Finical Term of the Day: Keynesian Economics

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Following will explain Keynesian Economics, but key word through out this article is “Government”. I have zero faith in government to control anything without them increasing in size and influence. When government controls anything the ability for me to determine my path is taken a way. I chose freedom not tyranny.

What is ‘Keynesian Economics’

An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Depression. Subsequently, the term “Keynesian economics” was used to refer to the concept that optimal economic performance could be achieved – and economic slumps prevented – by influencing aggregate demand through activist stabilization and economic intervention policies by the government. Keynesian economics is considered to be a “demand-side” theory that focuses on changes in the economy over the short run.

BREAKING DOWN ‘Keynesian Economics’

Prior to Keynesian economics, classical economic thinking held that cyclical swings in employment and economic output would be modest and self-adjusting. According to this classical theory, if aggregate demand in the economy fell, the resulting weakness in production and jobs would precipitate a decline in prices and wages. A lower level of inflation and wages would induce employers to make capital investments and employ more people, stimulating employment and restoring economic growth.

The depth and severity of the Great Depression, however, severely tested this hypothesis. Keynes maintained in his seminal book, “General Theory of Employment, Interest and Money,” and other works, that structural rigidities and certain characteristics of market economies would exacerbate economic weakness and cause aggregate demand to plunge further.

For example, Keynesian economics refutes the notion held by some economists that lower wages can restore full employment, by arguing that employers will not add employees to produce goods that cannot be sold because demand is weak. Similarly, poor business conditions may cause companies to reduce capital investment, rather than take advantage of lower prices to invest in new plant and equipment; this would also have the effect of reducing overall expenditures and employment.

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Finical Term of the Day: Call Option

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What is a ‘Call Option’

A call option is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period.

It may help you to remember that a call option gives you the right to call in, or buy, an asset. You profit on a call when the underlying asset increases in price.

BREAKING DOWN ‘Call Option’

Call options are typically used by investors for three primary purposes. These are tax management, income generation and speculation.

How Options Work

An options contract gives the holder the right to buy 100 shares of the underlying security at a specific price, known as the strike price, up until a specified date, known as the expiration date. For example, a single call option contract may give a holder the right to buy 100 shares of Apple stock at a price of $100 until Dec. 31, 2017. As the value of Apple stock goes up, the price of the options contract goes up, and vice versa. Options contract holders can hold the contract until the expiration date, at which point they can take delivery of the 100 shares of stock or sell the options contract at any point before the expiration date at the market price of the contract at the time.

Options Used for Tax Management

Investors sometimes use options as a means of changing the allocation of their portfolios without actually buying or selling the underlying security. For example, an investor may own 100 shares of Apple stock and be sitting on a large unrealized capital gain. Not wanting to trigger a taxable event, shareholders may use options to reduce the exposure to the underlying security without actually selling it. The only cost to the shareholder for engaging in this strategy is the cost of the options contract itself.

Options Used for Income Generation

Some investors use call options to generate income through a covered call strategy. This strategy involves owning an underlying stock while at the same time selling a call option, or giving someone else the right to buy your stock. The investor collects the option premium and hopes the option expires worthless. This strategy generates additional income for the investor but can also limit profit potential if the underlying stock price rises sharply.

Options Used for Speculation

Options contracts gives buyers the opportunity to obtain significant exposure to a stock for a relatively small price. Used in isolation, they can provide significant gains if a stock rises, but can also lead to 100% losses if the call option purchased expires worthless because the underlying stock price went down. Options contracts should be considered very risky if used for speculative purposes because of the high degree of leverage involved.

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Finical Term of the Day: Economies Of Scale

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What is ‘Economies Of Scale’

Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are spread out over a larger number of goods. Economies of scale may also reduce variable costsper unit because of operational efficiencies and synergies. Economies of scale can be classified into two main types: Internal – arising from within the company; and External – arising from extraneous factors such as industry size.

BREAKING DOWN ‘Economies Of Scale’

“Economies of scale” is a simple concept that can be demonstrated through an example. Assume you are a small business owner and are considering printing a marketing brochure. The printer quotes a price of $5,000 for 500 brochures, and $10,000 for 2,500 copies. While 500 brochures will cost you $10 per brochure, 2,500 will only cost you $4 per brochure. In this case, the printer is passing on part of the cost advantage of printing a larger number of brochures to you. This cost advantage arises because the printer has the same initial set-up cost regardless of whether the number of brochures printed is 500 or 2,500. Once these costs are covered, there is only a marginal extra cost for printing each additional brochure.

Economies of scale can arise in several areas within a large enterprise. While the benefits of this concept in areas such as production and purchasing are obvious, economies of scale can also impact areas like finance. For example, the largest companies often have a lower cost of capital than small firms because they can borrow at lower interest rates. As a result, economies of scale are often cited as a major rationale when two companies announce a merger or takeover.

