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Terms

 

A daily selection of business terms and their definitions / application.

Term: Aggressor

What Is an Aggressor?

Aggressors are traders that take liquidity out of the markets. Rather than entering bids for shares, aggressors buy at-market at the current ask price. They will also sell at the current at-market bid prices rather than specifying a selling price. By purchasing available shares or contracts at the current at-market price, aggressors place orders which have immediate execution.

Other traders are passive because they add liquidity to markets by entering bids and offers, which may not have an immediate filling or execution. In today’s electronic markets, traders may be human or they may be computers running automated algorithmic trading programs.

Key Takeaways

  • Aggressors are traders who remove liquidity from the markets by entering buy and sell orders at current at-market prices.
  • Because aggressors purchase available shares or contracts at the current at-market price, their orders are executed immediately.
  • This immediate action means aggressors sell at lower and lower prices and buy at higher and higher prices, thereby pushing other traders out and taking liquidity out of the market.
  • In contrast, passive traders add liquidity to the market by placing trades with bids and offers, which may not be immediately filled or executed.

Understanding Aggressors

Aggressors review pricing in markets such as futures exchanges, which have a basis on a range of orders at various prices. The best bid-to-buy and best offer-to-sell will set the bid-ask spread. The difference between those two prices will vary depending on the prevailing market conditions. The number of contracts available for purchase or sale may also be different.

For example, if the bid-ask spread for a specific crude oil contract is ten contracts at $60.01 bid/15 contracts at $60.11 ask, an aggressor would immediately buy 15 contracts at the best asking price of $60.11 or instantly sell ten contracts at the best bid of $60.01.

A passive trader motivated to buy a contract might offer a bit more, for example, $60.05. The passive trader inclined to sell might suggest less. Passive trading tends to narrow spreads and add liquidity to markets, while aggressive trading removes liquidity.

How Aggressors Impact Market Liquidity

Market participants have access to the order book, which shows a list of all current bids and offers, some of which may not be close to the current market price. Using our example above, the best proposal for a crude oil contract is ten contracts at $60.01. Other bids may rest below that price, such as 15 contracts for $60.00 or 20 contracts at $59.99.

Also, other ask offers may be above the best current asking price. If the best offer is currently $60.11, higher offerings might be 12 contracts for sale at $60.12 or 15 contracts at $60.13.

By taking immediate action at the current bid or asking price, aggressors continue to sell at lower and lower costs or buy at higher and higher prices. This squeezing causes volatility, which will become more common as markets get thin and imbalanced as other traders are pushed out.

Volatility in the stock market is associated with big swings in prices; typically, a volatile market is when the stock market rises or falls more than one percent over a sustained time.

Special Considerations

Liquid markets have many advantages, including the ability for investors to transfer their investments into cash in an accessible and timely fashion. Anything that reduces market liquidity can lead to volatility, which may drive investors away from a particular market.

Because of this, some electronic marketplaces now offer fee credits for traders who wait for order fills and add liquidity to the markets. In essence, they are rewarding the passive trading strategy. Conversely, they may charge additional fees to aggressors who remove liquidity by immediately taking the best bid or offer.

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Term: Commercial Investment

What is a Commercial Investment?

Commercial investment is an investment in a for-profit enterprise involved in the buying or selling of goods and services, with the expectation of generating cash flow. An individual, group or institution can assume this type of investment. Frequently, a group of investors who combine assets will fund a commercial venture.

Understanding Commercial Investment

A commercial investment occurs when an investor commits money or capital to purchase a for-profit property or business. This enterprise may be a partial investment as part of a group effort or may be purchased by a single investor. Some of the most common examples of commercial investments include real estate properties, such as apartment complexes, office buildings, hotels or industrial complexes.

Franchises are another favorite type of commercial investment. Many low-cost franchises require expenditures of $10,000 or less, which can be an excellent way to get experience in the commercial investment realm with a relatively small amount of initial capital.

Pros and Cons of Commercial Investments

Investing in commercial property can involve several pros and cons. Two of the positive aspects are measurable income, or profit potential, and relatively passive income.

Savvy investors who have a knack for spotting up-and-coming neighborhoods on the cusp of rapid growth can get relative bargains before the local market soars. Of course, as with most things in real estate, it’s all about “location, location, location.” Your profit potential will depend in large part on the location, and how property values and rental markets in that area are performing. In many areas, commercial and multi-unit properties tend to increase in value at a higher rate than residential properties.

But there are also a few potential downsides, including that values could drop and unexpected emergencies or disasters can occur. Even the most promising areas can suddenly take a turn in the wrong direction, and you could find yourself with a property that has dropped in value, or one with vacant units you are unable to rent.

Any type of property is subject to damages, breakdowns or other headaches you may not anticipate. This maintenance could range from fire or flood damage to a malfunctioning air conditioner or furnace. Depending on the situation, insurance may help recoup part of the costs, but it is smart to have a repair or emergency fund to help cover the costs of any needed repairs.

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Term: Book Transfer

What Is a Book Transfer?

A book transfer is the transfer of funds from one deposit account to another at the same financial institution. An example would be when an individual moves funds from their checking account to their savings account. It can also be used to refer to the change in ownership of an asset, such as a stock or bond, from one owner to another without any physical movement of the related documents. Book transfers are beneficial to a bank’s operations as they are instantaneous and remove the float time in checking transactions.

Key Takeaways

  • A book transfer is the movement of funds from one deposit account to another in the same bank.
  • A change in ownership of an asset, such as a stock or bond, from one owner to another without any physical movement can also be referred to as a book transfer.
  • Float time in a bank is eliminated through the use of book transfers.
  • Book transfers are primarily associated with checking accounts, savings accounts, and money market accounts.
  • A book transfer is different from a wire transfer in that a wire transfer is to an external bank account.
  • There are typically no fees with a book transfer whereas wire transfers cost money.

Understanding a Book Transfer

Book transfers are a means of eliminating float or the time between when an individual deposits a check and the institution clears it. For example, if someone writes a check today for payment, a period of days or weeks might lapse before the check is cleared and the funds removed from the payer’s account. This lapse enables the paying bank to earn interest on those funds for the period before the check is cleared but it is a form of double counting.

The use of a book transfer eliminates float time and really applies to customers within the same financial institution that exchange money. Book transfers are generally between deposit accounts, which can encompass savings accounts, checking accounts, and money market accounts.

Book Transfers vs. Wire Transfers

Slightly more complicated than a book transfer, a wire transfer is an electronic transfer of funds across a network, administered by hundreds of banks around the world. Wire transfers allow individuals or entities to send funds to other individuals or entities in different financial institutions, while still maintaining efficiency. U.S. law considers wire transfers to be remittance transfers. Like a book transfer, a wire transfer entails no physical exchange of money; instead, banking institutions pass information regarding the recipient, their bank account number, and how much money they are receiving.

A wire transfer costs money, and banks charge anywhere between $10 to $50 for domestic wire transfers and can typically charge more for international transfers. Book transfers, on the other hand, are typically free, as they are simply a movement of money within a financial institution. This is certainly the case when an individual moves money from their checking account to their savings account within the same bank.

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Term: Social Networking Service—SNS

What Is a Social Networking Service?

