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what is ethereum | ethereum is a decentralized global software platform powered by blockchain technology it is most commonly known by investors for its native cryptocurrency ether eth and by developers for its use in blockchain and decentralized finance application development anyone can use ethereum it s designed to be scalable programmable secure and decentralized to create any secured digital technology its token is designed to pay for work done supporting the blockchain but participants can also use it to pay for tangible goods and services if accepted investopedia michela buttignolhistory of ethereumvitalik buterin credited with conceiving ethereum published a white paper introducing it in 2014 2 the ethereum platform was launched in 2015 by buterin and joe lubin founder of the blockchain software company consensys 3the founders of ethereum were among the first to consider the full potential of blockchain technology beyond just enabling a secure virtual payment method since the launch of ethereum ether as a cryptocurrency has risen to become the second largest cryptocurrency by market value it is outranked only by bitcoin 4one notable event in ethereum s history is the hard fork or split of ethereum and ethereum classic in 2016 a group of network participants gained control of the smart contracts used by a project called the dao to steal more than 50 million worth of ether 5the raid s success was attributed to the involvement of a third party developer for the new project most of the ethereum community opted to reverse the theft by invalidating the existing ethereum blockchain and approving a blockchain with a revised history however a fraction of the community chose to maintain the original version of the ethereum blockchain that unaltered version of ethereum permanently split to become ethereum classic etc 6initially ethereum used a competitive proof of work validation process similar to that of bitcoin after several years of development ethereum finally switched to proof of stake in 2022 which uses much less processing power and energy the dencun hard fork was activated on march 13 2024 7 this hard fork introduced proto danksharding named in honor of the proposers protolambda and dankrad feist to the ethereum mainchain proto danksharding is a stepping stone for future upgrades to the ethereum blockchain | |
how does ethereum work | ethereum uses a blockchain which is a distributed ledger like a database information is stored in blocks each containing encoded data from the block before it and the new information this creates an encoded chain of information that cannot be changed throughout the blockchain network an identical copy of the blockchain is distributed each cell or block is created with new ether tokens awarded to the validator for the work required to validate the information in one block and propose a new one the ether is assigned to the validator s address once a new block is proposed it is validated by a network of automated programs that reach a consensus on the validity of transaction information on the ethereum blockchain consensus is reached after the data and hash are passed between the consensus layer and the execution layer enough validators must demonstrate that they all had the same comparative results and the block becomes finalized proof of stake differs from proof of work in that it doesn t require the energy intensive computing referred to as mining to validate blocks it uses a finalization protocol called casper ffg and the algorithm lmd ghost combined into a consensus mechanism called gasper gasper monitors consensus and defines how validators receive rewards for work or are punished for dishonesty or lack of activity 8solo validators must stake 32 eth to activate their validation ability individuals can stake smaller amounts of eth but they are required to join a validation pool and share any rewards a validator creates a new block and attests that the information is valid in a process called attestation the block is broadcast to other validators called a committee which verifies it and votes for its validity validators who act dishonestly are punished under proof of stake those who attempt to attack the network are identified by gasper which flags the blocks to accept and reject based on the validators votes 8dishonest validators are punished by having their staked eth burned and removed from the network burning is the term for sending crypto to a wallet without private keys effectively taking it out of circulation ethereum owners use wallets to store their ether keys a wallet is a digital interface that lets you access your cryptocurrency your wallet has an address which can be thought of as an email address in that it is where users send ether much like they would an email 9ether is not stored in your wallet your wallet holds private keys you use as you would a password when you initiate a transaction you receive a private key for each ether you own this key is essential for accessing your ether you can t use it without it that s why you hear so much about securing keys using different storage methods the smallest unit or denomination of ether is a wei there are seven total denominations wei kwei mwei gwei micro ether twei milli ether pwei and ether ethereum vs bitcoinethereum is often compared to bitcoin while the two cryptocurrencies have many similarities there are some important distinctions ethereum is described by founders and developers as the world s programmable blockchain positioning itself as a distributed virtual computer on which applications can be developed 10 the bitcoin blockchain by contrast was created only to support the bitcoin cryptocurrency as a payment method the maximum number of bitcoins that can enter circulation is 21 million 11 the amount of eth that can be created is unlimited although the time it takes to process a block of eth limits how much can be minted each year 12 the number of ethereum coins in circulation as of may 2024 is just over 120 million 13another significant difference between ethereum and bitcoin is how the respective networks treat transaction processing fees these fees known as gas on the ethereum network are paid by the participants in ethereum transactions and burned by the network the fees associated with bitcoin transactions are paid to bitcoin miners ethereum uses a proof of stake consensus mechanism bitcoin uses the energy intensive proof of work consensus which requires miners to compete for rewards the future of ethereumethereum s transition to the proof of stake protocol which enabled users to validate transactions and mint new eth based on their ether holdings was part of a significant upgrade to the ethereum platform however ethereum now has two layers the first layer is the execution layer where transactions and validations occur the second layer is the consensus layer where attestations and the consensus chain are maintained 14the upgrade added capacity to the ethereum network to support its growth which will eventually help to address chronic network congestion problems that have driven up gas fees 115to address scalability ethereum is continuing to develop a scalability solution called danksharding sharding was a planned concept that would allow portions shards of the blockchain to be stored on nodes rather than the entire blockchain however sharding was replaced with plans for danksharding where transactions are processed off chain rolled up summarized using data availability sampling and posted to the main chain via a blob binary large object danksharding using blobs rollups and data availability sampling is expected to greatly reduce costs and increase transaction processing speeds when eventually combined in a future update 7lastly ethereum publishes a roadmap for future plans as of may 2024 four primary categories were listed for future work those changes will push for web3 is still a concept but it is generally theorized that it will be powered by ethereum because many of the applications being developed for the future of the internet use it 17ethereum is also being implemented into gaming and virtual reality decentraland is a virtual world that uses the ethereum blockchain to secure items contained within it virtual land avatars wearables buildings and environments are all tokenized through the blockchain to create ownership 18axie infinity is another game that uses blockchain technology and has its own cryptocurrency called smooth love potion slp slp is used for rewards and transactions within the game 1920non fungible tokens nfts gained popularity in 2021 nfts are tokenized digital items created using ethereum 21 generally speaking tokenization gives one digital asset an identifying token with a private key the key gives only the owner access to the token the nft can be traded or sold and is a transaction on the blockchain the network verifies the transaction and ownership is transferred nfts are being developed for all sorts of assets for example sports fans can buy a sports token also called fan tokens of their favorite athletes which can be treated like trading cards some of these nfts are pictures that resemble a trading card and some of them are videos of a memorable or historic moment in the athlete s career the applications you may use in the metaverse such as your wallet a dapp or the virtual world and buildings you visit are likely to have been built on ethereum decentralized autonomous organizations daos are a collaborative method for making decisions across a distributed network 22 they have been created for many uses from web 3 development to gaming and venture capital here s how daos are generally designed imagine that you created a venture capital fund and raised money through fundraising but you want decision making to be decentralized and distributions to be automatic and transparent your dao could use smart contracts and applications to gather the votes from the fund members buy into ventures based on the majority of the group s votes and automatically distribute any returns the transactions could be viewed by all parties and there would be no third party involvement in handling any funds | |
what will ethereum be worth in 2030 | there are many predictions about ether s price but they are speculation at best there are too many factors at work in cryptocurrency valuation to accurately predict prices in one week let alone several years | |
why did ethereum drop | ether s price rises and falls for many reasons throughout a trading day and week market sentiments regulatory developments news hype and more all influence its price | |
how much is one ethereum coin worth | ether s price changes quickly but on may 24 2024 it was about 3 735 23the bottom lineethereum is a decentralized blockchain and development platform it allows developers to build and deploy applications and smart contracts ethereum utilizes its native cryptocurrency ether eth for transactions and incentivizes network participants through proof of stake pos validation the role that cryptocurrency will play in the future is still vague however ethereum appears to have a significant upcoming role in personal and corporate finance and many aspects of modern life the comments opinions and analyses expressed on investopedia are for informational purposes online read our warranty and liability disclaimer for more info | |
what is ethical investing | ethical investing refers to the practice of using one s ethical principles as the primary filter for the selection of securities investing ethical investing depends on the investor s views ethical investing is sometimes used interchangeably with socially conscious investing however socially conscious funds typically have one overarching set of guidelines that are used to select the portfolio whereas ethical investing brings about a more personalized result understanding ethical investingethical investing gives the individual the power to allocate capital toward companies whose practices and values align with their personal beliefs some beliefs are rooted in environmental religious or political precepts some investors may choose to eliminate specific industries or over allocate to other sectors that meet the individual s ethical guidelines for example some ethical investors avoid sin stocks which are companies that are involved or primarily deal with traditionally unethical or immoral activities such as gambling alcohol or firearms choosing an investment based on ethical preferences is not indicative of the investment s performance to begin investors should carefully examine and document which investments to avoid and which are of interest research is essential for accurately determining whether an investment or group of investments coincides with one s ethics especially when investing in an index or mutual fund history of ethical investingoften religion influences ethical investing when religion is the motivation industries with operations and practices that oppose the religion s tenets are avoided the earliest recorded instance of ethical investing in america was by the 18th century quakers who restricted members from spending their time or money in the slave trade 1during the same era john wesley a founder of methodism preached the importance of refraining from investing in industries that harm one s neighbor such as chemical plants 2 another example of a religious based ethical investing regime is seen in islamic banking which shuns investments in alcohol gambling pork and other forbidden items 3the amana mutual funds trust offers investment products adhering to islamic banking principles such as prohibiting gambling maisir paying or charging interest riba and charging more money for late payments mur ba ah 45in the 20th century ethical investing gained traction based on people s social views more than their religious views ethical investments tend to mirror the political climate and social trends of the time in the united states in the 1960s and 70s ethical investors focused on those companies and organizations that promoted equality and rights for workers and shunned those that supported or profited from the vietnam war 6starting in the 1990s ethical investments began to focus heavily on environmental issues ethical investors moved away from coal and fossil fuel companies and toward those that supported clean and sustainable energy today ethical investing continues to primarily focus on impacts on the environment and society 6 | |
how to invest ethically | in addition to analyzing investments using ethical standards the historical current and projected performance of the investment should be scrutinized to examine whether the investment is sound and has the potential to reap significant returns the review of a company s history and finances is warranted it is also important to confirm the company s commitment to ethical practices a company s mission statement may mirror the values and beliefs of an investor yet their practices may be contrary to them consider enron which published and distributed a 64 page code of ethics document to employees highlighting their commitment to integrity and ethics 7 indeed it was proven that they not only did not adhere to their policies but also violated a host of laws | |
what is the euro | the euro is the official currency of the european union eu adopted by 19 of its 27 member nations 1 it is the world s second most popular reserve currency after the u s dollar and the second most traded 23understanding the eurolaunched in 1999 as part of the eu s integration as the european economic and monetary union emu the euro was strictly an electronic currency until the introduction of paper notes and coins denominated in euros in 2002 the euro is sometimes abbreviated as eur the euro is the sole legal tender in the eu member states that have adopted it including austria belgium cyprus estonia finland france germany greece ireland italy latvia lithuania luxembourg malta the netherlands portugal slovakia slovenia and spain these countries form the eurozone a region where the euro serves as the common currency four small non eu nations andorra vatican city san marino and monaco also use the euro as their official currency and several countries have currencies pegged to the euro the european central bank ecb has an eu mandate to maintain price stability by preserving the value of the euro 4 the ecb is part of the european system of central banks escb along with the national central banks of all the eu member states including those that have not adopted the euro adopting the euro eliminated foreign exchange risk for european businesses and financial institutions with cross border operations in the increasingly integrated eu economy the fiscal and monetary prerequisites for adopting the euro have also encouraged deeper political integration of member states on the other hand the eurozone brought together economies with disparate characteristics and national budgets without the authority for the sort of cross border fiscal transfers that take place between the u s federal government and u s states that has forced the eu to introduce measures like ecb guarantees for the debt issued by member states in response to market turmoil caused by the european sovereign debt crisis 5 national governments and central banks remain constrained in responding to economic conditions in their country by their reliance on the ecb s monetary policy and budget rules set by the eu for example the central bank of a country experiencing an economic slowdown can no longer cut interest rates devaluing a national currency against that of its major european trading partners to stimulate exports while the euro can t be devalued to facilitate economic adjustments within the eu that s also made the common currency a more reliable store of value the euro remains overwhelmingly popular among the residents of the countries that have adopted it 6 | |
what is the euro interbank offer rate euribor | euribor or the euro interbank offer rate is a reference rate that is constructed from the average interest rate at which eurozone banks offer unsecured short term lending on the inter bank market the maturities on loans used to calculate euribor often range from one week to one year this is the benchmark rate with which banks lend or borrow excess reserves from one another over short periods of time from one week to 12 months 1 these short term loans are often structured as repurchase agreements repos and are intended to maintain bank liquidity and to make sure that excess cash is able to generate an interest return rather than sit idle understanding the euro interbank offer rate euribor the euro interbank offer rate euribor in fact refers to a set of five money market rates corresponding to different maturities the one week one month three month six month and twelve month rates 2 these rates which are updated daily represent the average interest rate that eurozone banks charge each other for uncollateralized loans euribor rates are an important benchmark for a range of euro denominated financial products including mortgages savings accounts car loans and various derivatives securities euribor s role in the eurozone is analogous to sofr which replaced libor in 2023 in britain and the united states 345who contributes to the euribor rate there are 19 panel banks that contribute to euribor these are the financial institutions that handle the largest volume of eurozone money market transactions as of july 2024 these panel banks include 6the difference between euribor and eoniaeonia or the euro overnight index average is also a daily reference rate that expresses the weighted average of unsecured overnight interbank lending in the european union and the european free trade association efta it is calculated by the european central bank ecb based on the loans made by 28 panel banks eonia is similar to euribor as a rate used in european interbank lending both benchmarks are offered by the european money markets institute emmi the main difference between eonia and euribor is the maturities of the loans they are based on eonia is an overnight rate while euribor is actually eight different rates based on loans with maturities varying from one week to 12 months the panel banks that contribute to the rates are also different only 19 banks contribute to euribor instead of 28 finally euribor is calculated by global rate set systems ltd not the ecb | |
what is euro medium term note emtn | a euro medium term note is a medium term flexible debt instrument that is traded and issued outside of the united states and canada understanding euro medium term note emtnemtns instruments require fixed payments and are directly issued to the market with maturities that are less than five years emtns allow an issuer to enter the foreign markets more easily to obtain capital firms also offer emtns continuously whereas a bond issue for example occurs all at once emtn issuers must maintain a standardized document known as a program the program can be transferred across all issues and has a high proportion of sales through predetermined syndication of buyers medium term notes mtns notes that bear the same definition as emtns but trade within the united states and canada must maintain a different program over the past 10 to 15 years medium term notes have emerged as a significant funding source for u s and foreign companies supranational institutions federal agencies and sovereign nations the united states has been issuing mtns since the beginning of the 1970s after introducing the debt instruments as an alternative to short term financing in the commercial paper market and long term borrowing in the bond market they named these instruments medium term because they serve the middle ground 1 mtns did not gain much momentum until the 1980s when the mtn market shifted from an obscure corner of the market heavily exploited by auto finance companies to a fundamental source of debt financing for hundreds of major corporations outside the united states the emtn market has grown phenomenally and continues to attract new and booming businesses and industries emtns offer diversity as companies can issue them in a wide range of currencies and with various maturities typically up to 30 years although some may have a much longer maturity firms can issue emtns in collateralized floating rate frn amortizing and credit supported forms single issues from an emtn program are comparable to a eurobond or a euro note international security identification numbers isins and common codes are 12 digit security identification numbers 2 for emtns a specific type of isin code is required the agent of the emtn program would normally obtain the isin numbers and common codes for the relevant emtn notes on behalf of the issuer euro medium term note emtn benefitsthe diversity and flexibility emtns offer are two of their many benefits another benefit is savings fixed costs for underwriting make it impractical for corporate bonds to make small offerings therefore bonds typically amount to more than 100 million conversely drawdowns from emtn programs over one month typically amount to 30 million these drawdowns often have varying maturities and specialized features tailored to meet the borrower s needs euro medium term note emtn exampleone example of an emtn program is that of telenor the program was established in 1996 3 this emtn program is updated annually and constitutes a standardized master agreement for the issuance of bonds including private placements and public benchmark bonds | |