However, there is a finite upper limit to how large an organization can grow to achieve economies of scale. After reaching a certain size, it becomes increasingly expensive to manage a gigantic organization for a number of reasons, including its complexity, bureaucratic nature and operating inefficiencies. This undesirable phenomenon is referred to as “diseconomies of scale”.

Want to know more? Read What Are Economies Of Scale?

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Finical Term of the Day: Credit Default Swap – CDS

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What is a ‘Credit Default Swap – CDS’

A credit default swap is a particular type of swap designed to transfer the credit exposure of fixed income products between two or more parties. In a credit default swap, the buyer of the swap makes payments to the swap’s seller up until the maturity date of a contract. In return, the seller agrees that, in the event that the debt issuer defaults or experiences another credit event, the seller will pay the buyer the security’s premium as well as all interest payments that would have been paid between that time and the security’s maturity date.

A credit default swap is the most common form of credit derivative and may involve municipal bonds, emerging market bonds, mortgage-backed securities or corporate bonds.

A credit default swap is also often referred to as a credit derivative contract.

BREAKING DOWN ‘Credit Default Swap – CDS’

Many bonds and other securities that are sold have a fair amount of risk associated with them. While institutions that issue these forms of debt may have a relatively high degree of confidence in the security of their position, they have no way of guaranteeing that they will be able to make good on their debt. Because these kinds of debt securities will often have lengthy terms to maturity, like ten years or more, it will often be difficult for the issuer to know with certainty that in ten years time or more, they will be in a sound financial position. If the security in question is not well-rated, a default on the part of the issuer may be more likely.

Credit Default Swap as Insurance

A credit default swap is, in effect, insurance against non-payment. Through a CDS, the buyer can mitigate the risk of their investment by shifting all or a portion of that risk onto an insurance company or other CDS seller in exchange for a periodic fee. In this way, the buyer of a credit default swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the debt security. For example, the buyer of a credit default swap will be entitled to the par value of the contract by the seller of the swap, should the issuer default on payments.

If the debt issuer does not default and if all goes well the CDS buyer will end up losing some money, but the buyer stands to lose a much greater proportion of their investment if the issuer defaults and if they have not bought a CDS. As such, the more the holder of a security thinks its issuer is likely to default, the more desirable a CDS is and the more the premium is worth it.

Credit Default Swap in Context

Any situation involving a credit default swap will have a minimum of three parties. The first party involved is the financial institution that issued the debt security in the first place. These may be bonds or other kinds of securities and are essentially a small loan that the debt issuer takes out from the security buyer. If an institution sells a bond with a $100 premium and a 10-year maturity to a buyer, the institution is agreeing to pay back the $100 to the buyer at the end of the 10-year period as well as regular interest payments over the course of the intervening period. Yet, because the debt issuer cannot guarantee that they will be able repay the premium, the debt buyer has taken on risk.

The debt buyer in question is the second party in this exchange and will also be the CDS buyer should they agree to enter into a CDS contract. The third party, the CDS seller, is most often an institutional investing organization involved in credit speculation and will guarantee the underlying debt between the issuer of the security and the buyer. If the CDS seller believes that the risk on securities that a particular issuer has sold is lower than many people believe, they will attempt to sell credit default swaps to people who hold those securities in an effort to make a profit. In this sense, CDS sellers profit from the security-holder’s fears that the issuer will default.

CDS trading is very complex and risk-oriented and, combined with the fact that credit default swaps are traded over-the-counter (meaning they are unregulated), the CDS market is prone to a high degree of speculation. Speculators who think that the issuer of a debt security is likely to default will often choose to purchase those securities and a CDS contract as well. This way, they ensure that they will receive their premium and interest even though they believe the issuing institution will default. On the other hand, speculators who think that the issuer is unlikely to default may offer to sell a CDS contract to a holder of the security in question and be confident that, even though they are taking on risk, their investment is safe.

Though credit default swaps may often cover the remainder of a debt security’s time to maturity from when the CDS was purchased, they do not necessarily need to cover the entirety of that duration. For example, if, two years into a 10-year security, the security’s owner thinks that the issuer is headed into dangerous waters in terms of its credit, the security owner may choose to buy a credit default swap with a five-year term that would then protect their investment until the seventh year. In fact, CDS contracts can be bought or sold at any point during their lifetime before their expiration date and there is an entire market devoted to the trading of CDS contracts. Because these securities often have long lifetimes, there will often be fluctuations in the security issuer’s credit over time, prompting speculators to think that the issuer is entering a period of high or low risk.

It is even possible for investors to effectively switch sides on a credit default swap to which they are already a party. For example, if a speculator that initially issued a CDS contract to a security-holder believes that the security-issuing institution in question is likely to default, the speculator can sell the contract to another speculator on the CDS market, buy securities issued by the institution in question and a CDS contract as well in order to protect that investment.

Want to learn more about CDS and other swaps? Check out Credit Default Swaps: An IntroductionDifferent Types of SwapsAn In-Depth Look At The Swap Market and The Alphabet Soup Of Credit Derivative Indexes.