A social networking service (SNS) is an online vehicle for creating relationships with other people who share an interest, background, or real relationship. Social networking service users create a profile with personal information, photos, etc. and form connections with other profiles.

These users then use their connection to grow relationships through sharing, emailing, instant messaging, and commenting. Social networking services may also be referred to as a “social networking site” or simply “social media.”

Understanding Social Networking Services

The first SNS, SixDegrees.com was started in 1997 and was soon followed by Friendster, MySpace, and Facebook. Today there are a wide range of SNS and approximately 80% of Americans have SNS profiles. SNS range from sites where users have general interests to those where users have very specific interests.

Key Takeaways

  • A social networking service (SNS) is an online vehicle for creating relationships with other people.
  • Social networking services are more commonly referred to as “social networking sites” or “social media.”
  • Social networking services business models are based on online advertising.

Successful specialized SNS include YouTube, Instagram, Twitter, LinkedIn, Reddit, Snapchat, Tumblr, Pinterest, and TikTok. SNS profiles are very popular across the globe.
Facebook alone boasts over 2.4 billion users worldwide.

The social networking service business model is based on online advertising, either through targeted advertising that utilizes an individual’s personal information, search habits, location or other such data, or by selling the personal information to third parties. Ubiquitous mobile technologies, such as smartphones and tablets, have helped the growth of social SNS adoption and use.

Social Networking Service Characteristics

While social networking services may take many forms, they share several characteristics, such as all utilizing the internet. Other similar characteristics include:

  • User-generated content, such as photos, videos, and posts that inform other users about the activities and interests of the poster.
  • The ability to connect individuals from all over the world, though some platforms recommend that individuals know one another in real life before connecting online.
  • They are free. Their business model is based on breadth of membership, therefore charging for use would be counterproductive. Still, the possibility remains that if a network grew large and useful enough, charging a fee may be possible.
  • They connect people with common histories, such as school attendance, work colleagues, or people who share a common interest.
  • They may help forge and develop relationships between people who share a profession or business network.
  • They may be used to help individuals find information, products, services or resources that are relevant to them.

Social Networking Service Risks

Some users worry about the security of SNS profiles, as seen in the March 2018 revelations about how Cambridge Analytica, a political information firm, illegally harvested information from roughly 50 million profiles of U.S. users to target for highly politicized content.

In addition to potential leaks of personal information, including tax and personal identification information, SNS users who are not careful about their privacy settings find that strangers can track their movements or see questionable photos.

This is especially a concern for job seekers whose potential employers might search for their profiles as part of the hiring process. Social networking service overuse may lead to depression and anxiety. Such services may also facilitate bullying and other risks to child safety.

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Term: Indenture

What Is an Indenture?

Indenture refers to a legal and binding agreement, contract, or document between two or more parties. Traditionally, these documents featured indented sides or perforated edges. Historically, indenture has also referred to a contract binding one person to work for another for a set period of time (indentured servant), particularly European immigrants. In modern day finance, the word indenture most commonly appears in bond agreements, real estate deals, and some aspects of bankruptcies.

Indenture Explained

Indenture is a term that originated from England. In the U.S., there can be several types of indentures, all typically involved with debt agreements, real estate, or bankruptcy.

Key Takeaways

  • An indenture is a legal and binding contract usually associated with bond agreements, real estate, or bankruptcy.
  • An indenture provides detailed information on terms, clauses, and covenants.
  • There can be a few different types of indentures and many different types of indenture clauses.

Types of Indentures

Below are some of the common types of indentures and clauses that may be associated with indenture contracts.

Real Estate Indenture

In real estate, an indenture is a deed in which two parties agree to continuing obligations. For example, one party may agree to maintain a property and the other may agree to make payments on it.

Bankruptcy Indenture

In bankruptcy law, an indenture may be referenced as proof of a claim on property. Indentures in general provide details on collateralized property, constituting the claim a lender has against a debtor, usually secured with a lien on the debtor’s property.

Credit Indentures

A credit indenture is the underlying contract agreement that details all of the provisions and clauses associated with a credit offering. In non-secured, uncollateralized bond offerings, these indentures can also be called debentures.

Typically a credit indenture is used for the sake of bond issuers and bondholders. It specifies the important features of a bond, such as its maturity date, the timing of interest payments, method of interest calculation, callability, and convertible features-if applicable. A bond indenture also contains all the terms and conditions applicable to the bond issue. Other critical information included in the indenture are the financial covenants that govern the issuer and the formulas for calculating whether the issuer is within the covenants (usually ratios based on corporate financials). Should a conflict arise between the issuer and bondholder, the indenture is the reference document utilized for conflict resolution.

In the fixed-income market, an indenture is hardly ever referred to when times are normal. But the indenture becomes the go-to document when certain events take place, such as if the issuer is in danger of violating a bond covenant. The indenture is then scrutinized closely to make sure there is no ambiguity in calculating the financial ratios that determine whether the issuer is abiding by the covenants.

Other Common Credit Indenture Terms

In a credit offering, a closed-end indenture clause may be used to detail any collateral involved that provides backing for the offering. Closed-end indentures include collateral as well as provisions that ensure the collateral may only be assigned to one specific offering.

Other terms that may also be associated with credit indenture clauses can include: open-end indenture, subordinated, callable, convertible, and non-convertible.

In some credit indentures, a trustee may be hired by a bond issuer. When a trustee is involved a trust indenture will also be needed. A trust indenture is similar to a bond indenture, except it also details the trustee’s responsibilities in overseeing all of a bond issue’s terms.

An indenture trustee handles fiduciary duties related to credit issuance. These professionals monitor interest payments, redemptions, and investor communications. They may also lead trust departments at institutions. Essentially, their role is to oversee and administer all of the terms, clauses, and covenants of an indenture issued by a company or government agency.

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Term: Privately Owned

What Is Privately Owned?

A privately-owned company is a company that is not publicly traded. This means that the company either does not have a share structure through which it raises capital or that shares of the company are being held and traded without using an exchange. Privately-owned companies include family-owned businesses, sole proprietorships, and the vast majority of small and medium-sized companies.

Key Takeaways

  • A privately-owned company does not have a share structure through which it raises capital, or its shares are being held and traded without using an exchange.
  • Privately-owned companies include family-owned businesses, sole proprietorships, and the vast majority of small and medium-sized companies.
  • Unlike a public company, a privately-owned company does not have to answer to public investors.

These companies are often too small to conduct an initial public offering (IPO) and tend to fulfill their financing needs using personal savings, inherited money, and/or loans from banks. Although many small businesses fit the definition of a privately-owned company, the term privately-owned is most often used to refer to companies that are large enough to be publicly traded but are still being held in private hands.

The shares of privately-owned companies are more challenging to sell due to the uncertain nature of their real value and the lack of an exchange that supports transparency and liquidity.

How a Privately-Owned Company Works

Privately-owned companies are far more common than publicly-traded companies. Privately-owned companies may be owned by an individual, a family, a small group, or even hundreds of private investors or venture capitalists.

Companies that were once publicly traded can also be made private again through a leveraged buyout (LBO). In 2016, for example, the ride-sharing company Uber had over seven million common shares outstanding and 11 million preferred shares held by a large number of venture capitalists. The Securities and Exchange Act of 1934 states that the total number of shareholders generally should not exceed 500. Crowdfunding and the trend of technology companies staying for longer in the venture capital phase have raised questions about whether this shareholder limit should be increased.