what is the euro overnight index average eonia | the euro overnight index average eonia is the average overnight reference rate for which european banks lend to one another in euros the eonia is the interest rate for one day loans between european banks and is considered an interbank rate however european regulatory reforms resulted in the eonia rate being replaced by the ester euro short term rate effective january 2022 1 | |
how the euro overnight index average works | eonia is a daily reference rate that expresses the weighted average of unsecured overnight interbank lending in the european union and the european free trade association efta it is calculated by the european central bank ecb based on the loans made by 28 panel banks 2banks must meet certain reserve requirements that are typically set by the central bank a reserve is the amount or percentage of total deposits that a bank must keep on hand and not lend out a reserve requirement helps protect banks so that they have enough cash or liquidity in case of loan losses however banks can experience short term cash flow shortages at the end of a business day such as when there are unexpected cash withdrawals as a result the banks that are short on cash can borrow from other banks that have cash flow surpluses the rate that banks borrow from each other is called the overnight rate in europe eonia represents the average overnight rate of 28 of the most established banks called panel banks eonia vs euriboreonia is similar to euribor which is short for euro interbank offered rate euribor is also an interbank rate and is comprised of the average interest rates from large european banks that are used for lending to one another however euribor has various maturities in which each maturity has its own interest rate 3both benchmarks are offered by the european money markets institute emmi which is a non profit organization founded in 1999 4 however euribor is calculated by a benchmark administrator called global rate set systems ltd and not by the ecb 5the key difference between eonia and euribor is the maturities of the loans upon which they are based eonia is an overnight rate while euribor has five interest rates based on loans with maturities that range from one week to 12 months 6 also euribor has 19 banks that contribute to the rates while eonia has 28 panel banks 7euribor is important since it is the benchmark rate used by banks when determining the interest rate for various financial products including mortgage loans and savings accounts 3esterin 2018 the ecb formed a working group to help establish a new benchmark rate for europe historically bank scandals have occurred using quote based interest rates as benchmarks as a result banking reforms led to ester or ster which is short for euro short term rate replacing eonia 8ester is also an overnight interest rate but represents an average of the wholesale rates in europe these wholesale rates are typically used with banks and institutional investors such as pension funds one of the key reasons for the switch to ester is that there will be more banks contributing to the average ester rate than currently with eonia | |
what is a eurobond | a eurobond is a debt instrument that s denominated in a currency other than the home currency of the country or market in which it is issued eurobonds are frequently grouped together by the currency in which they are denominated such as eurodollar or euro yen bonds since eurobonds are issued in an external currency they re often called external bonds eurobonds are important because they help organizations raise capital while having the flexibility to issue them in another currency issuance of eurobonds is usually handled by an international syndicate of financial institutions on behalf of the borrower one of which may underwrite the bond thus guaranteeing the purchase of the entire issue investopedia ryan oakleyunderstanding eurobondsthe popularity of eurobonds as a financing tool reflects their high degree of flexibility as they offer issuers the ability to choose the country of issuance based on the regulatory landscape interest rates and depth of the market they are also attractive to investors because they usually have small par values or face values providing a low cost investment eurobonds also have high liquidity meaning they can be bought and sold easily the term eurobond refers only to the fact the bond is issued outside of the borders of the currency s home country it does not mean the bond was issued in europe or denominated in the euro currency for example a company can issue a eurobond denominated in u s dollars in japan backgroundthe first eurobond was issued in 1963 by autostrade the company that ran italy s national railroads it was a 15 million eurodollar bond designed by bankers in london issued at amsterdam airport schiphol and paid in luxembourg to reduce taxes it provided european investors with a safe dollar denominated investment issuers run the gamut from multinational corporations to sovereign governments and supranational organizations the size of a single bond issuance can be well over a billion dollars and maturities are between five and 30 years although the largest portion has a maturity of fewer than 10 years eurobonds are especially attractive to issuers based in countries that do not have a large capital market while offering diversification to investors deliverythe earliest eurobonds were physically delivered to investors they are issued electronically through a range of services including the depository trust company dtc in the united states and the certificateless registry for electronic share transfer crest in the united kingdom eurobonds are usually issued in bearer form which makes it easier for investors to avoid regulations and taxes bearer form means the bond isn t registered and as a result there s no record of ownership instead physical possession of the bond is the only evidence of ownership market sizethe global bond market totals over 100 trillion in outstanding debt the fact many eurobonds are unregistered and trade in bearer form makes definitive numbers for the sector impossible to obtain but it is likely they account for about 30 of the total a growing portion of eurobond issuance is from emerging market nations with both governments and companies seeking deeper and more developed markets in which to borrow | |
what is euroclear | euroclear is one of two principal securities clearing houses in the eurozone euroclear specializes in verifying information supplied by brokers involved in a securities transaction and the settlement of securities transacted on european exchanges 1the other principal european clearing house is clearstream formerly the centrale de livraison de valeurs mobili res cedel 2 | |
how euroclear works | euroclear is one the oldest settlement systems and was originally subsidized by morgan guaranty trust company of new york which was a part of j p morgan co it was founded in 1968 to settle trades on the then developing eurobond market 4 its computerized settlement and deposit system helped ensure the safe delivery and payment of eurobonds in 2000 morgan guaranty trust transferred these activities to euroclear bank 5euroclear is publicly owned and governed between 2001 and 2007 the firm acquired several central securities depositories csds these include 4a clearinghouse is a financial institution that acts as an intermediary between buyers and sellers of financial instruments they take the opposite position on each side of a trade acting as the buyer to the seller and the seller to the buyer for example if wendy and nathan enter into a transaction in which wendy agrees to sell 100 shares of amzn to nathan for 1 180 per share nathan will have to pay 1 180 x 100 shares 118 000 the clearinghouse credits nathan s account with 100 amzn shares and deposits 118 000 to wendy s account clearinghouses thus ensure that the financial markets operate smoothly and efficiently one of the world s largest clearinghouses is euroclear understanding eurocleareuroclear acts as a central securities depository csd for its clients many of whom trade on european exchanges 3 most of its clients consist of banks broker dealers and other institutions professionally engaged in managing new issues of securities market making trading or holding a wide variety of securities euroclear settles domestic and international securities transactions covering bonds equities derivatives and investment funds over 190 000 national and international securities are accepted in the euroclear system covering a broad range of internationally traded fixed and floating rate debt instruments convertibles warrants and equities 6csd delivery and paymentin addition to its role as an international central securities depository icsd euroclear also acts as the central securities depository csd for belgian dutch finnish french irish swedish and uk securities 3a csd is a financial institution that holds securities such as bonds and shares and provides for the safekeeping of these assets a csd also allows for the settlement of securities transactions a transaction is settled once the buyer s account has been credited with the purchased shares and debited the agreed cash amount and the seller s account has been debited the shares and credited the sales amount the credit and debit movements occur simultaneously through a process known as delivery versus payment dvp transactions between euroclear participants are settled in the manner described above on a dvp basis on the books of euroclear securities and cash transfers between buyer and seller accounts are final and irrevocable upon settlement costs and risks involved in the settlement between euroclear participants and local market participants are heavily influenced by local market practices trades settling through domestic market links settle on a dvp basis only if dvp is provided in the local market in the same way settlement in the euroclear system becomes final and irrevocable in line with the rules of the domestic market as a rule euroclear bank credits securities to participants only if it has actually received the securities for the account of such participants 7all securities accepted by euroclear are eligible for securities lending and borrowing except those that are limited by liquidity fiscal or legal restrictions standard borrowings are allocated whenever a borrower has insufficient securities in its account to make a delivery provided sufficient securities are available from lending 7borrowings are reimbursed on the first overnight settlement process where securities are available in the borrower s account in the program all securities made available by lenders are aggregated in a lending pool securities are then distributed to borrowers and loans are allocated among lenders according to standard procedures 7 | |
what is eurocurrency | eurocurrency is currency held on deposit by governments or corporations operating outside of their home market for example a deposit of u s dollars usd held in a british bank would be considered eurocurrency as would a deposit of british pounds gbp made in the united states understanding eurocurrencythe term eurocurrency applies to any currency deposit held outside of the home market in which that currency is issued importantly despite its name it does not necessarily need to involve european currencies for instance south korean won kpw deposited at a bank in south africa would be considered eurocurrency even if no european currency is involved eurocurrency is an important part of the global financial system since globalization has led to a sharp rise in cross border transactions in recent decades many banks find themselves needing to access deposits of local currency in different regions throughout the world this has led to a large and active eurocurrency market in which international banks regularly exchange and lend foreign currencies with one another out of their eurocurrency deposits in addition to the rise of international transactions another explanation for the use of eurocurrency throughout the world concerns regulation for many banks borrowing from other banks through the eurocurrency market can be a faster and more efficient way to access short term financing as compared to finding alternative sources of funding within their home market real world example of eurocurrencythe most prominent example of a eurocurrency market are the usd denominated time deposits held at banks outside the united states colloquially referred to as eurodollars these deposits have become an integral part of the global financial system as a source of short term usd funding for financial firms throughout the world since the usd is the world s reserve currency virtually all multinational corporations banks and governments require large quantities of usd in order to satisfy their routine financial obligations often these firms rely on the eurodollar market to satisfy these short term funding needs although it is difficult to obtain reliable estimates of the size of the eurodollar market recent estimates have placed it at nearly 14 trillion | |
what is the eurocurrency market | the eurocurrency market is the money market for currency outside of the country where it is legal tender the eurocurrency market is utilized by banks multinational corporations mutual funds and hedge funds they wish to circumvent regulatory requirements tax laws and interest rate caps often present in domestic banking particularly in the united states the term eurocurrency is a generalization of eurodollar and should not be confused with the eu currency the euro the eurocurrency market functions in many financial centers around the world not just europe understanding the eurocurrency marketthe eurocurrency market originated in the aftermath of world war ii when the marshall plan to rebuild europe sent a flood of dollars overseas the market developed first in london as banks needed a market for dollar deposits outside the united states dollars held outside the united states are called eurodollars even if they are held in markets outside europe such as singapore or the cayman islands there is not necessarily any connection between eurocurrency markets and europe today although these markets did begin in europe the eurocurrency market has expanded to include other currencies such as the japanese yen and the british pound whenever they trade outside of their home markets however the eurodollar market remains the largest interest rates paid on deposits in the eurocurrency market are typically higher than in the domestic market that is because the depositor is not protected by the same national banking laws and does not have governmental deposit insurance rates on eurocurrency loans are typically lower than those in the domestic market for essentially the same reasons eurocurrency bank accounts are also not subject to the same reserve requirements as domestic accounts types of eurocurrency marketseurodollars were the first eurocurrency and they still have the most influence it is worth noting that u s banks can have overseas operations dealing in eurodollars these subsidiaries are often registered in the caribbean however the majority of actual trading takes place in the united states the eurodollar trades mostly overnight although deposits and loans out to 12 months are possible transactions are usually for a minimum of 25 million and can top 1 billion in a single deposit the offshore euroyen market was established in the 1980s and expanded with japan s economic influence as interest rates declined in japan during the 1990s the higher rates paid by euroyen accounts became more attractive 1there is an active bond market for countries companies and financial institutions to borrow in currencies outside of their domestic markets the first such eurobond was issued by the italian company autostrade in 1963 it borrowed 15 million for 15 years in a deal arranged in london and listed on the luxembourg stock exchange 2 issuing eurobonds remained popular in italy and the italian government sold us 7 billion in eurobonds in october 2019 3 it is essential to avoid confusing eurobonds with euro bonds which are simply bonds denominated in euros issued by countries or firms in the eurozone advantages and disadvantages of eurocurrency marketsthe main benefit of eurocurrency markets is that they are more competitive they can simultaneously offer lower interest rates for borrowers and higher interest rates for lenders that is mostly because eurocurrency markets are less regulated on the downside eurocurrency markets face higher risks particularly during a run on the banks | |
what is the eurodollar | the term eurodollar refers to u s dollar denominated deposits at foreign banks or at the overseas branches of american banks because they are held outside the united states eurodollars are not subject to regulation by the federal reserve board including reserve requirements dollar denominated deposits not subject to u s banking regulations were originally held almost exclusively in europe hence the name eurodollar now they are also widely held in branches located in the bahamas and the cayman islands understanding the eurodollarthe fact that the eurodollar market is relatively free of regulation means such deposits can pay higher interest their offshore location makes them subject to political and economic risk in the country of their domicile however most branches where the deposits are housed are in very stable locations the eurodollar market is one of the world s primary international capital markets they require a steady supply of depositors putting their money into foreign banks these eurodollar banks may have problems with their liquidity if the supply of deposits drops deposits from overnight out to a week are priced based on the fed funds rate prices for longer maturities are based on the corresponding london interbank offered rate libor eurodollar deposits are quite large they are made by professional counterparties for a minimum of 100 000 and generally for more than 5 million it is not uncommon for a bank to accept a single deposit of 500 million or more in the overnight market a 2014 study by the federal reserve bank showed an average daily volume in the market of 140 billion most transactions in the eurodollar market are overnight which means they mature on the next business day with weekends and holidays an overnight transaction can take as long as four days the transactions usually start on the same day they are executed with money paid between banks via the fedwire and chips systems eurodollar transactions with maturities greater than six months are usually done as certificates of deposit cds for which there is also a limited secondary market history of the eurodollarthe eurodollar market dates back to the period after world war ii much of europe was devastated by the war and the united states provided funds via the marshall plan to rebuild the continent this led to wide circulation of dollars overseas and the development of a separate less regulated market for the deposit of those funds unlike domestic u s deposits the funds are not subject to the federal reserve bank s reserve requirements they are also not covered by fdic insurance this results in higher interest rates for eurodollars many american banks have offshore branches usually in the caribbean through which they accept eurodollar deposits european banks are also active in the market the transactions for caribbean branches of u s banks are generally executed by traders physically situated in u s dealing rooms and the money is on loan to fund domestic and international operations | |
what is the euromarket | the term euromarket has two distinct meanings understanding the euromarketa euromarket can be used to describe the financial market for eurocurrencies a eurocurrency is any currency held or traded outside its country of issue for example a eurodollar is a dollar deposit held or traded outside the u s a key incentive for the development and continued existence of such a market is that it is free from the regulatory environment and sometimes political or other country specific risks of the home country the euro prefix in the term arose because originally such currencies were held in europe but that is no longer solely the case and a eurocurrency can now be held anywhere in the world that local banking regulations permit the eurocurrency market is a major source of finance for international trade because of ease of convertibility and the absence of domestic restrictions on trading euromarket as the single market of the euthe term can also be used to refer to the single market of the european union the single market was created by the abolition of restrictions on the movement of goods and services as well as people between member countries of the eu the european commission describes the single market as one territory without any internal borders or other regulatory obstacles to the free movement of goods and services 2the free flow of goods and services across borders makes it easier for companies to operate across countries it is intended to improve efficiency stimulate trade and help growth while also helping achieve the political objective of deeper integration between eu member countries note that most but not all members of the eu have adopted the euro as their currency so the eurozone which refers to the countries that have adopted the euro in a common monetary union is not synonymous with the euromarket let s look at a hypothetical example where bank a is based in france and bank b is based in the united states bank a is planning to make some rather large loans to a client of theirs and has determined that they would be able to make more money if they borrowed money from bank b in us dollars and loaned it out to their client bank b makes interest from the loan they offer to bank a whereas bank a profits from the difference in the loan terms between their client and the loan terms offered from bank b although in theory bank a might do this at zero cost in order to satisfy their client it is much more often the case that they use eurocurrency as a way to take advantage of an interest rate discrepancy | |
