market conditions and analysis goals 23limitations of the directional movement indexthe dmi is part of a larger system called the average directional movement index adx the trend direction of dmi can be added to the strength readings of the adx readings above 20 on the adx mean the price is trending strongly whether using adx or not the indicator is still prone to producing false signals notably di and di readings and crossovers are based on historical prices and don t necessarily reflect what will happen a crossover can occur but the price may not respond resulting in a losing trade lines can also crisscross resulting in multiple signals but no price trend this can be avoided by only taking trades in the larger trend direction based on long term price charts or incorporating adx readings to help isolate strong trends an example of using the dmithis example uses the dmi on the stock for microsoft corporation msft the historical testing was done for the year between feb 27 2023 and feb 26 2024 the buying condition occurs when the di crosses above the di this would close out any short positions conversely the sell condition occurs when the di crosses below the di this condition will close out any long positions the trading strategy assumptions for the dmi include the following tradingviewthe results are as follows tradingviewthis example illustrates the potential effectiveness of the dmi however it is critical to note that traders typically use more complex trading strategies and leverage and they subject technical analysis indicators to more extensive backtesting and optimization with many securities before applying any to real trading | |
are there any other indicators like the dmi | there are several indicators that share similar similarities with the dmi particularly in their focus on trend direction strength and potential reversals these include the moving average convergence divergence and the parabolic stop and reverse | |
how can the dmi be made more reliable | improving confidence in the dmi involves a combination of methodological adjustments and strategic integration with other analytical tools 1 some ways to improve its reliability include adjusting the length of the period using the dmi with the adx combining the dmi with other indicators incorporating it into the analysis price action and chart patterns using the dmi in suitable market conditions and implementing risk management techniques when using it | |
what works well with the dmi | the dmi works well with other technical analysis tools to provide a more comprehensive market view integrating the dmi with other indicators can help confirm signals identify entry and exit points and improve the overall trading strategy some valuable indicators include the adx moving averages the relative strength index the stochastic oscillator fibonacci retracement levels bollinger bands and volume indicators the bottom linethe dmi is a helpful technical analysis tool developed to identify the direction and strength of a price trend the indicator consists of two primary components the di and the di along with the adx which measures trend strength calculating the dmi involves comparing consecutive highs and lows to determine the direction of price moves and then smoothing these differences over a given period to isolate the trend direction the di and di are plotted alongside the adx to represent trend direction and strength visually traders use the dmi to pinpoint entry and exit opportunities gauge trend strength and in broader trading strategies often combining it with other indicators to enhance accuracy and reduce false signals the dmi s ability to distinguish between strong and weak trends makes it indispensable for many traders offering perspectives that can lead to more informed trading decisions | |
what is dirty price | a dirty price is a bond pricing quote which refers to the cost of a bond that includes accrued interest based on the coupon rate bond price quotes between coupon payment dates reflect the accrued interest up to the day of the quote in short a dirty bond price includes accrued interest while a clean price does not understanding dirty priceaccrued interest is earned when a coupon bond is currently in between coupon payment dates as the next coupon payment date approaches the accrued interest increases each day until the payment of the coupon on the day of the coupon payment the clean price and dirty price are equal since there is no accrued interest until the next market day the dirty price is sometimes called the price plus accrued in the united states the clean price is quoted more often while in europe the dirty price is the standard the dirty price allows a seller to calculate the actual cost of a bond since the bond might have accrued interest from the previous coupon payment date so the date of the sale would reflect the clean price plus any accrued interest calculated daily as a result a buyer s actual price paid for the bond is higher than the quoted price on financial websites because it accounts for the accrued interest and the broker s commission accrued interestthe interest increases at a steady rate on a bond and calculation of the earned amount happen each day as a result the dirty price will change daily until the payout or coupon payment date once the payout is complete and the accrued interest resets to zero the dirty and clean prices are the same in the case of bonds offering semiannual payments the dirty price would rise slightly higher every day over the course of six months once the six month mark arrives and the coupon payment is made the accrued interest resets to zero to begin the cycle again the dirty to clean process continues until the bond reaches maturity dirty vs clean pricingthe dirty price is typically quoted between brokers and investors but the clean price or the price without accrued interest is usually considered the published price the clean price or flat bond price would likely be recorded in newspapers or financial resources that perform price tracking although the dirty price includes accrued interest the clean price is often considered to be the value of the bond in the current market real world example of a dirty priceas an example let s say apple inc issued a bond with a 1 000 face value while 960 is the published price the bond pays an interest rate coupon rate of 4 annually and these payments are semiannual as a result investors would receive 20 every six months for holding the bond the price of 960 is the published price or the clean price however an investor looking to purchase the bond would receive a quote from a broker that includes the 960 plus any accrued interest the broker would calculate the daily per diem of interest that has accumulated let s assume there s no broker commission depending on the day the investor made the purchase the accrued interest would vary so if the investor bought the bond a day before the first coupon payment of 20 it results in 19 of accrued interest up to that date the investor s bond s price would be 979 or 960 plus 19 in accrued interest | |
what is disability insurance | as its name suggests disability insurance is a type of insurance product that provides income in the event that a policyholder is prevented from working and earning an income due to a disability in the united states individuals can obtain disability insurance from the government through the social security system they can also purchase disability insurance from private insurers | |
how disability insurance works | oftentimes insurance products will protect against a specific loss such as when a property and casualty insurance plan reimburses the policyholder for the value of stolen property however in the case of disability insurance this compensation relates to the lost income caused by a disability for example if a worker earned 50 000 per year prior to becoming disabled and if their disability prevents them from continuing to work their disability insurance would compensate them for a portion of their lost income provided that they qualify in this sense disability insurance essentially covers the opportunity cost of the now disabled worker in practice there are many conditions that a policyholder must satisfy in order to receive these payments this is particularly true in regard to the u s social security system to qualify for government sponsored disability insurance applicants must prove that their disability is so severe that it prevents them from engaging in any type of meaningful work at all by contrast some private plans only require the applicant to demonstrate that they can no longer continue in the same line of work that they were previously engaged in the social security system also requires applicants to demonstrate that their disability is expected to last for at least 12 months or that it is expected to result in death 1as with all types of insurance disability insurance plans will carry more expensive premiums if their terms and conditions are more favorable to the policyholder conversely plans with less generous terms will typically carry lower insurance premiums some of the key features that affect insurance premiums in disability insurance plans include the length of the elimination period which is the length of time that the applicant must wait after becoming disabled before they can begin receiving benefits the benefit period which is how long those benefits continue to be paid and how strict the definition of disability is under the policy real world example of disability insuranceas a rough estimate disability insurance typically costs about 2 of the annual salary of the person being insured of course the actual amount will depend on the insurance carrier and on policy features such as those discussed above different individuals will have different preferences in terms of how much they are willing to pay in exchange for greater or poorer protections from potential disability to illustrate consider two hypothetical workers worker a is a professional working in a highly specialized field it took worker a ten years of post secondary education to become qualified in their field and this has allowed them to generate a relatively large income of 250 000 per year worker b on the other hand is a high school graduate who regularly switches between jobs and earns about 30 000 per year worker a knows that if they become disabled they may still be able to work in another field but this would very likely require a significant loss of income for this reason they decide to purchase a relatively expensive disability insurance plan that has a flexible definition of disability because of worker a s high income they can easily afford their relatively high premiums worker b on the other hand decides to opt for a plan with lower premiums even if that plan has a stricter definition of disability in addition to having fewer resources available to pay for premiums worker b is also less reluctant to work in an area outside of their current occupation since the nature of their work is less specialized | |
what is a disbursement | a disbursement is a payment to an individual or entity from a private or public fund a disbursement may also be a payment made on behalf of a client to a third party it may be money paid into a business operating budget the delivery of a loan amount to a borrower or a dividend to shareholders examples of disbursementsremote or delayed disbursement deliberately stalls the payment process by paying with a check drawn from a bank located in a remote region when banks could process a payment only when the original paper check was received this delayed the debit to the payer s account for several business days electronic transfers have made delayed disbursements less common 7accounting for disbursementsin bookkeeping a company makes disbursements during a set period such as a quarter or a year a bookkeeper records each transaction and posts it to one or more ledgers such as a cash disbursement journal and the general ledger 8disbursements are recorded with the date the payee name the amount debited or credited the payment method and the purpose of the payment the overall cash balance of the business is adjusted to account for the disbursement disbursement journals and ledgers are records of the money flowing out and may differ from actual profit or loss a company using the accrual method of accounting reports expenses when they occur not necessarily when they are paid and reports income when earned not when it is received the type of items listed in the ledger depends on the business a retailer has payments for inventory accounts payable and salaries a manufacturer has transactions for raw materials and production costs disbursement vs drawdowna disbursement is a payment a drawdown is the consequence of a particular type of disbursement when money is withdrawn from a retirement account a retiree receives a disbursement that disbursement represents a drawdown on the balance in their account 9 | |
when a retiree withdraws 10 of a 100 000 balance in a traditional ira account they receive a 10 000 disbursement this represents a drawdown of 10 000 or 10 from the account which results in a balance of 90 000 | can a loan disbursement be negative a loan disbursement may be positive or negative a positive disbursement results in a credit to an account while a negative disbursement results in an account debit a negative disbursement may occur if financial aid funds are overpaid and later withdrawn from the student s account 10 | |
what is the difference between a disbursement and a payment | a disbursement is a payment from a fund disbursement implies a payment has been finalized and properly recorded as a debit on the payer s side and a credit on the payee s side | |
what is a disbursement fee | a disbursement fee is usually a charge to cover payments made by the vendor on behalf of a customer for example fedex may pay duty and tax charges for a shipment on behalf of a customer and then add a disbursement fee to its bill to the customer to cover the payments 11the bottom linea disbursement is a payment made from a fund or a payment debited from the payer s account and credited to the payee s account for a business recording all disbursements is a crucial method of keeping tabs on expenditures | |
what is disclosure | in the financial world disclosure refers to the timely release of all information about a company that may influence an investor s decision it reveals both positive and negative news data and operational details that impact its business similar to disclosure in the law the concept is that all parties should have equal access to the same set of facts in the interest of fairness the securities and exchange commission sec develops and enforces disclosure requirements for all firms incorporated in the u s companies that are listed on the major u s stock exchanges must follow the sec s regulations understanding disclosurefederal government mandated disclosure came into being in the u s with the passage of the securities act of 1933 and the securities exchange act of 1934 both laws were responses to the stock market crash of 1929 and the great depression that followed the public and politicians alike blamed a lack of transparency in corporate operations for intensifying if not outright causing the financial crisis since then additional legislation such as the sarbanes oxley act of 2002 extended public company disclosure requirements and government oversight of them as mandated by the sec disclosures include those related to a company s financial condition operating results and management compensation the sec requires specific disclosures because the selective release of information places individual shareholders at a disadvantage for example insiders can use material nonpublic information for personal gain at the expense of the general investing public clearly outlined disclosure requirements ensure companies adequately disseminate information so that all investors are on an even playing field companies are not the only entities subject to strict disclosure regulations brokerage firms investment managers and analysts must also disclose any information that might influence and affect investors to limit conflict of interest issues analysts and money managers must disclose any equities they personally own the sec requires all publicly traded companies to prepare and issue two disclosure related annual reports one for the sec itself and one for the company s shareholders these reports are filed as documents called 10 ks and must be updated by the company as events change substantially apple warns that the coronavirus pandemic will affect its quarterly earnings any company seeking to go public must disclose information as part of a two part registration that includes a prospectus and a second document that contains other material information that information includes the company s own strengths weaknesses opportunities and threats swot analysis of the competitive environment it operates within the sec imposes stricter disclosure requirements for firms in the securities industry for example company officers of investment banks must make personal disclosures regarding the investments they own and investments owned by their family members real world example of disclosureon march 4 2020 the global spread of the coronavirus led the sec to advise all public companies to make appropriate disclosures to their shareholders of the likely impact of the crisis on their future operations and financial results many companies had already done just that in mid february apple warned that the pandemic was a threat to its revenue numbers as it was jeopardizing its supply chain from china and slowing retail sales the company invalidated its previous projections without immediately offering new estimates airline and other travel related companies also warned of the impact on their businesses along with consumer goods manufacturers that depend on china for manufacturing or consumer sales or both | |
