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is price to cash flow the same as price to free cash flow | price to cash flow accounts for all cash a company has price to free cash flow removes capital expenditures working capital and dividends so that you compare the cash a company has left over after obligations to its stock price as a result it is a better indicator of the ability of a business to continue operating | |
what is the price to free cash flow ratio | price to free cash flow p fcf is an equity valuation metric that compares a company s per share market price to its free cash flow fcf this metric is very similar to the valuation metric of price to cash flow but is considered a more exact measure because it uses free cash flow which subtracts capital expenditures capex from a company s total operating cash flow thereby reflecting the actual cash flow available to fund non asset related growth companies can use this metric to base growth decisions and maintain acceptable free cash flow levels understanding the price to free cash flow ratioa company s free cash flow is essential because it is a primary indicator of its ability to generate additional revenues which is a crucial element in stock pricing the price to free cash flow metric is calculated as follows price to fcf market capitalization free cash flow begin aligned text price to fcf frac text market capitalization text free cash flow end aligned price to fcf free cash flowmarket capitalization for example a company with 100 million in total operating cash flow and 50 million in capital expenditures has a free cash flow total of 50 million if the company s market cap value is 1 billion it has a ratio of 20 meaning its stock trades at 20 times its free cash flow 1 billion 50 million you might find a company that has more free cash flows than it does market cap or one that is very close to equal amounts of both for example a market cap of 102 million and free cash flows of 110 million would result in a ratio of 93 there is nothing inherently wrong with this if it is typical for the company s industry however suppose the company operates in an industry where comparable company market caps hover around 200 million in that case you may want to investigate further to determine why the business s market cap is low free cash flows or market caps that are non typical for a company s size and industry should raise the flag for further investigation the business might be in financial trouble or it might not it s critical to find out | |
how is the price to free cash flow ratio used | because the price to free cash flow ratio is a value metric lower numbers generally indicate that a company is undervalued and its stock is relatively cheap in relation to its free cash flow conversely higher price to free cash flow numbers may indicate that the company s stock is somewhat overvalued in relation to its free cash flow therefore value investors tend to favor companies with low or decreasing p fcf values that indicate high or increasing free cash flow totals and relatively low stock share prices compared to similar companies in the same industry the price to free cash flow ratio is a comparative metric that needs to be compared to something to mean anything past p fcf ratios competitor ratios or industry norms are comparable ratios that can be used to gauge value they tend to avoid companies with high price to free cash flow values that indicate the company s share price is relatively high compared to its free cash flow in short the lower the price to free cash flow the more a company s stock is considered to be a better bargain or value as with any equity evaluation metric it is most useful to compare a company s p fcf to that of similar companies in the same industry however the price to free cash flow metric can also be viewed over a long term time frame to see if the company s cash flow to share price value is generally improving or worsening the price to free cash flow ratio can be manipulated by a company for example you might find some that preserve cash levels in a reporting period by delaying inventory purchases or their accounts payable payments until after they have published their financial statements the fact that reported numbers can be manipulated makes it essential that you analyze a company s finances entirely to achieve a larger picture of how it is doing financially when you do this over a few reporting periods you can see what a company is doing with its cash how it is using it and how other investors value the company | |
what is a good price to free cash flow ratio | a good price to free cash flow ratio is one that indicates its stock is undervalued a company s p fcf should be compared to the ratios of similar companies to determine whether it is under or over valued in the industry it operates in generally speaking the lower the ratio the cheaper the stock is | |
is a high price to free cash flow ratio good | a high ratio one that is higher than is typical for the industry it operates in may indicate a company s stock is overvalued | |
is price to cash flow the same as price to free cash flow | price to cash flow accounts for all cash a company has price to free cash flow removes capital expenditures working capital and dividends so that you compare the cash a company has left over after obligations to its stock price as a result it is a better indicator of the ability of a business to continue operating | |
what is the price to sales p s ratio | the price to sales p s ratio is a valuation ratio that compares a company s stock price to its revenues it is an indicator of the value that financial markets have placed on each dollar of a company s sales or revenues investopedia candra huffunderstanding price to sales p s ratiothe p s ratio is a key analysis and valuation tool for investors and analysts the p s ratio shows how much investors are willing to pay per dollar of sales it can be calculated either by dividing the company s market capitalization by its total sales over a designated period usually twelve months or on a per share basis by dividing the stock price by sales per share the p s ratio is also known as a sales multiple or revenue multiple like all ratios the p s ratio is most relevant when used to compare companies in the same sector a low ratio may indicate the stock is undervalued while a ratio that is significantly above the average may suggest overvaluation the typical 12 month period used for sales in the p s ratio is generally the past four quarters also called trailing 12 months or ttm or the most recent or current fiscal year fy a p s ratio that is based on forecast sales for the current year is called a forward p s ratio to determine the p s ratio one must divide the current stock price by the sales per share the current stock price can be found by plugging the stock symbol into any major finance website the sales per share metric is calculated by dividing a company s sales by the number of outstanding shares p s ratio mvsspswhere mvs market value per sharesps sales per share begin aligned text p s ratio frac mvs sps textbf where mvs text market value per share sps text sales per share end aligned p s ratio spsmvs where mvs market value per sharesps sales per share as is the case with other ratios the p s ratio is of greatest value when it is used for comparing companies within the same sector the p s ratio doesn t take into account whether the company makes any earnings or whether it will ever make earnings comparing companies in different industries can prove difficult as well for example companies that make video games will have different capabilities when it comes to turning sales into profits when compared to say grocery retailers in addition p s ratios do not account for debt loads or the status of a company s balance sheet that is a company with virtually no debt will be more attractive than a highly leveraged company with the same p s ratio while the p s ratio doesn t take debt into account the enterprise value to sales ratio ev sales does the ev sales ratio uses enterprise value and not market capitalization like the p s ratio enterprise value adds debt and preferred shares to the market cap and subtracts cash the ev sales ratio is said to be superior although it involves more steps and isn t always as readily available examples of the price to sales p s ratioas an example consider the quarterly sales for acme co shown in the table below the sales for fiscal year 1 fy1 are actual sales while sales for fy2 are analysts average forecasts assume that we are currently in the first quarter or q1 of fy2 acme has 100 million shares outstanding with the shares presently trading at 10 per share at the present time acme s p s ratio on a trailing 12 month basis would be calculated as follows acme s p s ratio for the current fiscal year would be calculated as follows if acme s peers which we assume are based in the same sector and are of similar size in terms of market capitalization are trading at an average p s ratio ttm of 1 5 compared with acme s 2 2 it suggests a premium valuation for the company one reason for this could be the 14 3 revenue growth that acme is expected to post in the current fiscal year 520 million versus 455 million which may be better than what is expected for its peers taking that a step further consider apple s fiscal 2020 revenues of 274 5 billion 1 with 16 53 billion in outstanding shares as of sept 30 2021 apple s sales per share are 16 60 2 with a stock price of 145 it would give the company a p s ratio of 8 73 3in comparison google trades with a p s ratio of 6 29 and microsoft at 10 87 suggesting that apple and google may potentially be undervalued or microsoft might be overvalued 45 | |
why is the price to sales p s ratio useful to investors | the p s ratio also known as a sales multiple or revenue multiple is a key analysis and valuation tool for investors and analysts the ratio shows how much investors are willing to pay per dollar of sales it can be calculated either by dividing the company s market capitalization by its total sales over a designated period usually twelve months or on a per share basis by dividing the stock price by sales per share like all ratios the p s ratio is most relevant when used to compare companies in the same sector a low ratio may indicate the stock is undervalued while a ratio that is significantly above the average may suggest overvaluation | |
what are the limitations of the price to sales p s ratio | the p s ratio doesn t take into account whether the company makes any earnings or whether it will ever make earnings comparing companies in different industries can prove difficult as well for example companies that make video games will have different capabilities when it comes to turning sales into profits when compared to say grocery retailers in addition p s ratios do not account for debt loads or the status of a company s balance sheet | |
what is enterprise value to sales ev sales | enterprise value to sales ev sales measures how much it would cost to purchase a company s value in terms of its sales a lower ev sales multiple indicates that a company is a more attractive investment as it may be relatively undervalued essentially it uses enterprise value and not market capitalization like the p s ratio enterprise value adds debt and preferred shares to the market cap and subtracts cash since it does account for a company s debt load the ev sales ratio is said to be superior although it involves more steps and isn t always as readily available | |
what is price to tangible book value ptbv | price to tangible book value ptbv is a valuation ratio used to compare the price of a security to the company s physical assets as reported in its balance sheet the tangible book value number includes all physical assets but excludes intangible assets such as goodwill patents intellectual property and trademarks since intangibles are excluded ptbv is considered a more accurate estimate of the company s net value to shareholders after debts are paid in the event of liquidation understanding price to tangible book value ptbv a company s tangible assets are the things of value that it owns examples include machinery equipment raw materials inventories vehicles and buildings in theory a stock s tangible book value per share represents the amount of money an investor would receive for each share if a company were to cease operations and liquidate all of its assets at the value recorded on the company s accounting books in fact in the event of a liquidation common stock shareholders are last in line to be repaid after all of the company s creditors as a rule of thumb stocks that trade at higher ptbv ratios have the potential to leave investors with greater share price losses than those that trade at lower ratios since the tangible book value per share can reasonably be viewed as the lowest price at which a stock could trade | |
when to use price to tangible book value | ptbv is applicable mainly to industrial or capital intensive companies like auto manufacturers and oil refiners these companies have hard assets of high value ptbv is relatively meaningless as a valuation measure in the technology sector for instance because much of a tech company s valuation derives from its intellectual property an intangible asset calculating ptbv can be tricky in some instances such as for companies that have land that has been held for decades the land is stated on the books at its historical cost not marked up each year on the balance sheet resulting in a deceptively high ptbv ratio example of price to tangible book valueas of the quarter ending june 30 2023 the tangible book value of general motors was about 71 billion total net assets of 276 billion less 5 billion of goodwill and intangible assets minus about 200 billion in liabilities there were 1 4 billion shares outstanding yielding a tangible book value per share of about 50 7the closing price per share of gm on the last day of 2020 was 38 56 therefore ptbv was 71 50 7 or 1 4 an analyst could study the trend of this ratio or compare it with those of its peer group | |
how does ptbv differ from price to book p b | ptbv and price to book are nearly identical except p b includes the value of all assets including intangible assets ptbv excludes intangible assets such as intellectual property and goodwill | |
when is ptbv most useful | many of today s public companies derive most of their value from intangible assets and may not have very many tangible assets on their balance sheet thus ptbv is not a reasonable way to measure the company s value ptbv is most useful when evaluating capital intensive companies that rely on hard assets such as manufacturers or mining companies | |
what does ptbv represent | ptbv represents the market value of a company s shares as a multiple against the amount it would receive if it was forced to sell off all of its hard assets the bottom lineprice to tangible book value ptbv is one of many calculations that analysts may use in an effort to pinpoint the fair value of a public company s stock it is not particularly relevant to some companies such as today s technology giants because their true value lies in their intangible assets such as their intellectual property and patents it is more relevant when considering a manufacturer such as general motors or any company that relies heavily on its investments in machinery equipment or buildings | |
what does price value of a basis point mean | price value of a basis point pvbp is a measure used to describe how a basis point change in yield affects the price of a bond price value of a basis point is also known as the value of a basis point vbp dollar value of a basis point dvbp or basis point value bpv understanding price value of a basis point pvbp the price value of a basis point is a method of measuring the price sensitivity of a bond this is often established by assessing the absolute change in the price of a bond if the required yield changes by one basis point bps in other words pvbp is the price change of a bond when there is a 01 one basis point change in the yield price volatility is the same for an increase or a decrease of one basis point in required yield because this measure of price volatility is in terms of dollar price change dividing the pvbp by the initial price gives the percentage price change for a 1 basis point change in yield since there is an inverse relationship between bond price and yield as bond prices fall by decreasing dollar amounts their yields increase and vice versa the degree of change in bond price for each basis point change in yield is determined by a number of other factors such as the bond s coupon rate time to maturity and credit rating a bigger price value of a basis point means a bigger move in the bond s price due to a given change in interest rates pvbp can be calculated on an estimated basis from the modified duration as modified duration x dirty price x 0 0001 the modified duration measures the proportional change in the price of a bond for a unit change in yield it is simply a measure of the weighted average maturity of a fixed income security s cash flows as yields fall modified duration increases and a higher modified duration implies that a security is more interest rate sensitive the dirty price factored into the formula is defined as the total price paid for a bond after including accrued interest on the date of purchase let s assume an analyst wants to understand how a price change for a bond will affect the value of the security if yields change by 100 basis points the par value of the bond purchased at par is 10 000 and the price value of a basis point is given as 13 55 pvbp modified duration x 10 000 x 0 000113 55 modified duration x 1modified duration 13 55this means that if rates go down 100bp i e 1 the value of the bond will increase by 13 55 x 10 000 1 355 another way to look at this is to remember that the pvbp is the price change of a bond when there is a 1 basis point change in the yield in this case the pvbp is 13 55 therefore a change of 100 basis point in the yield will be 13 55 x 100 1 355 | |