what is europe middle east and africa emea | europe middle east and africa emea is a geographical grouping and an acronym widely used by global corporations to define regional business activity it is a shorthand method to refer to the three continents and their regional areas understanding europe middle east and africa emea europe middle east and africa emea is a label that global firms use when dividing their operations by geography emea is a common division used in international business but it is not precisely defined it may or may not include russia or kazakhstan for example and european overseas territories on other continents are generally excluded a multinational may distinguish financial results by region reporting sales and profits in the americas the emea region asia pacific and japan leadership roles are also based on these divisions microsoft corp msft for example has a vice president for emea 1corporate use of emeaemea is useful for operational purposes and business organization because most of the included region falls within four time zones facilitating communication and travel however little unites the emea region which includes political economic linguistic and cultural diversity political systems range from stable democracies to autocracies and local languages included arabic french russian and english regions of emeaemea is often subdivided or rearranged depending on a corporation s need to distinguish a region or area if india is included in the grouping a company may use emeia or emia companies may sometimes separate their business operations in eastern and western europe referring instead to eastern europe middle east and africa eemea and the european union eu or european free trade association efta nations and regions are grouped based on what is most convenient for the corporation and may also include | |
what is apac | most countries located throughout eastern and southern asia those that touch the pacific ocean and oceania are usually considered apac or asia pacific countries there is no official definition of the asia pacific region and its boundaries and the list of apac countries varies depending on the context and distinctions required by corporations | |
how is emea used in business news reporting | stock market and exchange news traditionally categorize activity by region and use emea to distinguish financial news for that region such as emea stocks or emea market indexes | |
what challenges face corporations when targeting all regions in emea | some business activities like marketing or advertising can be challenging when companies target and divided business to encompass the entire emea region as opposed to conducting business in north america creating a marketing plan for emea means considering local laws cultures and holidays among different regions corporations also have to account for economic and political factors local government regulation and product fit the bottom lineeurope middle east and africa emea is a geographical acronym used by many multinational corporations it is a globally accepted term and standardizes news and business activity relating to the regional areas of emea corporations often distinguish sales divisions or leadership roles as emea positions | |
what is the european banking authority eba | the european banking authority eba is a regulatory body that strives to maintain financial stability throughout the european union s eu banking industry it was established in 2010 by the european parliament replacing the committee of european banking supervisors cebs the basics of the european banking authority eba the eba is tasked with developing regulatory technical standards and rules for financial firms in the eu internal market it oversees lending institutions investment firms and credit institutions the rules it imposes are designed to achieve the following objectives the european central bank ecb ensures that banks follow the rules set forth by the eba which runs annual transparency exercises and stress tests on more than 100 eu banks this involves cultivating fiscal data on a bank s capital risk weighted assets rwa recorded profits and losses market risk and credit risk the stress tests that the eba imposes on financial institutions seek to determine whether each institution would remain solvent in the wake of financial crises real world example the european banking authority eba the 2016 stress test carried out on 51 banks from 15 eu and european economic area eea countries revealed that only banca monte dei paschi di siena mps in italy lacked the adequate capital reserves needed to weather a three year economic shock after these results mps jettisoned many of its non performing loans from its balance sheet in a strategic effort to boost its capital levels to the required threshold the eba s powers are far reaching in that it may overrule national regulators that fall derelict in regulating their banks themselves background on the ebathe ecb supervises banks to ensure that they follow the rules set by the eba which emerged as part of the european supervisory authority esa which also consists of the european insurance and occupational pensions authority eiopa the eiopa is responsible for protecting insurance policyholders pension members and beneficiaries the effectiveness of bank operationsthe 2008 financial crisis and the european sovereign debt crisis have illuminated general shortcomings in eu banking operations after the collapse of the u s mortgage bubble and greece s revelation that its deficits were vastly larger than previously thought eurozone states like portugal ireland spain and greece itself faced soaring debt servicing costs these nations consequently sought bailouts from international institutions fiscal austerity measures designed to help countries exit bailout programs have slowed european economic growth at the same time the introduction of negative interest rates by the ecb and other central banks has squeezed banks margins these factors combined with increased regulation and poor management have caused worries about european banking sustainability for example in january 2018 italian banks were struggling under the weight of 360 billion 410 billion worth of non performing loans representing about 25 of the country s gdp as it stands currently italy s debt to gdp ratio still remains worrisome and the outlook remains uncertain | |
what is european central bank ecb | the european central bank ecb is the central bank responsible for monetary policy of the european union eu member countries that have adopted the euro currency this currency union is known as the eurozone and currently includes 19 countries the ecb s primary objective is price stability in the euro area understanding european central bank ecb the european central bank ecb is headquartered in frankfurt am main germany it has been responsible for monetary policy in the euro area since 1999 when the euro currency was first adopted by some eu members the ecb governing council makes decisions on eurozone monetary policy including its objectives key interest rates and the supply of reserves in the eurosystem comprising the ecb and national central banks of the eurozone countries it also sets the general framework for the ecb s role in banking supervision 1the council consists of six executive board members and a rotation of 15 national central bank governors instead of an annual rotation of voting rights as for regional federal reserve bank presidents the ecb rotates voting rights monthly central bank governors from the top five countries by the size of their economies and banking systems as of may 2022 germany france italy spain and the netherlands share four voting rights while the central banks of the other countries vote only slightly less frequently at 11 months out of every 14 2the ecb s mandate is for price stability and it targets an annual inflation rate of 2 over the medium term like the federal reserve s inflation targeting it is symmetrical so that inflation too low relative to its target is viewed as negatively as inflation above it 3the 2 target provides a buffer against the risk of a destabilizing deflation during a recession 4european central bank ecb functionsthe primary responsibility of the ecb linked to its mandate of price stability is formulating monetary policy monetary policy decision meetings are held every six weeks and the ecb is transparent about the reasoning behind the resulting policy announcements it holds a press conference after each monetary policy meeting and later publishes the meeting minutes the eurosystem comprises the ecb and the central banks of eurozone countries the eurosystem manages the euro currency and supports the ecb s monetary policy the parallel european system of central banks includes all central banks of eu states including those that have not adopted he euro 5the ecb is also the eu body responsible for banking supervision in conjunction with national central bank supervisors it operates what is called the single supervisory mechanism ssm to ensure the soundness of the european banking system 6 the ssm enforces the consistency of banking supervision practices for member countries lax supervision in some member countries contributed to the european financial crisis the ssm was launched in 2014 all euro area countries are in the ssm and non euro eu countries can choose to join | |
what is the european community ec | the european community ec was an economic association formed by six european member countries in 1957 consisting of three communities that eventually were replaced by the european union eu in 1993 the european community dealt with policies and governing in a communal fashion across all member states the primary goal of the european community was to foster a common trade policy that would eliminate trade barriers thereby improving economic conditions for the entire region additionally government officials from member states who were well aware of the tensions still simmering in the aftermath of world war ii wanted to promote a high level of integration and cooperation in order to reduce the likelihood of future wars understanding the european community ec the european community ec was developed after world war ii in the hopes that a more unified europe would find it harder to go to war with one another when the european community was created in 1957 there were six countries on the roster belgium germany france italy luxembourg and the netherlands 2the original european community was comprised of three organizations and governed by a series of treaties these treaty organizations worked together to ensure fair and even policies were enacted and enforced across participating countries the european economic community eec the first of the three organizations in the european community was the european economic community eec also known as the common market the eec was established in 1957 by the treaty of rome as a way to unify the economies of europe and reduce tensions that could lead to war 3 of particular concern was to promote a lasting reconciliation between france and germany in order to eliminate trade barriers and implement unified trade policies member countries needed to cooperate politically and arbitrate differences peacefully the benefit for all countries would be the ability to engage in profitable trade across borders in 1962 the eec implemented an agricultural policy that shielded eec farmers from competition arising from agricultural imports 4the european coal and steel community ecsc the second organization in the european community was the european coal and steel community ecsc it was put in place to attempt to regulate manufacturing practices across the member states by integrating the steel and coal industries in western europe the ecsc was able to remove almost all trade barriers among member states in coal steel coke scrap iron and pig iron the ecsc set treaty rules regarding pricing and quotas imposing fines on companies that broke the rules by the 1960s trade in the commodities overseen by the ecsc had risen throughout the region the focus of the ecsc shifted in the 1970s toward reducing excess production in the steel industry in order to maintain competitiveness as japan flooded the markets with cheap steel the european atomic energy communitylastly the european atomic energy community also known as euratom was created in 1958 to establish a common market among member nations for trade in nuclear materials and equipment 5 among euratom s goals was to coordinate research and promote peaceful uses for atomic energy the organization did not include military uses of nuclear materials as part of its oversight instead it focused on trade issues and establishing health and safety regulations for atomic energy the european unionin 1993 the european community was rolled into the european union eu when the maastricht treaty went into effect as of 2021 there are 27 countries in the eu austria belgium bulgaria croatia cyprus czechia denmark estonia finland france germany greece hungary ireland italy latvia lithuania luxembourg malta netherlands poland portugal romania slovakia slovenia spain and sweden 6on june 23 2016 the citizens of the united kingdom voted to leave the european union a move dubbed brexit in the press 7 the united kingdom officially ended its membership in the european union on jan 31 2020 6 | |
what is the european currency unit ecu | the european currency unit ecu was the official monetary unit of the european monetary system ems before it was replaced by the euro the value of the ecu was used to determine the exchange rates and reserves among the members of the ems but it was always an accounting unit rather than a real currency understanding the european currency unit ecu the european currency unit ecu was introduced on march 13 1979 along with the exchange rate mechanism erm which was designed to reduce exchange rate variability and achieve monetary stability in europe prior to the introduction of the euro at parity on jan 1 1999 1 the ecu replaced the european unit of account in 1979 2the erm was meant to limit fluctuations between ecu currencies the ecu was used in various international financial transactions allowing ecu denominated securities to offer foreign diversification 3the ecu was a composite of artificial currency based on a basket of european union eu member currencies weighted according to each country s share of eu output the ecu started off with nine currencies and by late 1989 through the end of 1999 the basket held 12 currencies the currencies were the belgian franc german mark danish krone spanish peseta french franc british pound greek drachma irish pound italian lira luxembourg franc dutch guilder and portuguese escudo 4special considerationsthe ems was marked by currency instability and political infighting over appropriate national exchange rates as the other currencies were forced to follow the bundesbank s lead on monetary policy the exchange rates of strong currencies like the deutsche mark and those of weaker ones like the danish krone were periodically adjusted but after 1986 changes in national interest rates were used to keep the currencies within a narrow range 45however because germany and britain s economic cycles were largely out of synch in part due to german reunification britain struggled to remain competitive within the erm it crashed out in 1992 after sterling came under attack by speculators including george soros on black wednesday 67 the uk and denmark would never join the eurozone and greece joined late 8910the name of the euro was first introduced in 1995 in spain 11 as an accounting currency the euro was introduced in 1999 it replaced the ecu at a 1 1 ratio euro coins and banknotes were put into circulation in 2002 making it the daily operating currency for the region 12 now the euro is the official currency of 19 of the 27 eu members including four european microstates that are not part of the eu 13the euro is the second largest and second most traded currency in the world behind the u s dollar 1415 as of august 2022 there were over 29 trillion euro banknotes and over 144 billion euro coins in circulation 16 | |
what is the european economic and monetary union emu | the european economic and monetary union emu combines several of the european union eu member states into a cohesive economic system it is the successor to the european monetary system ems note that there is a difference between the 19 member european economic and monetary union emu and the larger european union eu which has 27 member states as of 2022 also referred to as the eurozone the european economic and monetary union emu is quite a broad umbrella under which a group of policies has been enacted aimed at economic convergence and free trade among european union member states the emu s development occurred through a three phase process with the third phase initiating the adoption of the common euro currency in place of former national currencies this has been completed by all initial eu members except for the united kingdom and denmark who have opted out of adopting the euro the u k subsequently left the emu in 2020 following the brexit referendum 1history of the european monetary union emu the first efforts to create a european economic and monetary union began after world war i on sept 9 1929 gustav stresemann at an assembly of the league of nations asked where is the european currency the european stamp that we need stresemann s lofty rhetoric quickly became folly however when little more than a month later the wall street crash of 1929 marked the symbolic onset of the great depression which not only derailed talk of a common currency it also split europe politically and paved the way for the second world war the modern history of the emu was reignited with a speech given by robert schuman the french foreign minister at the time on may 9 1950 that later came to be called the schuman declaration schuman argued that the only way to ensure peace in europe which had been torn apart twice in thirty years by devastating wars was to bind europe as a single economic entity the pooling of coal and steel production will change the destinies of those regions which have long been devoted to the manufacture of munitions of war of which they have been the most constant victims 2 his speech led to the treaty of paris in 1951 that created the european coal and steel community ecsc between treaty signers belgium france germany italy luxembourg and the netherlands the ecsc was consolidated under the treaties of rome into the european economic community eec the treaty of paris was not a permanent treaty and was set to expire in 2002 to ensure a more permanent union european politicians proposed plans in the 1960s and 1970s including the werner plan but worldwide destabilizing economic events like the end of the bretton woods currency agreement and the oil and inflation shocks of the 1970s delayed concrete steps to european integration in 1988 jacques delors the president of the european commission was asked to convene an ad hoc committee of member states central bank governors to propose a concrete plan to further economic integration delors s report led to the creation of the maastricht treaty in 1992 the maastricht treaty was responsible for the establishment of the european union one of the maastricht treaty s priorities was economic policy and the convergence of eu member state economies so the treaty established a timeline for the creation and implementation of the emu the emu was to include a common economic and monetary union a central banking system and a common currency in 1998 the european central bank ecb was created and at the end of the year conversion rates between member states currencies were fixed a prelude to the creation of the euro currency which began circulation in 2002 convergence criteria for countries interested in joining the emu include reasonable price stability sustainable and responsible public finance reasonable and responsible interest rates and stable exchange rates european monetary union and the european sovereign debt crisisadoption of the euro forbids monetary flexibility so that no committed country may print its own money to pay off government debt or deficit or compete with other european currencies on the other hand europe s monetary union is not a fiscal union which means that different countries have different tax structures and spending priorities consequently all member states were able to borrow in euros at low interest rates during the period before the global financial crisis but bond yields did not reflect the different creditworthiness of member countries there have been several episodes with various member nations that have caused stress for the stability and future of the common currency namely among the so called piigs countries portugal ireland italy greece and spain greece perhaps represents the most high profile example of the challenges in the emu greece revealed in 2009 that it had been understating the severity of its deficit since adopting the euro in 2001 and the country suffered one of the worst economic crises in recent history greece accepted two bailouts from the eu in five years and short of leaving the emu future bailouts will be necessary for greece to continue to pay its creditors greece s initial deficit was caused by its failure to collect adequate tax revenue coupled with a rising unemployment rate and loose government spending in july 2015 greek officials announced capital controls and a bank holiday and restricted the number of euros that could be removed per day the eu had given greece an ultimatum accept strict austerity measures which many greeks now believe caused the crisis in the first place or leave the emu on july 5 2015 greece voted to reject eu austerity measures prompting speculation that greece might exit the emu the country then risked either economic collapse or forceful exit from the emu and a return to its former currency the drachma the downsides of greece returning to the drachma included the possibility of capital flight and a distrust of the new currency outside of greece the cost of imports on which greece is very dependent would have increased dramatically as the buying power of the drachma declines relative to the euro the new greek central bank could be tempted to print money to maintain basic services which could lead to severe inflation or in the worst case scenario hyperinflation black markets and other signs of a failed economy would appear the risk of contagion on the other hand was thought to have been limited because the greek economy accounted for only two percent of the overall eurozone economy in the end greece did remain in the emu and received a number of bailouts and emergence loans from the eu and other lenders in 2018 greece successfully exited its third and final bailout program and returned to relative financial stability and economic growth 3 | |
do all european countries use the euro | no some european countries have maintained their own currency and have not adopted the euro these include the u k switzerland sweden norway bulgaria croatia czech republic denmark hungary poland and romania some non eu jurisdictions such as vatican city andorra monaco and san marino also have monetary agreements with the eu allowing them to issue their own euro currency under certain restrictions | |