what are discontinued operations | in financial accounting discontinued operations refer to parts of a company s core business or product line that have been divested or shut down and which are reported separately from continuing operations on the income statement understanding discontinued operationsdiscontinued operations are listed separately on the income statement because it s important that investors can clearly distinguish the profits and cash flows of continuing operations from those activities that have ceased this distinction is especially useful when companies merge as parsing out which assets are being divested or folded gives a clearer picture of how a company will make money in the future on a company s income statement discontinued operations are segregated from continuing operations so that investors may see clearly what money is inflowing from current operations vs those that have ceased disclosure on income statements | |
when operations are discontinued a company has multiple line items to report on its financial statements although the business component is being shut down it still could generate a gain or loss in the current accounting period | the total gain or loss from the discontinued operations is thus reported followed by the relevant income taxes this tax is often a future tax benefit because discontinued operations often incur losses to determine the company s total net income ni the gain or loss from discontinued operations is aggregated with that of continuing operations to not confuse adjustments to the financial statements that relate to previously reported discontinued operations a company may classify the adjustments separately in the discontinued operations section of its financials adjustments may occur because of benefit plan obligations contingent liabilities or contingent contract terms if the buyer of a discontinued operation assumes the debt associated with the operation then any interest expense before the sale is allocated to discontinued operations generally accepted accounting principles gaap do not allow general corporate overhead to be allocated to discontinued operations a company may report discontinued operations under gaap as long as two conditions are met if these two conditions are met then a company may report discontinued operations on its financial statements 1the reporting rules under international financial reporting standards ifrs differ slightly from gaap a discontinued operation must meet two criteria unlike gaap reporting requirements ifrs rules permit equity method investments to be classified as held for sale moreover under ifrs entities may continue involvement with the discontinued operation as with gaap discontinued operations are reported in a special section of the income statement 2 | |
why are discontinued operations listed separately on the income statement | so that investors can clearly tell the profits and cash flows from continuing operations apart from activities that have ceased | |
how does a company report discontinued operations | a company has multiple line items to report on its financial statements regarding discontinued operations the total gain or loss from the discontinued operations is reported followed by the relevant income taxes | |
how can discontinued operations be reported under generally accepted accounting principles gaap | two conditions must be met | |
how can discontinued operations be reported under international financial reporting standards ifrs | two criteria must be met the bottom line discontinued operations is a term in financial accounting it refers to parts of a company s core business or product line that have been divested or shut down they are reported separately from continuing operations on the income statement | |
what is a discount | in finance and investing a discount refers to a situation when a security is trading for lower than its fundamental or intrinsic value in fixed income trading a discount occurs when a bond s price is trading below its par or face value with the size of the discount equal to the difference between the price paid for a security and its par value bonds or notes may trade at a discount for several reasons including rising interest rates or due to credit issues or riskiness associated with the underlying company compared to comparable bonds a discount should not be confused with the discount rate which is an interest rate used for computing the time value of money understanding bond discountsthe par value of a bond is most often set at 1 000 the par value is the amount that the issuer will repay to an investor when the debt security matures if the price of the bond in the market is lower than 1 000 it is said to be trading at a discount a discount bond may be contrasted with a bond trading at a premium where the market price is above its face a bond may trade at a discount for several reasons because bond prices and interest rates are inversely correlated if a bond offers a lower interest coupon rate than the prevailing interest rate in the economy it will become less attractive than newly issued bonds with higher coupons and it may be discounted accordingly in other words because the issuer is not paying as high of an interest rate to bondholders these bonds must command a lower price in order to be competitive for example if a bond with a par value of 1 000 is currently selling for 990 it is selling at a discount of 1 or 10 1000 990 1 the term coupon comes from the days of physical bond certificates as opposed to electronic ones when some bonds had coupons attached to them some examples of bonds that trade at a discount include u s savings bonds and treasury bills deep discounts and pure discount instrumentsone type of discount bond is a pure discount instrument this bond pays nothing until maturity the bond is instead sold at a sizeable discount however when it reaches maturity it repays the bondholder the full par value for example if you purchase a pure discount instrument for 900 and the par value is 1 000 you will receive a total of 1 000 when the bond reaches maturity and a profit of 100 investors will not receive regular interest income payments from pure discount bonds however their return on investment is measured by the price appreciation of the bond the more discounted the bond at the time of purchase the higher the investor s implied rate of return at the time of maturity an example of a pure discount bond is a zero coupon bond which doesn t pay interest but instead is sold at a deep discount the discount amount is equal to the amount lost by a lack of interest payments zero coupon bond prices tend to fluctuate more often than bonds with coupons the term deep discount doesn t only apply to zero coupon bonds it can be applied to any bond that is trading at 20 or more below market value discounts vs premiumsa discount is the opposite of a premium when a bond is sold for more than the par value it sells at a premium a premium occurs if the bond is sold at for example 1 100 instead of its par value of 1 000 conversely to a discount a premium occurs when the bond has a higher interest rate than the market interest rate or a better company history other types of discountother securities such as stocks or derivatives can similarly be sold at a discount however this reduction in price is not often due to interest rates instead a discount could be implemented for a stock issue in order to generate buzz around a particular company companies may also offer discounts on their products or services to lure customers or boost sales cash discounts refer to an incentive that a seller offers to a buyer in return for paying a bill before the scheduled due date in a cash discount the seller will usually reduce the amount that the buyer owes by either a small percentage or a set dollar amount | |
what is a discount bond | a discount bond is a security that is issued for less than its par or face value a discount bond may also be a bond that trades for less than its face value in the secondary market a bond is considered a deep discount bond if it is sold at a significantly lower price than par value usually at 20 or more a discount bond is contrasted with a bond sold at a premium understanding discount bondsa bond is a type of fixed income investment security they are issued by governments and companies that want to raise money the issuer becomes the debtor while the bondholder or investor becomes the creditor the bond s face value is how much the investor pays to purchase the security so they pay 1 000 for a bond with a face value of 1 000 since bonds are a type of debt security bondholders or investors receive interest from the bond s issuer this interest is called a coupon that is usually paid semiannually but depending on the bond may be paid monthly quarterly or even annually the investor also expects to receive the face value of the bond when it matures but some bonds trade at a lower value bonds that fall into this category are called discount bonds for example a bond with a 1 000 face value that s currently selling for 95 would be a discounted bond discount bonds can be bought and sold by both institutional and individual investors however institutional investors must adhere to specific regulations for the selling and purchasing of discount bonds a common example of a discount bond is a u s savings bond 1investors can convert older bond prices to their value in the current market by using a calculation called yield to maturity ytm ytm considers the bond s current market price par value coupon interest rate and time to maturity to calculate a bond s return the ytm calculation is relatively complex but many online financial calculators can determine the ytm of a bond 2special considerationssome bonds can come with deep discounts including distressed bonds this type of bond has a high likelihood of default and can trade at a significant discount to par which would effectively raise its yield to desirable levels however distressed bonds are not usually expected to pay full or timely interest payments as a result investors who buy these securities are making a speculative play a zero coupon bond is one example of a deep discount bond depending on the length of time until maturity zero coupon bonds can be issued at substantial discounts to par sometimes 20 or more because a bond always pays its full face value at maturity assuming no credit events occur zero coupon bonds will steadily rise in price as the maturity date approaches these bonds don t make periodic interest payments and will only make one payment of the face value to the holder at maturity 3advantages and disadvantages of discount bondsthere is just as much risk involved with discount bonds for the investor as there are rewards the same way there is for any other type of discounted product let s take a look at some of the pros and cons of buying this type of bond since the investor buys the investment at a discounted price it provides a greater opportunity for greater capital gains keep in mind that the investor must weigh this advantage against the disadvantage of paying taxes on those capital gains another key advantage is that discounted bonds may come with different maturity dates short and long term maturities this gives investors the ability to spread out default and interest rate risks even though it may be a discount bond the bondholder is also poised to get regular interest payments just like any regular bond there is an exception though as noted above zero coupon bonds do not pay any interest before the bond matures consideration of the creditworthiness of the issuer is important with any type of discount bond there are a couple of things that bondholders should be aware of when determining whether to purchase one of these bonds notably this is especially true with longer term bonds because they may be considered financially distressed companies high potential for capital gains as bonds sell at less than face valueavailable with short term and long term maturitiesinvestors may receive regular interest unless it s a zero coupon bondmay indicate issuer default falling dividends or reluctance of purchasershigher risk of default and financial distress with deeply discounted bondsdiscount bonds and interest ratesbond yields and prices have an inverse or opposite relationship as interest rates increase the price of a bond drops and vice versa a bond that offers investors a lower interest or coupon rate than the current market interest rate would likely be sold at a lower price than its face value this lower price is due to the opportunity investors have to buy a similar bond or other securities that give a better return 4let s say that interest rates rise after an investor purchases a bond the higher rate in the economy decreases the value of the newly purchased bond due to paying a lower rate versus the market that means if our investor wants to sell the bond on the secondary market they will have to offer it for a lower price should the prevailing market interest rates rise enough to push the price or value of a bond below its face value it s referred to as a discount bond however the discount in a discount bond doesn t necessarily mean that investors get a better yield than the market offers instead investors get a lower price to offset the bond s lower yield relative to interest rates in the current market for example if a corporate bond trades at 980 it is considered a discount bond since its value is below the 1 000 par value as a bond becomes discounted its coupon rate is lower than current yields conversely if current interest rates fall below the coupon rate offered on an existing bond the bond will trade at a premium or a price higher than face value 4discount bonds and default riskthe chances of seeing a discount bond appreciate are reasonably high as long as the lender doesn t default if you hold out until the bond matures you ll be paid the face value of the bond even though what you originally paid was less than the face value maturity rates vary between short term and long term bonds short term bonds mature in less than one year while long term bonds can mature in 10 to 15 years or even longer but the chances of default for longer term bonds might be higher as a discount bond can indicate that the bond issuer might be in financial distress discount bonds can also indicate the expectation of issuer default falling dividends or a reluctance to buy on the part of the investors as a result investors are compensated somewhat for their risk by being able to buy the bond at a discounted price example of a discount bondhere s a hypothetical example to show how discount bonds work let s say that company abc is offering investors a discount bond below are the details of the bond including the bond issue number coupon rate at the time of the offering and other information suppose the current price for the bond is 79 943 compared to the 100 price at the offering for reference the 10 year treasury yield trades at 2 45 making the yield on this bond much more attractive than current yields however company abc experienced financial difficulty over the last few years making the bond risky as we can see that it trades at a discount price despite the coupon rate being higher than the current yield on a 10 year treasury note the yield has traded higher than the coupon rate with some days as high as 7 which further indicates that the bond is deeply discounted since the yield is much higher than the coupon rate while its price is much lower than its face value | |
what is a distressed bond | a distressed bond is one that is issued by a company that is financially distressed the company may be at the point where it is close to bankruptcy these bonds come at a very steep discount but also come with a significant amount of risk to investors because there is a very big chance that the company won t live up to its financial obligation | |
how do zero coupon bonds work | zero coupon bonds are deeply discounted debt securities unlike other bonds these bonds do not pay investors any interest in exchange for a lower value and no interest bondholders receive the full face value of the bond when it matures for instance a company may sell a zero coupon bond with a face value of 1 000 for only 850 this bond may mature within a year but offers no interest payment before maturity some issuers may offer zero coupon bonds right off the bat while others may be forced to do so down the road if their financial situation changes | |