Privately-owned companies are also referred to as being privately-held.

Privately-Owned vs. Publicly-Traded

A privately-owned business may be contrasted with a publicly-traded company. A publicly-traded company is a corporation owned by multiple public shareholders. The shares of public company stock are traded on an exchange. These companies are considered “public” since shareholders, who become equity owners of the company, can be composed of anybody who purchases stock in the company. Although a small percentage of shares are initially floated to the public, daily trading in the market determines the value of the entire company.

A privately-owned business may “go public” through an initial public offering (IPO). This process means that shares of the company’s stock are issued to the public in a brand new stock issuance. An IPO can be a useful tool to raise capital from public investors. Some companies may have private shareholders prior to going public, in which case the private-share ownership may be converted to public ownership.

Prior to its IPO, the company will select an underwriter and choose an exchange where the shares will be issued and then traded publicly. The underwriters market the proposed share issuance in order to estimate market demand and establish a final offering price. A board of directors that consists of members both internal and external to the organization must be formed prior to the IPO date. The board is a governing body that meets at regular intervals to set policies for corporate management and oversight.

Additionally, the company must meet requirements set forth by the exchange listing and the Securities and Exchange Commission (SEC). This includes filing a Form S-1 registration statement with the SEC. The registration statement includes information on the planned use of capital proceeds, details of the business model and competition, a brief prospectus of the planned security, and the methodology used to calculate the offering price.

Advantages and Disadvantages of Being Privately-Owned

IPOs are an incredible tool for raising a large amount of capital to fund the growth of a business and cash out early investors. That said, there are many reasons why a company may choose to remain privately-owned. First, being a public company comes with an added layer of scrutiny. Public companies are required by the Securities and Exchange Commission (SEC) to issue shareholder reports that comply with Generally Accepted Accounting Principles (GAAP).

Privately-owned companies should still keep their books in shape and regularly report to their shareholders, but there are usually no immediate legal implications of late reporting or not reporting at all. Most privately-owned companies still use GAAP because it is considered the gold standard in accounting practice. In addition, most financial institutions will require annual GAAP compliant financial statements as a part of their debt covenants when issuing business loans. Therefore, although it’s not required, privately held companies tend to use GAAP.

Privately-owned companies can use corporate structures that public companies can’t, setting terms for investors that wouldn’t be allowed in the public market. In some ways, privately-owned companies have more freedom than public companies that must answer to a larger audience.

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Term: Piggyback Registration

What Is a Piggyback Registration?

Piggyback registration refers to a method of selling shares through an initial public offering (IPO). It is typically used by early investors, founders, and other company insiders who negotiated the right to sell their shares as part of any future IPO.

Unlike demand registration, where shareholders are entitled to demand that a company undertakes an IPO, investors relying on piggyback registration to sell their shares do not have the right to force an IPO. Instead, they must wait for the IPO to be demanded by other investors, effectively “piggybacking” on other investors’ demand registration rights.

Key Takeaways

  • Piggyback registration is a method of selling shares through an IPO.
  • Investors relying on piggyback registration cannot force an IPO to happen; they are reliant on the demand registration rights of other investors.
  • The main drawbacks of piggyback registration are its lack of control over the timing of an IPO and the fact that it is often treated as a lower priority by underwriters.

How Piggyback Registrations Work

When a company is moving toward an IPO, some investors may wish to position themselves to sell their shares as soon as the company goes public. To that end, those investors can lobby the company’s IPO underwriter to include their shares along with the broader pool of shares being sold in the IPO. If their request is accepted by the underwriter, then those investors’ shares would be referred to as a “piggyback registration” and would be disclosed as part of the IPO’s prospectus documents.

From the company’s perspective, piggyback registrations are a convenient way to allow a variety of early funders and other insiders to exit their investments and make room for new investors who might be more interested in the long-term prospects of the company. After all, companies will often go through several stages of fundraising in their early years, with each investor bringing their own investment style, objectives, and time horizon. Many of those investors are likely to view an upcoming IPO as a convenient time to cash in on their investment.

Aside from the fact that they do not allow their holder to determine the timing of their exit, the second major drawback of using a piggyback registration is that they are generally given lower priority than demand registrations by underwriters. In practice, this means that if the underwriter believes that there is insufficient market demand to sell all of the shares that investors wish to sell through the IPO, some or all of the piggybacking investors may be unable to participate.

Example of a Piggyback Registration

Michaela is the director of XYZ Capital Partners, a venture capital (VC) firm specializing in companies expected to IPO within five years. As part of her investment strategy, Michaela is careful to only invest in companies that have already received funding from other capital providers that have a demonstrated track record of guiding the companies they invest in through to successful IPOs.

Whereas these other investors generally insist on demand registration rights when negotiating their investments, XYZ specifically opts for piggyback registration rights. Since piggyback registration rights are technically inferior to demand registration rights from a legal perspective, XYZ is often able to negotiate slightly better terms in other areas of the negotiation. Moreover, by only partnering in ventures that are highly likely to IPO, XYZ is generally able to effectively exit their position by piggybacking on the demand rights of the other investors.

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Term: Basis Trading

What is Basis Trading?

In the context of futures trading, the term basis trading refers generally to those trading strategies built around the difference between the spot price of a commodity and the price of a futures contract for that same commodity. This difference, in futures trading, is referred to as the basis. If a trader expects this difference to grow, the trade they will initiate would be termed “long the basis”, and conversely, a trader enters “short the basis” when they speculate that the difference will decrease.

KEY TAKEAWAYS

  • Basis trading attempts to benefit from changes in the basis of futures contract prices.
  • The basis is the difference between the spot price of a commodity and a futures contract that expires two or more months later.
  • The basis, in futures trading, is not to be confused with the terms “basis price” or “cost basis” which are unrelated to the context of basis trading.

Understanding Basis Trading

Basis trading is common across futures commodities markets where producers look to hedge the cost of production against the anticipated sale of the commodity they are producing. The typical trade comes when one is midway through a production cycle and looks to lock in a favorable price for their product.

For example, suppose a corn farmer was two months away from delivering a crop of corn and noticed how favorable the weather conditions had been, that farmer might become concerned about a potential price drop resulting from an oversupply of corn. The farmer might sell enough futures contracts to cover the amount of corn he hoped to sell. If the spot price of the corn were $4.00 per bushel, and the futures contract that expired two months out were trading at $4.25 a bushel, then the farmer could now lock in a price with +.25 cent basis. The farmer, at this point, is making a trade that is short the basis, because he is expecting the price of the futures contract to fall and consequently come closer to the spot price.

The speculator who takes the opposite side of this trade will have purchased futures contracts for 25 cents per bushel higher than the spot price (the basis). If that speculator hedged their bet by selling contracts at the spot price ($4.00 per bushel), they would now have a position that is long the basis. That is because they are protected from price movements in either direction, but they want to see the current month contract become even less expensive relative to the contract that expires two-months later. This speculator may be expecting that despite the good weather and favorable growing conditions, consumer demand for ethanol and feed grain will overwhelm even the best supply predictions.