what is the difference between the european union eu and the eurozone | the european union eu is a political and economic grouping of 27 countries committed to shared democratic values eight of these countries do not use the euro leaving 19 nations in the so called eurozone who share the common currency | |
when did the european monetary union begin | the emu formally began on february 7 1992 with the signing of the maastricht treaty in the netherlands the euro itself was launched on january 1 1999 as a unit of account and coins and banknotes began circulating on january 1 2002 | |
what was the european monetary system ems | the european monetary system ems was an adjustable exchange rate arrangement set up in 1979 to foster closer monetary policy cooperation between members of the european community ec the european monetary system ems was later succeeded by the european economic and monetary union emu which established a common currency the euro understanding the european monetary system ems the ems was created in response to the collapse of the bretton woods agreement formed in the aftermath of world war ii wwii the bretton woods agreement established an adjustable fixed foreign exchange rate to stabilize economies and consolidate global financial power among the western allied nations when it was abandoned in the early 1970s currencies began to float fluctuating in market value relative to one another which prompted members of the ec to seek out a new exchange rate agreement to complement their customs union 1the ems s primary objective was to stabilize inflation and stop large exchange rate fluctuations between european countries this was part of a wider overall goal of fostering economic and political unity in europe which ultimately paved the way for a common currency the euro currency fluctuations were controlled through an exchange rate mechanism erm the erm was responsible for pegging national exchange rates allowing only slight deviations from the european currency unit ecu a composite artificial currency based on a basket of 12 eu member currencies weighted according to each country s share of eu output the ecu served as a reference currency for exchange rate policy and determined exchange rates among the participating countries currencies via officially sanctioned accounting methods 2under the presidency of jacques delors the delors report was produced that outlined how emu could be used in place of ems 3history of the emsthe early years of the ems were marked by uneven currency values and adjustments that raised the value of stronger currencies and lowered those of weaker ones after 1986 changes in national interest rates were specifically used to keep all the currencies stable 4a new crisis for the ems emerged in the early 1990s differing economic and political conditions of member countries notably the reunification of germany led to britain permanently withdrawing from the ems in 1992 britain s withdrawal foreshadowed its later insistence on independence from continental europe britain refused to join the eurozone along with sweden and denmark during this time efforts to form a common currency and cement greater economic alliances were ramped up in 1993 most ec members signed the maastricht treaty establishing the european union eu one year later the eu created the european monetary institute which became the european central bank ecb in 1998 the primary responsibility of the ecb was to institute a single monetary policy and interest rate at the end of 1998 the majority of eu nations simultaneously cut their interest rates to promote economic growth and prepare for the implementation of the euro in january 1999 a unified currency the euro was created the euro is used by most eu member countries the european economic and monetary union emu was also established succeeding the ems as the new name for the common monetary and economic policy organization of the eu 3criticism of the emsunder the ems exchange rates could only be changed if both member countries and the european commission were in agreement this was an unprecedented move that attracted a lot of criticism in the aftermath of the global economic crisis of 2008 2009 significant tension between the principles of the ems and the policies of national governments became evident certain member states greece in particular but also ireland spain portugal and cyprus pursued policies that created high national deficits this phenomenon was later referred to as the european sovereign debt crisis these countries could not resort to the devaluation of their currencies and were not allowed to spend to offset unemployment rates 5from the beginning the european monetary system ems policy intentionally prohibited bailouts to ailing economies in the eurozone despite vocal resistance from eu members with stronger economies the emu finally established bailout measures to provide relief to struggling members | |
how was the european monetary system established | the ems was established through the introduction of the european currency unit in 1979 the ecu served as a basket currency representing a weighted average of member currencies | |
what were the main objectives of the ems | he primary objectives of the ems were to achieve exchange rate stability encourage economic convergence among member states and create a framework for the eventual formation of the european economic and monetary union these goals aimed at fostering a more integrated and stable european economic environment | |
how did the ems evolve over time | over time the ems underwent several changes the most significant change was the transition from the ems to the european economic and monetary union with the introduction of the euro in 1999 this marked a culmination of efforts to establish a single currency for the eurozone | |
what events led to the collapse of the ems | the collapse of the ems occurred around 1992 and 1993 when several member states faced currency crises the crises exposed vulnerabilities in the ems and prompted a reevaluation of the system the bottom linethe european monetary system was established in 1979 as a framework for monetary cooperation among european union member states it tried to create exchange rate stability and economic convergence the ems played a pivotal role in the transition to the european economic and monetary union culminating in the introduction of the euro in 1999 | |
what is a european option | a european option is a version of an options contract that limits execution to its expiration date in other words if the underlying security such as a stock has moved in price an investor would not be able to exercise the option early and take delivery of or sell the shares instead the call or put action will only take place on the date of option maturity another version of the options contract is the american option which can be exercised any time up to and including the date of expiration the names of these two versions should not be confused with the geographic location as the name only signifies the right of execution understanding a european optioneuropean options define the timeframe when holders of an options contract may exercise their contract rights the rights for the option holder include buying the underlying asset or selling the underlying asset at the specified contract price the strike price with european options the holder may only exercise their rights on the day of expiration as with other versions of options contracts european options come at an upfront cost the premium it is important to note that investors usually don t have a choice of buying either the american or the european option specific stocks or funds might only be offered in one version or the other and not in both most indexes use european options because it reduces the amount of accounting needed by the brokerage many brokers use the black scholes model bsm to value european options european index options halt trading at business close thursday before the third friday of the expiration month this lapse in trading allows the brokers the ability to price the individual assets of the underlying index due to this process the settlement price of the option can often come as a surprise stocks or other securities may make drastic moves between the thursday close and market opening friday also it may take hours after the market opens friday for the definite settlement price to publish european options normally trade over the counter otc while american options usually trade on standardized exchanges types of european optionsa european call option gives the owner the right to acquire the underlying security at expiry for an investor to profit from a call option the stock s price at expiry has to be trading high enough above the strike price to cover the cost of the option premium a european put option allows the holder to sell the underlying security at expiry for an investor to profit from a put option the stock s price at expiry has to be trading far enough below the strike price to cover the cost of the option premium closing a european option earlytypically exercising an option means initializing the rights of the option so that a trade is executed at the strike price however many investors don t like to wait for a european option to expire instead investors can sell the option contract back to the market before its expiration option prices change based on the movement and volatility of the underlying asset and the time until expiration as a stock price rises and falls the value signified by the premium of the option increases and decreases investors can unwind their option position early if the current option premium is higher than the premium they initially paid in this case the investor would receive the net difference between the two premiums closing the option position before expiration means the trader realizes any gains or losses on the contract itself an existing call option could be sold early if the stock has risen significantly while a put option could be sold if the stock s price has fallen closing the european option early depends on the prevailing market conditions the value of the premium its intrinsic value and the option s time value the amount of time remaining before a contract s expiration if an option is close to its expiration it s unlikely an investor will get much return for selling the option early because there s little time left for the option to make money in this case the option s worth rests on its intrinsic value an assumed price based on if the contract is in out or at the money atm european option vs american optioneuropean options can only be exercised on the expiration date whereas american options can be exercised at any time between the purchase and expiration dates in other words american options allow investors to realize a profit as soon as the stock price moves in their favor and enough to more than offset the premium paid investors will use american options with dividend paying stocks in this way they can exercise the option before an ex dividend date the flexibility of american options allows investors to own a company s shares in time to get paid a dividend however the flexibility of using an american option comes at a price a premium to the premium the increased cost of the option means investors need the underlying asset to move far enough from the strike price to make the trade return a profit also if an american option is held to maturity the investor would have been better off buying a lower priced european version option and paying the lower premium lower premium costallows trading index optionscan be resold before the expiration datesettlement prices are delayedcannot be settled for underlying asset earlyexample of a european optionan investor purchases a july call option on citigroup inc with a 50 strike price the premium is 5 per contract 100 shares for a total cost of 500 5 x 100 500 at expiration citigroup is trading at 75 in this case the owner of the call option has the right to purchase the stock at 50 exercise their option making 25 per share profit when factoring in the initial premium of 5 the net profit is 20 per share or 2 000 25 5 20 x 100 2000 let s consider a second scenario whereby citigroup s stock price fell to 30 by the time of the call option s expiration since the stock is trading below the strike of 50 the option isn t exercised and expires worthless the investor loses the premium of 500 paid at the onset the investor can wait until expiry to determine whether the trade is profitable or they can try to sell the call option back to the market whether the premium received for selling the call option is enough to cover the initial 5 paid is dependent on many conditions including economic conditions the company s earnings the time left until expiration and the volatility of the stock s price at the time of the sale there s no guarantee the premium received from selling the call option before expiry will be enough to offset the 5 premium paid initially | |
what was europe s sovereign debt crisis | the european sovereign debt crisis was a period when several european countries experienced the collapse of financial institutions high government debt and rapidly rising bond yield spreads in government securities history of the crisisthe debt crisis began in 2008 with the collapse of iceland s banking system then spread primarily to portugal italy ireland greece and spain in 2009 leading to the popularization of a somewhat offensive moniker piigs it has led to a loss of confidence in european businesses and economies the crisis was eventually controlled by the financial guarantees of european countries who feared the collapse of the euro and financial contagion and by the international monetary fund imf rating agencies downgraded several eurozone countries debts greece s debt was at one point moved to junk status countries receiving bailout funds were required to meet austerity measures designed to slow down the growth of public sector debt as part of the loan agreements debt crisis contributing causessome of the contributing causes included the financial crisis of 2007 to 2008 the great recession of 2008 to 2012 the real estate market crisis and property bubbles in several countries the peripheral states fiscal policies regarding government expenses and revenues also contributed by the end of 2009 the peripheral eurozone member states of greece spain ireland portugal and cyprus were unable to repay or refinance their government debt or bail out their beleaguered banks without the assistance of third party financial institutions these included the european central bank ecb the imf and eventually the european financial stability facility efsf also in 2009 greece revealed that its previous government had grossly underreported its budget deficit signifying a violation of eu policy and spurring fears of a euro collapse via political and financial contagion seventeen eurozone countries voted to create the efsf in 2010 specifically to address and assist with the crisis the european sovereign debt crisis peaked between 2010 and 2012 with increasing fear of excessive sovereign debt lenders demanded higher interest rates from eurozone states in 2010 with high debt and deficit levels making it harder for these countries to finance their budget deficits when they were faced with overall low economic growth some affected countries raised taxes and slashed expenditures to combat the crisis which contributed to social upset within their borders and a crisis of confidence in leadership particularly in greece several of these countries including greece portugal and ireland had their sovereign debt downgraded to junk status by international credit rating agencies during this crisis worsening investor fears a 2012 report for the united states congress stated the following greek example of european crisisin early 2010 the developments were reflected in rising spreads on sovereign bond yields between the affected peripheral member states of greece ireland portugal spain and most notably germany the greek yield diverged with greece needing eurozone assistance by may 2010 greece received several bailouts from the eu and imf over the following years in exchange for the adoption of eu mandated austerity measures to cut public spending and a significant increase in taxes the country s economic recession continued these measures along with the economic situation caused social unrest with divided political and fiscal leadership greece faced sovereign default in june 2015 the greek citizens voted against a bailout and further eu austerity measures the following month this decision raised the possibility that greece might leave the european monetary union emu entirely the withdrawal of a nation from the emu would have been unprecedented and if greece had returned to using the drachma the speculated effects on its economy ranged from total economic collapse to a surprise recovery in the end greece remained part of the emu and began to slowly show signs of recovery in subsequent years unemployment dropped from its high of over 27 to 16 in five years while annual gdp when from negative numbers to a projected rate of over two percent in that same time brexit and the european crisisin june 2016 the united kingdom voted to leave the european union in a referendum this vote fueled eurosceptics across the continent and speculation soared that other countries would leave the eu after a drawn out negotiation process brexit took place at 11pm greenwich mean time jan 31 2020 and did not precipitate any groundswell of sentiment in other countries to depart the emu it s a common perception that this movement grew during the debt crisis and campaigns have described the eu as a sinking ship the uk referendum sent shock waves through the economy investors fled to safety pushing several government yields to a negative value and the british pound was at its lowest against the dollar since 1985 the s p 500 and dow jones plunged then recovered in the following weeks until they hit all time highs as investors ran out of investment options because of the negative yields italy and the european debt crisisa combination of market volatility triggered by brexit questionable performance of politicians and a poorly managed financial system worsened the situation for italian banks in mid 2016 a staggering 17 of italian loans approximately 400 billion worth were junk and the banks needed a significant bailout a full collapse of the italian banks is arguably a bigger risk to the european economy than a greek spanish or portuguese collapse because italy s economy is much larger italy has repeatedly asked for help from the eu but the eu recently introduced bail in rules that prohibit countries from bailing out financial institutions with taxpayer money without investors taking the first loss germany has been clear that the eu will not bend these rules for italy further effectsireland followed greece in requiring a bailout in november 2010 with portugal following in may 2011 italy and spain were also vulnerable spain and cyprus required official assistance in june 2012 the situation in ireland portugal and spain had improved by 2014 due to various fiscal reforms domestic austerity measures and other unique economic factors however the road to full economic recovery is anticipated to be a long one with an emerging banking crisis in italy instabilities that brexit may trigger and the economic impact of the covid 19 outbreak as possible difficulties to overcome | |
what is the european union eu | the european union eu is a political and economic alliance of 27 countries it promotes democratic values in its member nations and is one of the world s most powerful trade blocs nineteen of the countries share the euro as their official currency the eu grew out of a desire to strengthen economic and political cooperation throughout the continent of europe in the wake of world war ii its gross domestic product gdp totaled 14 45 trillion euros in 2021 that s about us 15 49 trillion the gdp of the u s for the same period was about us 23 trillion 12history of the european unionthe eu traces its roots to the european coal and steel community which was founded in 1950 and had just six members belgium france germany italy luxembourg and the netherlands it became the european economic community in 1957 under the treaty of rome and subsequently was renamed the european community ec 45this served to deepen the integration of the member nations foreign security and internal affairs policies the eu established a common market the same year to promote the free movement of goods services people and capital across its internal borders the ec initially focused on a common agricultural policy and the elimination of customs barriers denmark ireland and the u k joined in 1973 in the first wave of expansion direct elections to the european parliament began in 1979 5in 1986 the single european act embarked on a six year plan to create a common european market by harmonizing national regulations 5the maastricht treaty took effect in 1993 replacing the ec with the eu the euro debuted as a common single currency for participating eu members on january 1 1999 6 denmark and the u k negotiated opt out provisions that permitted countries to retain their own currencies if they chose 7several newer members of the eu have also either not yet met the criteria for adopting the euro or chosen to opt out the european debt crisisin the wake of the 2007 2008 global financial crisis the eu and the european central bank struggled to deal with high sovereign debt and sluggish growth in italy spain portugal ireland and greece greece and ireland received financial bailouts from the eu in 2010 conditioned on the implementation of fiscal austerity measures portugal followed in 2011 a second greek bailout was needed in 2012 8the crisis abated after the eu and the european central bank adopted a series of measures to support the sovereign and banking sector debt of the affected countries these included the establishment in october 2012 of the european stability mechanism esm established to assist eu members experiencing severe financial problems including an inability to access the bond markets the esm supplanted the temporary european financial stability facility backstop in place since 2010 9the european central bank conducted a series of targeted longer term refinancing operations in 2014 2016 and 2019 to provide financing on favorable terms for eu financial institutions 10in 2015 the eu loosened the provisions of the 2011 stability and growth act requiring member states to target public debt of below 60 of gross domestic product and annual government budget deficits below 3 of gdp over the medium term 11the same year a new eu agency the single resolution board assumed responsibility for resolving bank failures in the euro area 12eu s north south issueswhile the relief measures addressed the crisis they haven t tackled one of its principal causes the wide disparity in wealth and economic growth between the eu s heavily industrialized north and its poorer southern periphery which remains less urbanized and more dependent on agriculture 13because the industrialized north and the more rural south share a common currency struggling southern economies can t take advantage of currency depreciation to improve their international competitiveness without currency depreciation southern exporters ultimately struggle to compete with their northern rivals which benefit from faster productivity growth 14in the u s federal transfer payments help to address similar economic disparities between regions and states states with higher average incomes tend to contribute a disproportionately large share of federal revenue while those with lower incomes tend to account for a higher share of federal outlays 15in the eu the covid 19 pandemic prompted joint spending measures some have called an incomplete and fragile fiscal union in the making 16the brexit bombafter rejecting earlier calls for a popular referendum on the u k s eu membership conservative prime minister david cameron promised a vote in 2013 and scheduled it in 2016 it was a time of growing popularity for the u k independence party which opposed eu membership after trailing in late polls the leave option won with nearly 52 of the vote on june 23 2016 cameron resigned the next day the u k officially left the eu on january 31 2020 317in july 2020 a report by the intelligence and security committee of the u k parliament noted widespread media reports of russian efforts on behalf of the leave option and faulted the government for failing to investigate russian involvement in british politics 1819 | |