why would anyone want a discount bond | discount bonds are fixed income securities that are issued at a lower price than their face value since they come at a discount sometimes very deep discounts they promise a high return put simply you pay a lower price for the bond but may still get the full face value when the bond matures keep in mind that these bonds are typically offered by companies that have financial difficulty or are on the verge of bankruptcy as such they come with a high degree of risk still some investors believe they are good investments the bottom linebonds are often considered low risk investments that s because bond issuers promise to return the face value to investors with regular coupon payments but there are certain bonds that come with a greater degree of risk discount bonds promise higher returns but may not return their full face value if something happens to the company before they reach maturity as an investor you should do your research before you make any decisions about whether to jump into the discount bond market | |
what is a discount broker | a discount broker is a stockbroker who carries out buy and sell orders at reduced commission rates compared to a full service broker however a discount broker doesn t provide investment advice or perform analysis on a client s behalf like a full service broker only individuals with an annual income far above average could afford a broker and access to the stock market before the emergence of better communications technology the internet has brought an explosion of discount online brokers that allow individuals with smaller capital to trade for lower fees and with less capital in terms of the stock market most discount brokers operate through online platforms a discount broker is nearly synonymous with online brokerages as a result understanding discount brokersdiscount brokers carry out orders at less cost but they typically just execute orders for their clients these brokers don t offer personal consultations advice research tax planning and estate planning services for customers discount brokers can offer lower fees due to the lack of these services and because they don t spend money closing deals with high net worth individuals most discount brokers operate their businesses online where the overheads are low many discount brokers even went so far as to forego commissions altogether for certain types of securities beginning in 2019 1discount brokerages in the securities industry provide clients with their own accounts to enter orders for execution these investors usually don t interact with a live broker the communication is minimal and only engages in trade executions if and when they do the services provided by discount brokers are aimed at self directed traders and investors the electronic trading platforms are built in a way that s beneficial for active traders with charting and position monitoring services choosing between full service and discount brokerswhether an investor opts for a discount broker or a full service broker depends on their investing knowledge market experience financial goals and financial status commissions typically take a healthy chunk out of investment and trading returns so some individuals opt to instead go for products offered by discount brokers full service brokers are a better option for investors who need professional investment advice or require support to stay on top of their financial planning outside of investing 2 discount brokers are particularly useful to investors and traders who frequently and actively buy and sell securities investors who frequently trade benefit from the lower commissions that discount brokers charge investors who don t need advice have small portfolios or just want their trades executed are also usually better off using discount brokers discount brokers in other industriesdiscount brokers can also be found in real estate and other financial services fields discount brokers in the real estate industry help individuals buy and sell properties these discount brokers have access to the same home listings as full service real estate agents do and they help clients to access that information directly for a fee but they don t take the client through the purchase process as a traditional realtor would the national association of realtors nar settled a lawsuit in 2024 that was based on full service broker commissions the suit was brought on behalf of home sellers nar s settlement prohibits offers of broker compensation on the multiple listing service mls but this agreement would not affect discount brokers who aren t affiliated with nar it would not necessarily reduce or affect fees owed to a discount broker 3discount brokers may also sell insurance products although they don t provide professional financial advice either | |
do full service brokers have to be licensed | full service brokers may not need an official license but they must usually register with the securities and exchange commission sec and maintain membership in the financial industry regulatory authority finra states may also have their own additional rules 4 | |
how much do full service brokers charge | the u s securities and exchange commission indicates that the base fees connected to an investment portfolio handled by a full service broker can range from 0 25 up to 1 this may not sound like a lot but the fees are paid annually so your cost will grow in tandem with the value of your investments 5 | |
is it necessary to use any type of broker at all | no law says that you must use some type of broker although flying solo is generally not a good idea if you re not very knowledgeable about the industry two types of plans allow you to invest directly on your own direct stock plans dsps and dividend reinvestment plans drips both involve dealing directly with the company you want to invest in there s no guarantee that these plans won t also charge fees and drips don t commonly provide for selling shares 6the bottom linediscount brokers carry out orders for less cost to the investor but they typically just execute orders for their clients they don t offer personal consultations or advice discount brokers can offer lower fees due to the lack of these services you can find a discount broker who will do as you instruct for less money than an advice oriented broker but this is only a viable option if you know exactly what you need and want | |
what is a discount margin dm | a discount margin dm is the average expected return of a floating rate security typically a bond that s earned in addition to the index underlying or reference rate of the security the size of the discount margin depends on the price of the floating or variable rate security the return of floating rate securities changes over time so the discount margin is an estimate based on the security s expected pattern between issue and maturity another way to view the discount margin is to think of it as the spread that when added to the bond s current reference rate will equate the bond s cash flows to its current price understanding a discount margin dmbonds and other securities with variable interest rates are usually priced close to their par value 1 this is because the interest rate coupon on a variable rate bond adjusts to current interest rates based on changes in the bond s reference rate 2 a security s yield relative to the yield of its benchmark is called a spread and different types of yield spread calculations exist for the different pricing benchmarks the discount margin is one of the most common calculations it estimates the security s spread above the reference index that equates the present value of all expected future cash flows to the current market price of the floating rate note there are three basic situations involving a discount margin calculating the discount margin dmthe discount margin formula is a complicated equation that takes into account the time value of money and typically needs a financial spreadsheet or calculator to calculate accurately there are seven variables involved in the formula they are all coupon payments are unknown with the exception of the first and must be estimated in order to calculate the discount margin the formula which must be solved by iteration to find dm is as follows the current price p equals the summation of the following fraction for all time periods from the beginning time period to maturity numerator c i denominator 1 i 1 dm 100 x d 1 d s 360 x product i j 2 1 i j dm 100 x d j 360 | |
what is a discount rate | the discount rate is the interest rate the federal reserve charges commercial banks and other financial institutions for short term loans the discount rate is applied at the fed s lending facility which is called the discount window a discount rate can also refer to the interest rate used in discounted cash flow dcf analysis to determine the present value of future cash flows in this case investors and businesses can use the discount rate for potential investments | |
how the fed s discount rate works | commercial banks in the u s have two primary ways to borrow money for their short term operating needs they can borrow and loan money to other banks without the need for any collateral using the market driven interbank rate or they can borrow money for their short term operating requirements from the federal reserve bank federal reserve loans are processed through the 12 regional branches of the fed the loans are used by financial institutes to cover any cash shortfalls head off any liquidity problems or in the worst case scenario prevent the bank s failure this fed offered lending facility is known as the discount window the loans are incredibly short term 24 hours or less the rate of interest charged is the standard discount rate the board of governors of the federal reserve set this discount rate 1the fed s discount window program runs three tiers of loans each using a separate but related rate it also allows for emergency credit approvals for banks in distress the fed determines the discount rates for the first two tiers independently the rate for the third tier is based on the prevailing rates in the market all three types of the federal reserve s discount window loans are collateralized the bank needs to maintain a certain level of security or collateral against the loan emergency credit may require collateral but it s based on circumstances and the fed s vote borrowing institutions use this facility sparingly mostly when they cannot find willing lenders in the marketplace the fed offered discount rates are available at relatively high interest rates compared to the interbank borrowing rates to discourage using the discount window too often the discount window is primarily intended as an emergency option for distressed banks borrowing from it can even signal weakness to other market participants and investors example of fed discount ratethe use of the fed s discount window soared in late 2007 and 2008 as financial conditions deteriorated sharply and the central bank took steps to inject liquidity into the financial system in august 2007 the board of governors cut the primary discount rate from 6 25 to 5 75 reducing the premium over the fed funds rate from 1 to 0 5 in october 2008 the month after lehman brothers collapse discount window borrowing peaked at 403 5 billion against the monthly average of 0 7 billion from 1959 to 2006 owing to the financial crisis the board extended the lending period from overnight to 30 days then to 90 days in march 2008 2 once the economy recovered those temporary measures were revoked and the discount rate was reverted to overnight lending only the fed maintains its own discount rate under the discount window program in the u s most central banks across the globe use similar measures although they vary by area for instance the european central bank ecb offers standing facilities that serve the same purpose financial organizations can obtain overnight liquidity from the central bank against the presentation of sufficient eligible assets as collateral 3most commonly the fed s discount window loans are overnight only but the loan period can be extended in periods of extreme economic distress such as the 2008 2009 credit crisis | |
how the discount rate works in cash flow analysis | the same term discount rate is used in discounted cash flow analysis dcf is used to estimate the value of an investment based on its expected future cash flows based on the concept of the time value of money dcf analysis helps assess the viability of a project or investment by calculating the present value of expected future cash flows using a discount rate such an analysis begins with an estimate of the investment that a proposed project will require then the future returns it is expected to generate are considered using the discount rate it is possible to calculate the current value of any future cash flows the project is considered viable if the net present value pv is positive if it is negative the project isn t worth the investment in this context of dcf analysis the discount rate refers to the interest rate used to determine the present value for example 100 invested today in a savings scheme with a 10 interest rate will grow to 110 in other words 110 which is the future value fv when discounted by the rate of 10 is worth 100 present value as of today if one knows or can reasonably predict all such future cash flows like the future value of 110 then using a particular discount rate the present value of such an investment can be obtained investopedia theresa chiechi | |
what is the appropriate discount rate to use for an investment or a business project while investing in standard assets like treasury bonds the risk free rate of return generally considered the interest rate on the three month treasury bill is often used as the discount rate | on the other hand if a business is assessing the viability of a potential project the weighted average cost of capital wacc may be used as a discount rate this is the average cost the company pays for capital from borrowing or selling equity in either case the net present value of all cash flows should be positive if the investment or project is to get the green light types of discounted cash flowthere are different types of discount rates that apply to various investments of a business what type is required depends on the needs and demands of investors and the company itself here are the most common calculating the discount rateto calculate the discount rate use the following formula | |
where | here s an example to show how the discount rate works let s say you want to determine the discount rate on a certain investment using the following variables now let s use the formula above to determine the discount rate for the fractional exponent you can convert it to a decimal 1 10 dr fv pv 1 n 1dr 5 000 3 500 1 10 1dr 1 42857 0 1 1dr 1 03631 1dr 0 03631so in this case the discount rate is 3 631 | |
what effect does a higher discount rate have on the time value of money | the discount rate reduces future cash flows so the higher the discount rate the lower the present value of the future cash flows a lower discount rate leads to a higher present value as this implies when the discount rate is higher money in the future will be worth less than it is today meaning it will have less purchasing power | |
how is discounted cash flow calculated | there are three steps to calculating the dcf of an investment | |
how do you choose the appropriate discount rate | the discount rate used depends on the type of analysis undertaken when considering an investment the investor should use the opportunity cost of putting their money to work elsewhere as an appropriate discount rate that is the rate of return that the investor could earn in the marketplace on an investment of comparable size and risk a business can choose the most appropriate of several discount rates this might be an opportunity cost based discount rate its weighted average cost of capital or the historical average returns of a similar project in some cases using the risk free rate may be most appropriate the bottom linethe discount rate is the lending rate at the federal reserve s discount window where banks can get a loan if they can t secure funding from another bank on the market a discount rate is also calculated to make business or investing decisions using the discounted cash flow model | |