what is a price weighted index | a price weighted index is a stock index in which each company included in the index makes up a fraction of the total index proportional to that company s share stock price per share in its simplest form adding the price of each stock in the index and dividing by the total number of companies determines the index s value a stock with a higher price will be given more weight than a stock with a lower price and will thus have a greater influence on the index s performance understanding a price weighted indexin a price weighted index a stock that increases from 110 to 120 will have the same effect on the index as a stock that increases from 10 to 20 even though the percentage move for the latter is far greater than that of the higher priced stock higher priced stocks exert a greater influence on the index s or the basket s overall direction to calculate the value of a simple price weighted index find the sum of the share prices of the individual companies and divide by the number of companies in some averages this divisor is adjusted in order to maintain continuity in the event of stock splits or changes to the list of companies included in the index price weighted indexes are useful because the index value will be equal to or at least proportionate to the average stock price for the companies included in the index this allows the construction of indexes that will track the average stock price performance of a specific sector or market one of the most popular price weighted stocks is the dow jones industrial average djia which consists of 30 different stocks or components in this index the higher price stocks move the index more than those with lower prices thus the price weighted designation the nikkei 225 is another example of a price weighted index other weighted indexesin addition to price weighted indexes other basic types of weighted indexes include value weighted indexes and unweighted indexes for a value weighted index like those in the msci family of strategy indexes the number of outstanding shares is a factor to determine the weight of each stock in a value weighted index the price of the stock is multiplied by the number of shares outstanding for example if stock a has five million outstanding shares and is trading at 15 then its weight in the index is 75 million if stock b is trading at 30 but only has one million outstanding shares its weight is 30 million so in a value weighted index stock a would have more say in how the index moves than stock b in an unweighted index all stocks have the same impact on the index no matter their share volume or price any price change in the index is based on the return percentage of each component for example if stock a is up 30 stock b is up 20 and stock c is up 10 the index is up 20 or 30 20 10 3 i e the number of stocks in the index other types of weighted indexes include revenue weighted fundamentally weighted and float adjusted all have their positives and negatives depending on the investor s goals and market knowledge | |
what is prima facie | the latin expression prima facie means at first sight at first view or based on first impression in both civil and criminal law the term is used to denote that upon initial examination a legal claim has sufficient evidence to proceed to trial or judgment | |
what is a primary market | a primary market is a source of new securities often on an exchange it s where companies governments and other groups go to obtain financing through debt based or equity based securities primary markets are facilitated by underwriting groups consisting of investment banks that set a beginning price range for a given security and oversee its sale to investors once the initial sale is complete further trading is conducted on the secondary market where the bulk of exchange trading occurs each day understanding primary marketsthe primary market is where securities are created it s in this market that firms sell or float in finance lingo new stocks and bonds to the public for the first time during the primary distribution these stocks and bonds also called primary instruments trade on mainstream exchanges with prices based on their market value companies and government entities sell new issues of common and preferred stock corporate bonds and government bonds notes and bills on the primary market to fund business improvements or expand operations although an investment bank may set the securities initial price and receive a fee for facilitating sales most of the money raised from the sales goes to the issuer the primary market isn t a physical place it reflects more the nature of the goods the key defining characteristic of a primary market is that securities on it are purchased directly from an issuer as opposed to being bought from a previous purchaser or investor second hand so to speak | |
what is a prime brokerage | a prime brokerage is a bundled group of services that investment banks and other financial institutions offer to hedge funds and other large investment clients that need to be able to borrow securities or cash in order to engage in netting to achieve absolute returns the services provided under prime brokering include securities lending leveraged trade execution and cash management among other things prime brokerage services are provided by most of the largest financial services firms including goldman sachs ubs and morgan stanley and the inception of units offering such services traces back to the 1970s understanding a prime brokerageprime brokerage services revolve around facilitating the multifaceted and active trading operations of large financial institutions such as hedge funds central to their role prime brokers allow hedge funds to borrow securities and increase their leverage while also acting as an intermediary between hedge funds and counterparties such as pension funds and commercial banks prime brokerages at times referred to as prime brokers are generally larger financial institutions that have dealings with other large institutions and hedge funds the majority of large banks have prime brokerage units that service hundreds of clients though prime brokerages offer a large variety of services a client is not required to take part in all of them and can have services performed by other institutions as they see fit prime brokerage servicesa prime brokerage offers a set of services to qualifying clients the assigned broker or brokers may provide settlement agent services along with financing for leverage custody of assets may be offered as well as daily preparations of account statements prime brokers offer a level of resources many institutions may not be able to have in house in essence a prime brokerage service gives large institutions a mechanism allowing them to outsource many of their investment activities and shift focus onto investment goals and strategy concierge style services may also be offered these can include risk management capital introduction securities financing and cash financing some go as far as to offer the opportunity to sublease office space and provide access to other facility based benefits as with more traditional offerings participation in any of the concierge services is optional in cases of securities lending collateral is often required by the prime brokerage this allows it to minimize the risk it experiences as well as give it quicker access to funds if needed requirements for prime brokerage accountsthe majority of prime brokerage clients are made of large scale investors and institutions money managers and hedge funds often meet the qualifications as well as arbitrageurs and a variety of other professional investors in the case of hedge funds prime brokerage services are often considered significant in determining a fund s success two common types of clients are pension funds a form of institutional investor and commercial banks these forms of investors often deal with a large amount of cash for investment but do not have the internal resources to manage the investments on their own the minimum account size to open and obtain prime brokerage account services is 500 000 in equity however such an account is unlikely to get many benefits over and above what would be offered by discount brokers some of the largest prime brokers in the u s are investment banks including bank of america j p morgan goldman sachs and citigroup for hedge funds or other institutional clients to get the kind of services that make having a prime brokerage account worthwhile most notably discounted fees for trading an account size of 50 million in equity is a likely starting point even so these services are highly sought after by clients and the best banks only accept the clients that are most likely to be beneficial to them over time for this reason a hedge fund would probably need to have as much as 200 million in equity in order to qualify for the best treatment example of a prime brokeragehedge fund abc just launched with 75 million that it raised from investors it is a small hedge fund that employs 15 people the majority of these individuals are traders researchers and a few administrative people the fund has limited resources that it can allocate to the various needs that are required of the business to alleviate some of the burdens abc transacts with j p morgan s prime brokerage unit the two entities sign a prime brokerage agreement detailing that j p morgan will assume the responsibilities of managing abc s cash management calculating its net asset value nav on a monthly basis and performing a risk management analysis on its portfolio for these services it is agreed that j p morgan will charge a monthly fee of 20 000 after six months abc has grown and its investment strategy has become more complex it needs to borrow securities as part of its investment strategy and transacts with j p morgan to provide securities lending services for this j p charges 5 on the amount of money borrowed abc also engages with j p for capital introduction services whereby j p introduces abc to potential investors charging 2 of the invested amount by each investor all of these services that j p provides to hedge fund abc constitute prime brokerage services prime brokerage faqsa broker is an individual or entity that facilitates the purchase or sale of securities such as the buying or selling of stocks and bonds for an investment account a prime broker is a large institution that provides a multitude of services from cash management to securities lending to risk management for other large institutions prime brokers charge different rates for different clients and each prime broker has its own fees they also charge different rates depending on the volume of transactions a client does the number of services a client uses and so on margin is when a prime broker lends money to a client so that they can purchase securities it is also known as margin financing the prime broker has no risk on the underlying positions only on the ability of the client to make margin payments margin terms are also agreed upon beforehand to determine any lending limits a prime brokerage agreement is an agreement between a prime broker and its client that stipulates all of the services that the prime broker will be contracted for it will also lay out all the terms including fees minimum account requirements minimum transaction levels and any other details needed between the two entities a prime brokerage generates revenue in a few different ways which include overall fees commissions on transactions and lending charges the bottom lineprime brokerage is an important service that is provided to large institutions to help them facilitate their business and outsource activities that allow them to focus on their core responsibilities prime brokerage is an important part of the financial sector that creates jobs for thousands of peoples and contributes significantly to the economy for many large institutions a prime broker can be a one stop shop that makes doing business much easier | |
what is prime cost | prime costs are a firm s expenses directly related to the materials and labor used in production it refers to a manufactured product s costs which are calculated to ensure the best profit margin for a company the prime cost calculates the direct costs of raw materials and labor that are involved in the production of a good direct costs do not include indirect expenses such as advertising and administrative costs investopedia jiaqi zhou | |
what is the formula and calculation of prime cost | prime cost direct raw materials direct labor text prime cost text direct raw materials text direct labor prime cost direct raw materials direct labor | |
what is the purpose of prime costs | a prime cost is the total direct costs which may be fixed or variable of manufacturing an item for sale businesses use prime costs as a way of measuring the total cost of the production inputs needed to create a given output by analyzing its prime costs a company can set prices that yield desired profits by lowering its prime costs a company can increase its profit or undercut its competitors prices companies need to calculate the prime cost of each product manufactured to ensure they are generating a profit self employed individuals such as artisans who create and sell custom made furniture often use the prime cost calculation to ensure they are making the hourly wage they desire while also profiting from each product made indirect costs such as utilities manager salaries and delivery costs are not included in prime costs one reason why indirect costs are excluded from the prime cost calculation is that they can be difficult to quantify and allocate example of how to use prime costlet s say as an example a professional woodworker is hired to construct a dining room table for a customer the prime costs for creating the table include direct labor and raw materials such as lumber hardware and paint the materials directly contributing to the table s production cost 200 the woodworker charges 50 per hour for labor and this project takes three hours to complete the prime cost to produce the table is 350 200 for the raw materials 150 in direct labor to generate a profit the table s price should be set above its prime cost consider the same woodworker who constructed and sold a new hand crafted table for 250 the cost of the raw materials was 200 and it took them three hours to construct without regard to labor costs the woodworker realized a gain of 50 if their direct labor costs were 15 per hour they realized a modest gain of 5 therefore it is especially important for self employed persons to employ the prime cost method when determining what price to set for their goods and services if the same artisan desired a labor wage of 20 per hour and a profit of 100 the prime cost and price would be 260 200 for materials and 60 for labor and 360 prime cost desired profit respectively prime costs vs conversion costsconversion costs are also used to calculate profitability based on the cost of production but these include direct labor as well as overhead expenses incurred due to the transformation of raw materials into finished products overhead costs are defined as expenses that cannot be directly attributed to the production process but are necessary for operations such as electricity or other utilities needed for the manufacturing plant direct labor costs are the same as those used in prime cost calculations conversion costs are also used as a measure to gauge the efficiencies in production processes but take into account the overhead expenses left out of prime cost calculations operations managers also use conversion costs to determine where there may be waste within the manufacturing process conversion costs and prime costs can be used together to help calculate the minimum profit needed when determining prices to charge customers limitations of using prime costbecause prime cost only considers direct costs it does not capture the total cost of production as a result the prime cost calculation can be misleading if indirect costs are relatively large a company likely incurs several other expenses that would not be included in the calculation of the prime cost such as manager salaries or expenses for additional supplies needed to keep the factory running these other expenses are considered manufacturing overhead expenses and are included in the calculation of the conversion cost the conversion cost takes labor and overhead expenses into account but not the cost of materials a second limitation of prime cost involves the challenges associated with identifying which production costs are indeed direct there are numerous expenses associated with producing goods for sale to calculate the prime cost of an item accurately there must be a clear division between those expenses that can directly link to the production of each unit versus those that are required to run the overall business the specific expenses included in the prime cost calculation can vary depending on the item being produced | |
what is the prime cost formula | to calculate the prime cost formula take the direct raw materials costs and add them to a business s direct labor costs both found on the balance sheet | |
what is the difference between prime cost and overhead cost | prime costs are the direct costs involved in production including raw materials and labor by contrast overhead costs refer to costs that are indirectly related to production which include electricity rent or salaries among others | |
is depreciation a prime cost | depreciation is considered an indirect cost and is typically included in a company s overhead for instance manufacturing overhead may include utility costs or the depreciation expense of factory equipment | |
is salary a direct expense | salary is considered an indirect expense as it is not directly involved in a manufacturer s production | |