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Finical Term of the Day: Sin Stock

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DEFINITION of ‘Sin Stock’

A stock of a company either directly involved in or associated with activities widely considered to be unethical or immoral. Sin stocks are found in sectors whose activities are frowned upon by some or most of society, because they are perceived as making money from exploiting human weaknesses and frailties. Sin stock sectors therefore include alcohol, tobacco, gambling, sex-related industries, weapons manufacturers and the military. Also known as “sinful stocks”, they are the polar opposite of ethical investing and socially responsible investing, whose proponents emphasize investments that benefit society.

 

BREAKING DOWN ‘Sin Stock’

Investing in sin stocks may be anathema to some investors, but the fact is that many of them are sound investments. The very nature of their business ensures that they have a steady stream of consumers. As well, since demand for their products or services is relatively inelastic, their business is fairly recession-proof. The lesser degree of competition also ensures fat margins and solid profits for sin stocks.

Research suggests that sin stocks are also likely to be undervalued because their negative image leads to them being shunned by analysts and institutional investors. This makes them attractive investments for investors willing to take the plunge, since a number of the biggest sin stocks have great long-term records of generating shareholder value. From 2008 to 2012, the U.S. tobacco, distilleries and brewers sub-sectors generated double-digit annual returns, easily outperforming the broad market.

Some of the best-known sin stocks include Altria Group, Anheuser-Busch InBev, Diageo, General Dynamics, Smith & Wesson, Caesar’s Entertainment, Las Vegas Sands and Philip Morris.

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Function Stacking.

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Permaculture is for everyone.

In Permaculture Design there is a term called stacking functions.  We stack functions by designing elements to serve many functions.  This can be in either space or time.

In the video below I show you an example of how two elements on my homestead, and how they serve many functions. Enjoy!

I post videos on my You Tube first. Please subscribe there also if you want a sneak preview of what is to some.

 

 

Monetary Policy

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What is ‘Monetary Policy’

Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).

The Federal Reserve is in charge of the United States’ monetary policy.

 

BREAKING DOWN ‘Monetary Policy’

Broadly, there are two types of monetary policy, expansionary and contractionary. Expansionary monetary policy increases the money supply in order to lower unemployment, boost private-sector borrowing and consumer spending, and stimulate economic growth. Often referred to as “easy monetary policy,” this description applies to many central banks since the 2008 financial crisis, as interest rates have been low and in many cases near zero.

Contractionary monetary policy slows the rate of growth in the money supply or outright decreases the money supply in order to control inflation; while sometimes necessary, contractionary monetary policy can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. An example would be the Federal Reserve’s intervention in the early 1980s: in order to curb inflation of nearly 15%, the Fed raised its benchmark interest rate to 20%. This hike resulted in a recession, but did keep spiraling inflation in check.

Central banks use a number of tools to shape monetary policy. Open market operations directly affect the money supply through buying short-term government bonds (to expand money supply) or selling them (to contract it). Benchmark interest rates, such as the LIBOR and the Fed funds rate, affect the demand for money by raising or lowering the cost to borrow—in essence, money’s price. When borrowing is cheap, firms will take on more debt to invest in hiring and expansion; consumers will make larger, long-term purchases with cheap credit; and savers will have more incentive to invest their money in stocks or other assets, rather than earn very little—and perhaps lose money in real terms—through savings accounts. Policy makers also manage risk in the banking system by mandating thereserves that banks must keep on hand. Higher reserve requirements put a damper on lending and rein in inflation.

In recent years, unconventional monetary policy has become more common. This category includes quantitative easing, the purchase of varying financial assets from commercial banks. In the US, the Fed loaded its balance sheet with trillions of dollars in Treasury notes and mortgage-backed securities between 2008 and 2013. The Bank of England, the European Central Bank and the Bank of Japanhave pursued similar policies. The effect of quantitative easing is to raise the price of securities, therefore lowering their yields, as well as to increase total money supply. Credit easing is a related unconventional monetary policy tool, involving the purchase of private-sector assets to boost liquidity. Finally, signaling is the use of public communication to ease markets’ worries about policy changes: for example, a promise not to raise interest rates for a given number of quarters.

Central banks are often, at least in theory, independent from other policy makers. This is the case with the Federal Reserve and Congress, reflecting the separation of monetary policy from fiscal policy. The latter refers to taxes and government borrowing and spending.

The Federal Reserve has what is commonly referred to as a “dual mandate”: to achieve maximum employment (in practice, around 5% unemployment) and stable prices (2-3% inflation). In addition, it aims to keep long-term interest rates relatively low, and since 2009 has served as a bank regulator. Its core role is to be the lender of last resort, providing banks with liquidity in order to prevent the the bank failures and panics that plagued the US economy prior to the Fed’s establishment in 1913. In this role, it lends to eligible banks at the so-called discount rate, which in turn influences the Federal funds rate (the rate at which banks lend to each other) and interest rates on everything from savings accounts to student loans, mortgages and corporate bonds.

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