Basis Trading in Practice

Basis trading is common among agricultural futures because of the nature of these commodities. However, it is not limited to grain contracts. Though grain is a tangible commodity, and the grain market has a number of unique qualities, basis trading is done for precious metals, interest rate products, and indexes as well.

In each case the variables are different, but the strategies remain the same: a trader attempts to benefit from an increase (long) or a decrease (short) in the basis amount. Such changes are not related to actual changes in supply and demand, but rather the anticipation of such changes. Basis trading participates in a sophisticated game of trying to anticipate changes in the expectations of hedgers and speculators.

Basis trading, or the basis, as described here relating to futures contracts, is an entirely different concept than the basis price or cost basis of a given security. The difference between these phrases and a futures trading basis should not be confused.

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Term: Put Bond

What Is a Put Bond?

A put bond is a debt instrument that allows the bondholder to force the issuer to repurchase the security at specified dates before maturity. The repurchase price is set at the time of issue and is usually at par value (the face value of the bond).

KEY TAKEAWAYS

  • A put bond is a debt instrument with an embedded option that gives bondholders the right to demand early repayment of the principal from the issuer.
  • The embedded put option acts an incentive for investors to buy a bond that has a lower return.
  • The put option on the bond can be exercised upon the occurrence of specified events or conditions or at a certain time or times.

How a Put Bond Works

A bond is a debt instrument that makes periodic interest payments, known as coupons, to investors. When the bond matures, the investors or lenders receive their principal investment valued at par. It is cost-effective for bond issuers to issue bonds with lower yields as this reduces their cost of borrowing. However, to encourage investors to accept a lower yield on a bond, an issuer might embed options that are advantageous to bond investors. One type of bond that is favorable to investors is the put, or puttable, bond.

A put bond is a bond with an embedded put option, giving bondholders the right, but not the obligation, to demand early repayment of the principal from the issuer or a third party acting as an agent for the issuer. The put option on the bond can be exercised upon the occurrence of specified events or conditions or at a certain time or times prior to maturity. In effect, bondholders have the option of “putting” bonds back to the issuer either once during the lifetime of the bond (known as a one-time put bond) or on several different dates.

Bondholders can exercise their options if interest rate levels in the markets increase. As there is an inverse relationship between interest rates and bond prices, when interest rates increase, the value of a bond decreases to reflect the fact that there are bonds in the market with higher coupon rates than what the investor is holding. In other words, the future value of coupon rates becomes less valuable in a rising interest rate environment. Issuers are forced to repurchase the bonds at par, and investors use the proceeds to buy a similar bond offering a higher yield, a process known as bond swap.

Of course, the special advantages of put bonds mean that some yield must be sacrificed. Investors are wiling to accept a lower yield on a put bond than the yield on a straight bond because of the value added by the put option. Likewise, the price of a put bond is always higher than the price of a straight bond. While a put bond allows the investor to redeem a long-term bond before maturity, the yield generally equals the one on short-term rather than long-term securities.

A put bond can also be called a puttable bond or a retraction bond.

Special Considerations for Put Bonds

The terms governing a bond and the terms governing the embedded put option, such as the dates the option can be exercised, are specified in the bond indenture at time of issuance. The bond may have put protection associated with it, which details the period of time during which the bond cannot be “put” to the issuer.

Some types of put bonds include the multi maturity bond, option tender bond, and variable rate demand obligation (VRDO).

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Term: Agency Bond

What is Agency Bond?

An agency bond is a security issued by a government-sponsored enterprise or by a federal government department other than the U.S. Treasury. Some are not fully guaranteed in the same way that U.S. Treasury and municipal bonds are.
An agency bond is also known as agency debt.

Understanding the Agency Bond

There are two types of agency bonds, including federal government agency bonds and government-sponsored enterprise (GSE) bonds.

Federal Government Agency Bonds

Federal government agency bonds are issued by the Federal Housing Administration (FHA), Small Business Administration (SBA), and the Government National Mortgage Association (GNMA). GNMAs are commonly issued as mortgage pass-through securities.

KEY TAKEAWAYS

  • Federal government agency bonds and government-sponsored enterprise bonds pay slightly higher interest than U.S. Treasury bonds.
  • Most, but not all, are exempt from state and local taxes.
  • Like any bonds, they have interest rate risks.

Like Treasury securities, federal government agency bonds are backed by the full faith and credit of the U.S. government. An investor receives regular interest payments while holding this agency bond. At its maturity date, the full face value of the agency bond is returned to the bondholder.

Federal agency bonds offer a slightly higher interest rate than Treasury bonds because they are less liquid. In addition, agency bonds may be callable, which means that the agency that issued them may decide to redeem them before their scheduled maturity date.

Government-Sponsored Enterprise Bonds

A GSE is issued by entities such as the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage (Freddie Mac), Federal Farm Credit Banks Funding Corporation, and the Federal Home Loan Bank.

These are not government agencies. They are private companies that serve a public purpose, and thus may be supported by the government and subject to government oversight.

GSE agency bonds do not have the same degree of backing by the U.S. government as Treasury bonds and government agency bonds. Therefore, there is some credit risk and default risk, and the yield offered on them typically higher.

How Agency Bonds Work

Most agency bonds pay a semi-annual fixed coupon. They are sold in a variety of increments, generally with a minimum investment level of $10,000 for the first increment and $5,000 for additional increments. GNMA securities, however, come in $25,000 increments.

Some agency bonds have fixed coupon rates while others have floating rates. The interest rates on floating rate agency bonds are periodically adjusted according to the movement of a benchmark rate such as LIBOR.

Government-sponsored enterprise bonds do not have the same degree of backing by the U.S. government as Treasury bonds and other agency bonds.

To meet short-term financing needs, some agencies issue no-coupon discount notes, or “discos,” at a discount to par. Discos have maturities ranging from a day to a year and, if sold before maturity, may result in a loss for the agency bond investor.

Tax Considerations

The interest from most, but not all, agency bonds is exempt from local and state taxes. Farmer Mac, Freddie Mac, and Fannie Mae agency bonds are fully taxable.

Agency bonds, when bought at a discount, may subject investors to capital gains taxes when they are sold or redeemed. Capital gains or losses when selling agency bonds are taxed at the same rates as stocks.

Tennessee Valley Authority (TVA), Federal Home Loan Banks, and Federal Farm Credit Banks agency bonds are exempt from local and state taxes.

Bond Risks

Like all bonds, agency bonds have interest rate risks. That is, a bond investor may buy bonds only to find that interest rates rise. The real spending power of the bond is less than it was. The investor could have made more money by waiting for a higher interest rate to kick in.

Naturally, this risk is greater for long-term bond prices.

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Term: Prepetition Liability

What Is a Prepetition Liability?

When a company or individual files for bankruptcy, they must first list all their debts. These are called prepetition liabilities. Post-petition liability, on the other hand, is all the debt incurred after the bankruptcy case is logged. These two types of liabilities are often shown on the balance sheets of companies in bankruptcy protection and are separated to distinguish which outstanding balances are expected to be paid in full.