why is it called prime cost | the word prime stems from the latin word pr tos which means first in existence or the first in order just as prime numbers are indivisible prime costs refer to the direct costs of raw materials and labor that are essential to manufacturing a product the bottom lineprime costs are the direct costs of creating a product or service such as materials and labor it does not take into consideration other costs such as utilities and rent understanding prime costs helps businesses set price levels and understand the margin they re generating from their goods or services | |
what is the prime interest rate | the prime interest rate is the percentage that u s commercial banks charge their most creditworthy customers for loans like all loan rates the prime interest rate is derived from the federal funds overnight rate set by the federal reserve at meetings held eight times a year the prime interest rate is the benchmark banks and other lenders use when setting their interest rates for every category of loan from credit cards to car loans and mortgages as of april 2024 the prime interest rate was 8 5 1 the federal funds rate was set at 5 25 to 5 50 in july 2023 2 the federal open market committee fomc kept the rate at this range in its last meeting on march 20 2024 3 | |
how the prime rate works | an interest rate is the percentage of a loan amount that a lender charges it is the lender s compensation and the percentage varies with each type of loan generally any unsecured loan such as a credit card balance is charged interest at a higher rate than a secured loan such as an auto loan or a mortgage the rate that an individual or business receives will vary depending on the borrower s credit history and other financial details these rates are normally defined as an annual percentage rate apr the prime interest rate which is also called the prime lending rate is largely determined by the federal funds rate set by the fomc of the federal reserve the fed funds rate is the overnight rate banks and other financial institutions use to lend money to each other the process is a constant electronic flow of money that ensures that each bank has sufficient liquidity to operate from day to day banks generally use a formula of federal funds rate 3 to determine the prime rate it charges its best customers primarily large corporations that borrow and repay loans on a more or less constant basis 5that prime rate is the starting point for all other interest rates which are set at the prime rate plus an additional percentage the bank sets a range of interest rates for each loan type the rates individual borrowers are charged are based on their credit scores income and current debts for example a person with an outstanding credit score might be charged say prime plus 9 for a credit card while an individual with only a good score might get a rate of prime plus 15 the prime rate plus a percentage forms the base of almost all consumer and business interest rates determining the prime ratethe prime rate is determined by individual banks and used as the base rate for many types of loans including loans to small businesses and credit cards the federal reserve has no direct role in setting the prime rate but most financial institutions choose to set their prime rates based partly on the target level of the federal funds rate established by the fomc 4one of the most used prime rates is the one that the wall street journal publishes daily as noted above banks generally use fed funds 3 to determine the prime rate the prime rate in the united states as of early february 2024 is 8 5 as it has been since july 27 2023 1 at that time the fed funds rate was set at a target of between 5 25 and 5 5 2the prime rate had increased since may 2022 moving in tandem with the fomc s increases to the fed funds rate to combat high inflation 61although other u s financial services institutions regularly note any changes that the fed makes to its prime rate and may use them to justify changes to its prime rates institutions are not required to change their prime rates following the fed s decisions the prime rate changes daily in line with other interest rates a snapshot of the prime rate can be found on the federal reserve s website | |
what is the impact of the prime rate | the prime rate affects a variety of bank loans when the prime rate goes up so does the cost to obtain small business loans lines of credit car loans mortgages and credit cards 4debt with a variable interest rate can be affected by the prime rate because a bank can change your rate this includes credit cards as well as variable rate mortgages home equity loans personal loans and variable interest rate student loans the prime rate is reserved for only the most qualified customers those who pose the least amount of default risk if the prime rate is set at 5 a lender still may offer rates below 5 to well qualified customers the prime rate in canada was 6 95 and 1 48 in japan as of january 2024 1 | |
how does the prime rate affect borrowers | the prime rate is not fixed and can change over time based on changes in the federal funds rate inflation the demand for loans and other economic factors when the prime rate changes the interest rates on loans and financial products that are based on the prime rate may also change the prime rate can affect you in different ways depending on the type of loan or financial product you have here are some of the most common ways history of the prime ratethe prime rate dates back to the 1930s when banks first used it to set interest rates for short term lending to their most creditworthy customers following the great depression in the decades following world war ii the prime rate remained relatively stable hovering around 2 to 3 7the prime rate began to rise significantly in the 1970s as the united states experienced an economic recession and high inflation the prime rate reached its all time high of 21 5 in dec 1980 as the federal reserve sought to curb inflation by raising interest rates 7over the next few decades the prime rate fluctuated widely reflecting the ups and downs of the economy and largely mirroring other benchmark interest rates during times of economic growth the prime rate tends to be higher while it tends to be lower during times of recession or financial turmoil | |
how has the prime rate changed over time | prime rates fluctuate over time depending on the movement of the federal funds rate which in turn reflects the state of the economy the most recent prime rate history has been 89 | |
what loans are not affected by a change in the prime rate | any existing loan or line of credit that has a fixed interest rate is not affected by a change in the prime rate this includes any student loans mortgages savings accounts and credit cards that are issued with fixed rates rather than variable rates | |
what does a change in the prime rate signal | a significant change in the prime rate often signals that the federal reserve has changed the federal funds rate it increases the federal funds rate to bring inflation under control it decreases the rate to encourage economic growth the goal of the federal reserve is to encourage or discourage borrowing by businesses and consumers higher rates discourage borrowing while lower rates encourage it | |
what was the highest prime rate ever recorded in the united states | the highest prime rate ever recorded in the u s was 21 5 which was reached in december 1980 7the bottom linethe prime rate is the interest rate that commercial banks charge creditworthy customers and is based on the federal reserve s federal funds overnight rate banks generally use fed funds 3 to determine the current prime rate the rate forms the basis for other interest rates including rates for mortgages small business loans or personal loans | |
what is principal | principal is the original sum of money that s borrowed in a loan or placed into an investment the term translates to first in importance in latin and a loan or investment begins with this amount principal serves as the foundation for calculating interest on a loan or for the returns on an investment amortization schedules and other components of a transaction also rely on principal it s also the face value of a bond that will be returned to the bondholder when the bond matures principal also refers to the leader of a company or the primary parties involved in legal contracts the concept of principal is pivotal for understanding your costs and your potential financial returns whether you re taking out a mortgage investing in bonds or starting a business understanding the principal of a loanthe initial amount you borrow when you accept money to purchase a car a house or education is referred to as the principal it forms the basis upon which interest rates and repayment conditions are applied it s the money you receive from the lender and must repay during the loan period along with interest and fees principal can also refer to the amount still owed on a loan over time there are essentially two kinds of principal balances in the context of loans let s say you take out a car loan with an initial principal balance of 20 000 your outstanding principal might be reduced to 16 000 after a year of making payments the interest for future payments is calculated based on this new outstanding principal the size of the principal amount is directly proportional to the overall cost of the loan a higher principal will result in higher interest payments over the life of the loan assuming that the interest rate and loan term remain constant understanding your principal amount is essential for determining whether a loan is within your budget | |
how interest affects principal | the amount of interest you pay on a loan is determined by the principal amount the larger the principal the higher your interest payments will be interest is either simple or compounded depending on the loan terms simple interest is calculated on only the original principal compound interest is calculated on the principal and any accumulated interest much of the payment goes towards interest when you begin making monthly payments on a loan the remainder is applied to your principal more payments will be applied to the principal as you continue paying the loan paying down the principal of a loan can reduce the amount of interest that accrues each month the amount of the principal balance of a loan can influence its interest rate especially in the context of mortgages jumbo mortgages that exceed the loan limits set by fannie mae and freddie mac often have higher interest rates than smaller conforming loans but this rate difference isn t always consistent jumbo rates can sometimes be lower than conforming rates due to fluctuations in supply and demand for both types of loans | |
how inflation affects principal | inflation effectively decreases the purchasing power of money over time the real value of the principal amount you borrowed may decline if you re repaying it over an extended period suppose you borrowed 10 000 as a personal loan with a 10 year term the value of that 10 000 would only be equivalent to about 10 000 1 0 03 10 or 7 441 58 at the end of the loan term if the annual inflation rate is 3 you re repaying the same nominal amount but the real value has declined due to inflation inflation and interest rates both interact with the principal amount of a loan but their combined effect can be quite different from the result of just calculating one of these alone you re paying more in nominal terms due to interest but the real burden of your debt could be less severe when you factor in inflation here s how let s revisit the example of borrowing 10 000 for 10 years with a 3 annual inflation rate now note that the loan was taken out with 5 simple interest assume both rates remain constant over the term of the loan principal in investingprincipal is also the original amount of money you ve invested separate from any earnings or interest accrued assume you deposit 5 000 in a high interest savings account bond or cd your account balance would have grown to 7 765 00 at the end of 10 years if the interest rate was 4 5 the 5 000 you initially deposited is your principal the remaining 2 765 00 is attributed to earnings principal in bondsthe principal of a bond or other fixed income investment is the amount the issuer agrees to pay back to the investor upon the bond s maturity a bond s principal is also known as its par value or face amount because this amount was printed on the face of the bond itself back when bonds were issued on actual pieces of paper 1the bond s principal excludes any coupon recurring interest payments or accrued interest although the issuer is obligated to pay these as well a 10 year bond with a 10 000 face value may be issued and have 50 recurring coupon payments semiannually the principal is 10 000 independent of the 1 000 worth of coupon payments over the bond s life a bond s principal isn t necessarily the same as its market price except when it s first issued a bond may be purchased for more or less than its principal depending on the state of the bond market principal in ownershipthe owner of a private company partnership or other firm type is also referred to as a principal this isn t necessarily the same as a ceo a principal might be an officer a shareholder a board member or even a key sales employee a company may also have several principals with the same equity stake in the firm anyone considering investing in a private venture will want to know who its principals are so they can assess the business s creditworthiness and potential for growth principals as responsible partiesthe term principal also refers to the party who can transact on behalf of an organization or account and who takes on the attendant risk a principal can be an individual a corporation a partnership a government agency or a nonprofit organization in this case principals may elect to appoint agents to operate on their behalf a principal could be involved in transactions ranging from a corporate acquisition to a mortgage the principals are usually listed in the transaction s legal documents they include everyone who signed the agreement and who therefore has rights duties and obligations for the transaction an individual who hires a financial advisor is considered to be a principal the advisor is the agent the agent follows the instructions given by the principal and may act on their behalf under specified conditions and terms the advisor is often bound by fiduciary duty to act in the principal s best interests the principal is at risk for any action or inaction on the agent s part 2 the principal takes the loss if the agent makes a bad investment a problem with the principal agent relationship can arise when there s a conflict in priorities between a person or group and the representative authorized to act on their behalf an agent may act contrary to the principal s best interests this can occur in many situations from the relationship between a client and a lawyer to the relationship between stockholders and a ceo | |
how do you find the principal amount | the formula for calculating the principal amount p when there s simple interest is p i rt or the interest amount i divided by the product of the interest rate r and the amount of time t | |
how does compounding grow your principal | the principal amount of an investment can earn interest compounding occurs when the interest you earn is added back to the principal balance you re effectively earning interest on your interest in this case compounding your return | |
what factors determine the interest charged on principal | your credit score and credit history largely determine the interest you ll pay on the principal balance of a loan other factors can include the loan type its term length any collateral you have and broader economic conditions the property location loan amount and down payment for a home loan will also be critical factors 3 | |
how do you calculate the return on an investment | knowing how to calculate the return on an investment roi is crucial for evaluating your investment s performance roi gives you a quantitative measure of how well an investment is doing taking into consideration either gains or losses the most straightforward way to calculate roi uses the following formula roi final investment value initial principal initial principal x 100the bottom linethe concept of principal serves as a key term for understanding financial products like loans bonds and investments knowing how principal interacts with interest inflation and returns can empower you to make more informed financial decisions a firm grasp of the idea of principal is vital for your financial well being whether you re borrowing money or looking to grow your nest egg through investments | |
what is the principal agent problem | the principal agent problem is a conflict in priorities between a person or group and the representative authorized to act on their behalf an agent may act in a way that is contrary to the best interests of the principal the principal agent problem is as varied as the possible roles of a principal and agent it can occur in any situation in which the ownership of an asset or a principal delegates direct control over that asset to another party or agent understanding the principal agent problemthe principal agent problem has become a standard factor in political science and economics the theory was developed in the 1970s by michael jensen of harvard business school and william meckling of the university of rochester in a paper published in 1976 they outlined a theory of an ownership structure designed to avoid what they defined as agency cost and its cause which they identified as the separation of ownership and control this separation of control occurs when a principal hires an agent the principal delegates a degree of control and the right to make decisions to the agent but the principal retains ownership of the assets and the liability for any losses for example a company s stock investors as part owners are principals who rely on the company s chief executive officer ceo as their agent to carry out a strategy in their best interests that is they want the stock to increase in price or pay a dividend or both if the ceo opts instead to plow all the profits into expansion or pay big bonuses to managers the principals may feel they have been let down by their agent there are a number of remedies for the principal agent problem and many of them involve clarifying expectations and monitoring results the principal is generally the only party who can or will correct the problem | |