what is the purpose of the european union | the european union was created to bind the nations of europe closer together for the economic social and security welfare of all it is one of several efforts after world war ii to bind together the nations of europe into a single entity 20 | |
how is the european union changing in the 21st century | the original members of the european union were the nations of western europe in the 21st century the eu has expand membership to the eastern european nations that emerged after the collapse of the soviet union its current member nations include bulgaria croatia the czech republic estonia latvia lithuania poland romania slovakia and slovenia 20 | |
why was the european union created | the overarching purpose of the european union in the years after world war ii was to put an end to the devastating wars that had wracked europe for centuries at the same time it became increasingly clear that a united europe would have far greater economic and political power than the individual nations in the post war world 21the bottom linethe eu is a powerful alliance of 27 european countries that promotes democratic values among its members it serves to faciliate political and economic integration throughout the region many though not all of its members share the euro as their official currency historically it was made up primarily of the nations of western europe it has since expanded to include member nations that had previously been socialist states prior to the collapse of the ussr in 2020 the u k officially left the eu | |
what is the eurozone | the eurozone officially known as the euro area is a geographic and economic region that consists of all the european union countries that have fully incorporated the euro as their national currency as of 2022 the eurozone consists of 19 countries in the european union eu austria belgium cyprus estonia finland france germany greece ireland italy latvia lithuania luxembourg malta netherlands portugal slovakia slovenia and spain 1 approximately 340 million people live in the eurozone area 2understanding the eurozonethe eurozone is one of the largest economic regions in the world and its currency the euro is considered one of the most liquid when compared to others this region s currency continues to develop over time and is taking a more prominent position in the reserves of many central banks it is often used as an example when studying trilemmas an economic theory that postulates that nations have three options when making decisions regarding their international monetary policies history of the eurozonein 1992 the countries making up the european community ec signed the maastricht treaty thereby creating the eu the creation of the eu had a few areas of major impact it promoted greater coordination and cooperation in policy broadly speaking but it had specific effects on citizenship security and defense policy and economic policy regarding economic policy the maastricht treaty aimed to create a common economic and monetary union with a central banking system the european central bank ecb and a common currency the euro in order to do this the treaty called for the free movement of capital between the member states which then graduated into increased cooperation between national central banks and the increased alignment of economic policy among member states the final step was the introduction of the euro itself along with the implementation of a singular monetary policy coming from the ecb special considerationsfor various reasons not all eu nations are members of the eurozone denmark has opted out from joining although it can do so in the future 1 some eu nations have not yet met the conditions needed to join the eurozone other countries choose to use their own currency as a way to maintain their financial independence regarding key economic and monetary issues some countries that are not eu nations have adopted the euro as their national currency the vatican city andorra monaco and san marino have monetary agreements with the eu allowing them to issue their own euro currency under certain restrictions 1requirements for joining the eurozonein order to join the eurozone and use the euro as their currency eu nations must meet certain criteria consisting of four macroeconomic indicators that focus on price stability sound and sustainable public finances the durability of convergence and exchange rate stability 3for an eu nation to demonstrate price stability it must demonstrate sustainable price performance and average inflation no more than 1 5 percent above the rate of the three best performing member states to demonstrate sound public finances the government must run a budget deficit no greater than 3 of gdp and hold public debt no greater than 60 of gdp 43a nation s durability of convergence is assessed through its long term interest rates which cannot be more than 2 percent above the rate in the three member states with the most stable prices lastly the nation must demonstrate exchange rate stability by participating in the exchange rate mechanism erm ii for at least two years without severe tensions and without devaluing against the euro 3 | |
what is the ev 2p ratio | the ev 2p ratio is a ratio used to value oil and gas companies it consists of the enterprise value ev divided by the proven and probable 2p reserves the enterprise value reflects the company s total value proven and probable 2p refers to energy reserves such as oil that are likely to be recovered the formula for the ev 2p ratio isev 2p enterprise value2p reserveswhere 2p reserves total proven and probable reservesenterprise value mc total debt tcmc market capitalizationtc total cash and cash equivalents begin aligned text ev 2p frac text enterprise value text 2p reserves textbf where text 2p reserves text total proven and probable reserves text enterprise value text mc text total debt text tc text mc text market capitalization text tc text total cash and cash equivalents end aligned ev 2p 2p reservesenterprise value where 2p reserves total proven and probable reservesenterprise value mc total debt tcmc market capitalizationtc total cash and cash equivalents 2p reserves are the total of proven and probable reserves proved reserves are likely to be recovered whereas probable reserves are less likely to be recovered than proved reserves the sum of proved and probable reserves is represented by 2p | |
what does the ev 2p ratio tell you | enterprise value compared to proven and probable reserves is a metric that helps analysts understand how well a company s resources will support its operations and growth ideally the ev 2p ratio should not be used in isolation as not all reserves are the same however it can still be an important metric if little is known about the company s cash flow reserves can be proven probable or possible reserves the proven reserves are typically known as 1p with many analysts referring to it as p90 or having a 90 probability of being produced probable reserves are referred to as p50 or having a 50 certainty of being produced when used in conjunction with one another it is referred to as 2p | |
when the ev 2p multiple is high it means the company is trading at a premium for a given amount of oil in the ground conversely a low value would suggest a potentially undervalued company | the ev 2p ratio is comparable to other more common ratios used in valuation such as enterprise value or p e ratios these ratios express a company s value as a multiple of earnings or assets it s important to compare a company s ev 2p ratio with those of similar companies and with the historical values of the ratio using historical and industry comparisons can help investors determine if a company is undervalued overvalued or fairly valued example of the ev 2p ratiolet us assume that an oil company has an enterprise value of 2 billion and proven and probable reserves of 100 million barrels ev 2p 2 billion 100 million 20 begin aligned text ev 2p frac 2 text billion 100 text million 20 end aligned ev 2p 100 million 2 billion 20 the ev 2p ratio 20 or the company has a 20 multiple in other words the company is valued at 20 times its enterprise value to 2p reserves whether the 20 multiple is high low or fairly valued depends on other oil companies within the same industry the difference between the ev 2p ratio and ev ebitdaenterprise value compared to earnings before interest tax depreciation and amortization is also referred to as the enterprise multiple the ev ebitda ratio compares the oil and gas business free of debt to ebitda this is an important metric as oil and gas firms typically have a great deal of debt and the ev includes the cost of paying it off by stripping out debt analysts can see how well the company is valued the ev 2p ratio on the other hand also uses enterprise value in its formula but instead of using ebitda the ratio includes proven and probable 2p reserves the ev 2p ratio is important when judging the potential or possible growth of an oil company since proven and probable 2p reserves are likely to be recovered limitations of the ev 2p ratioas mentioned earlier the ev 2p ratio includes total debt in its calculation because enterprise value also includes total debt oil companies typically carry significant amounts of debt on their balance sheets which is normal for the industry debt is used to top finance oil rigs equipment and the cost of exploration as a result the extra debt would put the ev of oil companies at a much higher valuation than most other industries that carry less debt investors should be aware of the unique capital structures of oil and gas companies when using any valuation metric including the ev 2p ratio | |
what is an evening star | an evening star is a stock price chart pattern that s used by technical analysts to detect when a trend is about to reverse it s a bearish candlestick pattern that consists of three candles a large white candlestick a small bodied candle and a red candle evening star patterns are associated with the top of a price uptrend signifying that the uptrend is nearing its end the opposite of the evening star is the morning star pattern which is viewed as a bullish indicator | |
how an evening star works | a candlestick pattern is a way of presenting certain information about a stock it represents the open high low and close price for the stock over a period of time each candlestick consists of a candle and two wicks the length of the candle is a function of the range between the highest and lowest price during that trading day a long candle indicates a large change in price and a short candle indicates a small change in price long candlestick bodies are indicative of intense buying or selling pressure depending on the direction of the trend short candlesticks are indicative of little price movement the evening star pattern is considered to be a very strong indicator of future price declines its pattern forms over three days special considerationsthe evening star pattern is considered to be a reliable indication that a downward trend has begun but it can be difficult to discern amid the noise of stock price data traders often use price oscillators and trendlines to help identify it reliably and to confirm whether an evening star pattern has in fact occurred it s advisable to consult various technical indicators to predict price movements rather than rely solely on the signals provided by one the evening star pattern isn t the only bearish indicator despite its popularity among traders other bearish candlestick patterns include the dark cloud cover and the bearish engulfing traders have their own preferences regarding what patterns to watch for when they want to detect trend changes 2example of an evening star patternthe following chart provides an example of the evening star pattern the three days depicted here begin with a long white candle indicating that prices have risen from significant buying pressure the second day also shows a rise in prices but the extent of the increase is modest compared to the previous day the third day shows a long red candle in which selling pressure has forced the price to around the midpoint of the first day these are the tell tale signs that an evening star pattern has occurred technical analysts trading this security would consider selling or shorting the security in anticipation of an upcoming decline | |
what are the open high low and close prices | these prices monitor the value of a stock over a period of time an open or opening price is the first price a stock trades at when the market opens in the morning the closing price is the last price of the day high and low prices track whether a stock has lost or gained value during the day 3 | |
how does the evening star pattern use these prices | the evening star pattern correlates these prices over three days this can be a prime indicator of when a trend in price is about to reverse 1 | |
what is the doji candlestick pattern | the doji pattern occurs when the open price of a stock is the same or nearly the same as the close price upward movement indicates that the stock may begin sinking soon downward movement is a sign that the stock may go up this information can be an indicator of what will happen the next day 4the bottom lineit s a good idea to employ various indicators to help you predict price movements but the evening star pattern can be a solid tool it s particularly useful in identifying downward trends but it can admittedly be a bit difficult to pin down options like trendlines and oscillators can help and don t overlook the value of a broker s advice and assistance | |
what is an event study | an event study is an empirical analysis that examines the impact of a significant catalyst occurrence or contingent event on the value of a security such as company stock event studies can reveal important information about how a security is likely to react to a given event examples of events that influence the value of a security include a company filing for chapter 11 bankruptcy protection the positive announcement of a merger or a company defaulting on its debt obligations | |
how an event study works | an event study also known as event history analysis employs statistical methods using time as the dependent variable and then looking for variables that explain the duration of an event or the time until an event occurs event studies that use time in this way are often employed in the insurance industry to estimate mortality and compute life tables in business these types of studies may instead be used to forecast how much time is left before a piece of equipment fails alternatively they could be used to predict how long until a company goes out of business an event study whether on the micro or macro level tries to determine if a specific event has or will have an impact on a business s or economy s financial performance other event studies such as an interrupted time series analysis itsa compare a trend before and after an event to explain how and to what degree the event changed a company or a security this method may also be employed to see if the implementation of a particular policy measure has resulted in some statistically significant change after it has been put in place an event study conducted on a specific company examines any changes in its stock price and how it relates to a given event it can be used as a macroeconomic tool as well as analyzing the influence of an event on an industry sector or the overall market by looking at the impact of the change in supply and demand event study methodologytheoretically a stock price takes into account all available information and expectations about the future according to this theory it is possible to analyze the effect of a specific event on a company by looking at the associated impact on the company s stock the market model is the most common analysis used for an event study this methodology looks at the actual returns of a baseline reference market and tracks the correlation of a company s stock with the baseline the market model monitors the abnormal returns on the specific day of an event studying the stock s returns and comparing them to the normal or average returns the difference is the actual impact on the company this technique can be used over time analyzing consecutive days to understand how an event affects a stock over time an event study can reveal greater market trends or patterns if the same type of model is used to analyze multiple events of the same type it can predict how stock prices typically respond to a specific event | |
what is an event study in economics | in economics as well as in finance an event study refers to whether or not a statistical relationship exists in the financial markets between a specific event and a public company s stock price or value | |
what is a stock event | a stock event is when a company s stock undergoes a change such as a stock split reclassification dividend payment stock combination or any other event that impacts shareholders | |
what are the steps in conducting an event study | the first step in an event study is defining the event then picking the companies that the event will theoretically impact from there normal returns and abnormal returns should be determined using various models such as the constant mean return model the market model various economic models and so on the next step would be to measure and analyze the abnormal returns | |
what is an evergreen contract | an evergreen contract automatically renews on or after the expiry date the parties involved in the contract agree that it rolls over automatically until one gives the notice to terminate it evergreen contracts are used for a number of different purposes including rental leases purchasing contracts and service agreements understanding evergreen contractsone of the details the parties sign off on in a contract is the term or the length of time the contract will remain in force the contract duration varies widely and all parties are required to fulfill their obligations for as long as the contract outlines if neither party terminates it on the expiry date they are all bound to abide by the contract policy for another similar duration most evergreen contracts come with a 60 to 90 day renewal period before it renews evergreen clauses can be used in different kinds of contracts including employee stock option schemes dividend reinvestment plans drips rental lease agreements guaranteed investment certificate gic healthcare plans insurance coverage policies magazines subscriptions and revolving loans | |
how to cancel an evergreen contract | evergreen contracts can be canceled in several ways they can be ended the same way they are drafted through the mutual agreement form of the parties involved if the parties want to make changes to the original agreement they can draft a new contract which outlines the alterations this new contract voids the original one the other option may be for one party to default on the agreement although this is an undesirable choice it still nullifies the contract considerations with evergreen contract provisionswhile an evergreen clause provides convenience for either party because they don t have to renegotiate the terms of the contract on the expiry date one party may feel stuck and unsatisfied in a case where a dissatisfied party forgets to cancel the agreement when it expires they may be locked in for another period of time for example an investor with a 2 investment vehicle may have plans to roll over the invested funds into another vehicle with a different company offering 5 on the maturity date if they fail to give termination instructions within the timeframe stipulated in the policy the investment may be automatically renewed with the same fund company for the lower 2 rate parties should do their due diligence to know how and when to dissolve an evergreen contract examples of an evergreen contract provisionmany different contracts such as perpetual futures contain evergreen clauses these examples are by no means an exhaustive list of evergreen contracts some employee stock option plans provide an evergreen option where additional shares are automatically included in the plan annually these plans are used to attract and retain quality employees who are incentivized to grow the company evergreen options are renewed every year and remain active unless the board of directors decides to terminate them an evergreen rental lease term is structured to renew automatically at the end of the term it is then rolled over to another term with a similar period or activated on a month to month basis for example a tenant who signs an evergreen lease with their landlord must live in the property for a year after which the contract becomes an indefinite month to month live in arrangement during the monthly auto renewal period both parties can break the agreement many insurance contracts have evergreen clauses when a policyholder takes out a car or home insurance policy the insurer typically renews the policy for another year unless the insured person indicates otherwise if any terms of the policy are set to change in the new term the provider would notify the insured a borrower with a revolving loan can use the funds repay it in full and use the funds all over again borrowers have indefinite access to the loan amounts unless they fall out of good standing with the bank if this occurs the bank may opt to withdraw the loan at the end of the contract period | |