KEY TAKEAWAYS

  • When a company petitions for bankruptcy, everything it owes is categorized as either prepetition debts, incurred prior to filing, or post-petition liabilities, assumed after the bankruptcy filing.
  • Classification of a liability as either prepetition or post-petition on the balance sheet has a significant influence on the amount the company will have to pay.
  • Creditors are likely to collect only a fraction of the value of the prepetition liabilities they are owed, unlike post-petition liabilities, which must be paid in full.
  • Not all prepetition liabilities are subject to compromise, and a company must distinguish which are not in its financial statements.

Understanding a Prepetition Liability

When a company petitions for bankruptcy, it must list in full everything it owes. These liabilities are then split into two categories: prepetition debts incurred prior to filing and post-petition liabilities taken on afterward.

This classification is important as it has a significant influence on how much the company will have to pay. Once the defaulting entity files for Chapter 11 bankruptcy, creditors will have difficulty collecting on its prepetition obligations including amounts owed on loans and bonds, lease payments, pension payments, and other contractual obligations.

Most prepetition liabilities are reduced or dismissed during bankruptcy proceedings, so creditors are likely to only get a fraction of the original value of what they are owed unless these liabilities are secured by assets. In other words, that means that clawing back payments is “subject to compromise.”

When a liability is recorded on the balance sheet prior to the bankruptcy petition, creditors can expect to retrieve only a fraction of that debt.

Liabilities registered as post-petition on the balance sheet, on the other hand, are not considered a part of the bankruptcy case and, as a result, must be honored and paid in full—assuming the company exits bankruptcy protection in good shape.

Limitations of a Prepetition Liability

Not all prepetition liabilities are unrecoverable. A secured creditor can still enforce a lien against property owned by the debtor, while some liabilities might not be subject to compromise. When exiting bankruptcy, a company must distinguish in its financial statements between its prepetition liabilities that are subject to compromise and those that are not. Obligations not open to negotiation usually include taxes owed and anything that was not listed by the debtor.

Another category of liabilities, or claims, can come into play during the bankruptcy process. Contingent liabilities are triggered by a future event and may or may not appear on a company’s financial statements—often, they are described in the footnotes accompanying the statements. Should unliquidated claims of this nature not be included in the bankruptcy petition, it might be difficult for the debtor to avoid payment.

Typically, reorganization agreements also contain a provision forbidding any payments to shareholders “unless creditors agree” until prepetition liabilities have been paid in full.

Special Considerations

In certain cases, companies in the Chapter 11 bankruptcy process may designate suppliers of key components or services with which it does business as “critical vendors.” If the bankruptcy court approves the designation, the company can pay prepetition claims from these vendors in full to keep important operations running. There are, however, limitations to this practice.

Companies in bankruptcy might also reject contractual and lease obligations and liabilities and clawback payments made to creditors while technically insolvent but prior to the bankruptcy filing. It may also ask the bankruptcy judge overseeing its reorganization to discharge, or cancel, its prepetition liabilities.

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Term: Zombie Title

What is Zombie Title?

A zombie title is a real estate title that remains with a homeowner who is under the impression that he or she has lost the property to foreclosure, and that the title has passed to the lender.  Zombie titles are the result of lenders initiating foreclosure proceedings by issuing a notice of foreclosure and then unexpectedly dismissing it.

If the homeowner is unaware of the foreclosure dismissal, he or she will be left holding a zombie title. A lender may decide to dismiss the foreclosure for a variety of reasons, including a surplus of inventory or unjustifiable costs.

A zombie title poses a significant financial risk to the homeowner who continues to be shown on the property title, since he or she is liable for property taxes and code violations.

KEY TAKEAWAYS

  • A zombie title is a real estate title that remains with a homeowner, unbeknownst to him or her, because the property was in foreclosure and the homeowner believes the title has passed to the lender.
  • The lender may choose not to take title to the foreclosed property if the costs associated with selling the property (arising from unpaid taxes, liens and penalties) or potential liability are too high, and may walk away rather taking title.
  • Zombie titles arise because a financial institution is under no obligation to take legal title to a property in foreclosure, and may not (or may be unable to) contact the homeowner if it dismisses the foreclosure.

Understanding Zombie Title

Zombie titles are often the result of confusion on the part of homeowners regarding foreclosure rules. A homeowner who has defaulted on his or her mortgage may abandon the property and move out upon receiving a foreclosure notice from the lender. The lender will assess the property prior to the foreclosure sale. If the property is in disrepair and needs a substantial outlay for repairs and unpaid taxes before it can be sold, the lender may choose to not take title, based on the premise that there is no point in throwing good money after bad. If the lender cancels or dismisses the foreclosure process, the homeowner is left with a zombie title.

Zombie titles arise for two reasons. Firstly, a lender or financial institution is under no obligation to take legal title to a property in foreclosure, even if the homeowner has defaulted on the loan. If the costs of selling the property or potential liability associated with the property are too high, the lender may walk away rather than taking title to the property. Secondly, the lender is also not required to let the homeowner know if it has decided to dismiss the foreclosure; even if the lender does decide to inform the homeowner, it may have not have an address or contact information for the homeowner who is now living elsewhere.

A homeowner in this situation will unknowingly still hold title to the property, along with all of the associated costs and responsibilities of owning a home, without any of the attendant benefits. Ownership does not change until someone else’s name is on the title.

The 2007-2008 mortgage lending crisis resulted in millions of homeowners facing foreclosure. While the majority of those foreclosures were carried through, many were left dangling in the middle of the process or unexpectedly dismissed, resulting in tens of thousands of homeowners unknowingly holding zombie titles in the years after the financial crisis.

As the U.S. housing market gradually strengthened, the number of zombie foreclosures began declining. According to RealtyTraca,by the end of the second quarter of 2016, vacant zombie homes across the U.S. numbered just over 19,000, a 30% decrease from a year ago, and representing 4.7% of all residential properties in foreclosure.

According to property data provider ATTOM Data Solutions, of approximately 288,000 homes that were in the process of foreclosure during the fourth quarter of 2019, just over 8,500 or 2.96% were sitting empty as zombie foreclosures.

Financial Impact on Lenders and Homeowners

What are the financial implications for the lender? A Reuters report cites a 2010 Federal Reserve paper which states that by walking away from such mortgages, banks can at least reap the the insurance, tax and accounting benefits arising from such losses. A lender may also sell the unpaid debt to debt collectors to recoup all or part of the loan.

While the financial impact of zombie titles on deep-pocketed financial institutions may thus be limited, they can lead to significant, and often catastrophic, financial problems for homeowners who thought they had moved out and moved on. A zombie title represents a double-whammy for a homeowner who is already financially stressed due to bankruptcy, and may be faced with a hefty bill for back taxes and code violations just as he or she is getting back on their feet financially.

An unoccupied home, for example, can easily fall into disrepair. Not only does the homeowner remain liable for property taxes, but he or she can also be held liable by the local government for maintenance and repairs on the property. If the house is derelict and has to be demolished, these costs have to be borne by the zombie title homeowner.

The homeowner also has to contend with the host of problems that arise in connection with an abandoned property. These may range from public nuisance issues arising from the property developing pest infestations or being used for criminal activity, to complications arising from illegal squatters or adverse possession.

Abandoned properties also have a negative impact on the value of other houses in the neighborhood. Complaints from neighbors and area residents about abandoned and neglected houses often forces the local municipality to step in and perform basic maintenance such as trimming overgrown yards or trash removal, since neither the lender nor the absentee homeowner will take responsibility for the property’s upkeep.