what is the discount yield | the discount yield is a way of calculating a bond s return when it is sold at a discount to its face value expressed as a percentage discount yield is commonly used to calculate the yield on municipal notes commercial paper and treasury bills sold at a discount the formula for discount yield is discount yield is calculated as and the formula uses a 30 day month and 360 day year to simplify the calculation image by sabrina jiang investopedia 2021understanding the discount yielddiscount yield computes a discount bond investor s return on investment roi if the bond is held until maturity a treasury bill is issued at a discount from par value face amount along with many forms of commercial paper and municipal notes which are short term debt instruments issued by municipalities u s treasury bills have a maximum maturity of six months 26 weeks while treasury notes and bonds have longer maturity dates if a security is sold before the maturity date the rate of return earned by the investor is different and the new rate of return is based on the sale price of the security if for example the 1 000 corporate bond purchased for 920 is sold for 1 100 five years after the purchase date the investor has a gain on the sale the investor must determine the amount of the bond discount that is posted to income before the sale and must compare that with the 1 100 sale price to calculate the gain a zero coupon bond is a another example of a discount bond depending on the length of time until maturity zero coupon bonds can be issued at substantial discounts to par sometimes 20 or more because a bond will always pay its full face value at maturity assuming no credit events occur zero coupon bonds will steadily rise in price as the maturity date approaches these bonds don t make periodic interest payments and will only make one payment of the face value to the holder at maturity exampleassume for example that an investor purchases a 10 000 treasury bill at a 300 discount from par value a price of 9 700 and that the security matures in 120 days in this case the discount yield is 300 discount 10 000 par value 360 120 days to maturity or a 9 dividend yield the differences between discount yield and accretionsecurities that are sold at a discount use the discount yield to calculate the investor s rate of return and this method is different than bond accretion bonds that use bond accretion can be issued a par value at a discount or a premium and accretion is used to move the discount amount into bond income over the remaining life of the bond assume for example that an investor purchases a 1 000 corporate bond for 920 and the bond matures in 10 years since the investor receives 1 000 at maturity the 80 discount is bond income to the owner along with interest earned on the bond bond accretion means that the 80 discount is posted to bond income over the 10 year life and an investor can use a straight line method or the effective interest rate method straight line posts the same dollar amount into bond income each year and the effective interest rate method uses a more complex formula to calculate the bond income amount | |
what is discounted cash flow dcf | discounted cash flow dcf refers to a valuation method that estimates the value of an investment using its expected future cash flows dcf analysis attempts to determine the value of an investment today based on projections of how much money that investment will generate in the future it can help those considering whether to acquire a company or buy securities discounted cash flow analysis can also assist business owners and managers in making capital budgeting or operating expenditures decisions investopedia jiaqi zhou | |
how does discounted cash flow dcf work | the purpose of dcf analysis is to estimate the money an investor would receive from an investment adjusted for the time value of money the time value of money assumes that a dollar that you have today is worth more than a dollar that you receive tomorrow because it can be invested as such a dcf analysis is useful in any situation where a person is paying money in the present with expectations of receiving more money in the future for example assuming a 5 annual interest rate 1 in a savings account will be worth 1 05 in a year similarly if a 1 payment is delayed for a year its present value is 95 cents because you cannot transfer it to your savings account to earn interest discounted cash flow analysis finds the present value of expected future cash flows using a discount rate investors can use the concept of the present value of money to determine whether the future cash flows of an investment or project are greater than the value of the initial investment if the dcf value calculated is higher than the current cost of the investment the opportunity should be considered if the calculated value is lower than the cost then it may not be a good opportunity or more research and analysis may be needed before moving forward with it to conduct a dcf analysis an investor must make estimates about future cash flows and the ending value of the investment equipment or other assets the investor must also determine an appropriate discount rate for the dcf model which will vary depending on the project or investment under consideration factors such as the company or investor s risk profile and the conditions of the capital markets can affect the discount rate chosen if the investor cannot estimate future cash flows or the project is very complex dcf will not have much value and alternative models should be employed for dcf analysis to be of value estimates used in the calculation must be as solid as possible badly estimated future cash flows that are too high can result in an investment that might not pay off enough in the future likewise if future cash flows are too low due to rough estimates they can make an investment appear too costly which could result in missed opportunities discounted cash flow formulathe formula for dcf is d c f c f 1 1 r 1 c f 2 1 r 2 c f n 1 r n where c f 1 the cash flow for year one c f 2 the cash flow for year two c f n the cash flow for additional years r the discount rate begin aligned dcf frac cf 1 1 r 1 frac cf 2 1 r 2 frac cf n 1 r n textbf where cf 1 text the cash flow for year one cf 2 text the cash flow for year two cf n text the cash flow for additional years r text the discount rate end aligned dcf 1 r 1cf1 1 r 2cf2 1 r ncfn where cf1 the cash flow for year onecf2 the cash flow for year twocfn the cash flow for additional yearsr the discount rate example of dcf | |
when a company analyzes whether it should invest in a certain project or purchase new equipment it usually uses its weighted average cost of capital wacc as the discount rate to evaluate the dcf | the wacc incorporates the average rate of return that shareholders in the firm are expecting for the given year for example say that your company wants to launch a project the company s wacc is 5 that means that you will use 5 as your discount rate the initial investment is 11 million and the project will last for five years with the following estimated cash flows per year using the dcf formula the calculated discounted cash flows for the project are as follows adding up all of the discounted cash flows results in a value of 13 306 727 by subtracting the initial investment of 11 million from that value we get a net present value npv of 2 306 727 the positive number of 2 306 727 indicates that the project could generate a return higher than the initial cost a positive return on the investment therefore the project may be worth making if the project had cost 14 million the npv would have been 693 272 that would indicate that the project cost would be more than the projected return thus it might not be worth making dividend discount models such as the gordon growth model ggm for valuing stocks are other analysis examples that use discounted cash flows advantages and disadvantages of dcfdiscounted cash flow analysis can provide investors and companies with an idea of whether a proposed investment is worthwhile it is an analysis that can be applied to a variety of investments and capital projects where future cash flows can be reasonably estimated its projections can be tweaked to provide different results for various what if scenarios this can help users account for different projections that might be possible the major limitation of discounted cash flow analysis is that it involves estimates not actual figures so the result of dcf is also an estimate that means that for dcf to be useful individual investors and companies must estimate a discount rate and cash flows correctly furthermore future cash flows rely on a variety of factors such as market demand the status of the economy technology competition and unforeseen threats or opportunities these can t be quantified exactly investors must understand this inherent drawback for their decision making dcf shouldn t necessarily be relied on exclusively even if solid estimates can be made companies and investors should consider other known factors as well when sizing up an investment opportunity in addition comparable company analysis and precedent transactions are two other common valuation methods that might be used | |
how do you calculate dcf | calculating the dcf involves three basic steps one forecast the expected cash flows from the investment two select a discount rate typically based on the cost of financing the investment or the opportunity cost presented by alternative investments three discount the forecasted cash flows back to the present day using a financial calculator a spreadsheet or a manual calculation | |
what is an example of a dcf calculation | you have a discount rate of 10 and an investment opportunity that would produce 100 per year for the following three years your goal is to calculate the value today the present value of this stream of future cash flows since money in the future is worth less than money today you reduce the present value of each of these cash flows by your 10 discount rate specifically the first year s cash flow is worth 90 91 today the second year s cash flow is worth 82 64 today and the third year s cash flow is worth 75 13 today adding up these three cash flows you conclude that the dcf of the investment is 248 68 | |
is discounted cash flow the same as net present value npv | no it s not although the two concepts are closely related npv adds a fourth step to the dcf calculation process after forecasting the expected cash flows selecting a discount rate discounting those cash flows and totaling them npv then deducts the upfront cost of the investment from the dcf for instance if the cost of purchasing the investment in our above example were 200 then the npv of that investment would be 248 68 minus 200 or 48 68 the bottom linediscounted cash flow is a valuation method that estimates the value of an investment based on its expected future cash flows by using a dfc calculation investors can estimate the profit they could make with an investment adjusted for the time value of money the value of expected future cash flows is first calculated by using a projected discount rate if the discounted cash flow is higher than the current cost of the investment the investment opportunity could be worthwhile | |
what is the discounted payback period | the discounted payback period is a capital budgeting procedure used to determine the profitability of a project a discounted payback period gives the number of years it takes to break even from undertaking the initial expenditure by discounting future cash flows and recognizing the time value of money the metric is used to evaluate the feasibility and profitability of a given project the more simplified payback period formula which simply divides the total cash outlay for the project by the average annual cash flows doesn t provide as accurate of an answer to the question of whether or not to take on a project because it assumes only one upfront investment and does not factor in the time value of money investopedia matthew collinsunderstanding the discounted payback period | |
when deciding on any project to embark on a company or investor wants to know when their investment will pay off meaning when the cash flows generated from the project will cover the cost of the project | this is particularly useful because companies and investors usually have to choose between more than one project or investment so being able to determine when certain projects will pay back compared to others makes the decision easier the basic method of the discounted payback period is taking the future estimated cash flows of a project and discounting them to the present value this is compared to the initial outlay of capital for the investment the period of time that a project or investment takes for the present value of future cash flows to equal the initial cost provides an indication of when the project or investment will break even the point after that is when cash flows will be above the initial cost the shorter a discounted payback period is means the sooner a project or investment will generate cash flows to cover the initial cost a general rule to consider when using the discounted payback period is to accept projects that have a payback period that is shorter than the target timeframe a company can compare its required break even date for a project to the point at which the project will break even according to the discounted cash flows used in the discounted payback period analysis to approve or reject the project calculating the discounted payback periodto begin the periodic cash flows of a project must be estimated and shown by each period in a table or spreadsheet these cash flows are then reduced by their present value factor to reflect the discounting process this can be done using the present value function and a table in a spreadsheet program next assuming the project starts with a large cash outflow or investment to begin the project the future discounted cash inflows are netted against the initial investment outflow the discounted payback period process is applied to each additional period s cash inflow to find the point at which the inflows equal the outflows at this point the project s initial cost has been paid off with the payback period being reduced to zero the inflation rate for consumer prices in the united states according to the bureau of labor statistics in june 2024 1 investors should consider the diminishing value of money when planning future investments payback period vs discounted payback periodthe payback period is the amount of time for a project to break even in cash collections using nominal dollars alternatively the discounted payback period reflects the amount of time necessary to break even in a project based not only on what cash flows occur but when they occur and the prevailing rate of return in the market these two calculations although similar may not return the same result due to the discounting of cash flows for example projects with higher cash flows toward the end of a project s life will experience greater discounting due to compound interest for this reason the payback period may return a positive figure while the discounted payback period returns a negative figure example of the discounted payback periodassume that company a has a project requiring an initial cash outlay of 3 000 the project is expected to return 1 000 each period for the next five periods and the appropriate discount rate is 4 the discounted payback period calculation begins with the 3 000 cash outlay in the starting period the first period will experience a 1 000 cash inflow using the present value discount calculation this figure is 1 000 1 04 961 54 thus after the first period the project still requires 3 000 961 54 2 038 46 to break even after the discounted cash flows of 1 000 1 04 2 924 56 in period two and 1 000 1 04 3 889 00 in period three the net project balance is 3 000 961 54 924 56 889 00 224 90 therefore after receipt of the fourth payment which is discounted to 854 80 the project will have a positive balance of 629 90 therefore the discounted payback period is sometime during the fourth period | |
how do i calculate the payback period | the standard payback period is simply the amount of time an investment takes to recoup the initial cost it can be calculated by dividing the initial investment cost by the annual net cash flow generated by that investment | |
how do i calculate the discounted payback period | the discounted payback period is more accurate than the standard payback period but more difficult to calculate the first step is to estimate the expected annual cash flows from the investment as well as the discount rate the amount of value an amount of cash loses with each successive year due to inflation and the diminishing time value of money this is used to calculate the present value of each instance of cash flow and the discount payback period is the number of years it takes for the discounted cash flows to exceed the initial investment | |
what is the decision rule for a discounted payback period | the decision rule is a simple rule to determine if an investment is worthwhile and which of several investments is most worthwhile if the discounted payback period for a certain asset is less than the useful life of that asset the investment may be approved if a business is choosing between several potential investments the one with the shortest discounted payback period will be the most profitable the bottom linethe discounted payback period is a simple metric to determine if an investment will be sufficiently profitable to justify the initial cost it uses the predicted returns from the investment but also takes into consideration the diminishing value of future returns | |
what is discounting | discounting is the process of determining the present value of a payment or a stream of payments that is to be received in the future given the time value of money a dollar is worth more today than it would be worth tomorrow discounting is the primary factor used in pricing a stream of tomorrow s cash flows | |