what causes the principal agent problem | logically the principal cannot constantly monitor the agent s actions the risk that the agent will shirk a responsibility make a poor decision or otherwise act in a way that is contrary to the principal s best interest can be defined as agency costs additional agency costs can be incurred while dealing with problems that arise from an agent s actions agency costs are viewed as a part of transaction costs agency costs may also include the expenses of setting up financial or other incentives to encourage the agent to act in a particular way principals are willing to bear these additional costs as long as the expected increase in the return on the investment from hiring the agent is greater than the cost of hiring the agent including the agency costs solutions to the principal agent problemthere are ways to resolve the principal agent problem the onus is on the principal to create incentives for the agent to act as the principal wants consider the first example the relationship between shareholders and a ceo the shareholders can take action before and after hiring a manager to overcome some risks first they can write the manager s contract in a way that aligns the incentives of the manager with the incentives of the shareholders the principals can require the agent to regularly report results to them they can hire outside monitors or auditors to track information in the worst case they can replace the manager designing a contract involves linking the interests of the principal and agent by tackling issues such as misaligned information setting methods to monitor the agents and incentivizing the agent to act in the best way possible for the principal compensation is always a motivating factor and a high priority for an agent linking compensation to certain criteria such as a performance evaluation can ensure that the agent performs at a high level if their compensation depends on it this is almost a surefire way to align the interests of both the principal and the agent methods of agent compensation include stock options deferred compensation plans and profit sharing in these methods if the agent performs well they will see a direct benefit if they do not they will be hurt financially at its root it s the same principle as tipping for good service theoretically tipping aligns the interests of the customer the principal and the agent the waiter their priorities are now aligned and are focused on good service examples of the principal agent problemthe principal agent problem can crop up in many day to day situations beyond the financial world in all of these cases the principal has little choice in the matter an agent is necessary to get the job done | |
what is a principal agent problem example | a common example of the principal agent problem is that of c level managers and shareholders c level managers may make decisions in their best interest that are not in the best interest of shareholders this could involve enacting certain policies making deals with politicians and so on that may hurt the company but benefit the manager tying the c level manager s compensation to the performance of the company would be a way to overcome this conflict | |
what causes the principal agent problem | the primary cause of the principal agent problem is agency costs these costs arise due to the inability of the principal to constantly monitor the work of the agent which could result in the agent avoiding responsibilities making poor decisions or acting in a way contrary to the benefit of the principal | |
what is a good way to overcome the principal agent problem | a good way to overcome the principal agent problem is by aligning the interests of both the principal and the agent and removing any conflict of interest one of the best ways to do this is by aligning the compensation of the agent to a performance evaluation if the agent performs well they will see a direct financial benefit if they perform poorly the opposite will be true methods to achieve a link between performance and compensation are stock options deferred compensation plans and profit sharing the bottom linethe principal agent problem is a conflict that arises between an individual or group and the individual charged with representing them due to agency costs whereby the agent avoids responsibilities makes poor decisions or otherwise engages in actions that work against the benefit of the individual they represent to remedy the agent principal problem the principal must take action to create an environment or incentives that would motivate the agent to work in the best interest of the principal when engaging any representative on your behalf it s important to be aware of the principal agent problem to ensure you are getting the best service possible | |
what is the principal agent relationship | the principal agent relationship is an arrangement in which one entity legally appoints another to act on its behalf 1 in a principal agent relationship the agent acts on behalf of the principal and should not have a conflict of interest in carrying out the act the relationship between the principal and the agent is called the agency and the law of agency establishes guidelines for such a relationship investopedia joules garciaunderstanding a principal agent relationshipa principal agent relationship is often defined in formal terms described in a contract for example when an investor buys shares of an index fund he is the principal and the fund manager becomes his agent as an agent the index fund manager must manage the fund which consists of many principals assets in a way that will maximize returns for a given level of risk in accordance with the fund s prospectus agents have an obligation to perform tasks with a certain level of skill and care and may not intentionally or negligently complete the task in an improper manner 2the principal agent relationship can be entered into by any willing and able parties for the purpose of any legal transaction in simple cases the principal within the relationship is a sole individual who assigns an agent to carry out a task however other relationships under this guise have a principal that is a corporation a nonprofit organization a government agency or a partnership the agent is most often an individual capable of understanding and ultimately carrying out the task assigned by the principal common examples of the principal agent relationship include hiring a contractor to complete a repair on a home retaining an attorney to perform legal work or asking an investment advisor to diversify a portfolio of stocks in each scenario the principal is the individual seeking out the service or advice of a professional while the agent is the professional performing the work special considerationswhether the principal agent relationship is expressed clearly through a written contract or implied through actions the principal agent relationship creates a fiduciary relationship between the parties involved this means the agent acting on behalf of the principal must carry out the assigned tasks with the principal s best interest as a priority 3the agent is responsible for completing tasks given by the principal so long as the principal provides reasonable instruction additionally the agent has an obligation to perform tasks that will not intentionally harm the principal a duty of loyalty is also implied within the principal agent relationship which requires the agent to refrain from putting himself in a position that creates or encourages conflict between his interest and the interest of the principal also known as the principal agent problem 3 | |
what is principal interest taxes insurance piti | principal interest taxes and insurance piti are the components of a mortgage payment specifically they are the principal amount loan interest property tax homeowners insurance and private mortgage insurance premiums 1understanding how each component of principal interest taxes and insurance impacts your monthly mortgage payment is essential in determining the affordability of a home understanding principal interest taxes insurance piti the principal and interest on your loan usually make up the majority of your mortgage payment mortgage lenders may require borrowers to buy homeowners insurance to protect the property from damage you may also need to pay property taxes depending on the state in which the home is located together the principal interest taxes and insurance represent the monthly cost of buying a home mortgage lenders use piti to calculate various financial ratios and the total housing expense to determine whether or not to lend you the money to buy a home let s review the four components of piti a portion of each mortgage payment is dedicated to repayment of the principal the original amount borrowed for example if you take out a 100 000 mortgage loan the principal is 100 000 typically only a small portion of your monthly mortgage payment goes to paying down the principal in the early years of the loan interest is the price you pay for borrowing money and the mortgage lender s reward for taking on the risk of lending to you in the early years of a fixed rate mortgage loan a greater portion of the monthly payment goes towards paying interest rather than the principal the ratio gradually shifts as time goes by for example if the interest rate on our 100 000 mortgage is 6 the combined principal and interest monthly payment on a 30 year fixed rate loan would be 599 55 the first monthly payment would have 500 applied to interest and 99 55 to principal over the life of the loan the amount of the payment applied towards interest and principal changes the table below shows a truncated payment schedule of a 100 000 mortgage loan at a fixed rate of 6 for 30 years 2from the table above we can see that most of each monthly payment went to interest in the early years by 180 months or 15 years the halfway point another 144 was being applied to the principal instead of interest but the interest still made up more than half of the payment however by the 223rd month or approximately 18 5 years the proportion switched with more of the payment applied to principal rather than interest by the end of the loan very little was allocated to interest with most of the payment going to the principal real estate or property taxes are assessed by local governments and used to fund public services such as schools police forces and fire departments taxes are calculated on a per year basis but you can include them as part of your monthly mortgage payments the amount of taxes due is divided by the total number of mortgage payments in a given year the lender collects the payments and holds them in escrow until the taxes are due like real estate taxes insurance premiums can be paid with each mortgage installment and held in escrow until the bill is due there are two types of insurance coverage that may be included homeowners insurance protects the home and its contents from fire theft and other disasters private mortgage insurance pmi protects the lender in case the borrower defaults on the payments it is mandatory if your down payment is less than 20 of the home s value 3mortgages backed by the federal housing administration fha sometimes called fha loans include a mortgage insurance premium mip it is similar to private mortgage insurance but requires a large upfront payment along with monthly payments 4piti and mortgage affordabilityprincipal interest taxes and insurance piti are typically quoted on a monthly basis and compared to a borrower s monthly gross income to help the buyer and the lender determine the affordability of an individual mortgage because piti represents the total monthly payment the borrower will need to make a lender will look at an applicant s piti to determine if they represent a good risk for a home loan buyers may also calculate their piti to determine if they can afford to buy a particular home the housing expense ratio measures how much of your monthly gross income your income before taxes are deducted goes to paying your total housing costs in short the housing expense ratio also called the front end ratio compares piti to your gross monthly income most lenders prefer a housing expense ratio of 31 or less however some lenders may allow up to 40 5for example say a borrower has a piti totaling 2 000 broken down as follows if the borrower has 6 500 in gross monthly income their housing expense ratio equals 31 2 000 6 500 the debt to income ratio dti compares piti and other monthly debt obligations to gross monthly income also known as the back end ratio most lenders prefer a dti of 36 or less however for fha insured loans some borrowers may qualify with a dti as high as 43 67suppose the borrower above has two other non mortgage monthly obligations for a total of 2 350 the borrower s dti is 36 2 350 6 500 some lenders also use piti to calculate reserve requirements for a borrower typically there is no minimum reserve requirement for all lenders however some lenders may require reserves to secure mortgage payments in the event a borrower suffers an income loss often lenders quote reserve requirements as a multiple of piti for example two months of piti might represent a reserve requirement 8in addition to savings monitor your credit score which is a three digit number representing your creditworthiness based on your credit history borrowers with cash reserves and a credit score higher than 580 have less stringent qualifications such as a 47 debt to income ratio and a 37 total housing expense ratio 5special considerationsnot all mortgage payments include taxes and insurance some lenders do not require borrowers to escrow these costs as part of their monthly mortgage payments in these scenarios the homeowner pays insurance premiums directly to the insurance company and property taxes directly to the tax assessor the homeowner s mortgage payment then consists of only principal and interest still even if not escrowed most lenders still consider the amounts of property taxes and insurance premiums when calculating front end and back end ratios moreover additional mortgage related monthly obligations such as homeowners association hoa fees may be included in piti to calculate debt ratios frequently asked questions faqs | |
is property tax included in piti | it depends some mortgage payments don t include taxes and insurance in this case the homeowner pays insurance premiums directly to the insurance company and property taxes directly to the tax assessor 4 | |
what does piti stand for | the term piti is an acronym for principal interest taxes and insurance all of the standard components of a mortgage payment because piti represents the total monthly mortgage payment it helps both the buyer and the lender determine the affordability of an individual mortgage | |
what is principal and interest | your principal is the money that you originally agreed to pay back interest is the cost of borrowing the principal for example if the interest rate on a 100 000 mortgage is 6 the combined principal and interest monthly payment on a 30 year mortgage would be about 599 55 500 interest 99 55 principal for the first payment over time the amount of the payment stays the same but the proportions change so that eventually more of the payment goes toward the principal and less toward interest | |
what s the maximum piti | the front end ratio compares piti to gross monthly income most lenders prefer a front end ratio of 31 or less though a few will allow a ratio as high as 40 7 for example the front end ratio of a piti totaling 1 500 to a gross monthly income of 6 000 is 25 the bottom linepiti or principal interest taxes and insurance refers to all of the standard components of a mortgage payment because piti contains everything that homeowners will typically have to pay toward their mortgage every month it is a useful way of working out whether a person can afford a mortgage to make that calculation a borrower s piti is compared to their monthly gross income generally mortgage lenders prefer a piti of 31 or less of a borrower s gross monthly income since it indicates they are more likely to be able to afford the mortgage loan | |