The costs of such third-party maintenance, and the penalties levied for code violations can mount up over time. If those costs are left unpaid, the homeowner could incur penalties and fees, and even face legal action. In addition, holders of zombie titles may have their wages and tax refunds garnished and their credit destroyed, resulting in more financial trouble in the future. Many homeowners do not realize they hold zombie titles until they find themselves being pursued by mortgage servicers, debt collectors and local governments.

Buyers who unwittingly buy homes with zombie titles can also be left in legal limbo, as the previous homeowner may be unable to transfer title to the buyer due liens on the property arising from unpaid taxes and penalties. Caveat emptor should be the main guiding principle before buying a house, the biggest purchase decision for most people.

Some real estate professionals advise that the homeowner’s only recourse is to continue staying in the home through the foreclosure process, in order to keep it secure and well-maintained. In any case, homeowners can protect themselves against zombie titles by seeing the foreclosure process through to completion, as well as making sure that the title to their home legally transfers to another party.

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Term: Business-to-Business (B2B)

What Is Business-to-Business (B2B)?

Business-to-business (B2B), also called B-to-B, is a form of transaction between businesses, such as one involving a manufacturer and wholesaler, or a wholesaler and a retailer. Business-to-business refers to business that is conducted between companies, rather than between a company and individual consumer. Business-to-business stands in contrast to business-to-consumer (B2C) and business-to-government (B2G) transactions.

KEY TAKEAWAYS

  • Business-to-business (B2B) is a transaction or business conducted between one business and another, such as a wholesaler and retailer.
  • B2B transactions tend to happen in the supply chain, where one company will purchase raw materials from another to be used in the manufacturing process.
  • B2B transactions are also commonplace for auto industry companies, as well as property management, housekeeping, and industrial cleanup companies.
  • Meanwhile, business-to-consumer transactions (B2C) are those made between a company and individual consumers.

Business-to-business transactions are common in a typical supply chain, as companies purchase components and products such as other raw materials for use in the manufacturing processes. Finished products can then be sold to individuals via business-to-consumer transactions.

In the context of communication, business-to-business refers to methods by which employees from different companies can connect with one another, such as through social media. This type of communication between the employees of two or more companies is called B2B communication.

B2B E-Commerce

Late in 2018, Forrester said the B2B e-commerce market topped $1.134 trillion—above the $954 billion it had projected for 2018 in a forecast released in 2017. That’s roughly 12% of the total $9 trillion in total US B2B sales for the year. They expect this percentage to climb to 17% by 2023. The internet provides a robust environment in which businesses can find out about products and services and lay the groundwork for future business-to-business transactions.

Company websites allow interested parties to learn about a business’s products and services and initiate contact. Online product and supply exchange websites allow businesses to search for products and services and initiate procurement through e-procurement interfaces. Specialized online directories providing information about particular industries, companies and the products and services they provide also facilitate B2B transactions.

Special Considerations

Business-to-business transactions require planning to be successful. Such transactions rely on a company’s account management personnel to establish business client relationships. Business-to-business relationships must also be nurtured, typically through professional interactions prior to sales, for successful transactions to take place.

Traditional marketing practices also help businesses connect with business clients. Trade publications aid in this effort, offering businesses opportunities to advertise in print and online. A business’s presence at conferences and trade shows also builds awareness of the products and services it provides to other businesses.

Example of Business-to-Business (B2B)

Business-to-business transactions and large corporate accounts are commonplace for firms in manufacturing. Samsung, for example, is one of Apple’s largest suppliers in the production of the iPhone. Apple also holds B2B relationships with firms like Intel, Panasonic and semiconductor producer Micron Technology.

B2B transactions are also the backbone of the automobile industry. Many vehicle components are manufactured independently, and auto manufacturers purchase these parts to assemble automobiles. Tires, batteries, electronics, hoses and door locks, for example, are usually manufactured by various companies and sold directly to automobile manufacturers.

Service providers also engage in B2B transactions. Companies specializing in property management, housekeeping, and industrial cleanup, for example, often sell these services exclusively to other businesses, rather than individual consumers.

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Term: Lambda

What is Lambda?


What is Lambda?

In options trading, Lamba is the Greek letter assigned to variable which tells the ratio of how much leverage an option is providing as the price of that option changes. This measure is also referred to as the leverage factor, or in some countries, effective gearing. Lambda tells what ratio of leverage the option will provide as the price of the underlying asset changes by one percent.

KEY TAKEAWAYS

  • Lambda values identify the amount of leverage employed by an option.
  • It is considered one of the “Minor Greeks” in financial literature, this measure is usually found by working with Delta.
  • The measure is sensitive to changes in volatility but it is not calculated the same as Vega.

Understanding Lambda

Lambda is a measurement considered to be one of the “Minor Greeks,” and it isn’t widely used because most of what it identifies can be discovered by using a combination of other of the option Greeks. However the information it provides is useful for understanding how much leverage a trader is employing into an option trade. Where leverage is a key factor for a particular trade, Lambda becomes a useful measure.

The full equation of Lambda is as follows:


Lambda Full Equation

Lambda Full Equation.

The simplified Lambda calculation reduces to the value of Delta multiplied by the ratio of the stock price divided by the option price. Delta is one of the standard Greeks and represents the amount an option price is expected to change if the underlying asset changes by one dollar in price.

Lambda in Action

Assuming a share of stock trades at $100 and the at-the-money call option with a strike price of $100 trades for $2.10, and also assuming that the delta score is .58, then the Lambda value can be calculated with this equation: .58 x (100 / 2.10). This value equates to the option’s lambda which, in this case, is 27.61. This lambda value indicates the comparable leverage in the option compared to the stock. Therefore a one percent increase in the value of stock holdings would yield a 27 percent increase in the same dollar value being held in the option.

Consider what happens to a $1000 stake in this $100 stock. The trader holds 10 shares and if the stock in this example were to increase by one percent (from $100 to $101 per share), the trader’s stake increases in value by $10 to $1010. But if the trader held a similar $1050 stake in the option (5 contracts at $2.10), the resulting increase in value of that stake is much different. Because the value of the option would increase from $2.10 to $2.68 (based on the delta value) then the value of the $1050 held in those five option contracts would rise to $1340, a 27.61% increase.

Lambda and Volatility

Academic papers have, in some cases, equated Lambda and Vega. The confusion created by this would suggest that the calculations of their formulae are the same, but that is incorrect. However because the influence of implied volatility on option prices is measured by Vega, and because this influence is captured in changing delta values, Lambda and Vega often point to the same or similar outcomes in price changes.

For example, Lambda’s value is higher the further away an option’s expiration date is and falls as the expiration date approaches. This observation is also true for Vega. Lambda changes when there are large price movements, or increased volatility, in the underlying asset, because this value is captured in the price of the options. If the price of an option moves higher as volatility rises, then its lambda value will decrease because the greater expense of the options means a decreased amount of leverage.


In options trading, Lamba is the Greek letter assigned to variable which tells the ratio of how much leverage an option is providing as the price of that option changes. This measure is also referred to as the leverage factor, or in some countries, effective gearing. Lambda tells what ratio of leverage the option will provide as the price of the underlying asset changes by one percent.