what is evergreen funding | evergreen funding or evergreen finance is the gradual infusion of capital into a new or recapitalized enterprise this type of funding differs from traditional funding in which all the capital required for a business venture is supplied up front by venture capitalists or other investors as part of a private funding round when the money is provided up front the company then invests in short term low risk securities until it is ready to use the money for business operations | |
how evergreen funding works | evergreen funding takes its name from coniferous evergreen trees which keep their leaves and stay green throughout the year similarly evergreen funding provides capital throughout the seasons of a company s development in a normal debt financing arrangement company issued bonds or debentures have a maturity date and require principal repayment at some future point in time an evergreen funding arrangement however allows a business to renew its debt periodically repeatedly pushing back the maturity date so that the time until maturity remains relatively constant while the arrangement is in place in the case of venture capital dollars the financing is done by selling ownership stakes in the venture but the infusions of capital are spread out over set periods this approach is used to avoid pushing a company to grow too fast evergreen funding of this nature assures entrepreneurs that the money is there but by limiting the pace of capital infusions it prevents them from growing too rapidly with evergreen funding capital is provided to the management of the company either on a schedule or upon request by the investment team evergreen funding has also been used to describe a revolving credit arrangement in which the borrower periodically renews the debt financing rather than having the debt reach maturity in this sense lines of credit and overdrafts are types of evergreen funding as the borrower applies for it once and then is not required to reapply to access the credit at a later date evergreen funding is distinct from an evergreen fund which is an investment fund that has an indefinite life meaning that investors can come and go throughout the life of the fund evergreen funding for cautious growththe main arguments for evergreen funding for new ventures are the cautionary tales of startups that grew too fast and quickly outpaced their business model to the point that a profitable business on a small scale became a ruined venture on a larger one ways of business funding are multiplying but the traditional up front variety of venture capital remains popular reasons include founders and investors being eager to scale up as fast as possible to fill any market voids in their sector before other startups can emerge to compete also venture capitalists want as much of the growth as possible to occur when the company is in the private market so that the value of a potential initial public offering ipo pays the maximum return | |
what is evergreen funding | evergreen funding provides infusions of capital to a new or existing business at repeated intervals instead of all of it up front it keeps extending the maturity date of the debt | |
what is the traditional debt financing arrangement | with traditional debt financing venture capital is raised at the beginning of a startup s existence and has a set maturity date at which time principal and interest must be repaid | |
what are the benefits of evergreen funding | evergreen funding prevents a company from growing too fast and collapsing as a result of that growth the company knows that the money is available but is prevented from spending it unwisely and hastily | |
what is an evergreen loan | an evergreen loan is a loan that does not require the repayment of principal during the life of the loan or during a specified period of time in an evergreen loan the borrower is required to make only interest payments during the life of the loan evergreen loans are usually in the form of a line of credit that is continuously paid down leaving the borrower with available funds for credit purchases evergreen loans may also be known as standing or revolving loans | |
how an evergreen loan works | evergreen loans can take many forms and are offered through varying types of banking products credit cards and checking account overdraft lines of credit are two of the most common evergreen loan products offered by credit issuers evergreen loans are a handy type of credit because they revolve meaning users do not need to reapply for a new loan every time they need money they can be used by both consumers and businesses non revolving credit differs in that it issues a principal amount to a borrower when a loan is approved it then requires that a borrower pay a scheduled amount over the duration of the loan until the loan is paid off once the loan is repaid the borrower s account is closed and the lending relationship ends evergreen loans provide borrowers with monetary flexibility but require the ability to regularly make minimum monthly payments | |
how businesses and consumers use evergreen loans | in the credit market borrowers can choose from both revolving and non revolving credit products when seeking to borrow funds revolving credit offers the advantage of an open line of credit that borrowers can draw from over their entire life as long as they remain in good standing with the issuer revolving credit may also offer the advantage of lower monthly payments than non revolving credit with revolving credit issuers provide borrowers with a monthly statement and minimum monthly payment that they must make to keep their account current examples of evergreen loanscredit cards are one of the most common types of evergreen loans credit cards may be issued by a bank and added to a customer s account in addition to a checking account they may also be issued by other companies with which the consumer does not have additional account relationships credit card borrowers must complete a credit application which is based on their credit score and credit profile information is obtained from a credit bureau as a hard inquiry and used by underwriters for making a credit decision if approved a borrower is granted a maximum borrowing limit and issued a credit payment card for making transactions the borrower can make purchases with credit at any time up to the available limit the borrower pays down the card balance each month by making at least the minimum monthly payment which includes principal and interest making a monthly payment increases the available funds the borrower can use an overdraft line of credit is another common evergreen loan product utilized by borrowers and is associated with a borrower s checking account for approval borrowers must complete a credit application that considers their credit profile typically retail borrowers approved for overdraft credit accounts receive a maximum borrowing limit of approximately 1 000 the overdraft line of credit can be used to protect the borrower from overdrafts with funds immediately withdrawn from the line of credit account if insufficient funds are available in a customer s checking account borrowers may also take funds from the account through cash advances to their checking account for other purchases as well similar to a credit card account borrowers will receive monthly statements in regard to their line of credit account the statements provide details on the outstanding balance and the minimum monthly payments borrowers must make the minimum monthly payment to keep the account in good standing | |
what is ex ante | ex ante refers to future events that are based on forecasts or predictions rather than concrete results translated from latin it means before the event ex ante can be used to describe the potential returns of a particular security or company much of the analysis conducted in the markets is ex ante focusing on the impacts of long term cash flows earnings and revenue while this type of ex ante analysis focuses on company fundamentals it often relates to asset prices forecastingin finance any prediction or forecast ahead of an event before market participants become aware of the pertinent facts is ex ante research or analysis that financial professionals conduct is generally considered ex ante the information they provide in their reports isn t based on actual results because the event hasn t yet happened predictions are often based on a company or security s historical performance and may include outcomes in an ex ante analysis are not known for certain but making a prediction sets an expectation that serves as a basis of comparison versus reported actuals types of ex ante analysisinvestors commonly use ex ante earnings per share eps analysis in the aggregate consensus estimates help to set a baseline for corporate earnings it s also possible to gauge which analysts among the group covering a particular stock tend to be the most predictive when their expectations are notably above or below those of their peers analysts may also provide ex ante predictions when a merger is widely expected but before it takes place such analysis takes into account potential cost savings related to paring redundant activities as well as possible revenue synergies brought about by cross selling there s considerable uncertainty related to fundamental company performance following a merger the merger is the initial event but the ex ante analysis makes projections related to the next major upcoming event such as the first time the combined firm reports earnings it s often impossible to account for all the variables for every form of ex ante analysis the market sometimes behaves erratically that s why price targets that account for many fundamental variables sometimes miss the mark due to exogenous market shocks that affect nearly all stocks ex postex post is the opposite of ex ante it s latin for after the event and compares expectations versus actuals once the ex ante analysis s event passes looking back at predictions ex post helps to refine them going forward analysts and investors can use historic returns to make predictions on the performance of investments and companies as such any risks that an investor or other individual may experience in the future can be determined using statistical measurements based on the investment s long term returns investors advisers and analysts can use ex post analyses to calculate the largest scope of losses possible this doesn t include future market swings abnormalities or other unexpected events that may take place advantages and disadvantagesex ante analyses use past performance and allow investors and companies to better prepare themselves for every possible outcome of investing whether that s positive or negative using historical data makes investors analysts and companies more prepared to make important investment decisions however this type of analysis is only a prediction and isn t based on actual results as such it doesn t provide any concrete determinations nor does it account for unexpected events such as market swings investor sentiment or other surprising industry news investors and companies can prepare themselves for every possible outcomeuses past performance as its basishelps investors make better and more informed investment decisions | |
doesn t account for unexpected events or news | examplesuppose company abc is expected to report earnings on a certain date analysts at a research firm will use economic and financial data from its past and present operating conditions to predict its eps they may analyze the overall economic climate and whether the company s business operation costs might be affected by it they may also use past business decisions and earnings statements to hypothesize about the company s sales figures | |
what is an ex ante interest rate | the term ex ante interest rate refers to the real interest rate calculated before the actual rate is revealed the ex ante interest rate is what lenders and bond issuers publish for loans and bonds one of the key factors about the ex ante interest rate is that it isn t adjusted for inflation | |
how do analysts use ex ante in merger evaluations | experts break down and compare the revenue streams of both entities and determine how compatible they are with one another they can also use forecasting to determine if the merger will result in savings if a new company is formed by conducting a cost benefit analysis | |
what is an ex ante investment | ex ante investment commonly refers to a company s planned investment during a period and the investment expenditure that is intended ex post investment refers to the actual investment during the period the bottom linethere are many different ways for investors and companies to make important decisions about their investments one of the most common ways to do so is by conducting or reviewing ex ante analysis this type of research is done using forecasting by taking historical returns and performance into account this is common for earnings reports and other major events like mergers | |
what is the ex dividend date | the ex dividend date is one of four stages that companies go through when they pay dividends to their shareholders the ex dividend date determines whether the buyer of a stock will be entitled to receive its upcoming dividend the ex dividend date is typically one day before the record date if an investor purchases stock on the ex dividend date or after they will not be paid the next dividend payment understanding the ex dividend datea dividend is typically a cash payment that a company pays to its shareholders as a reward for investing in its stock or equity shares as companies generate a profit they usually accumulate or save those profits in an account called retained earnings some companies reinvest those retained earnings back into the company while others may take a portion of retained earnings and pay it back to shareholders through dividends depending on your broker s trading platform you may see an xd footnote or suffix added to the stock s ticker symbol to indicate it is trading ex dividend to understand the ex dividend date we need to understand the stages companies go through when they pay dividends to their shareholders below are the four key dates during the process of issuing a dividend the first of these stages is the declaration date this is the date on which the company announces that it will be issuing a dividend in the future the second stage is the record date which is when the company examines its current list of shareholders to determine who will receive dividends only those who are registered as shareholders in the company s books as of the record date will be entitled to receive dividends the third stage is the ex dividend date which is the date that determines which of these shareholders will be entitled to receive the dividend typically the ex dividend date is set one business day before the record date 1shareholders who bought the stock on the ex dividend date or after will not receive a dividend however shareholders who owned their shares at least one full business day before the ex dividend date will be entitled to receive a dividend the fourth and final stage is the payable date also known as the payment date the payable date is when the dividend is actually paid to eligible shareholders ex dividend date and the stock pricemany investors want to buy their shares before the ex dividend date to ensure that they are eligible to receive the upcoming dividend however if you find yourself buying shares and realizing that you missed the ex dividend date you may not have missed out as much as you thought this is because share prices usually drop by the amount of the dividend on the ex dividend date this makes sense because the company s assets will soon be declining by the amount of the dividend 1let s say a company announces a dividend equivalent to 2 of its stock price its stock may decline by 2 on the ex dividend date therefore if you bought the shares on or shortly after the ex dividend date you may have obtained a discount of about 2 relative to the price you would have paid shortly before the ex dividend date in this way you may not have been any worse off than the investors who purchased the stock before the ex dividend date and received the dividend because stocks usually decline in price on the ex dividend date investors who missed buying the stock before the ex dividend date may be able to get the stock at a discount equal to the dividend on or after the ex dividend date example of an ex dividend dateto illustrate this process consider a company that declares an upcoming dividend on tuesday july 30 if the record date is thursday aug 8 the ex dividend date would be wednesday aug 7 meaning anyone who bought the stock on aug 7 or later would not receive a dividend conversely shareholders who bought their shares on tuesday aug 6 or earlier would be entitled to receive a dividend since it s one business day before the ex dividend date in our example the payable date is sept 6 the payable date can vary depending on the preferences of the company but will always be the last of the four dates the table below highlights what the key dividend dates might be in our example | |
is it better to buy before or after the ex dividend date | while it might seem to make sense to buy before the ex dividend date so you can receive the dividend buying after has perks too that s because the market usually adjusts the stock price to reflect the dividend payout meaning you ll typically see a reduction in price equal to the amount of the dividend will i get a dividend if i sell before the ex date no you won t get the dividend if you sell before the ex date because you would not be recorded as an investor entitled to dividends on the record date you ll need to hold the shares until the ex date or later to receive the payout | |
how long should i hold a stock to get the dividend | to get the dividend you need to hold the stock at least until the ex dividend date if you sell before the ex dividend date you also sell your right to the dividend 1the bottom lineif you re looking to receive dividends knowing when to buy sell and hold a dividend paying stock is important you ll need to buy before the ex dividend date and sell on the ex dividend date or after if you hope to receive the dividend for that stock if you buy after the ex dividend date however you may still be able to take advantage of market adjustments that usually factor in the dividend reducing the purchase price accordingly | |
what is ex dividend | a dividend is a cash payment to shareholders as a reward for investing in company stock or equity shares ex dividend means a company s dividend allocations have been specified the ex dividend date or ex date is usually one business day before the record date investors who purchase a stock on its ex dividend date or after will not receive the next dividend payment instead the seller gets the dividend investors only get dividends if they buy the stock before the ex dividend date ex dividend datea stock trades ex dividend on and after the ex dividend date or ex date investors who buy a stock on the ex dividend date or after will not receive the next dividend payment since buyers aren t entitled to the next dividend payment on the ex date the stock will be priced lower by the amount of the dividend by the exchange 1some broker platforms might use an xd suffix to the stock s ticker to indicate it is trading ex dividend declaring dividends | |
when a company declares a dividend its board of directors establishes a record date when investors must be on record as shareholders to receive the dividend payment once the record date is set the ex dividend date is also determined according to the exchange rules on which the stock is traded | the ex dividend date is one business day before the record date for example if a company declares a dividend on march 3 with a record date of monday april 11 the ex dividend date would be friday april 8 because it s one business day before the record date 1 the ex dividend date is before the record date because of how stock trades are settled after a stock trade the transaction isn t settled for one business day known as the t 1 settlement investors with stock on thursday april 7 that is sold on friday april 8 would still be the shareholder of record on monday april 11 because the trade hasn t settled however if the stock sold on wednesday april 6 the trade would be settled on thursday april 7 before the ex dividend date of friday april 8 and the new buyer would be entitled to the dividend stock price and ex dividendon average a stock price will drop slightly less than the dividend amount given that stock prices move daily the fluctuation caused by small dividends may be difficult to detect the effect on stocks from larger dividend payments can be easier to observe if a company issues a dividend in stock instead of cash or the cash dividend is 25 or more of the value of the stock the ex dividend date rules differ with a stock or large cash dividend the ex dividend date is set on the first business day after the dividend is paid 1key dividend related dates | |
what is an example of a dividend payment | suppose company xyz pays a 0 53 per share dividend on june 2 2024 the payment goes to shareholders who had purchased stock before the ex date of may 5 2024 the company declared the dividend on feb 19 2024 and the record date was set as may 6 2024 only shareholders who purchased the stock before the ex dividend date are entitled to the payment | |
why does the stock price fall on the ex dividend date | the price of a stock tends to fall by the amount of the dividend on its ex dividend date reflecting that its assets will soon be dropping by the amount of the dividend | |
how does the ex dividend date help investors | if an investing strategy is focused on income knowing when the ex date occurs helps investors plan their trade entries however because the stock s price drops by about the same value as the dividend buying a stock right before the ex date shouldn t result in any profits the same applies if investors buy on or after the ex date and get a discount for the dividend they won t receive the bottom linethe ex dividend date is one of four steps a company follows when paying dividends the declaration date is when a company states its plans to issue a dividend the record date is when the company determines which shareholders are entitled to a dividend the ex dividend date is usually the day before the record date the payment date is the day when dividend payments are made correction nov 28 2023 this article has been corrected to state the date when a new buyer would be entitled to a dividend | |