what is the prisoner s dilemma | the prisoner s dilemma is a paradox in decision analysis in which two individuals acting in their own self interests do not produce the optimal outcome a prime example of game theory the prisoner s dilemma was developed in 1950 by rand corporation mathematicians merrill flood and melvin dresher during the cold war but later given its name by the game theorist alvin tucker 1 some have speculated that the prisoner s dilemma was crafted to simulate strategic thinking between the u s a and u s s r during the cold war today the prisoner s dilemma is a paradigmatic example of how strategic thinking between individuals can lead to suboptimal outcomes for both players investopedia laura porterunderstanding the prisoner s dilemmathe typical prisoner s dilemma is set up in such a way that both parties choose to protect themselves at the expense of the other participant as a result both participants find themselves in a worse state than if they had cooperated with each other in the decision making process the prisoner s dilemma is one of the most well known concepts in modern game theory the prisoner s dilemma presents a situation where two parties separated and unable to communicate must each choose between cooperating with the other or not the highest reward for each party occurs when both parties choose to co operate the classic prisoner s dilemma goes like this 1the respective penalties can be expressed visually as follows in this case each robber always has an incentive to defect regardless of the choice the other makes from elizabeth s point of view if henry remains silent then elizabeth can either co operate with henry and do a year in jail or defect and go free obviously she would be better off betraying henry in this case on the other hand if henry defects and testifies against elizabeth then her choice becomes either to remain silent and do five years or to talk and do three years in jail again obviously she would prefer to do the three years over five in both cases whether henry cooperates with elizabeth or defects to the prosecution elizabeth will be better off if she defects and testifies now since henry faces the exact same set of choices he also will always be better off defecting as well the paradox of the prisoner s dilemma is this both robbers can minimize the total jail time that the two of them will do only if they both cooperate and stay silent two years total but the incentives that they each face separately will always drive them each to defect and end up doing the maximum total jail time between the two of them of six years total the prisoner s dilemma is frequently used in economics or business situations to explain why individual incentives might lead actors to choose a sub optimal outcome examples of the prisoner s dilemmathe economy is replete with examples of prisoner s dilemmas which can have outcomes that are either beneficial or harmful to the economy and society as a whole the common thread is this a situation where the incentives faced by each individual decision maker would induce them each to behave in a way that makes them all collectively worse off while individually avoiding choices that would make them all collectively better off if all could somehow cooperatively choose one such example is the tragedy of the commons it may be to everyone s collective advantage to conserve and reinvest in the propagation of a common pool of natural resources in order to be able to continue consuming it but each individual always has an incentive to instead consume as much as possible as quickly as possible which then depletes the resource finding some way to co operate would clearly make everyone better off here on the other hand the behavior of cartels can also be considered a prisoner s dilemma all members of a cartel can collectively enrich themselves by restricting output to keep the price that each receives high enough to capture economic rents from consumers but each cartel member individually has an incentive to cheat on the cartel and increase output to also capture rents away from the other cartel members in terms of the welfare of the overall society that the cartel operates in this is an example of how individual incentives can sometimes actually make society better off as a whole escape from the prisoner s dilemmaover time people have worked out a variety of solutions to prisoner s dilemmas in order to overcome individual incentives in favor of the common good first in the real world most economic and other human interactions are repeated more than once a true prisoner s dilemma is typically played only once or else it is classified as an iterated prisoner s dilemma in an iterated prisoner s dilemma the players can choose strategies that reward cooperation or punish defection over time by repeatedly interacting with the same individuals we can even deliberately move from a one time prisoner s dilemma to a repeated prisoner s dilemma second people have developed formal institutional strategies to alter the incentives that individual decision makers face collective action to enforce cooperative behavior through reputation rules laws democratic or other collective decision making procedures and explicit social punishment for defections transforms many prisoner s dilemmas toward the more collectively beneficial cooperative outcomes last some people and groups of people have developed psychological and behavioral biases over time such as higher trust in one another long term future orientation in repeated interactions and inclinations toward positive reciprocity of cooperative behavior or negative reciprocity of defecting behaviors these tendencies may evolve through a kind of natural selection within a society over time or group selection across different competing societies in effect they lead groups of individuals to irrationally choose outcomes that are actually the most beneficial to all of them together put together these three factors the repeated prisoner s dilemmas formal institutions that break down prisoner s dilemmas and behavioral biases that undermine rational individual choice in prisoner s dilemmas help resolve the many prisoner s dilemmas we would all otherwise face in the iterated prisoner s dilemma it is possible for both players to devise a strategy that punishes betrayal and rewards cooperation the tit for tat strategy has been determined to be the optimal way for optimizing a prisoner s dilemma tit for tat was introduced by anatol rapoport who developed a strategy in which each participant in an iterated prisoner s dilemma follows a course of action consistent with their opponent s previous turn 2 for example if provoked a player subsequently responds with retaliation if unprovoked the player cooperates | |
what is the likely outcome of a prisoner s dilemma | the likely outcome for a prisoner s dilemma is that both players defect i e behave selfishly leading to suboptimal outcomes for both this is also the nash equilibrium a decision making theorem within game theory that states a player can achieve the desired outcome by not deviating from their initial strategy the nash equilibrium in this example is for both players to betray one other even though mutual cooperation leads to a better outcome for both players however if one prisoner chooses mutual cooperation and the other does not one prisoner s outcome is worse 3 | |
what are some ways to combat the prisoner s dilemma | solutions to prisoner s dilemmas focus on overcoming individual incentives in favor of the common good in the real world most economic and other human interactions are repeated more than once this allows parties to choose strategies that reward cooperation or punish defection over time another solution relies on developing formal institutional strategies to alter the incentives that individual decision makers face finally behavioral biases will likely develop over time that undermine rational individual choice in prisoner s dilemmas and lead groups of individuals to irrationally choose outcomes that are actually the most beneficial to all of them together can the prisoner s dilemma be useful to society prisoners dilemma problems can sometimes actually make society better off as a whole a prime example is the behavior of an oil cartel all cartel members can collectively enrich themselves by restricting output to keep the price of oil at a level where each maximizes revenue received from consumers but each cartel member individually has an incentive to cheat on the cartel and increase output to also capture revenue away from the other cartel members the end result is not the optimal outcome that the cartel desires but rather an outcome that benefits the consumer in terms of lower oil prices | |
what is the tragedy of the commons | the tragedy of the commons is a theoretical problem in economics that proposes every individual has an incentive to consume a resource but at the expense of every other individual with no way to exclude anyone from consuming generally the resource of interest is easily available to all individuals without barriers i e the commons this hypothetically leads to over consumption and ultimately depletion of the common resource to everybody s detriment 4 basically it highlights the concept of individuals neglecting the well being of society in the pursuit of personal gain its accuracy and application are debated the bottom linethe prisoner s dilemma is a well known parable for the difficulty of solving collective action problems by acting in their own self interests the metaphorical prisoners find themselves with a greater penalty than they would face if they had worked together however when the experiment is repeated over the long term it is possible for the players to devise incentives for cooperation correction june 30 2022 the example of the prisoner s dilemma was edited to demonstrate how following individual interests can lead to the worst possible outcome | |
what is private banking | private banking consists of personalized financial services and products offered to the high net worth individual hnwi clients of a retail bank or other financial institution it includes a wide range of wealth management services and all provided under one roof services include investing and portfolio management tax services insurance and trust and estate planning while private banking is aimed at an exclusive clientele consumer banks and brokerages of every size offer it this offering is usually through special departments dubbed private banking or wealth management divisions | |
how private banking works | private banking includes common financial services like checking and savings accounts but with a more personalized approach a relationship manager or private banker is assigned to each customer to handle all matters the private banker handles everything from involved tasks like arranging a jumbo mortgage to the mundane like paying bills however private banking goes beyond cds and safe deposit boxes to address a client s entire financial situation specialized services include investment strategy and financial planning advice portfolio management customized financing options retirement planning and passing wealth on to future generations while an individual may be able to conduct some private banking with 50 000 or less in investable assets most financial institutions set a benchmark of six figures worth of assets and some exclusive entities only accept clients with at least 1 million to invest advantages of private bankingprivate banking offers clients a variety of perks privileges and personalized service which has become an increasingly prized commodity in an automated digitized banking world however there are advantages to both the private bank clients as well as the banks themselves privacy is the primary benefit of private banking customer dealings and services provided typically remain anonymous private banks often provide hnwis with tailored proprietary solutions which are kept confidential to prevent competitors from luring a prominent customer with a similar solution private banking clients typically receive discounted or preferential pricing on products and services for example they may receive special terms or prime interest rates on mortgages specialized loans or lines of credit loc their savings or money market accounts might generate higher interest rates and be free of fees and overdraft charges also customers who operate import export ventures or do business overseas might receive more favorable foreign exchange rates on their transactions if they are managing a client s investments private banks often provide the client with extensive resources and opportunities not available to the average retail investor for example an hnwi may be given access to an exclusive hedge fund or a private equity partnership or some other alternative investment in addition to the customized products there is the convenience of consolidated services everything under one financial roof private banking clients received enhanced services from their private banker that acts as a liaison with all of the other departments within the bank to ensure that the client receives the best possible product offerings and service the bank or brokerage firm benefits from having the clients funds add to their overall assets under management aum even at discounted rates the private bank s management fees for portfolio management and interest on loans underwritten can be substantial in an environment where interest rates in the u s have remained low banks have been unable to charge higher loan rates to grow their profits as a result fee income has become an increasingly important financial metric in helping banks diversify their revenue stream banks have made strides in expanding beyond traditional banking products such as loans and deposits to more service oriented and fee based offerings like private banking one stop shopping for financial affairsconcierge services and dedicated employeesfavorable rates discounted chargesperks and privilegesless institutional expertiseoptions limited to proprietary productshigh staff turnoverpossible conflict of interest for employeesdisadvantages of private bankingalthough there are many advantages to private banking drawbacks do exist to this exclusivity employee turnover rates at banks tend to be high even in the elite private banking divisions there may also be some concern over conflicts of interest and loyalty the private banker is compensated by the financial institution not the client in contrast to an independent money manager in terms of investments a client might be limited to the bank s proprietary products also while the various legal tax and investment services offered by the bank are doubtlessly competent they may not be as creative or as expert as those offered by other professionals that specialize in various types of investments for example small regional banks might provide stellar service that beats out the larger institutions however the investment choices at a smaller regional bank might be far less than a major player such as jpmorgan chase company jpm lucrative as private banking can be it can pose challenges for the institution as well private banks have dealt with a restrictive regulatory environment since the global financial crisis of 2008 the dodd frank wall street reform and consumer protection act along with other legislation passed in the u s and around the world has resulted in a higher level of transparency and accountability there are more stringent licensing requirements for private banking professionals that help ensure customers are appropriately advised about their finances real world example of private bankingubs merrill lynch wells fargo morgan stanley citibank and credit suisse are all examples of financial institutions with substantial private banking operations another bank that offers private banking is td bank td with its td wealth private client group 1 available to clients with at least 750 000 in assets it offers many services to its clients services include money management strategies for business owners real estate financing and custom lending solutions the private banking team also offers retirement succession and estate planning which help reduce taxes the td website promises that beyond the product offerings each private client will receive a local relationship manager that will deliver exceptional customized service as outlined in the quote below | |
what is a private company | a private company is a firm held under private ownership private companies may issue stock and have shareholders but their shares are not issued through an initial public offering ipo and do not trade on public exchanges private firms are not subject to the securities and exchange commission s sec filing requirements the shares of these businesses are generally less liquid and their valuations are more difficult to determine investopedia jake shi | |
how private companies work | private companies are sometimes referred to as privately held companies they can range in size and scope encompassing the millions of individually owned businesses in the u s and the dozens of unicorn startups worldwide private companies have different rules for shareholders members and taxation in 2024 u s firms such as cargill and koch industries with large annual revenues fall under the private company umbrella 1remaining a private company can make raising money difficult this is why many large private firms choose to go public through an ipo while private companies access bank loans and certain equity funding public companies can often sell shares or raise money through bond offerings types of private companiessome family owned companies have gone public and many maintain family ownership and control through a dual class share structure meaning family owned shares can have more voting rights advantages and disadvantages of private companieshigh costs and strict regulations are two reasons companies often remain private doing so allows companies to keep costs down such as those related to an ipo avoid burdensome paperwork like financial statements or annual reports 10 k and avoid disclosing company progress and spending to regulators and the public 3private means that company owners can retain more control and is especially effective for family run companies koch industries has remained in the koch family since its founding in 1940 4 although there are many advantages to remaining private these companies may find it difficult to raise capital unlike public companies private entities don t trade on public stock exchanges owners may be liable for the financial well being of their private companies when a private company faces financial difficulties the owner may be held responsible for debt and other financial obligations this can negatively impact the owner owners credit scores especially if the company defaults avoid high costs of going publicavoid regulatory paperwork and hurdlesno need for public disclosureretain controlraising capital may be difficultfinancial liability falls on owner s potential for disagreements and conflicts among partnersprivate vs public companiesunlike private companies public entities abide by the rules outlined by financial regulators such as the sec this means they must be fully transparent and file paperwork at regular intervals these documents include quarterly and annual reports proxy statements changes in beneficial ownership and income statements | |