KEY TAKEAWAYS

  • Lambda values identify the amount of leverage employed by an option.
  • It is considered one of the “Minor Greeks” in financial literature, this measure is usually found by working with Delta.
  • The measure is sensitive to changes in volatility but it is not calculated the same as Vega.

Understanding Lambda

Lambda is a measurement considered to be one of the “Minor Greeks,” and it isn’t widely used because most of what it identifies can be discovered by using a combination of other of the option Greeks. However the information it provides is useful for understanding how much leverage a trader is employing into an option trade. Where leverage is a key factor for a particular trade, Lambda becomes a useful measure.

The full equation of Lambda is as follows:


Lambda Full Equation

Lambda Full Equation.

The simplified Lambda calculation reduces to the value of Delta multiplied by the ratio of the stock price divided by the option price. Delta is one of the standard Greeks and represents the amount an option price is expected to change if the underlying asset changes by one dollar in price.

Lambda in Action

Assuming a share of stock trades at $100 and the at-the-money call option with a strike price of $100 trades for $2.10, and also assuming that the delta score is .58, then the Lambda value can be calculated with this equation: .58 x (100 / 2.10). This value equates to the option’s lambda which, in this case, is 27.61. This lambda value indicates the comparable leverage in the option compared to the stock. Therefore a one percent increase in the value of stock holdings would yield a 27 percent increase in the same dollar value being held in the option.

Consider what happens to a $1000 stake in this $100 stock. The trader holds 10 shares and if the stock in this example were to increase by one percent (from $100 to $101 per share), the trader’s stake increases in value by $10 to $1010. But if the trader held a similar $1050 stake in the option (5 contracts at $2.10), the resulting increase in value of that stake is much different. Because the value of the option would increase from $2.10 to $2.68 (based on the delta value) then the value of the $1050 held in those five option contracts would rise to $1340, a 27.61% increase.

Lambda and Volatility

Academic papers have, in some cases, equated Lambda and Vega. The confusion created by this would suggest that the calculations of their formulae are the same, but that is incorrect. However because the influence of implied volatility??????? on option prices is measured by Vega, and because this influence is captured in changing delta values, Lambda and Vega often point to the same or similar outcomes in price changes.

For example, Lambda’s value is higher the further away an option’s expiration date is and falls as the expiration date approaches. This observation is also true for Vega. Lambda changes when there are large price movements, or increased volatility???????, in the underlying asset, because this value is captured in the price of the options. If the price of an option moves higher as volatility rises, then its lambda value will decrease because the greater expense of the options means a decreased amount of leverage.

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Term: Uncovered Option

What is an Uncovered Option?

In option trading, the term “uncovered” refers to an option that does not have an offsetting position in the underlying asset. Uncovered option positions are always written options, or in other words options where the initiating action is a sell order. This is also known as selling a naked option.

KEY TAKEAWAYS

  • Uncovered options are sold, or written, options where the seller does not have a position in the underlying security.
  • Selling this kind of option creates the risk that the seller may have to quickly acquire a position in the security when the option buyer wants to exercise the option.
  • The risk of an uncovered option is that the profit potential is limited, but the loss potential may generate a loss that is multiple times the greatest profit that can be made.

How an Uncovered Option works

Any trader who sells an option has a potential obligation. That obligation is met, or covered, by having a position in the security which underlies the option. If the trader sells the option but has no position in the underlying security, then the position is said to be uncovered, or naked.

Traders who buy a simple call or put option have no obligation to exercise that option. However those traders who sell those same options do have an obligation to provide a position in the underlying asset if the traders to whom they sold the options do actually exercise their options. This can be true for put or call options.

An uncovered or naked put strategy is inherently risky because of the limited upside profit potential, and at the same time holding a significant downside loss potential, theoretically. The risk exists because maximum profit is achievable if the underlying price closes at or above the strike price at expiration. Further increases in the cost of the underlying security will not result in any additional profit. The maximum loss is theoretically significant because the price of the underlying security can fall to zero. The higher the strike price, the higher the loss potential.

An uncovered or naked call strategy is also inherently risky, as there is limited upside profit potential and, theoretically, unlimited downside loss potential. Maximum profit will be achieved if the underlying price falls to zero. The maximum loss is theoretically unlimited because there is no cap on how high the price of the underlying security can rise.

An uncovered options strategy stands in direct contrast to a covered options strategy. When investors write a covered put, they will keep a short position in the underlying security for the put option. Also, the underlying security and the puts are sold or shorted, in equal quantities. A covered put works in virtually the same way as a covered call. The exception is that the underlying position is a short instead of a long position, and the option sold is a put rather than a call.

However, in more practical terms, the seller of uncovered puts, or calls, will likely repurchase them well before the price of the underlying security moves adversely too far away from the strike price, based on their risk tolerance and stop loss settings.

Using Uncovered Options

Uncovered options are suitable only for experienced, knowledgeable investors who understand the risks and can afford substantial losses. Margin requirements are often quite high for this strategy, due to the capacity for significant losses. Investors who firmly believe the price for the underlying security, usually a stock, will rise, in the case of uncovered puts, or fall, in the case of uncovered calls, or stay the same may write options to earn the premium.

With uncovered puts, if the stock persists above the strike price between the option’s writing and the expiration, then the writer will keep the entire premium, minus commissions. The writer of an uncovered call will keep the whole premium, minus commissions, if the stock persists below the strike price between writing the option and its expiration.

The breakeven point for an uncovered put option is the strike price minus the premium. Breakeven for the uncovered call is the strike price plus the premium. This small window of opportunity would give the option seller little leeway if they were incorrect.

Example of an Uncovered Put

When the price of the stock falls below the strike price before, or by, the expiration date, the buyer of the options product can demand the seller take delivery of shares of the underlying stock. The options seller must go to the open market to sell those shares at the market price loss, even though the option writer paid the strike price. For example, imagine the strike price is $60, and the open market price for the stock is $55 at the time the options contract is exercised. The options seller will incur a loss of $5 per share of stock.

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Term: Naked Position

What is a Naked Position?

In securities trading in general, a naked position refers to a securities position, long or short, that is not hedged from market risk. Both the potential gain and the potential risk are greater when a position is naked instead of covered or hedged in some way. In options trading this phrase specifically refers to an option sold by a trader without an established position in the underlying security.

KEY TAKEAWAYS

  • A naked stock position is a position that is not hedged.
  • This phrase is more often associated with short-selling stocks.
  • A naked position is also commonly used to referred to an option that is sold without a position in the underlying security as protection against the risk of option assignment.

Understanding a Naked Position

A naked stock position does not have the hedging associated with a call or put option or perhaps an opposite position in a related stock. For example, a long in Coke and a short in Pepsi.

A naked position is inherently risky because there is no protection against an adverse move. Most investors do not consider owning stocks to be excessively risky, especially because in most cases it is easy to sell the position back to the market. However, a declining market for an investor holding a long position in a stock still has the potential to deliver significant losses. In this case, holding a put option against the long stock position could, for a small price, cap losses to a manageable amount.

The investor’s profit potential, before commissions, would be reduced by the premium, or cost, of the option. Consider it to be an insurance policy the investor hopes never to use.