how discounting works | the coupon payments found in a regular bond are discounted by a certain interest rate they re then added together with the discounted par value to determine the bond s current value 1from a business perspective an asset has no value unless it can produce cash flows in the future stocks pay dividends bonds pay interest and projects provide investors with incremental future cash flows the value of those future cash flows in today s terms is calculated by applying a discount factor to future cash flows time value of money and discountingit represents a discount on the price of a car when the car is on sale for 10 off the same concept of discounting is used to value and price financial assets the discounted or present value is the value of the bond today the future value is the value of the bond at some future time the difference in value between the future and the present is created by discounting the future back to the present using a discount factor which is a function of time and interest rates a bond can have a par value of 1 000 and be priced at a 20 discount which would be 800 the investor can purchase the bond today for a discount and receive the full face value of the bond at maturity the difference is the investor s return a larger discount results in a greater return which is a function of risk discounting and riska higher discount generally means that there s a greater level of risk associated with an investment and its future cash flows discounting is the primary factor used in pricing a stream of tomorrow s cash flows the cash flows of company earnings are discounted back at the cost of capital in the discounted cash flows model future cash flows are discounted back at a rate equal to the cost of obtaining the funds required to finance the cash flows a higher interest rate paid on debt also equates with a higher level of risk which generates a higher discount and lowers the present value of the bond junk bonds are sold at a deep discount 2likewise a higher level of risk associated with a particular stock is represented as beta in the capital asset pricing model it means a higher discount which lowers the present value of the stock 3 | |
what is a breakpoint discount | breakpoint discounts apply to class a mutual funds investors must qualify for them through purchasing these mutual fund shares and meeting a few other requirements they re volume discounts on the front end sales load that are charged to the investor they increase with the amount invested 4 | |
what does it mean when a bond is callable | a callable bond is a municipal bond that s subject to redemption by a state or local government before its maturity date a government might do this because the bond is paying an interest rate that s higher than the market rate at the time you can determine whether a bond is callable before you commit by looking it up on the electronic municipal market access website provided by the municipal securities rulemaking board 5 | |
what is a junk bond | junk bond is another name for a high yield bond these bonds pay a higher interest rate or yield because they re rated poorly by moody s and s p due to a high risk of default they are considered to be risky for investors 6the bottom linediscounting is the process of selling an asset for something less than its value a 35 000 car that s on sale with a 10 discount can be bought for 31 500 it s discounted by 3 500 a 1 000 bond that comes with a 20 discount can be purchased for 800 bonds are typically discounted because they carry a higher degree of risk to the purchaser or investor the discount is based on the value of an asset s income at the present moment | |
what does discounts for lack of marketability mean | discounts for lack of marketability dlom refer to the method used to help calculate the value of closely held and restricted shares the theory behind dlom is that a valuation discount exists between a stock that is publicly traded and thus has a market and the market for privately held stock which often has little if any marketplace various methods have been used to quantify the discount that can be applied including the restricted stock method ipo method and the option pricing method understanding discounts for lack of marketability dlom the restricted stock method purports that the only difference between a company s common stock and its restricted stock is the lack of marketability of the restricted stock subsequently the price difference between both units should arise due to this lack of marketability the ipo method relates to the price difference between shares that are sold pre ipo and post ipo the percent difference between the two prices is considered the dlom using this method the option pricing method uses the option s price and the strike price of the option as the determinants of the dlom the option price as a percentage of the strike price is considered the dlom under this method the consensus of many studies suggests that the dlom ranges between 30 to 50 discounts for lack of marketability challengesnoncontrolling nonmarketable ownership interests in closely held companies pose some unique challenges for valuation analysts these issues often arise during gift tax estate tax generation skipping transfer tax income tax property tax and other taxation disputes to assist valuators in the field the internal revenue service irs offers some guidance particularly around two related issues that further cloud analysis discount for lack of liquidity dlol and discount for lack of control dloc without question selling an interest in a privately held company is a more costly uncertain and time consuming process than liquidating a position in a publicly traded entity an investment in which the owner can achieve liquidity in a timely fashion is worth more than an investment in which the owner cannot sell the investment quickly as such privately held companies should sell at a discount to actual intrinsic value because of additional costs increased uncertainty and longer time horizons tied to selling unconventional securities | |
what is a discouraged worker | a discouraged worker is a person who is eligible for employment and can work but who is currently unemployed and has not attempted to find employment in the last four weeks discouraged workers usually have given up on searching for a job because they found no suitable employment options or failed to secure a job when they applied understanding discouraged workersthe u s department of labor s bureau of labor statistics bls defines discouraged workers as those persons not in the labor force who want and are available for work and who have looked for a job sometime in the prior 12 months but were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey the bls adds that discouraged workers were not currently looking for work specifically because they believed no jobs were available for them or there were none for which they would qualify 2as discouraged workers are no longer looking for employment they are not counted as active in the labor force this means that the headline unemployment rate which is based solely on the active labor force number does not take into account the number of discouraged workers in the country 34the causes for worker discouragement are complex and varied in some cases workers fall out of the workforce because they are not equipped to deal with technological change in their workplace an example of this occurred during the great recession when the manufacturing sector shed senior staff unable to work on the new computer numeric control cnc machines used for cutting wood and other hard materials according to a report by the washington post 5nick eberstadt of the american enterprise institute aei has blamed the flight from work on a lack of supply of skilled able and willing workers and an increasing reliance on disability insurance 6 his theory is backed by alan krueger s 2016 research which found that self reported pain and disability insurance was higher among discouraged workers 7other possible reasons for discouraged workers include restrictions that limit employment options for formerly incarcerated individuals and jobs that are perceived as being inaccessible to a specific gender 89the number of discouraged workers in the u s in june 2024 according to the bureau of labor statistics bls 10bls accounting for discouraged workersto better analyze unemployment in the u s the bls created alternative measures for the underutilization of labor u 4 u 5 and u 6 capture discouraged workers 1from the second quarter of 2023 through the first quarter of 2024 the u 4 rate seasonally adjusted was 3 9 just a shade higher than the headline or official unemployment rate of 3 7 11in spite of the pandemic s impact on the economy the current u 4 number is not as bad as the 2009 annual average which stood at 9 7 in the throes of the great recession 12helping the discouragedthe u 4 rate helps to quantify how many discouraged workers exist and keep tabs on the change in their numbers further analysis of age groups race and geographic location is also made possible by u 4 measures policymakers at federal state and local levels can use these numbers to formulate plans to assist them such plans may consist of training programs education subsidies or tax credits for companies that hire long term unemployed individuals | |
what are discouraged workers | discouraged workers are people who are eligible and able but not actively seeking work specifically these workers have not tried to become gainfully employed in the last four weeks and have given up on searching for work typically because nothing is suitable | |
how many discouraged workers are in the u s | in june 2024 there were 369 000 discouraged workers in the u s this was a significant decrease from june 2023 when there were 320 000 discouraged workers 10 | |
why are discouraged workers not counted as unemployed | an unemployed person is defined as someone who is able and eligible to work and has been actively looking for work in the last four weeks discouraged workers are able and eligible but not currently looking for work more specifically discouraged workers have not actively looked for work in the last four weeks therefore they are not counted as unemployed | |
what is discrete distribution | a discrete distribution is a probability distribution that depicts the occurrence of discrete individually countable outcomes such as 1 2 3 yes no true or false the binomial distribution for example is a discrete distribution that evaluates the probability of a yes or no outcome occurring over a given number of trials given the event s probability in each trial such as flipping a coin one hundred times and having the outcome be heads statistical distributions can be either discrete or continuous a continuous distribution is built from outcomes that fall on a continuum such as all numbers greater than 0 including numbers whose decimals continue indefinitely such as pi 3 14159265 overall the concepts of discrete and continuous probability distributions and the random variables they describe are the underpinnings of probability theory and statistical analysis understanding discrete distributiondistribution is a statistical concept used in data research those seeking to identify the outcomes and probabilities of a particular study will chart measurable data points from a data set resulting in a probability distribution diagram many probability distribution diagram shapes can result from a distribution study such as the normal distribution bell curve statisticians can identify the development of either a discrete or continuous distribution by the nature of the outcomes to be measured unlike the normal distribution which is continuous and accounts for any possible outcome along the number line a discrete distribution is constructed from data that can only follow a finite or discrete set of outcomes discrete distributions thus represent data with a countable number of outcomes meaning that the potential outcomes can be put into a list and then graphed the list may be finite or infinite for example when determining the probability distribution of a die with six numbered sides the list is 1 2 3 4 5 6 if you re rolling two dice the chances of rolling two sixes 12 or two ones two are much less than other combinations on a graph you d see the probabilities of the two represented by the smallest bars on the chart types of discrete probability distributionsthe most common discrete probability distributions include binomial bernoulli multinomial and poisson 1a binomial probability distribution is one in which there is only a probability of two outcomes in this distribution data are collected in one of two forms after repetitive trials and classified into either success or failure it generally has a finite set of just two possible outcomes such as zero or one for instance flipping a coin gives you the list heads tails the binomial distribution is used in options pricing models that rely on binomial trees in a binomial tree model the underlying asset can only be worth exactly one of two possible values with the model there are just two probable outcomes with each iteration a move up or a move down with defined values bernoulli distributions are similar to binomial distributions because there are two possible outcomes one trial is conducted so the outcomes in a bernoulli distribution are labeled as either a zero or one a one indicates success and a zero means failure one trial is called a bernoulli trial so if you used one green marble for success and one red marble for failure in a covered bowl and chose without looking you would record each result as a zero or one rather than success or failure for your sample bernoulli distributions are used to view the probability that an investment will succeed or fail multinomial distributions occur when there is a probability of more than two outcomes with multiple counts for instance say you have a covered bowl with one green one red and one yellow marble for your test you record the number of times you randomly choose each of the marbles for your sample in finance and investing these distributions estimate the probability that a specific set of financial events will occur the poisson distribution expresses the probability that a given number of events will occur over a fixed period the poisson distribution is a discrete distribution that counts the frequency of occurrences as integers whose list 0 1 2 can be infinite for instance say you have a covered bowl with one red and one green marble and your chosen period is two minutes your test is to record whether you pick the green or red marble with the green indicating success after each test you place the marble back in the bowl and record the results in this model the distribution would be plotting the results over a period of time indicating how often green is chosen poisson distribution is commonly used to model financial data where the tally is small and often zero for example it can be used to model the number of trades a typical investor will make in a given day which can be 0 often 1 2 and so on discrete distributions can also be seen in the monte carlo simulation a monte carlo simulation is a modeling technique that identifies the probabilities of different outcomes through programmed technology it is primarily used to help forecast scenarios and identify risks in a monte carlo simulation outcomes with discrete values will produce discrete distributions for analysis these distributions determine risk and trade offs among different items being considered calculation of discrete probability distribution | |
how you calculate a discrete probability distribution depends on your test what you re trying to measure and how you measure it for instance if you re flipping a coin twice the possible combinations are | because you re flipping the coin twice and there are two possible outcomes there are four possibilities each of the results represents one quarter of the possibilities the ht and th combinations are each one quarter and essentially the same thing representing one half of the results therefore the probability is that one quarter of the time you ll get a tt or hh and one half of the time you ll get ht or th this works similarly for rolling two dice because the results of a dice roll are discrete there are 36 possibilities because each die has six faces but there cannot be a result of one since the lowest number on each die is one so the lowest result you can get is two and the highest is 12 many of the combinations will repeat just as in the coin example so the more possibilities that repeat the more instances will be graphed as seen in the table below if you add the figures for dice roll results together you have one instance where the result is two and one where it is 12 creating odds of one in 36 for the numbers two and 12 the probability p that x the outcome will equal x the chosen number would be the probability that the roll equals two is one in 36 the probability of it equalling three is two in 36 and so on in the binomial tree model below the analyst has chosen intervals of three months with a starting price of 10 they have used past data from the investment to calculate the probability that the price will increase or decrease in the same way that the dice rolls were calculated in this image the analyst worked out that the probability of the price rising to 12 is 1 03 the probability that the price will drop to 8 is 3 43 from each increase or decrease in price you can see the analysts has worked out the discrete probabilities for nine months at the end of nine months you see that the probability of the stock price rising to 17 28 is zero while the probability of it dropping to 7 68 is 4 32 the probability of it reaching 5 12 is 6 98 so the stock is more likely to drop in price over the next nine months than it is to increase image by sabrina jiang investopedia 2020discrete distribution vs continous distributionif a discrete distribution is one that graphs discrete variables then a continuous distribution is one that graphs continuous variables the difference can be seen on graphs where discrete probability distributions are generally represented by bars because the data is discrete continuous probability distributions generally appear as a curve or a line on a graph because the data under the line is continuous and not finite | |