what are examples of private companies | koch industries cargill deloitte ikea and ernst young are all private companies in 2022 x formerly twitter was public until elon musk bought it and took the company private 5 | |
what is the average size of a private company | private companies range in size from small businesses to large corporations they include a small mom and pop convenience store or dry cleaner and mid sized and large corporations | |
how does ownership of a private company differ from a public company | public companies are the opposite of private companies ownership of public companies is divided into shares which are sold to the public this is first done through an ipo once that is complete the shares of a public company are sold on the secondary market through stock exchanges a public company s equity is held by insiders and outside investors the bottom linemany global companies are private including ikea ernst young and x the company s owner or owners retain control and aren t subject to scrutiny from regulators these companies however cannot raise money through capital markets to fund their growth or pay their debts their shares are not sold to the public | |
what is private equity | private equity describes investment partnerships that buy and manage companies before selling them private equity firms operate these investment funds on behalf of institutional and accredited investors private equity funds may acquire private companies or public ones in their entirety or invest in such buyouts as part of a consortium they typically do not hold stakes in companies that remain listed on a stock exchange private equity is often grouped with venture capital and hedge funds as an alternative investment investors in this asset class are usually required to commit significant capital for years which is why access to such investments is limited to institutions and individuals with high net worth 1understanding private equityin contrast with venture capital most private equity firms and funds invest in mature companies rather than startups they manage their portfolio companies to increase their worth or to extract value before exiting the investment years later the private equity industry has grown rapidly amid increased allocations to alternative investments and following private equity funds relatively strong returns since 2000 2 in 2022 private equity buyouts totaled 654 billion the second best performance in history 3 private equity investing tends to grow more lucrative and popular during periods when stock markets are riding high and interest rates are low and less so when those cyclical factors turn less favorable 456private equity firms raise client capital to launch private equity funds and operate them as general partners managing fund investments in exchange for fees and a share of profits above a preset minimum known as the hurdle rate 78image by sabrina jiang investopedia 2020private equity funds have a finite term of 10 to 12 years and the money invested in them isn t available for subsequent withdrawals the funds do typically start to distribute profits to their investors after a number of years 9 the average holding period for a private equity portfolio company was about 5 6 years in 2023 10several of the largest private equity firms are now publicly listed companies in the wake of the landmark initial public offering ipo by blackstone group inc bx in 2007 11 in addition to blackstone kkr co inc kkr carlyle group inc cg and apollo global management inc apo all have shares traded on u s exchanges a number of smaller private equity firms have also gone public via ipos primarily in europe 12mira norian investopediaprivate equity specialtiessome private equity firms and funds specialize in a particular category of private equity deals while venture capital is often listed as a subset of private equity its distinct function and skillset set it apart and have given rise to dedicated venture capital firms that dominate their sector other private equity specialties include private equity deal typesthe deals private equity firms make to buy and sell their portfolio companies can be divided into categories according to their circumstances the buyout remains a staple of private equity deals involving the acquisition of an entire company whether public closely held or privately owned private equity investors acquiring an underperforming public company will often seek to cut costs and may restructure its operations another type of private equity acquisition is the carve out in which private equity investors buy a division of a larger company typically a non core business put up for sale by its parent corporation examples include carlyle s acquisition of tyco fire security services korea co ltd from tyco international ltd in 2014 and francisco partners deal to acquire corporate training platform litmos from german software giant sap se sap announced in august 2022 1314 carve outs tend to fetch lower valuation multiples than other private equity acquisitions but can be more complex and riskier 1516in a secondary buyout a private equity firm buys a company from another private equity group rather than a listed company such deals were assumed to constitute a distress sale but have become more common amid increased specialization by private equity firms 1718 for instance one firm might buy a company to cut costs before selling it to another pe partnership seeking a platform for acquiring complementary businesses 19other exit strategies for a private equity investment include the sale of a portfolio company to one of its competitors as well as its ipo 20 | |
how private equity creates value | by the time a private equity firm acquires a company it will already have a plan in place to increase the investment s worth that could include dramatic cost cuts or a restructuring steps the company s incumbent management may have been reluctant to take private equity owners with a limited time to add value before exiting an investment have more of an incentive to make major changes the private equity firm may also have special expertise the company s prior management lacked it may help the company develop an e commerce strategy adopt new technology or enter additional markets a private equity firm acquiring a company may bring in its own management team to pursue such initiatives or retain prior managers to execute an agreed upon plan the acquired company can make operational and financial changes without the pressure of having to meet analysts earnings estimates or to please its public shareholders every quarter ownership by private equity may allow management to take a longer term view unless that conflicts with the new owners goal of making the biggest possible return on investment industry surveys suggest operational improvements have become private equity managers main focus and source of added value 2122but debt remains an important contributor to private equity returns even as the increase in fundraising has made leverage less essential debt used to finance an acquisition reduces the size of the equity commitment and increases the potential return on that investment accordingly albeit with increased risk private equity managers can also cause the acquired company to take on more debt to accelerate their returns through a dividend recapitalization which funds a dividend distribution to the private equity owners with borrowed money dividend recaps are controversial because they allow a private equity firm to extract value quickly while saddling the portfolio company with extra debt 23 on the other hand the increased debt presumably lowers the company s valuation when it is sold again while lenders must agree with the owners that the company will be able to manage the resulting debt load | |
why private equity draws criticism | private equity firms have pushed back against the stereotype depicting them as strip miners of corporate assets stressing their management expertise and examples of successful transformations of portfolio companies 2124many are touting their commitment to environmental social and governance esg standards directing companies to mind the interests of stakeholders other than their owners 25still rapid changes that often follow a private equity buyout can often be difficult for a company s employees and the communities where it has operations 26another frequent focus of controversy is the carried interest provision allowing private equity managers to be taxed at the lower capital gains tax rate on the bulk of their compensation legislative attempts to tax that compensation as income have met with repeated defeat notably when this change was dropped from the inflation reduction act of 2022 27 | |
how are private equity funds managed | a private equity fund is managed by a general partner gp typically the private equity firm that established the fund the gp makes all of the fund s management decisions it also contributes 1 to 3 of the fund s capital to ensure it has skin in the game in return the gp earns a management fee often set at 2 of fund assets and may be entitled to 20 of fund profits above a preset minimum as incentive compensation known in private equity jargon as carried interest limited partners are clients of the private equity firm that invest in its fund they have limited liability 28 | |
what is the history of private equity investments | in 1901 j p morgan bought carnegie steel corp for 480 million and merged it with federal steel company and national tube to create u s steel in one of the earliest corporate buyouts and one of the largest relative to the size of the market and the economy 2930in 1919 henry ford used mostly borrowed money to buy out his partners who had sued when he slashed dividends to build a new auto plant 31 in 1989 kkr engineered what is still the largest leveraged buyout in history after adjusting for inflation buying rjr nabisco for 25 billion 32 | |
are private equity firms regulated | while private equity funds are exempt from regulation by the securities and exchange commission sec under the investment company act of 1940 or the securities act of 1933 their managers remain subject to the investment advisers act of 1940 as well as the anti fraud provisions of federal securities laws 33 in february 2022 the sec proposed extensive new reporting and client disclosure requirements for private fund advisers including private equity fund managers 3435 the new rules would require private fund advisers registered with the sec to provide clients with quarterly statements detailing fund performance fees and expenses and to obtain annual fund audits all fund advisors would be barred from providing preferential terms for one client in an investment vehicle without disclosing this to the other investors in the same fund 36the bottom linefor a large enough company no form of ownership is free of the conflicts of interests arising from the agency problem like managers of public companies private equity firms can at times pursue self interest at odds with those of other stakeholders including limited partners still most private equity deals create value for the funds investors and many of them improve the acquired company in a market economy the owners of the company are entitled to choose the capital structure that works best for them subject to sensible regulation | |
what is private equity real estate | private equity real estate is an alternative asset class composed of professionally managed pooled private and public investments in the real estate markets investing in private equity real estate involves the acquisition financing and ownership either direct or indirect of property or properties via an investment fund private equity real estate should not be confused with an equity real estate investment trust or equity reit which are publicly traded shares representing real estate investments whose revenues are mainly generated through rental incomes on their real estate holdings understanding private equity real estateprivate equity real estate funds allow high net worth individuals hwnis and institutions such as endowments and pension funds to invest in equity and debt holdings related to real estate assets using an active management strategy private equity real estate takes a diversified approach to property ownership general partners gps invest in a variety of property types in different locations which can range from new development and raw land holdings to complete redevelopment of existing properties or cash flow injections into struggling properties private equity real estate investments are commonly pooled and can be structured as limited partnerships lps limited liability companies llcs s corps c corps collective investment trusts private reits separate insurer accounts or other legal structures special considerationsinvesting in private equity real estate requires an investor with a long term outlook and a significant upfront capital commitment over 250 000 initially and follow on investments over time little flexibility and liquidity are offered to investors since the capital commitment window typically requires several years lock up periods for private equity real estate can sometimes last for more than a dozen or more years also distributions can be slow because they are often paid from cash flow rather than outright liquidation investors have no right to demand a liquidation moreover fund managers typically charge a 2 and 20 fee structure costing investors 2 of invested assets per year plus 20 of profits the following category of investor invests in private equity real estate funds created for individual investors generally require that the investment be funded at the time of the signing of the investment agreement whereas funds created for institutional investors require a capital commitment that capital is then drawn down as suitable investments are made if no investments are made during the investment period specified by the agreement nothing can be drawn from the commitment private equity real estate investing is risky but it can also provide high returns private equity real estate returnsdespite the lack of flexibility and liquidity this type of investment can provide high potential levels of income with strong price appreciation annual returns in the 6 to 8 range for core strategies and 8 to 10 for core plus strategies are not uncommon returns for value added or opportunistic strategies can be considerably higher that said private equity real estate is risky enough that investors can lose their entire investment if a fund underperforms private equity real estate funds became popular in the 1990s amid falling property prices as a way to scoop up properties as values fell previously most institutional real estate investing adhered to core assets types of private equity real estate investmentsoffice buildings high rise urban suburban and garden offices industrial properties warehouse research and development flexible offices or industrial space retail properties shopping centers neighborhood community and power centers and multifamily apartments garden and high rise are the most common private equity real estate investments there are also niche property investments such as senior or student housing hotels self storage medical offices single family housing to own or rent undeveloped land manufacturing space and more | |
what is a private finance initiative pfi | a private finance initiative pfi is a way of financing public sector projects through the private sector pfis alleviate the government and taxpayers of the immediate burden of coming up with the capital for these projects under a private finance initiative a private company handles the up front costs instead of the government in return the government authority makes payments to the private company over the long term the term private finance initiative is used primarily in the united kingdom and australia in the united states pfis are typically called public private partnerships ppps 1 | |