what is an ex gratia payment | an ex gratia payment is made to an individual by an organization government or insurer for damages or claims but it does not require the admittance of liability by the party making the payment an ex gratia payment is considered voluntary because the party making the payment is not obligated to compensate the individual in latin ex gratia means by favor understanding ex gratia paymentsex gratia payments differ from legally mandated payments because ex gratia payments are voluntary usually organizations governments and insurers will only provide compensation to victims if they are legally required to do so because of this ex gratia payments are not very common in the case of an insurance company if a policyholder suffers an injury that is covered by the terms of their insurance policy the insurer is legally obligated to pay for the claim this type of payment is not voluntary it is the result of a legal obligation and it typically carries with it an admission of liability a company may make ex gratia payments in cases where the recipient has experienced a loss however such a transaction is not considered an admission of liability in contrast an ex gratia payment is a gesture of goodwill the type of payment is made following a specific loss or damage to a property an ex gratia payment does not carry with it any admission of liability a company providing a one time credit to its customers would not be considered to be making an ex gratia payment because the payment is not related to a specific loss however a company that provides a credit after a service disruption would be considered to be making an ex gratia payment an organization may use ex gratia payments as part of a longer term strategy to maintain good relations with the individual receiving the payment for example a large retailer that is forced to reduce staff may provide a severance payment that is larger than the legal requirement the retailer may determine that this gesture of goodwill will reduce the negative publicity generated by the layoffs similarly british airways often gives an ex gratia payment card to past customers who may have been inconvenienced to maintain good customer relations 1special considerationsex gratia payments in the u s are typically subject to federal and state income taxes however in the united kingdom ex gratia payments under 30 000 are not taxable as long as the payment is not for work undertaken or services rendered 2while the first 30 000 of an ex gratia payment made to you will be tax free taxpayers in the united kingdom must inform her majesty s revenue and customs hmrc of the payment at the end of the tax year in order to guarantee that they do not have to pay any income tax or national insurance on it | |
what is ex post | ex post is another word for actual returns and is latin for after the fact the use of historical returns has customarily been the most well known approach to forecast the probability of incurring a loss on investment on any given day ex post is the opposite of ex ante which means before the event sydney saporito investopediaunderstanding ex postex post information is attained by companies to forecast future earnings ex post information is utilized in studies such as value at risk var a probability study that approximates the maximum amount of loss that an investment portfolio may incur on any day var is defined for a specified investment portfolio probability and time horizon ex post yield differs from ex ante yield because it represents actual values essentially what investors earn rather than estimated values investors base their decisions on expected returns vs actual returns which is an important aspect of an investment s risk analysis ex post is the current market price minus the price that the investor paid it shows the performance of an asset however it excludes projections and probabilities calculating ex postex post is calculated using the beginning and ending asset values for a specific period any growth or decline in the asset value plus any earned income produced by the asset during the period analysts use ex post data on investment price fluctuations earnings and other metrics to predict expected returns it is measured against the expected return to confirm the accuracy of risk assessment methods ex post is best used for periods less than a year and measures the yield earned for an investment year to date for example for a march 31 quarterly report the actual return measures how much an investor s portfolio has increased in percentage from jan 1 to march 31 if the number is 5 then the portfolio gained 5 since jan 1 ex post analysisex post performance attribution analysis or benchmark analysis gauges the performance of an investment portfolio based on the return of the portfolio and its correlation with numerous factors or benchmarks ex post analysis is the traditional approach of performance analysis for long only funds ex post performance analysis typically centers on regression analysis an analyst executes a regression of the portfolio s yields vs the returns of the market index to determine how much of a portfolio s profit and loss might be the result of market exposure the regression provides the portfolio s beta to the market index and the amount of alpha the fund was gaining or losing in relation to the market index ex post forecastingthe formula for calculating ex post is ending value beginning value beginning value the beginning value is the market value when an asset was purchased the ending value is the current market value of an asset ex post is a forecast prepared at a certain time that uses data available after that time the forecasts are created when future observations are identified during the forecasting period it is used to observe known data to assess the forecasting model | |
how is ex post information used | companies attain ex post information to forecast future earnings | |
how does ex post factor into analysis | ex post performance attribution analysis gauges an investment portfolio s performance based on the portfolio s return and its correlation with numerous factors or benchmarks it is also known as benchmark analysis | |
what is the formula for ex post | subtract beginning value from ending value and divide the result by beginning value to determine ex post the bottom lineex post which translates from latin as after the fact is a word for actual returns ex post analysis views financial results after they have occurred and utilizes them to predict the likelihood of future returns | |
what is ex works exw | ex works exw is an international trade term that describes when a seller makes a product available at a designated location and the buyer of the product must cover the transport costs ex works exw is one of the 11 current incoterms international commercial terms a set of standardized international trade terms published by the international chamber of commerce 1investopedia jiaqi zhouunderstanding ex works exw ex works exw requires a seller to safely package goods label them appropriately and deliver them to a previously agreed upon location such as the seller s nearest port the seller must also help the buyer get export licenses or other required paperwork although the buyer must pay the actual fees for the documents once the buyer has the goods it is up to the buyer to cover any expenses and account for any risks that pertain to the goods risks could include loading the products onto a truck transferring them to a ship or plane dealing with customs officials unloading them at their destination and storing or reselling them even if the seller helps the buyer by loading the product onto a ship it s still up to the buyer to pay if anything goes wrong during the loading with ex works the seller can load the goods on the buyer s designated method of transport but is not required to do so all the seller is required to do is make the product available at a selected location while the buyer pays for transport example of ex worksex works costs are calculated by businesses that want to cut costs by removing the so called seller s value added for shipping for example suppose company a has priced a pair of printers from company b at 4 000 with an ex works shipping cost of 200 to save money company a finds a third party shipper to deliver the printers for 170 so to save the 30 on shipping they make an ex works deal with company b an ex works agreement differs from a free on board fob agreement where the seller covers the cost of getting its goods to a shipping terminal and pays all the customs costs to get them on board 2 meanwhile the buyer still has to pay to find contract and pay the shipping company as well as the customs costs incurred when the goods reach their country of destination in addition the buyer also pays the insurance costs ex works vs fobex works is the obligation on the buyer s part to incur the costs of loading goods for transport free on board fob is the term used to refer to the seller s obligation to load goods fob is used only for sea or inland waterway transport under fob the seller is responsible for delivering the goods on board the vessel nominated by the buyer at the named port of shipment the seller also handles export clearance the risk transfers to the buyer when the goods are on board the vessel and the buyer bears all costs from that point onward generally fob transfers ownership of goods to the buyer once they are loaded on the buyer s transportation method however there is a possibility that the seller might remain responsible for them during transport to the final destination this depends on the contract and the terms the buyer and seller have agreed on ex works places almost all responsibility on the buyer while fob requires the seller to handle more of the export process and initial transportation fob is generally more favorable to the buyer compared to ex works responsibilities under ex worksunder exw the buyer assumes most responsibilities once they collect the purchased goods from the seller some of the duties transferred include sellers in an exw agreement in contrast to buyers have very few responsibilities generally they are responsible for packing the goods to be loaded and transported and providing a place for the buyer to pick them up advantages and disadvantages of ex worksallows buyers to consolidate multiple purchasesability to anonymize a supplierleast expensive optionallows buyers to purchase in the domestic marketbuyer assumes all risk and costsneed a trusted representative in the country goods are purchased fromyou might pay more than intended if you re unfamiliar with the process and costsincotermsex works free on board and free carrier are all part of the international chamber of commerce s incoterms 1 they are used in international trade contracts to outline matters including the time and place of delivery and payment when the risk of loss shifts from the seller to the buyer and the party responsible for paying the freight and insurance costs the incoterms aren t actual contracts and don t supersede the governing law in their jurisdiction incoterms can be modified by explicit clauses in a trade contract incoterms were first established in 1936 and the current version incoterms 2020 has 11 terms 3 these are often identical in form to domestic terms such as the american uniform commercial code but may have different meanings additionally other countries and jurisdictions that govern import and export may have different methods of calculating duties on shipping based on their incoterms as a result parties to a contract must indicate the governing law of their terms 4 | |
what does ex works mean in incoterms | ex works is a term used in shipping arrangements where the seller is only required to deliver goods at a predetermined location and the buyer bears responsibility for shipping costs along with these costs the buyer assumes responsibility for the related risks of the goods which may include anything from customs regulations to loading and transferring to other ships ex works falls under the incoterms international commercial terms a standard framework of 11 terms designed to clarify various trade contracts 1 | |
what is the difference between ex works and fob | in shipping arrangements the difference between free on board and ex works is based on transferring the liability of goods between the buyer and seller in free on board contracts the seller takes responsibility for bringing goods to a terminal in addition to customs costs and loading the goods onto the ship the buyer meanwhile is liable for shipping costs insurance and customs costs at the final point of arrival in other words once the goods are shipped the buyer assumes liability and ownership of the goods known as fob origin or fob shipping point by contrast in an ex works agreement the seller is only responsible for delivering goods to an agreed upon location | |
what does ex works mean for shipping | with an ex works agreement the seller saves on shipping customs and liability for damaged goods after being delivered packaged and labeled at the shipping terminal while this may be optimal sometimes for sellers it is not always possible due to customs requirements in certain jurisdictions take the european union for example which restricts non resident corporations from completing export declaration forms in this case an ex works contract would be detrimental to both the seller and the buyer in contrast a free carrier contract that bears shipping responsibility on the seller could offer a more suitable alternative | |
how does insurance work with ex works terms | under ex works terms the responsibility for insurance falls entirely on the buyer since the risk transfers to the buyer as soon as the goods are made available at the seller s premises the buyer must arrange insurance coverage from this point onward who arranges customs documentation in ex works in ex works terms the buyer is responsible for arranging all customs documentation both for export and import this includes obtaining any necessary export licenses or permits from the seller s country as well as managing import documentation in the destination country the bottom lineex works is an international trading agreement that spells out the responsibilities of the buyer and seller under an exw agreement the buyer accepts all responsibilities and costs of picking up and transporting goods to their desired destination under specific circumstances an exw agreement is less expensive than the fob alternative but the buyer must be prepared for and know the costs of transporting goods to the place they want them the best instances for using an exw are when the seller cannot export goods or when the buyer intends to consolidate purchases to reduce costs | |
what is excess capacity | excess capacity is a condition that occurs when demand for a product is less than the amount of product that a business could potentially supply to the market when a firm is producing at a lower scale of output than it has been designed for it creates excess capacity the term excess capacity is generally used in manufacturing if you see idle workers at a production plant it could imply that the facility has excess capacity however excess capacity can also apply to the service sector in the restaurant industry for example there are establishments that chronically have empty tables along with a staff that appears unproductive this inefficiency indicates that the venue can accommodate more guests but that the demand for that restaurant is not equal to its capacity | |
what causes excess capacity | some factors that can cause excess capacity are overinvestment repressed demand technological improvement and external shocks such as a financial crisis among other components excess capacity can also arise from mispredicting the market or by allocating resources inefficiently to remain healthy and financially balanced a company s management needs to stay attuned to the realities of supply and demand | |
why does excess capacity matter | although excess capacity can indicate healthy growth too much excess capacity can hurt an economy if a company cannot sell a product for an amount at or above its production cost then the company could lose money by selling the product for less than it paid to make the product or the product could just go to waste by just sitting on the shelf if a company needs to close a plant because of having too much capacity then jobs are lost and resources are wasted a company with a lot of excess capacity can lose sizable amounts of money if the business cannot pay for the high fixed costs that are associated with production on the other hand excess capacity can benefit consumers as a company can utilize its excess capacity to offer customers special discounted prices companies also may choose to maintain excess capacity deliberately as part of a competitive strategy to deter or prevent new firms from entering their market example of excess capacity chinasince 2009 the chinese economy has been engulfed in its third round of excessive capacity earlier periods of excess capacity ran between 1998 and 2001 and again between 2003 and 2006 even though china became the world s second largest economy in 2010 it continues to face both internal and external economic challenges excess capacity in china s manufacturing industries including steel cement aluminum flat glass and especially automobiles is one of its biggest challenges excess capacity potential output actual outputthe chinese government has taken numerous steps to address this problem but it continues still in industrial economies excess capacity is generally a short term condition that is self correcting however the severity and persistence of excess capacity in china s manufacturing sectors suggest that there are deeper more fundamental issues within the chinese economy these problems also have significant implications for international trade given the growing influence of china in the global marketplace typically auto assembly plants have a lot of fixed costs to cover also most new factories in china depend on economic incentives from local governments so there is pressure to keep the factories open and people employed whether they can sell the excess output or not moreover all of those extra cars need to find a home which could mean price wars and lower profits in china s domestic market along with a flood of exports to the u s and elsewhere for companies like general motors gm who now derive significant sales and earnings from china that cannot be good news one issue is that there is little incentive to remove excess capacity from the chinese market nobody wants to close a relatively new factory in china and risk the acrimony of a local government also after almost two decades it seems improbable that the excess capacity trend in china would abate any time soon coronavirus covid 19 slammed the auto industry amid the outbreak in february 2020 china experienced a greater than 80 decline in auto sales but because more than 80 of the world s auto supply chain is connected to china production shortfalls resulting from disruptions to the auto industry in china affected automakers across the globe most of the world s automotive and related companies believe that the covid 19 pandemic would have a direct impact on their 2020 revenues because covid 19 originated in china china also likely would begin its recovery from the pandemic earlier than europe and north america yet it is still too soon to know for certain not only what the long term economic effects of covid 19 will be but also the degree to which this newest setback would affect china s historically troubled relationship with the phenomenon of excess capacity | |