what are the types of discrete distribution | the most common discrete distributions used by statisticians or analysts include the binomial poisson bernoulli and multinomial distributions others include the negative binomial geometric and hypergeometric distributions | |
what are the 2 requirements for a discrete probability distribution | the probabilities of random variables must have discrete as opposed to continuous values as outcomes for a cumulative distribution the probability of each discrete observation must be between 0 and 1 and the sum of the probabilities must equal one 100 | |
how do you know if a distribution is discrete | the data are discrete if there are only a set array of possible outcomes e g zero one or only integers | |
what is a continuous distribution | unlike a discrete distribution a continuous probability distribution can contain outcomes that have any value including indeterminant fractions a normal distribution for instance is depicted by a bell shaped curve with an uninterrupted line covering all values across its probability function | |
what is a discrete probability model | a discrete probability model is a statistical tool that takes data following a discrete distribution and tries to predict or model some outcome such as an options contract price or how likely a market shock will be in the next five years the bottom linediscrete probability distributions are graphs of the outcomes of test results that are finite such as a value of 1 2 3 true false success or failure investors use discrete probability distributions to estimate the chances that a particular investing outcome is more or less likely to happen armed with that information they can choose a hedging strategy that matches the probabilities found in their analysis | |
what is discrete distribution | a discrete distribution is a probability distribution that depicts the occurrence of discrete individually countable outcomes such as 1 2 3 yes no true or false the binomial distribution for example is a discrete distribution that evaluates the probability of a yes or no outcome occurring over a given number of trials given the event s probability in each trial such as flipping a coin one hundred times and having the outcome be heads statistical distributions can be either discrete or continuous a continuous distribution is built from outcomes that fall on a continuum such as all numbers greater than 0 including numbers whose decimals continue indefinitely such as pi 3 14159265 overall the concepts of discrete and continuous probability distributions and the random variables they describe are the underpinnings of probability theory and statistical analysis understanding discrete distributiondistribution is a statistical concept used in data research those seeking to identify the outcomes and probabilities of a particular study will chart measurable data points from a data set resulting in a probability distribution diagram many probability distribution diagram shapes can result from a distribution study such as the normal distribution bell curve statisticians can identify the development of either a discrete or continuous distribution by the nature of the outcomes to be measured unlike the normal distribution which is continuous and accounts for any possible outcome along the number line a discrete distribution is constructed from data that can only follow a finite or discrete set of outcomes discrete distributions thus represent data with a countable number of outcomes meaning that the potential outcomes can be put into a list and then graphed the list may be finite or infinite for example when determining the probability distribution of a die with six numbered sides the list is 1 2 3 4 5 6 if you re rolling two dice the chances of rolling two sixes 12 or two ones two are much less than other combinations on a graph you d see the probabilities of the two represented by the smallest bars on the chart types of discrete probability distributionsthe most common discrete probability distributions include binomial bernoulli multinomial and poisson 1a binomial probability distribution is one in which there is only a probability of two outcomes in this distribution data are collected in one of two forms after repetitive trials and classified into either success or failure it generally has a finite set of just two possible outcomes such as zero or one for instance flipping a coin gives you the list heads tails the binomial distribution is used in options pricing models that rely on binomial trees in a binomial tree model the underlying asset can only be worth exactly one of two possible values with the model there are just two probable outcomes with each iteration a move up or a move down with defined values bernoulli distributions are similar to binomial distributions because there are two possible outcomes one trial is conducted so the outcomes in a bernoulli distribution are labeled as either a zero or one a one indicates success and a zero means failure one trial is called a bernoulli trial so if you used one green marble for success and one red marble for failure in a covered bowl and chose without looking you would record each result as a zero or one rather than success or failure for your sample bernoulli distributions are used to view the probability that an investment will succeed or fail multinomial distributions occur when there is a probability of more than two outcomes with multiple counts for instance say you have a covered bowl with one green one red and one yellow marble for your test you record the number of times you randomly choose each of the marbles for your sample in finance and investing these distributions estimate the probability that a specific set of financial events will occur the poisson distribution expresses the probability that a given number of events will occur over a fixed period the poisson distribution is a discrete distribution that counts the frequency of occurrences as integers whose list 0 1 2 can be infinite for instance say you have a covered bowl with one red and one green marble and your chosen period is two minutes your test is to record whether you pick the green or red marble with the green indicating success after each test you place the marble back in the bowl and record the results in this model the distribution would be plotting the results over a period of time indicating how often green is chosen poisson distribution is commonly used to model financial data where the tally is small and often zero for example it can be used to model the number of trades a typical investor will make in a given day which can be 0 often 1 2 and so on discrete distributions can also be seen in the monte carlo simulation a monte carlo simulation is a modeling technique that identifies the probabilities of different outcomes through programmed technology it is primarily used to help forecast scenarios and identify risks in a monte carlo simulation outcomes with discrete values will produce discrete distributions for analysis these distributions determine risk and trade offs among different items being considered calculation of discrete probability distribution | |
how you calculate a discrete probability distribution depends on your test what you re trying to measure and how you measure it for instance if you re flipping a coin twice the possible combinations are | because you re flipping the coin twice and there are two possible outcomes there are four possibilities each of the results represents one quarter of the possibilities the ht and th combinations are each one quarter and essentially the same thing representing one half of the results therefore the probability is that one quarter of the time you ll get a tt or hh and one half of the time you ll get ht or th this works similarly for rolling two dice because the results of a dice roll are discrete there are 36 possibilities because each die has six faces but there cannot be a result of one since the lowest number on each die is one so the lowest result you can get is two and the highest is 12 many of the combinations will repeat just as in the coin example so the more possibilities that repeat the more instances will be graphed as seen in the table below if you add the figures for dice roll results together you have one instance where the result is two and one where it is 12 creating odds of one in 36 for the numbers two and 12 the probability p that x the outcome will equal x the chosen number would be the probability that the roll equals two is one in 36 the probability of it equalling three is two in 36 and so on in the binomial tree model below the analyst has chosen intervals of three months with a starting price of 10 they have used past data from the investment to calculate the probability that the price will increase or decrease in the same way that the dice rolls were calculated in this image the analyst worked out that the probability of the price rising to 12 is 1 03 the probability that the price will drop to 8 is 3 43 from each increase or decrease in price you can see the analysts has worked out the discrete probabilities for nine months at the end of nine months you see that the probability of the stock price rising to 17 28 is zero while the probability of it dropping to 7 68 is 4 32 the probability of it reaching 5 12 is 6 98 so the stock is more likely to drop in price over the next nine months than it is to increase image by sabrina jiang investopedia 2020discrete distribution vs continous distributionif a discrete distribution is one that graphs discrete variables then a continuous distribution is one that graphs continuous variables the difference can be seen on graphs where discrete probability distributions are generally represented by bars because the data is discrete continuous probability distributions generally appear as a curve or a line on a graph because the data under the line is continuous and not finite | |
what are the types of discrete distribution | the most common discrete distributions used by statisticians or analysts include the binomial poisson bernoulli and multinomial distributions others include the negative binomial geometric and hypergeometric distributions | |
what are the 2 requirements for a discrete probability distribution | the probabilities of random variables must have discrete as opposed to continuous values as outcomes for a cumulative distribution the probability of each discrete observation must be between 0 and 1 and the sum of the probabilities must equal one 100 | |
how do you know if a distribution is discrete | the data are discrete if there are only a set array of possible outcomes e g zero one or only integers | |
what is a continuous distribution | unlike a discrete distribution a continuous probability distribution can contain outcomes that have any value including indeterminant fractions a normal distribution for instance is depicted by a bell shaped curve with an uninterrupted line covering all values across its probability function | |
what is a discrete probability model | a discrete probability model is a statistical tool that takes data following a discrete distribution and tries to predict or model some outcome such as an options contract price or how likely a market shock will be in the next five years the bottom linediscrete probability distributions are graphs of the outcomes of test results that are finite such as a value of 1 2 3 true false success or failure investors use discrete probability distributions to estimate the chances that a particular investing outcome is more or less likely to happen armed with that information they can choose a hedging strategy that matches the probabilities found in their analysis | |
what is a discretionary expense | a discretionary expense is a non essential expense discretionary expenses are costs without which businesses or households can survive as such they are defined as being wants rather than expenses that are needed this means a business or household is still able to maintain itself even if all discretionary consumer spending stops meals at restaurants and entertainment costs are examples of discretionary expenses understanding discretionary expensesexpenses are divided into several categories namely non discretionary and discretionary while non discretionary expenses are considered mandatory housing taxes debt and groceries discretionary expenses are incurred above and beyond what is deemed necessary these are generally considered wants while non discretionary expenses are usually referred to as needs as such discretionary expenses rarely have anything to do with a business or household s day to day operations rather they cater to choice and lifestyle 1businesses and individuals pay for discretionary expenses with discretionary income the amount of money left over after paying for housing food taxes and other necessities when times are good people have more money to spend and they normally do so on things they don t need such as luxury items and other services cars vacations restaurants entertainment electronics etc | |
when times get tough and short term cash flow issues emerge managers and individuals often try to weed out any unnecessary costs discretionary expenses are normally the first to go because stopping them is unlikely to have a major impact on a business or household | corporate discretionary expenses are usually linked to the promotion of a company s market position buying the raw materials used to produce goods is usually considered essential spending money on employee training programs is not usually considered essential individuals may also find times when they need to consider cutting out certain expenses for example a person who runs into financial difficulties is more likely to prioritize paying utility bills over financing a vacation understanding and identifying your non discretionary and discretionary expenses and which ones matter most to you can help you save set your goals and plan for your financial future special considerations | |
what constitutes a discretionary expense is subjective as such it may differ considerably among individuals and businesses | for example a stable well established company could probably get away with slashing its advertising budget for a while if the need arises a new company facing hardship on the other hand would probably need to make cutbacks elsewhere being mindful that boosting exposure and getting its name out there is imperative to keeping the business afloat the same principle applies to individual consumers as well some people may only be able to afford a daily starbucks run when things are going well they may consider cutting out this expense when times are tough or if they re saving up for a big expense like a home or a car types of discretionary expensesas mentioned above discretionary expenses are any costs that a consumer or business wants rather than needs some common discretionary items include it s important to point out again that what defines a discretionary expense depends on who s doing the buying for instance buying a new car may be considered a want for one person but it may be considered essential for someone who has a long commute to work where driving is the only option | |
how to budget for discretionary expenses | it may be necessary for households and businesses to cut back on certain expenditures in response to decreases in income during tough economic times that s why it s a good idea to track discretionary expenses separately from essential ones so that it is easy to see how costs can be reduced one helpful budgeting tactic is to rank discretionary expenses in order of importance from the least to most important if a job loss or income reduction forces budget cuts household members or a company s management team can easily identify the first discretionary expense to place on the chopping block discretionary expenses vs non discretionary expensesexpenses are divided into discretionary and non discretionary costs in other words essential and non essential expenses some expenses such as vacation costs and luxury items are not necessary to maintain a household and thus are classified as discretionary expenses the income earner can pay for these goods or services at their discretion certain expenses though must be paid to keep things running these are called non discretionary expenses these are considered essential expenses as the income earner must regularly pay them or suffer the consequences 1examples of non discretionary spending include housing costs taxes and health insurance for individuals payroll warehousing costs and transport are non discretionary expenses for businesses | |