how private finance initiatives pfis work | private finance initiatives are used to fund major public works many are infrastructure projects that benefit the public sector these include highways and roadways and transport projects such as railroads airports bridges and tunnels private sector firms may also be contracted to construct water and wastewater facilities prisons public schools arenas and sports facilities 2instead of funding these projects up front from taxpayers private firms are hired to finance manage and complete the projects the private firms typically make their money back through long term repayments from the government or revenue generated from the project for example highway tolls under this arrangement the government does not have to lay out a large sum of money at once to fund a major project 3depending on the type of project pfi contracts typically last 20 to 30 years they can run longer or shorter depending on the project 2the public sector partner is responsible for clearly defining the objectives of the project and making sure that the private sector partner complies with the terms of the partnership real world example of a private finance initiativein 2020 the u s government engaged in public private partnerships in response to the covid 19 pandemic it partnered with private vaccine developers such as pfizer biontech and moderna the end result was launching effective vaccines in less than a year 4public private partnerships were also responsible for innovations in covid 19 testing treatment options and vaccine distribution throughout the country 5advantages of private finance initiativesgovernments have traditionally had to raise money on their own to fund public infrastructure projects if they aren t able to find the money governments may also borrow from the bond market then hire and pay contractors to complete the job this can often be very cumbersome which is where the pfi comes in pfis are intended to improve on time project completion and transfer some of the risks associated with constructing and maintaining these projects from the public sector to the private sector 2pfis also improve the relationship between the public and private sectors while providing both with long term advantages through this relationship both sectors can share knowledge and resources 2financial advisors such as investment banks help manage the bidding negotiating and financing of a pfi disadvantages of private finance initiativesa key drawback of private finance initiatives is that since the repayment terms typically include payments plus interest the burden may end up being transferred to future taxpayers in addition the arrangements sometimes include not only construction but also ongoing maintenance once the projects are complete which further increases a project s future cost and tax burden 6there is also a risk that private sector firms may not comply with relevant safety or quality standards when managing a project 6in addition terminating a pfi contract before it ends can be highly complex as most projects are not able to secure private financing without assurances that the financing of the project will be repaid in the case of termination in most termination cases the public sector is required to repay the debt and take ownership of the project in practice termination is considered only as a last resort 7criticism of pfis in the u k private finance initiatives were first implemented in the united kingdom in 1992 and became more popular after 1997 in the 2000s controversy surrounding pfis revealed that the government was spending significantly more on these projects than they were worth to the benefit of the private firms running them and to the taxpayers detriment in addition pfis have been criticized by some as an accounting gimmick to reduce the appearance of public sector borrowing 89 | |
what are examples of private finance initiative pfi projects | private finance initiatives pfis typically include major government projects such as highways public transport airports bridges and tunnels other examples of private finance initiatives include hospitals arenas prisons and public schools | |
what are the benefits of private finance initiatives | one of the main benefits of private finance initiatives is alleviating the immediate financial burden on a government and taxpayers to finance major public sector projects pfis can also transfer some of the risks associated with a project from the public sector to the private sector | |
how long do private finance initiative projects last | private finance initiative projects usually take decades to complete contracts typically last 20 to 30 years the bottom lineprivate finance initiatives pfis allow governments and the private sector to join forces to finance and implement projects that benefit the public sector while pfis have some potential downsides governments around the world have used them for decades to finance a wide variety of projects ranging from highways to hospitals referred to as public private partnerships ppps in the united states such partnerships were instrumental in developing covid 19 vaccines | |
what is a private good | a private good is a product that must be purchased to be consumed and consumption by one individual prevents another individual from consuming it in other words a good is considered to be a private good if there is competition between individuals to obtain the good and if consuming the good prevents someone else from consuming it economists refer to private goods as rivalrous and excludable and can be contrasted with public goods understanding private goodswe encounter private goods every day examples include a dinner at a restaurant a grocery shopping airplane rides and cellphones a private good is thus any item that can only be used or consumed by one party at a time many tangible home goods qualify as they can only be used by those who have access to them any item that is effectively destroyed or rendered unusable for its original purpose through use such as food and toilet paper are also private goods often private goods have finite availability making them excludable in nature by preventing others access to it for example only a certain number of a certain pair of designer shoes are produced so not everyone can have those shoes even if they wish to purchase them not only is a single pair seen as a private good but the entire product line can be classified as such the majority of private goods must be purchased for a cost this cost offsets the fact that the use of the good by one prevents the use of the good by another purchasing the item secures the right to consume it and compensates the producer for the costs involved in making it private vs public goodsa private good is the opposite of a public good public goods are generally open for all to use and consumption by one party does not deter another party s ability to use it it is also not excludable preventing the use of the good by another is not possible many public goods can be consumed at no cost water fountains in public places would qualify as public goods since they can be used by anyone and there is no reasonable possibility of it becoming fully used up public television received over the air and standard am or fm local radio also qualify as any number of people can watch of listen to the broadcast without affecting other people s ability to do so private goods are less likely to experience the free rider problem because a private good has to be purchased it is not readily available for free a company s goal in producing a private good is to make a profit without the incentive created by revenue a company is unlikely to want to produce the good meanwhile public goods may be subject to the tragedy of the commons problem | |
what is a private investment fund | a private investment fund is an investment company that does not solicit capital from retail investors or the general public members of a private investment company typically have deep knowledge of the industry as well as investments elsewhere to be classified as a private fund a fund must meet one of the exemptions outlined in the investment company act of 1940 the 3c1 or 3c7 exemptions within the act are frequently used to establish a fund as a private investment fund there is an advantage to maintaining private investment fund status as the regulatory and legal requirements are much lower than what is required for funds that are traded publicly understanding a private investment fundprivate funds are expected to meet certain criteria to keep their status generally the requirements limit both the number and type of investors that can own shares in the fund in the u s under the aforementioned investment company act of 1940 a 3c1 fund can have up to 100 accredited investors and a 3c7 fund can have a soft limit of around 2 000 qualified investors both the definition of qualified and accredited investor come with individual wealth tests accredited investors need to have more than 1 million in net worth without counting their primary residence and or 200 000 in annual income for an individual and 300 000 for a couple qualified investors have to hold assets in excess of 5 million | |
why funds stay private | a private investment fund may choose to stay private for a number of reasons as mentioned the regulations around private investment funds are much looser than for public funds private investment funds enjoy more freedom in how they handle everything from reporting to redemptions this allows private investment funds to look at illiquid investments that a public fund would shun due to the difficulties of regular valuation and liquidation in the case of rising redemptions many hedge funds are private investment funds so they can continue to use aggressive trading strategies that the manager of a public fund would avoid due to the potential for investor lawsuits resulting from unreasonable risk taking most importantly there is no public reporting of positions for private investment funds which allows them to avoid tipping their hand to the market and eroding the profitability of a stealthily built position in addition to investment flexibility private investment funds can be vehicles of choice for handling significant family wealth extremely wealthy families can create private investment funds to invest the wealth with the family members as shareholders often a company serves as the initial structure for this arrangement and it is repurposed to create a capital investment arm from the profits of the business in this case the family doesn t want or need outside capital so there is no incentive to take the fund public | |
what is a private investment in public equity pipe | private investment in public equity pipe is the buying of shares of publicly traded stock at a price below the current market value cmv per share this buying method is a practice of investment firms mutual funds and other large accredited investors a traditional pipe is one in which common or preferred stock is issued at a set price to the investor while a structured pipe issues common or preferred shares of convertible debt the purpose of a pipe is for the issuer of the stock to raise capital for the public company this financing technique is more efficient than secondary offerings because they offer fewer regulatory hurdles with the securities and exchange commission sec on the downside pipes tend to be an expensive source of capital since the issuer must take a discount on the stocks sold | |
how a private investment in public equity works | a publicly traded company may utilize a pipe when securing funds for working capital to fund day to day operations expansion or acquisitions the company may create new stock shares or use some from its supply but the equities never go on sale on a stock exchange 1instead these large investors purchase the company s stock in a private placement and the issuer files a resale registration statement with the sec the issuing business typically obtains its funding that is the investors money for the shares within two to three weeks rather than waiting several months or longer as it would with a secondary stock offering registration of the new shares with the sec typically becomes effective within a month of filing special considerations for pipe buyerspipe investors may purchase stock below the market price as a hedge of protection against the share price going down after news of the pipe gets out the discount also acts as compensation for a certain lack of liquidity in the shares meaning there can be delays in selling or converting the shares to cash since this offering was a pipe the buyers cannot sell their shares until the company files its resale registration statement with the sec 2 however an issuer generally cannot sell more than 20 of its outstanding stock at a discount without receiving prior approval from current shareholders a traditional pipe agreement lets investors purchase common stock or preferred stock that is convertible to common shares at a predetermined price or exchange rate if the business is merged with another or sold soon investors may be able to receive dividends or other payoffs dividends are cash or stock payments from companies to their shareholders or investors because of these benefits traditional pipes are typically priced at or near the stock s market value with a structured pipe preferred stock or debt securities convertible to common stock are sold if the securities contain a reset clause new investors are shielded from downside risks but existing stockholders are exposed to the greater risk of dilution in share values for this reason a structured pipe transaction may need prior stockholder approval companies must sell their shares at a discount meaning that they sell their shares for less than market price in 2023 the average discount on pipe offerings was about 5 3advantages and disadvantages of pipesprivate investment in public equity carries several advantages for issuers large amounts of shares are typically sold to knowledgeable investors over the long term ensuring the company secures the funding it needs pipes can be particularly advantageous for small to medium sized public companies that may have a hard time accessing more traditional forms of equity financing because pipe shares do not need to be registered in advance with the sec or meet all the usual federal registration requirements for public stock offerings transactions proceed more efficiently with fewer administrative requirements however on the downside investors may sell their stock in a short amount of time driving down the market price if the market price drops below a set threshold the company may have to issue additional stock at a significantly reduced price this new share issue dilutes the value of shareholders investments which can lead to a lower stock price short sellers may take advantage of the situation by repeatedly selling their shares and lowering the share price potentially resulting in pipe investors having majority ownership of the company setting a minimum share price below which no compensatory stock is issued can avoid this problem fast source of capital fundsless paperwork and filing requirementslower transactional costsdiscounted share prices for investors diluted share value for current stockholders buyers limited to accredited investorsdiscounted share price less capital for company potential need for shareholder approvalexample of a pipein aug 2023 the aircraft manufacturer archer aviation closed a 215 million investment round that included a pipe financing agreement investors included united airlines ark invest the auto manufacturer stellantis and boeing 4the oversubscribed offering allowed archer to raise an additional 215 million in capital in exchange for equity sales to the investors the raised money will be used as working capital and for general corporate expenses in the company s goal of testing and building new passenger aircraft for the investing companies the deal allowed them to increase their stakes in the company and develop closer cooperation with a potential supplier | |
what s the difference between an ipo and a pipe | an initial public offering ipo represents the first time a company s securities are sold on a public stock market in a pipe the stock is already available on public markets but private equity investors make a deal to buy the stock at a discount from the issuer although the price is lower than the market price pipe agreements are faster than public offerings and face fewer regulatory hurdles | |
what s the difference between a pipe and a private placement | a private placement is a deal where shares are sold to a small number of pre selected buyers rather than being sold on a public stock market this is common for smaller or privately held companies that do not qualify for public offerings a pipe private investment in public equity is a type of private placement except the company selling the shares already trades on a public stock exchange in order to be successful issuers must sell their shares for less than market price but this route can be more straightforward than a public offering | |
what is a subscription agreement in finance | in finance a subscription agreement is an agreement to buy shares of a limited partnership an investor agrees to buy shares in a certain company in exchange for a share of that company s equity the agreement will include the time and date of the sale the price and quantity of shares traded and any additional terms or backout conditions for the sale the bottom linea private investment in public equity pipe is a transaction where companies sell shares in return for capital from a major investor although the issuing company is already listed in the stock market selling equity through a pipe can be faster and more efficient than selling their shares to the public on the downside the issuer must accept a discount from the market price | |