what is excess cash flow | excess cash flow is a term used in loan agreements or bond indentures and refers to the portion of cash flows of a company that are required to be repaid to a lender excess cash flow is typically cash received or generated by a company in the form of revenues or investments that triggers a payment to the lender as stipulated in their credit agreement since the company has an outstanding loan with one or more creditors certain cash flows are subject to various earmarks or restrictions for usage by the company understanding excess cash flowsexcess cash flows conditions are written into loan agreements or bond indentures as restrictive covenants to provide additional cover for credit risk for lenders or bond investors if an event occurs that results in excess cash flows as defined in the credit agreement the company must make a payment to the lender the payment could be made a percentage of the excess flow which is usually dependent on what event generated the excess cash flow lenders thus impose restrictions on how excess cash can be spent in an effort to maintain control of the company s cash flow but the lender must also be careful that these restrictions and limitations are not so strict that they impede the company s financial standing or ability to grow which could end up causing self inflicted harm to the lender lenders define what is considered an excess cash flow usually by a formula that consists of a percentage or amount above and beyond expected net income or profit over some time period however that formula will vary from lender to lender and it is up to the borrower to negotiate these terms with the lender events triggering mandatory paymentsif a company raises additional capital through some funding measure such as a stock issuance the company would likely be required to pay the lender the amount generated minus any expenses that occurred to generate the capital for example if a company issues new equity in a secondary offering the money raised would trigger a payment to the lender also if a company issued debt through a bond offering the proceeds would likely trigger a payment to the lender asset sales could also trigger a payment a company might have investments or hold shares such as a minority interest in other companies if the company sold those investments for a profit the lender would likely require payment for those funds proceeds earned from a spin off acquisition or windfall income from winning a lawsuit may also trigger the clause exceptions to excess cash flowcertain asset sales might be excluded from triggering a payment such as the sale of inventory a company in its normal course of operation might need to buy and sell inventory to generate its operating income as a result it s likely that an asset sale which comprises of inventory would be exempt from a prepayment obligation other operating expenses or capital expenditures capex might be exempt from triggering a payment such as cash used as deposits to land new business or cash held at a bank that s used to help pay for a financial product that hedges market risk for the company calculating excess cash flowsthere is no set formula for calculating excess cash flows since each credit agreement will tend to have somewhat different requirements that will result in a payment to the lender an approximation of a calculation of excess cash flow could begin with taking the company s profit or net income adding back depreciation and amortization and deducting capital expenditures that are necessary to sustain business operations and dividends if any in other words a credit agreement might outline an amount of excess cash flow that triggers a payment but also how cash is used or spent a lender might allow cash to be used for business operations possibly dividends and certain capital expenditures the terms defining excess cash flow and any payments are typically negotiated between the borrower and the lender if excess cash flow is generated a lender might require a payment that is 100 75 or 50 of the excess cash flow amount excess cash vs free cash flowsfree cash flow i fcf s the cash a company produces through its operations less the cost of expenditures on assets in other words free cash flow is the cash left over after a company pays for its operating expenses and capital expenditures fcf shows how efficient a company is at generating cash investors use free cash flow to measure whether a company might have enough cash after funding operations and capital expenditures to pay investors through dividends and share buybacks the excess cash flow amount for a company is different than a company s free cash flow figure excess cash flow is defined in the credit agreement which might stipulate for certain expenditures to be excluded in the calculation of excess cash flow exceptions to excess cash flow might be taxes paid cash used to generate new business but these cash outlays would be included in the free cash flow calculation conceptual example of excess cash flowin 2010 dunkin brands inc entered into a credit agreement with barclays bank plc and a number of other lenders party to the agreement for a us 1 25 billion term b loan and 100 million revolver lines of credit below are the legal terms used in the credit agreement defining excess cash flow under defined terms of the agreement excess cash flow is spelled out in a verbal formula as an amount equal to the excess of over all the capitalized terms in the above excerpt are defined terms in the agreement the excess of a items over b items are carefully laid out as the definition of excess cash flow the highlighted items in the above example are by no means exhaustive instead they illustrate the fine details of a definition of excess cash flow as with any financial metric there are limitations to using excess cash flow as a measure of a company s performance the amount that s considered excess is determined by the lender and doesn t represent the true cash flow of the company since items are excluded from its calculation to help the business improve its performance to ensure repayment of the debt a numerical examplesay that hypothetical company a has the following financial results at the end of the year assume that both capex and the interest paid are allowed under the credit agreement meaning the company can use cash for those expenses however any cash left over after deducting the expenses from net income would be considered excess and trigger a payment to the lender | |
what is excess of loss reinsurance | excess of loss reinsurance is a type of reinsurance in which the reinsurer indemnifies or compensates the ceding company for losses that exceed a specified limit a reinsurer is a company that provides financial protection to insurance companies a ceding company is an insurance company that transfers the insurance portfolio to a reinsurer excess of loss reinsurance is a form of non proportional reinsurance non proportional reinsurance is based on loss retention with non proportional reinsurance the ceding company agrees to accept all losses up to a predetermined level depending on the language of the contract excess of loss reinsurance can apply to either all loss events during the policy period or losses in aggregate treaties may also use bands of losses that are reduced with each claim reinsurers and ceding companies will use cost calculations such as the burning cost ratio to determine prices understanding excess of loss reinsurancetreaty or facultative reinsurance contracts often specify a limit in losses for which the reinsurer will be responsible this limit is agreed to in the reinsurance contract it protects the reinsurance company from dealing with unlimited liability in this way treaty and facultative reinsurance contracts are similar to a standard insurance contract which provides coverage up to a specific amount while this is beneficial to the reinsurer it places the onus on the insurance company to reduce losses excess of loss reinsurance takes a different approach than treaty or facultative reinsurance the reinsurance company is held responsible for the total amount of losses above a certain limit for example a reinsurance contract with an excess of loss provision may indicate that the reinsurer is responsible for losses over 500 000 in this case if aggregate losses amount to 600 000 then the reinsurer will be responsible for 100 000 excess of loss reinsurance can also work in a slightly different way rather than require the reinsurer to be responsible for all losses over a certain amount the contract may instead indicate that the reinsurer is responsible for a percentage of losses over that threshold this means that the ceding company and the reinsurer will share aggregate losses for example a reinsurance contract with an excess of loss provision may indicate that the reinsurer is responsible for 50 of the losses over 500 000 in this case if aggregate losses amount to 600 000 the reinsurer will be responsible for 50 000 and the ceding company will be responsible for 50 000 by covering itself against excessive losses an excess of loss reinsurance policy gives the ceding insurer more security for its equity and solvency it can also provide more stability when unusual or major events occur reinsurance also allows an insurer to underwrite policies that cover a larger volume of risks without excessively raising the costs of covering their solvency margins the amount by which the assets of the insurance company at fair values are considered to exceed its liabilities and other comparable commitments in fact reinsurance makes substantial liquid assets available for insurers in case of exceptional losses | |
what are excess reserves | excess reserves are capital reserves held by a bank or financial institution above amounts required by regulators creditors or internal controls for commercial banks excess reserves are measured against standard reserve requirement ratios set by central banking authorities these required reserve ratios set the minimum liquid deposits such as cash that must be in reserve at a bank more is considered excess excess reserves may also be known as secondary reserves these funds are different from free reserve money free reserves are excess funds held less money from the fed s discount window borrowing | |
how excess reserves are used | reserves are designed to be a safety buffer for banks who might not anticipate the need for extra capital in their daily operations the idea of excess reserves was created alongside an incentive called interest on excess reserves in which the federal reserve paid banks interest on funds that exceeded reserve requirements financial institutions that carry excess reserves are thought to have an extra measure of safety in the event of sudden loan loss or significant cash withdrawals by customers history of excess reserves in the u s reserves have been a part of banking in the u s since the 1800s state laws enacted after a real estate bubble and bad banking practices caused a crash in 1837 began requiring reserves 1 these requirements changed over time to deal with other financial industry and economic circumstances eventually leading up to the monetary policies of the late twentieth and early twenty first centuries the financial services regulatory relief act of 2006 authorized the federal reserve to pay banks a rate of interest for the first time suddenly and for the first time in history banks were incentivized to hold reserves with a central bank 2 the rule was to go into effect on oct 1 2011 however the great recession advanced the decision following the passing of the emergency economic stabilization act of 2008 in the years following excess reserves hit a record 2 7 trillion in august 2014 due to quantitative easing qe payouts after the great financial crisis and the recession it caused 3 between january 2019 and february 2020 excess reserves ranged between 1 3 trillion and 1 6 trillion proceeds from qe were paid to banks by the federal reserve in the form of reserves not cash banks kept this money in reserve to allow it to gain interest the image below demonstrates the increase in reserve balances after qe and ioer were implemented note the sudden steep climb in excess reserves in the shaded area that indicates a recession where qe was used levels remained elevated after qe was discontinued in 2014 although it did decline suggesting that banks continued to take advantage of the interest offered by the fed on excess reserves federal reserve bank of st louisthe mini recession caused by the covid 19 pandemic and qe implemented by the fed once again increased the excess reserve balance to more than 3 2 trillion although interest rates on reserves had dropped from a high of 2 4 in april 2019 to 0 1 in march 2020 4in 2020 the federal reserve eliminated requirements for u s banks to hold reserves by dropping the required reserve ratio to zero when the fed removed reserve requirements it implemented a program in which voluntary reserve balances would be paid interest this is called interest on reserve balances iorb which is used to help create a floor for the rates that banks charge each other overnight 5factors that affected excess reserve balancesmany factors affected banks use of excess reserves one of the main factors is the interest paid on excess reserves when the fed implemented ioer the interest it paid on the excess reserves reduced the forgone interest costs banks incurred for holding funds in reserve the fed was pumping money into the economy via quantitative easing into reserve accounts which increased the amount banks held instead of using the money to issue loans to consumers and businesses the banks left the money in reserve to act as a cost buffer another factor that determined how much banks kept in excess reserves was their bottom line a bank needs to manage its reserves to maintain liquidity and cover the transactions it anticipates in the short term so banks kept as much as they were required to in reserve and then determined if they benefitted financially from keeping amounts above that requirement 6 | |
what is the difference between excess and required reserves | required reserves are the amount of capital a nation s central bank makes depository institutions hold in reserve to meet liquidity requirements excess reserves are amounts above and beyond the required reserve set by the central bank | |
what happens if banks keep excess reserves | it depends on the circumstances if the central bank pays interest many banks will likely hold more excess reserves to offset the costs of having reserve capital but there is an opportunity cost to consider the question banks have to answer is if it is financially more beneficial to lend that money and generate interest income or to have it in reserve for liquidity purposes | |
are excess reserves a liability | if there is interest paid on reserves or excess reserves it is a liability for the central bank because it owes money the bottom lineexcess reserves is capital held above and beyond any requirement for banks to hold a specific amount of money in reserve the federal reserve discontinued its reserve requirements in 2020 thus eliminating the concept of excess reserves central banks in other countries may still use excess reserves to ensure bank liquidity in fact the international monetary fund publishes guidance for central banks on using reserves and excess reserves in their operations demonstrating that it is still a viable tool in some economies 7 | |
what are excess returns | excess returns are returns achieved above and beyond the return of a proxy excess returns will depend on a designated investment return comparison for analysis some of the most basic return comparisons include a riskless rate and benchmarks with similar levels of risk to the investment being analyzed investopedia matthew collinsunderstanding excess returnsexcess returns are an important metric that helps an investor to gauge performance in comparison to other investment alternatives in general all investors hope for positive excess return because it provides an investor with more money than they could have achieved by investing elsewhere excess return is identified by subtracting the return of one investment from the total return percentage achieved in another investment when calculating excess return multiple return measures can be used some investors may wish to see excess return as the difference in their investment over a risk free rate other times an excess return may be calculated in comparison to a closely comparable benchmark with similar risk and return characteristics using closely comparable benchmarks is a return calculation that results in an excess return measure known as alpha in general return comparisons may be either positive or negative a positive excess return shows that an investment outperformed its comparison while a negative difference in returns occurs when an investment underperforms investors should keep in mind that purely comparing investment returns to a benchmark provides an excess return that does not necessarily take into consideration all of the potential trading costs of a comparable proxy for example using the s p 500 as a benchmark provides an excess return calculation that does not typically take into consideration the actual costs required to invest in all 500 stocks in the index or management fees for investing in an s p 500 managed fund excess return vs riskless ratesriskless and low risk investments are often used by investors seeking to preserve capital for various goals u s treasuries are typically considered the most basic form of riskless securities investors can buy u s treasuries with maturities of one month two months three months six months one year two years three years five years seven years 10 years 20 years and 30 years 12each maturity will have a different expected return found along the u s treasury yield curve 3 other types of low risk investments include certificates of deposits money market accounts and municipal bonds investors can determine excess return levels based on comparisons to risk free securities for example if the one year treasury has returned 2 0 and the technology stock meta formerly facebook has returned 15 then the excess return achieved for investing in meta is 13 oftentimes an investor will want to look at a more closely comparable investment when determining excess return that s where alpha comes in alpha is the result of a more narrowly focused calculation that includes only a benchmark with comparable risk and return characteristics to an investment alpha is commonly calculated in investment fund management as the excess return a fund manager achieves over a fund s stated benchmark broad stock return analysis may look at alpha calculations in comparison to the s p 500 or other broad market indexes like the russell 3000 when analyzing specific sectors investors will use benchmark indexes that include stocks in that sector the nasdaq 100 for example can be a good alpha comparison for large cap technology in general active fund managers seek to generate some alpha for their clients in excess of a fund s stated benchmark passive fund managers will seek to match the holdings and return of an index consider a large cap u s mutual fund that has the same level of risk as the s p 500 index if the fund generates a return of 12 in a year when the s p 500 has only advanced 7 the difference of 5 would be considered as the alpha generated by the fund manager excess return vs risk conceptsas discussed an investor has the opportunity to achieve excess returns beyond a comparable proxy however the amount of excess return is usually associated with risk investment theory has determined that the more risk an investor is willing to take the greater their opportunity for higher returns as such there are several market metrics that help an investor to understand if the returns and excess returns they achieve are worthwhile beta is a risk metric quantified as a coefficient in regression analysis that provides the correlation of an individual investment to the market usually the s p 500 a beta of one means that an investment will experience the same level of return volatility from systematic market moves as a market index a beta above one indicates that an investment will have higher return volatility and therefore higher potential for gains or losses a beta below one means an investment will have less return volatility and therefore less movement from systematic market effects with less potential for gain but also less potential for loss beta is an important metric used when generating an efficient frontier graph for the purposes of developing a capital allocation line which defines an optimal portfolio asset returns on an efficient frontier are calculated using the following capital asset pricing model r a r r f r m r r f where r a expected return on a security r r f risk free rate r m expected return of the market beta of the security r m r r f equity market premium begin aligned r a r rf beta times r m r rf textbf where r a text expected return on a security r rf text risk free rate r m text expected return of the market beta text beta of the security r m r rf text equity market premium end aligned ra rrf rm rrf where ra expected return on a securityrrf risk free raterm expected return of the market beta of the securityrm rrf equity market premium beta can be a helpful indicator for investors when understanding their excess return levels treasury securities have a beta of approximately zero this means that market changes will have no effect on the return of a treasury and the 2 0 earned from the one year treasury in the example above is riskless meta on the other hand has a beta of approximately 1 29 so systematic market moves that are positive will lead to a higher return for meta than the s p 500 index overall and vice versa 4in active management fund manager alpha can be used as a metric for evaluating the performance of a manager overall some funds provide their managers a performance fee which offers extra incentive for fund managers to exceed their benchmarks in investments there is also a metric known as jensen s alpha jensen s alpha seeks to provide transparency around how much of a manager s excess return was related to risks beyond a fund s benchmark jensen s alpha is calculated by jensen s alpha r i r f r m r f where r i realized return of the portfolio or investment r f risk free rate of return for the time period beta of the portfolio of investment with respect to the chosen market index r m realized return of the appropriate market index begin aligned text jensen s alpha r i r f beta r m r f textbf where r i text realized return of the portfolio or investment r f text risk free rate of return for the time period beta text beta of the portfolio of investment text with respect to the chosen market index r m text realized return of the appropriate market index end aligned jensen s alpha ri rf rm rf where ri realized return of the portfolio or investmentrf risk free rate of return for the time period beta of the portfolio of investmentwith respect to the chosen market indexrm realized return of the appropriate market index a jensen s alpha of zero means that the alpha achieved exactly compensated the investor for the additional risk taken on in the portfolio a positive jensen s alpha means the fund manager overcompensated its investors for the risk and a negative jensen s alpha would be the opposite in fund management the sharpe ratio is another metric that helps an investor understand their excess return in terms of risk the sharpe ratio is calculated by sharpe ratio r p r f portfolio standard deviation where r p portfolio return r f riskless rate begin aligned text sharpe ratio frac r p r f text portfolio standard deviation textbf where r p text portfolio return r f text riskless rate end aligned sharpe ratio portfolio standard deviationrp rf where rp portfolio returnrf riskless rate the higher the sharpe ratio of an investment the more an investor is being compensated per unit of risk investors can compare sharpe ratios of investments with equal returns to understand where excess return is more prudently being achieved for example two funds have a one year return of 15 with a sharpe ratio of 2 vs 1 the fund with a sharpe ratio of 2 is producing more return per one unit of risk special considerationscritics of mutual funds and other actively managed portfolios contend that it is next to impossible to generate alpha on a consistent basis over the long term as a result investors are then theoretically better off investing in stock indexes or optimized portfolios that provide them with a level of expected return and a level of excess return over the risk free rate this helps to make the case for investing in a diversified portfolio that is risk optimized to achieve the most efficient level of excess return over the risk free rate based on risk tolerance this is where the efficient frontier and capital market line can come in the efficient frontier plots a frontier of returns and risk levels for a combination of asset points generated by the capital asset pricing model an efficient frontier considers data points for every available investment an investor may wish to consider investing in once an efficient frontier is graphed the capital market line is drawn to touch the efficient frontier at its most optimal point with this portfolio optimization model developed by financial academics an investor can choose a point along the capital allocation line for which to invest based on their risk preference an investor with zero risk preference would invest 100 in risk free securities the highest level of risk would invest 100 in the combination of assets suggested at the intersect point investing 100 in the market portfolio would provide a designated level of expected return with excess return serving as the difference from the risk free rate as illustrated from the capital asset pricing model efficient frontier and capital allocation line an investor can choose the level of excess return they wish to achieve above the risk free rate based on the amount of risk they wish to take on |
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