what are discretionary funds | discretionary funds is a term used to describe the money an individual or business has left over to spend on non essential goods and services this money is left over after an individual household or organization pays for essential costs for instance governments may use discretionary funds for small scale projects after taking care of all essential services | |
what s the difference between discretionary and fixed expenses | discretionary expenses are expenses paid for by individuals or businesses that aren t essential to their day to day lives or operations these costs may not be predictable and can change over time fixed expenses on the other hand are costs that are incurred regularly these are predictable which means households and businesses can count on them being the same or roughly the same each period examples of fixed costs are housing and rent insurance and utilities | |
what does discretionary income mean | the term discretionary income refers to the total income left after a household or business pays for necessities including taxes housing groceries and utilities this type of income is used to maintain a certain standard of living or operations as such discretionary income can be used to pay for things like vacations luxury items and savings the bottom linecosts are divided into several categories some are essential while others are not the first which includes essential and mandatory items are called non discretionary expenses this is contrasted to discretionary expenses these costs are deemed non essential such as vacations luxury goods and nights out discretionary spending happens when all non discretionary costs are covered keep in mind that these are needs and can be sacrificed when times get tough | |
what is discretionary income | discretionary income is the amount of an individual s income that is left for spending investing or saving after paying taxes and paying for personal necessities such as food shelter and clothing discretionary income includes money spent on luxury items vacations and nonessential goods and services because discretionary income is the first to shrink amid a job loss or pay reduction businesses that sell discretionary goods tend to suffer the most during economic downturns and recessions understanding discretionary incomediscretionary spending is an important part of a healthy economy people only spend money on things like travel movies and consumer electronics if they have the funds to do so some people use credit cards to purchase discretionary goods but increasing personal debt is not the same as having a discretionary income discretionary income vs disposable incomediscretionary income and disposable income are terms often used interchangeably but they refer to different types of income discretionary income is derived from disposable income which equals gross income minus taxes disposable income in other words is a person s take home pay used to meet both essential and nonessential expenses this income is what is left over after taxes and it is the amount of net income available to spend save or invest discretionary income is what is leftover from disposable income after the income earner pays for rent mortgage transportation food utilities insurance and other essential costs out of their disposable income for most consumers discretionary income gets depleted first when a pay cut happens an example is if a person makes 4 000 per month after taxes and has 2 000 in essential costs they have 2 000 in monthly discretionary income if their paycheck gets cut to 3 000 per month they can still meet their essential costs but only has 1 000 leftover in discretionary income discretionary income and the economydiscretionary income is an important marker of economic health economists use it along with disposable income to derive other important economic ratios such as the marginal propensity to consume mpc marginal propensity to save mps and consumer leverage ratios in 2005 in the midst of a debt fueled economic bubble the u s personal savings rate went negative for four consecutive months after paying for necessary expenses out of disposable income the average consumer spent all of their discretionary income and then some using credit cards and other debt instruments to make additional discretionary purchases beyond what they could afford in 2020 during the covid 19 pandemic and the widespread lockdowns that resulted the personal savings rate reached all time highs in the u s of more than 30 for several months from the end of 2021 into 2022 the rate has moderated to around 7 more in line with the long term average 1aggregate discretionary income levels for an economy fluctuate over time typically in line with business cycle activity when economic output is strong as measured by the gross domestic product gdp or another gross measure discretionary income levels tend to be high as well if inflation occurs in the price of life s necessities then discretionary income falls assuming that wages and taxes remain relatively constant | |
how is discretionary income calculated | discretionary income is a subset of disposable income or part of all the income left over after you pay taxes from disposable income deduct all necessities and obligations like rent or mortgage utilities loans car payments and food etc once you ve paid all of those items whatever is left to save spend or invest is your discretionary income | |
what is considered a good level of discretionary income | this is somewhat a matter of lifestyle however many experts agree that around 10 30 of your take home after tax pay should consist of discretionary income the so called 50 20 30 rule suggests that 50 of your net income goes towards living expenses 20 to savings or investments and 30 to discretionary spending 2 | |
how is discretionary income looked at for student loans | if you are looking at federal student loans or student loan repayment plans the u s government will calculate your eligibility based on discretionary income however the government defines discretionary income as your annual gross after tax income less than 150 of the federal poverty line which will depend on your state and family size and takes into account any subsequent rise or fall in your income 3 | |
what is discretionary investment management | discretionary investment management is a form of investment management in which buy and sell decisions are made by a portfolio manager or investment counselor for the client s account the term discretionary refers to the fact that investment decisions are made at the portfolio manager s discretion this means that the client must have the utmost trust in the investment manager s capabilities discretionary investment management can only be offered by individuals who have extensive experience in the investment industry and advanced educational credentials with many investment managers possessing one or more professional designations such as chartered financial analyst cfa chartered alternative investment analyst chartered alternative investment analyst caia chartered market technician cmt or financial risk manager frm understanding discretionary investment managementservices and transactions under discretionary investment management are tailored to high net worth individuals hnwi and institutional investors such as pension funds since discretionary accounts have higher minimum investment requirements often starting at 250 000 the investment manager s strategy may involve purchasing a variety of securities in the market as long as it falls in line within the client s risk profile and financial goals for example discretionary investment managers can purchase securities such as stocks bonds etfs and financial derivatives | |
how discretionary investment management works | discretionary investment managers demonstrate their strategies using a systematic approach that makes it easier to report results and for investment strategies to be exercised in a specific way investments are not customized or tailored to a client rather investments are made according to clients strategies in other words clients are grouped according to their highlighted goals and risk tolerance each group will then have the same investment portfolio created from the pool of money deposited by the clients the actual client account is segregated and the funds invested are weighted to the individuals capital investments for example consider a portfolio with an initial capital of 10 million a high net worth individual that contributed 1 million will be said to have a 10 investment in the portfolio while another that contributed 300 000 will have a 3 investment in the portfolio benefits of discretionary managementdiscretionary investment management offers several benefits to clients it frees clients from the burden of making day to day investment decisions which can arguably be better made by a qualified portfolio manager who is attuned to the vagaries of the market delegating the investing process to a competent manager leaves the client free to focus on other things that matter discretionary investment management also aligns the investment manager s interest with that of the client since managers typically charge a percentage of the assets under administration as their management fee thus if the portfolio grows under the investment manager s stewardship the manager is compensated by receiving a higher dollar amount as the management fee this reduces the adviser s temptation to churn the account to generate more commissions which is a major flaw of the transaction based investment model discretionary investment management may also ensure that the client has access to better investment opportunities through the portfolio manager the client may also receive better prices for executed trades as the portfolio manager can put through a single buy or sell order for multiple clients for clients in discretionary accounts portfolio managers can act on available information quickly and efficiently selling the position out of all their accounts in a single cost effective transaction likewise the portfolio manager is better positioned to seize buying opportunities when the markets dip and a good quality stock temporarily drops in value risks of discretionary managementon the downside the minimum account balance and high fees can be a big hindrance to many investors especially those just starting out a new investor with a small amount to invest would not be able to benefit from this style of investment from the client s point of view there must be confidence in the portfolio manager s competence integrity and trustworthiness it is therefore incumbent upon clients to conduct adequate due diligence on potential portfolio managers before entrusting them with their life savings there is a risk of entrusting money to a portfolio manager who is either unscrupulous or pays little heed to a client s stated goals | |
what are diseconomies of scale | diseconomies of scale happen when a company or business grows so large that the costs per unit increase it takes place when economies of scale no longer function for a firm with this principle rather than experiencing continued decreasing costs and increasing output a firm sees an increase in costs when output is increased investopedia michela buttignolunderstanding diseconomies of scalethe diagram below illustrates a diseconomy of scale at point q this firm is producing at the point of lowest average unit cost if the firm produces more or less output then the average cost per unit will be higher to the left of q the firm can reap the benefit of economies of scale to decrease average costs by producing more to the right of q the firm experiences diseconomies of scale and an increasing average unit cost special considerationsdiseconomies of scale specifically come about due to several reasons but all can be broadly categorized as internal or external internal diseconomies of scale can arise from technical issues of production or organizational issues within the structure of a firm or industry external diseconomies of scale can arise due to constraints imposed by the environment within which a firm or industry operates essentially diseconomies of scale are the result of the growing pains of a company after it s already realized the cost reducing benefits of economies of scale the first is a situation of overcrowding where employees and machines get in each other s way lowering operational efficiencies the second situation arises when there is a higher level of operational waste due to a lack of proper coordination the third reason for diseconomies of scale happens when there is a mismatch in the optimum level of outputs within different operations types of diseconomies of scaleinternal diseconomies of scale involve either technical constraints on the production process that the firm uses or organizational issues that increase costs or waste resources without any change to the physical production process technical diseconomies of scale involve physical limits on handling and combining inputs and goods in process these can include overcrowding and mismatches between the feasible scale or speed of different inputs and processes diseconomies of scale can occur for a variety of reasons but the cause often comes from the difficulty of managing an increasingly large workforce an overcrowding effect within an organization is often the leading cause of diseconomies of scale this happens when a company grows too quickly thinking that it can achieve economies of scale in perpetuity if for example a company can reduce the per unit cost of its product each time it adds a machine to its warehouse it might think that maxing out the number of machines is a great way to reduce costs however if it takes one person to operate a machine and 50 machines are added to the warehouse there is a good chance that these 50 additional employees will get in each other s way and make it harder to produce the same level of output per hour this increases costs and decreases output sometimes diseconomies of scale happen within an organization when a company s plant cannot produce the same quantity of output as another related plant for example if a product is made up of two components gadget a and gadget b diseconomies of scale might occur if gadget b is produced at a slower rate than gadget a this forces the company to slow the production rate of gadget a increasing its per unit cost organizational diseconomies of scale can happen for many reasons but overall they arise because of the difficulties of managing a larger workforce several problems can be identified with diseconomies of scale first communication becomes less effective as a business expands communication between different departments becomes more difficult employees may not have explicit instructions or expectations from management in some instances written communication becomes more prevalent over face to face meetings which can lead to less feedback another drawback to diseconomies of scale is motivation larger businesses can isolate employees and make them feel less appreciated which can result in a drop in productivity external diseconomies of scale can result from constraints of economic resources or other constraints imposed on a firm or industry by the external environment within which it operates typically these include capacity constraints on common resources and public goods or increasing input costs due to price inelasticity of supply for inputs external capacity constraints can arise when a common pool resource or local public good cannot sustain the demands placed on it by increased production congestion on public highways and other transportation needed to ship a firm s products is an example of this type of diseconomy of scale as output increases the logistical costs of transporting goods to distant markets can increase enough to offset any economies of scale a similar example is the depletion of a critical natural resource below its ability to reproduce itself in a tragedy of the commons scenario as the resource becomes ever more scarce and ultimately runs out the cost to obtain it increases dramatically price inelasticity of supply for key inputs traded on a market is a related cause of diseconomies of scale in this case if a firm attempts to increase output it will need to purchase more inputs but price inelastic inputs will mean rapidly increasing input costs out of proportion to the increase in the amount of output realized | |