what is a private placement | a private placement is a sale of stock shares or bonds to pre selected investors and institutions rather than publicly on the open market it is an alternative to an initial public offering ipo for a company seeking to raise capital for expansion private placements are regulated by the u s securities and exchange commission under regulation d investors invited to participate in private placement programs include wealthy individual investors banks and other financial institutions mutual funds insurance companies and pension funds one advantage of a private placement is its relatively few regulatory requirements investopedia nono floresunderstanding private placementsprivate placements have become a common way for startups to raise financing particularly those in the internet and financial technology sectors they allow these companies to grow and develop while avoiding the full glare of public scrutiny that accompanies an ipo there are minimal regulatory requirements and standards for a private placement even though like an ipo it involves the sale of securities the sale does not even have to be registered with the u s securities and exchange commission sec the company is not required to provide a prospectus to potential investors and detailed financial information may not be disclosed 1the sale of stock on public exchanges is regulated by the securities act of 1933 among other laws the law was enacted after the market crash of 1929 to ensure that investors receive sufficient disclosure when they purchase securities regulation d of that act provides a registration exemption for private placement offerings 23the same regulation allows an issuer to sell securities to a pre selected group of investors that meet specified requirements instead of a prospectus private placements are sold using a private placement memorandum ppm and cannot be broadly marketed to the general public 2it specifies that only accredited investors may participate these may include individuals or entities such as venture capital firms that qualify under the sec s terms 2advantages and disadvantages of private placementsabove all a young company can remain a private entity avoiding the many regulations and annual disclosure requirements that follow an ipo the light regulation of private placements allows the company to avoid the time and expense of registering with the sec 21that means the process of underwriting is faster and the company gets its funding sooner if the issuer is selling a bond it also avoids the time and expense of obtaining a credit rating from a bond agency a private placement allows the issuer to sell a more complex security to accredited investors who understand the potential risks and rewards the buyer of a private placement bond issue expects a higher rate of interest than can be earned on a publicly traded security because of the additional risk of not obtaining a credit rating a private placement buyer may not buy a bond unless it is secured by specific collateral a private placement stock investor may also demand a higher percentage of ownership in the business or a fixed dividend payment per share of stock this puts pressure on the company to perform at a higher level which could lead it to ignore the careful process of healthy growth additionally there could be a loss of control if private placements result in increased ownership from investors | |
how does a private placement work | private placements are the sale of a company s shares to a number of pre selected investors the process takes place privately hence the name meaning that a company does not have to go through the regulatory hurdles of an ipo and being a public company but is still able to raise external funds to expand the business | |
what is the difference between a po and an ipo | an ipo is an initial public offering when a company sells shares publicly for the first time a po is a public offering when a company sells shares publicly again after its ipo a company can only have one ipo but many pos | |
why do companies go for private placements | there are many benefits that would make a company choose a private placement these include a faster process to selling shares than an ipo having to meet fewer regulatory requirements than an ipo would require having to meet fewer regulatory obligations on an ongoing basis than being public would require and the ability to retain more control of the company the bottom lineprivate placements allow business owners to raise capital by foregoing the ipo process which is often long difficult and burdensome by opening their doors to pre selected investors through private placements businesses can raise funds for expansion while not having to abide by the many regulatory requirements that an ipo and being public demand though it comes with benefits there are downsides with demanding investors seeking high returns for the increased risk they take on through private placements | |
what is the private sector | the private sector is the part of the economy run by individuals and companies for profit and is not state controlled therefore it encompasses all for profit businesses not owned or operated by the government government run companies and corporations are part of what is known as the public sector while charities and other nonprofit organizations are part of the voluntary sector investopedia joules garciaunderstanding the private sectorthe private sector is the segment of a national economy that is owned controlled and managed by private individuals or enterprises the private sector has a goal of making money and employs more workers than the public sector a private sector organization is created by forming a new enterprise or privatizing a public sector organization a large private sector corporation may be privately or publicly traded businesses in the private sector drive down prices for goods and services while competing for consumers money in theory customers do not want to pay more for something when they can buy the same item elsewhere at a lower cost in most free economies the private sector makes up a big portion of the economy as opposed to nations that have more state control over their economies which have a larger public sector for example the united states has a strong private sector because it has a free economy while china where the state controls many of its corporations has a larger public sector types of private sector businessesthe private sector is a very diverse sector and makes up a big part of many economies it is based on many different individuals partnerships and groups the entities that form the private sector include even though the private sector is not directly controlled by any government entity the government does legally regulate it any business or corporate entity must operate under the laws of the country it is based in private vs public sectorthe private sector employs workers through individual business owners corporations or other non government agencies jobs include those in manufacturing financial services professions hospitality or other non government positions workers are paid with part of the company s profits private sector workers tend to have more pay increases more career choices greater opportunities for promotions less job security and less comprehensive benefit plans than public sector workers working in a more competitive marketplace often means longer hours in a more demanding environment than working for the government the public sector employs workers through the federal state or local government typical civil service jobs are in healthcare teaching emergency services armed forces and various regulatory and administrative agencies workers are paid through a portion of the government s tax dollars public sector workers tend to have more comprehensive benefit plans and more job security than private sector workers once a probationary period concludes many government positions become permanent appointments moving among public sector positions while retaining the same benefits holiday entitlements and sick pay is relatively easy while receiving pay increases and promotions is difficult working with a public agency provides a more stable work environment free of market pressures unlike working in the private sector the bureau of labor statistics tracks and reports both private and public employment in the united states private and public sector partnershipsthe private and public sectors sometimes work together while promoting common interests private sector businesses leverage governmental assets and resources while developing financing owning and operating public facilities or services for example a private company might pay a state a one time fee to operate a specific length of freeway for a set time in exchange for revenue from tolls | |
what is the purpose of the private sector | in addition to generating profits the private sector provides employment opportunities delivers specific goods and services helps develop industries or technologies enables the functioning of a diverse group of businesses and adds to the national income | |
what types of companies are considered to be in the private sector | there are many types of companies or entities that constitute the private sector they include sole proprietorships partnerships and privately owned corporations | |
what are examples of the public sector | the public sector consists of all companies or agencies that are government owned or associated examples include federal agencies such as the internal revenue service irs and the u s department of labor state services such as police and fire departments and a variety of additional organizations that provide services to the public overall the bottom linethe private sector is the part of the economy not run by the government it comprises the businesses and enterprises that are controlled by private individuals and groups for the purpose of making a profit companies and organizations run by the state are considered to be the public sector in free market capitalist based societies the private sector tends to make up a considerably larger portion of the economy than the public sector | |
what is privatization | privatization occurs when a government owned business operation or property becomes owned by a private nongovernment party privatization also may describe a transition that takes a company from being publicly traded to becoming privately held this is referred to as corporate privatization | |
how privatization works | privatization of specific government operations happens in a number of ways though generally the government transfers ownership of specific facilities or business processes to a private for profit company privatization generally helps governments save money and increase efficiency in general two main sectors comprise an economy the public sector and the private sector government agencies generally run operations and industries within the public sector in the united states the public sector includes the u s postal service public schools and universities the police and fire departments the national park service and the national security and defense services enterprises not run by the government comprise the private sector private companies include the majority of firms in the consumer discretionary consumer staples finance information technology industrial real estate materials and healthcare sectors there are two types of privatization government and corporate however the term generally applies to government to private transfers public to private privatization vs corporate privatizationcorporate privatization allows a company to manage its business or restructure its operations without the strict regulatory or shareholders oversight imposed on publicly listed companies this often appeals to companies if the leadership wants to make structural changes that would negatively impact shareholders corporate privatization sometimes takes place after a merger or following a tender offer to purchase a company s shares to be considered privately owned a company cannot get financing through public trading via a stock exchange dell inc is an example of a company that transitioned from being publicly traded to privately held in 2013 with approval from its shareholders dell offered shareholders a fixed amount per share plus a specified dividend as a way to buy back its stock and delist once the company paid off its existing shareholders it ceased any public trading and removed its shares from the nasdaq stock exchange completing the transition to being privately held 1 in 2018 dell reverted to being a public company dell 2advantages and disadvantages of privatizationproponents of privatization argue that privately owned companies run businesses more economically and efficiently because they are profit incentivized to eliminate wasteful spending furthermore private entities don t have to contend with the bureaucratic red tape that can plague government entities on the other hand privatization naysayers believe necessities like electricity water and schools shouldn t be vulnerable to market forces or driven by profit in certain states and municipalities liquor stores and other nonessential businesses are run by public sectors as revenue generating operations real world examples of privatizationbefore 2012 the state of washington controlled all sales of liquor within the state meaning that only the state could operate liquor stores this policy allowed the state to regulate how and when liquor was sold and to collect all revenue from liquor sales within the state however in 2012 the state moved to privatize liquor sales 34once privatized private businesses such as costco and walmart could sell liquor to the general public all previously state run stores were sold to private owners or closed and the state ceased collecting all revenue from liquor sales one of the most famous and historically important examples of privatization occurred after the fall of the soviet union the soviet union s form of government was communism where everything was owned and run by the state there was no private property or business privatization began before the collapse of the soviet union under mikhail gorbachev its then leader who implemented reforms to hand over certain government enterprises to the private sector after the soviet union collapsed there was mass privatization of previous government enterprises to a select portion of the populace in russia known as oligarchs that dramatically increased inequality within the nation 5 | |
what types of institutions can become privatized | many types of institutions and facilities typically run by public officials or governments can be and have been privatized these include among others prisons public schools and universities hospitals highways airports and harbors public utilities e g water electricity waste disposal mail delivery and communications infrastructure | |
why are some prisons privatized | prisons and jails are often owned and operated by local or state governments however there has been a trend to privatize these facilities as governments seek to lower costs raise capital and create jobs in their communities proponents argue that specialist companies are better equipped and skilled at controlling prison populations critics however argue that for profit prisons are rife with scandal cutting corners prisoner abuse and other ethics violations 6 | |
do shareholders get anything if a company goes private | yes shareholders first must agree to give up ownership in the company in exchange for some amount of money if approved all shareholders will receive a certain amount per share often at a premium to the market price afterward they are no longer shareholders and the company s shares would be delisted from exchanges the bottom linetransferring services provided by the government to private businesses is known as privatization another use of the term involves publicly traded companies becoming privately owned jails and prisons are examples of government run services that sometimes are transferred to private businesses something like liquor sales varies from state to state some states manage all liquor sales while others allow private businesses to sell liquor | |
what is privileged communication | privileged communication is an interaction between two parties in which the law recognizes a private protected relationship whatever is communicated between the two parties must remain confidential and the law cannot force their disclosure even disclosure by one of the parties comes with legal limitations there are however exceptions that can invalidate a privileged communication relationship there are also various circumstances under which privileged communication can be waived either deliberately or unintentionally commonly cited relationships where privileged communication exists are those between attorney and client doctor or therapist and patient and priest and parishioner | |
how privileged communication works | in addition to attorney client privilege and conversations with medical professionals and religious officials privileged communications include those between two spouses accountant and client and in some states reporters and their sources in professional relationships the right of protection for the communication belongs to the client patient or penitent the recipient of the information must keep the communication private unless the privilege is waived by the discloser of the information if the recipient of the information fails to keep the information private in many instances they can lose their operating license the key provisions of privilege between spouses are that courts cannot force husbands or wives to disclose the contents of confidential communications made during marriage nor can either spouse be compelled to testify against the other these rights which endure even after a marriage is dissolved are designed to protect the honesty and confidentiality of marriage however these protections do not prevent one or the other spouse from testifying against the other in court should they choose to do so special considerationsto ensure confidential status in a privileged communication relationship the communication made between the two parties must take place in a private setting for example a meeting room where the parties have a reasonable expectation that others might not overhear them however the privileged status of the communication ends if or when the communication is shared with a third party that is not part of the protected relationship however a person who is an agent of the recipient of the information an accountant s secretary say or a doctor s nurse is generally not considered to be a third party who jeopardizes the privileged status of the communication it is important to keep in mind that there are situations where privileged communications stops being private for example if there have been disclosures of harm to people or the threat of harm to people in the future communications with medical professionals are not protected when the professional has reason to believe the patient may bring harm to themselves or others the lack of protection typically extends to suspected abuse of children or other vulnerable people such as the elderly or disabled even between spouses privileged communication typically does not apply in cases involving the harm or the threat of harm to a spouse or children in the couple s care or to crimes jointly committed with the other spouse |
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