what is disequilibrium | disequilibrium is a situation where internal and or external forces prevent market equilibrium from being reached or cause the market to fall out of balance this can be a short term byproduct of a change in variable factors or a result of long term structural imbalances disequilibrium is also used to describe a deficit or surplus in a country s balance of payments understanding disequilibriumsometimes certain forces bring about a movement in the price of a commodity or service when this happens the proportion of goods supplied to the proportion demanded becomes imbalanced and the market for the product is said to be in a state of disequilibrium this theory was originally put forth by economist john maynard keynes many modern economists have likened using the term general disequilibrium to describe the state of the markets as we most often find them keynes noted that markets will most often be in some form of disequilibrium there are so many variable factors that affect financial markets today that true equilibrium is more of an idea a market in equilibrium is said to be operating efficiently as its quantity supplied equals its quantity demanded at an equilibrium price or a market clearing price in an equilibrium market there are neither surpluses nor shortages for a good or service equilibrium is thus the state in which market supply and demand balance each other and as a result prices become stable generally an over supply of goods or services causes prices to go down which results in higher demand while an under supply or shortage causes prices to go up resulting in less demand the balancing effect of supply and demand results in a state of equilibrium disequilibrium occurs when this adjustment of supply demand and or prices does not work as theorized market forces tend to restore disequilibrium states back to their equilibrium this is because people stand to profit from buying underpriced assets and selling overpriced ones leading arbitrageurs to push supply and demand back into balance disequilibrium in actionbelow is a hypothetical graph depicting supply and demand in the market for wheat as the graph shows the price at pe is the single price that incentivizes both farmers or suppliers and consumers to engage in an exchange at pe there is a balance in the supply and demand for wheat following our graph for the wheat market if prices increased to p2 suppliers will be willing to provide more wheat from their storage barns to sell in the market since the higher price would cover their production costs and lead to higher profits however consumers may reduce the quantity of wheat that they purchase given the higher price in the market when this imbalance occurs the quantity supplied will be greater than the quantity demanded and a surplus will exist causing a disequilibrium market the surplus in the graph is represented by the difference between q2 and q1 where q2 is the quantity supplied and q1 is the quantity demanded given the excess commodity supplied suppliers will want to quickly sell the wheat before it gets rancid and will proceed to reduce the sales price economic theory suggests that in a free market the market price for wheat will eventually fall to pe if the market is left to function without any interference | |
what if the market price for wheat was p1 at this price consumers are willing to purchase more wheat q2 at a lower price on the other hand since the price is below the equilibrium price suppliers will provide a smaller amount of wheat q1 to sell as the price may be too low to cover their marginal costs of production in this case when pe falls to p1 there will be a shortage of wheat as the quantity demanded exceeds the quantity supplied for the commodity | since resources are not allocated efficiently the market is said to be in disequilibrium in a free market it is expected that the price would increase to the equilibrium price as the scarcity of the good forces the price to go up reasons for disequilibriumthere are a number of reasons for market disequilibrium sometimes disequilibrium occurs when a supplier sets a fixed price for a good or service for a certain time period during this period of sticky prices if the quantity demanded increases in the market for the good or service there will be a shortage of supply another reason for disequilibrium is government intervention if the government sets a floor or ceiling for a good or service the market may become inefficient if the quantity supplied is disproportionate to the quantity demanded for example if the government sets a price ceiling on rent landlords may be reluctant to rent out their extra property to tenants and there will be excess demand for housing due to the shortage of rental property from the standpoint of the economy disequilibrium can occur in the labor market a labor market disequilibrium can occur when the government sets a minimum wage that is a price floor on the wage that an employer can pay its employees if the stipulated price floor is higher than the labor equilibrium price there will be an excess supply of labor in the economy | |
when a country s current account is at a deficit or surplus its balance of payments bop is said to be in disequilibrium a country s balance of payments is a record of all transactions conducted with other countries during a given time period its imports and exports of goods are recorded under the current account section of the bop a significant deficit on the current account where imports are greater than exports would result in disequilibrium | the us uk and canada have large current account deficits likewise when exports are greater than imports creating a current account surplus there is a disequilibrium china germany and japan have large current account surpluses a balance of payments disequilibrium can occur when there is an imbalance between domestic savings and domestic investments a deficit in the current account balance will result if domestic investments is higher than domestic savings since the excess investments will be financed with capital from foreign sources in addition when the trade agreement between two countries affects the level of import or export activities a balance of payments disequilibrium will surface furthermore changes in an exchange rate when a country s currency is revalued or devalued can cause disequilibrium other factors that could lead to disequilibrium include inflation or deflation changes in the foreign exchange reserves population growth and political instability | |
how is disequilibrium resolved | disequilibrium is a result of a mismatch between the market forces of supply and demand the mismatch is generally resolved through market forces or government intervention in the example of the labor market shortage above the excess labor supply situation can be corrected either through policy proposals that address unemployed workers or through a process of investment in training workers to make them fit for new jobs within a market innovations in manufacturing or supply chain or technology can help address imbalances between supply and demand for example suppose the demand for a company s product has receded due to its expensive price the company can regain its share of the market by innovating its manufacturing or supply chain processes for a lower product price the new equilibrium however might be one where the company has a greater supply of its product in the market at a lower price real world exampledisequilibrium can happen relatively quickly in an otherwise stable market or can be a systematic characteristic of certain markets as an example of the former flash crashes are examples of market disequilibrium involving a mass of sequential sell orders that clear all bids causing prices to fall dramatically in a rapid downward spiral made worse by algorithmic trading systems that detect the selloff and introduce new automated sell orders the first prominent flash crash occurred shortly after 2 30 p m est on may 6 2010 when the dow jones industrial average fell more than 1 000 points in just under 10 minutes the biggest drop in history at that point within the hour the dow jones index lost almost 9 of its value over one trillion dollars in equity was evaporated although the market regained 70 by the end of the day 1initial reports claiming that the crash was caused by a mistyped order proved to be erroneous and the causes of the flash were attributed to a u k futures trader who later pled guilty for attempting to spoof the market by quickly buying and selling hundreds of e mini s p futures contracts through the chicago mercantile exchange cme according to an investigative report by the u s securities and exchange commission sec the flash crash of 2010 was triggered by a single order selling a large amount of e mini s p contracts that created an unstable disequilibrium 1disequilibrium faqs | |
when market equilibrium remains out of balance for a period of time prices can become overly depressed or inflated which can have real negative ramifications on markets and the broader economy market actors will be incentivized to try and restore equilibrium by buying and bidding up underprices goods or securities and selling or producing more of the overpriced ones | disequilibrium is often caused by an imbalance in supply vs demand at times disequilibrium can spill over from one market to another for instance if there aren t enough transport companies or resources available to ship coffee internationally then the coffee supply for certain regions could be reduced affecting the equilibrium of coffee markets economists view many labor markets as being in disequilibrium due to how legislation and public policy protect people and their jobs or the amount they are compensated for their labor removing market frictions trade barriers certain regulations and improving market efficiency and information dissemination can all help maintain equilibrium | |
what is disguised unemployment | disguised unemployment exists when part of the labor force is either left without work or is working in a redundant manner such that worker productivity is essentially zero it is unemployment that does not affect aggregate output an economy demonstrates disguised unemployment when productivity is low and too many workers are filling too few jobs understanding disguised unemploymentdisguised unemployment exists frequently in developing countries whose large populations create a surplus in the labor force it can be characterized by low productivity and frequently accompanies informal labor markets and agricultural labor markets which can absorb substantial quantities of labor disguised or hidden unemployment can refer to any segment of the population not employed at full capacity but it is often not counted in official unemployment statistics within the national economy this can include those working well below their capabilities those whose positions provide little overall value in terms of productivity or any group that is not currently looking for work but is able to perform work of value another way to think about disguised unemployment is to say that people are employed but not in a very efficient way they have skills that are being left on the table are working jobs that do not fit their skills possibly due to an inefficiency in the market that fails to recognize their skills or are working but not as much as they would like there are varying types of disguised unemployment including people working jobs beneath their skill set unutilized workers who are ill or disabled but still able to be productive and job seekers who are demoralized by their inability to find work and so stop looking for it types of disguised unemploymentin certain circumstances people doing part time work may qualify as disguised unemployment if they desire to obtain and are capable of performing full time work it also includes those accepting employment well below their skill set in these cases disguised unemployment may also be referred to as underemployment covering those who are working in some capacity but not at their full capacity for example a person with a master of business administration mba accepting a full time cashier position due to the inability to find work in their field may be considered underemployed as the person is working below their skill set additionally a person working part time in their field who wants to work full time may also qualify as underemployed illness and disabilityanother group that may be included is those who are ill or considered partially disabled while they may not be actively working they may be capable of being productive within the economy this form of disguised unemployment is temporary in the case of illness and categorized when someone is receiving disability assistance this means the person is often not considered part of the unemployment statistics for a nation no longer looking for workonce a person stops looking for work regardless of the reason they are often no longer considered unemployed when it comes to calculating the unemployment rate many nations require a person to be actively seeking employment to be counted as unemployed if a person gives up looking for employment whether on a short or long term basis they are no longer counted until resuming the pursuit of employment options this can count as disguised unemployment when the person wants to find work but has stopped looking due to being demoralized by a long search | |
what is disinflation | disinflation is a temporary slowing of the pace of price inflation and is used to describe instances when the inflation rate has reduced marginally over the short term understanding disinflationdisinflation is commonly used by the federal reserve fed to describe a period of slowing inflation it should not be confused with deflation which can be harmful to the economy unlike inflation and deflation which refer to the direction of prices disinflation refers to the rate of change in the rate of inflation disinflation is not considered problematic because prices do not actually drop and disinflation does not usually signal the onset of a slowing economy deflation is represented as a negative growth rate such as 1 while disinflation is shown as a change in the inflation rate say from 3 one year to 2 the next disinflation is considered the opposite of reflation which occurs when a government stimulates an economy by increasing the money supply a healthy amount of disinflation is necessary since it represents economic contraction and prevents the economy from overheating as such instances of disinflation are not uncommon and are viewed as normal during healthy economic times disinflation benefits certain segments of a population such as people who are inclined to save their earnings disinflation triggersseveral things can cause an economy to experience disinflation if a central bank decides to impose a tighter monetary policy and the government starts to sell off some of its securities it could reduce the supply of money in the economy causing a disinflationary effect similarly a contraction in the business cycle or a recession can also trigger disinflation for example businesses may choose not to increase prices to gain greater market share leading to disinflation disinflation since 1980the u s economy experienced one of its longest periods of disinflation from 1980 through 2015 during the 1970s the rapid rise of inflation came to be known as the great inflation with prices increasing more than 110 during the decade the annual rate of inflation topped out at 14 76 in early 1980 following the implementation of aggressive monetary policies by the fed to reduce inflation the increase in prices slowed in the 1980s rising just 59 for the period in the 1990s prices rose 32 followed by a 27 increase from 2000 to 2009 and a 9 increase from 2010 to 2015 during this period of disinflation stocks performed well averaging 8 65 in real returns from 1982 through 2015 disinflation also allowed the fed to lower interest rates in the 2000s which led to bonds generating above average returns here is the danger that disinflation presents when the rate of inflation falls near to zero as it did in 2015 it raises the specter of deflation although the rate of inflation was near zero in 2015 concerns over deflation were dismissed because it was largely attributed to falling energy prices as energy prices recovered in the period from 2016 to 2020 the rate of inflation picked up somewhat averaging 1 8 during that period moderated in 2020 by the covid 19 pandemic 1disinflation returnsdisinflation has reappeared in 2023 following inflation jumping to its highest level in four decades last year since the consumer price index cpi peaked at 9 1 in june 2022 the closely watched metric which measures the overall change in consumer prices has retreated 2 however inflation still sits at historically high levels well above the federal reserve s target of 2 a boston university research paper published in the mid 2000s examining a sustained period of disinflation in the early 1980s under then fed chair paul volcker provides perhaps the best indication of how the economy will perform in 2023 under similar conditions to those years 3 |
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