Investors selling stocks short without hedges face even greater risk since the upside potential for a stock is theoretically unlimited. In this case, owning a call on the underlying stock would limit that risk.

Naked Options

In the options market, uncovered or naked calls and puts also have risk. In this case, it is the options seller, or writer, that has no hedge against being assigned. Options buyers only risk the amount paid to buy the options, which is normally significantly less than the amount needed to purchase actual shares of stock or another underlying asset.

Options sellers, on the other hand, can have unlimited risk if not hedged. For example, an investor sells a call option on a stock and that stock soars higher in price before expiration. The options buyer could likely exercise the option, forcing the seller to go out into the open market to buy the stock at the higher price in order to deliver it to the options buyer. If the options seller owned an offsetting position in the underlying stock, his or her risk would be limited.

Put sellers would have nearly unlimited risk should the underlying security fall towards zero. A corresponding short position in the underlying stock would limit that risk.

However, in more practical terms, the seller of uncovered puts or calls will likely repurchase them well before the price of the underlying security moves adversely too far away from the strike price, based on their risk tolerance and stop loss settings.

More advanced options traders can hedge risk with multiple positions of puts and calls, called combinations.

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Term: Unusual Item

What is an Unusual Item?

An unusual item is a nonrecurring or one-time gain or loss that is not considered part of normal business operations. Unusual gains or losses may be recorded on the income statement as a separate component of income from continuing operations, or alternatively, may be identified in the footnotes to the financial statements or the management discussion and analysis (MD&A) section of the annual report.

Understanding Unusual Items

Reporting unusual items separately is important to ensure the transparency of financial reporting. Because unusual items are unlikely to recur, separating these items — either explicitly on an income statement or in the management discussion and analysis (MD&A) or footnotes — allows investors to better assess the income-generating capacity of the core business activities.

Unusual items may include:

  • restructuring charges inclusive of severance pay and factory closings
  • asset impairment charges or write-offs
  • losses from discontinued operations
  • losses from early retirement of debt
  • >M&A or divestiture-related expenses
  • gains or losses from sale of assets
  • gains or losses from a lawsuit
  • damage costs or slowdown of operations due to a natural disaster
  • charges stemming from changes in accounting policy

The Financial Accounting Standards Board (FASB), the independent nonprofit organization responsible for issuing generally accepted accounting principles (GAAP), has given management leeway to provide a more descriptive separate line item on the income statement when appropriate, such as “Loss from Hurricane Damages to Office Building.”

Special Considerations

The treatment of unusual items has several implications related to the analysis of company performance and valuation of its shares, credit agreements, and executive compensation schemes. An analyst would have to make adjustments to the income statement to produce a “clean” EBIT, EBITDA, and net income figures on which to calculate price multiples. Debt agreements would have to specify the exclusions to how certain covenants are calculated. Executive pay plans, too, would need to explain how unusual items are handled in compensation formulas.

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Term: Infrastructure Trust

What is an Infrastructure Trust?

An infrastructure trust is a type of income trust that exists to finance, construct, own, operate and maintain different infrastructure projects in a given region or operating area. The infrastructure trust will also provide distribution payments to units holders on a periodic basis.

KEY TAKEAWAYS

  • An infrastructure trust is a type of income trust that exists to finance, construct, own, operate and maintain different infrastructure projects in a given region or operating area. The infrastructure trust will also provide distribution payments to units holders on a periodic basis.
  • Infrastructure REITS own and manage infrastructure real estate while collecting rent from tenants that occupy or use that property. Infrastructure REIT property types include fiber cables, wireless infrastructure, telecommunications towers and energy pipelines.

Understanding an Infrastructure Trust

When evaluating an infrastructure trust, it is important to consider the trust’s underlying holdings before making a purchasing decision. As with any trust, it is useful to determine the trust’s intrinsic value by using any number of valuation techniques, including a discounted cash flow, or price/EBIT and price/EBITDA multiple.

Infrastructure REITs

A real estate investment trust, or REIT, is a company that owns, operates or finances income-producing real estate. For a company to qualify as a REIT, it must meet certain regulatory guidelines. REITs often trade on major exchanges like other securities and provide investors with a liquid stake in real estate. REITs are also known for their steady income from dividends.

Infrastructure REITS own and manage infrastructure real estate while collecting rent from tenants that occupy or use that property. Infrastructure REIT property types include fiber cables, wireless infrastructure, telecommunications towers and energy pipelines.

Example of an Infrastructure Trust

For example, American Tower Corporation (AMT), one of the largest global REITs, owns, develops and operates over 160,000 communications sites. It leases space on communications towers, operates outdoor distributed antenna systems and managed rooftops and services that speed network deployment. The REIT shares are listed on the NYSE.

Another example of an infrastructure trust is Crown Castle International Corp. (CCI) which is the nation’s (U.S.) largest provider of shared communications infrastructure. Their infrastructure portfolio consists of approx. 40,000 cell towers, 65,000 on-air or under-contract small cell nodes, and 75,000 route miles of fiber.

Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. There are popular REIT ETFs like: IYR (iShares U.S. Real Estate ETF), VNQ (Vanguard Real Estate ETF), and XLRE (The Real Estate Select Sector ETF). Some REITs are SEC-registered and public, but not listed on an exchange; others are private.

Infrastructure trusts that are traded on major exchanges are relatively rare – only a handful are available in the U.S. One reason may be the complexity of their operations. AMT, for example, has over 160,000 properties that it manages across an array of different types of communication sites. Capital needs for such companies are high and operations may be subject to weather-related events such as hurricanes and other natural disasters.

In general, when evaluating REITs, earnings per share and P/E ratios aren’t helpful. One must look at funds from operations (FFO) rather than net income. Prospective investors should also calculate adjusted funds from operations (AFFO), which deducts the likely expenditures necessary to maintain the real estate portfolio. AFFO provides an excellent tool to measure the REIT’s dividend-paying capacity and growth prospects.

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Term: Fairness Opinion

What Is a Fairness Opinion?

A fairness opinion is a report that evaluates the facts of a merger, acquisition, carve-out, spin-off, buyback, or another type of business purchase. It provides an opinion about whether or not the proposed stock price is fair to the selling or target company.

Understanding Fairness Opinions

A fairness opinion provides guidance to the parties involved in a merger, takeover, or acquisition. This could include the shareholders of the company being acquired or the acquiring company. It is essentially a professional opinion supported by collected data.

Fairness opinions are written by qualified analysts or advisors, usually from an investment bank, and are provided to these key decision-makers for a fee. The analysts examine the specifics of the deal, including any possible business synergies that benefit the target/seller if applicable, the terms of the agreement, and the price offered for the stock of the target/seller.

KEY TAKEAWAYS

  • A fairness opinion is a report regarding the fairness of a major financial action like a merger or takeover that an investment banker or an analyst may provide for a fee.
  • Sometimes fairness opinions are required in the sales of public companies.
  • Fairness opinions are most often requested as part of a merger or acquisition.

Fairness opinions are not always required in transactions involving public companies, but they can be helpful in reducing the risk associated with major financial actions or purchases, including the risk of litigation. While they are not required, they can also be a good way to facilitate communication between the various involved parties.

Fairness opinions are a particularly good idea if the transaction is pending as the result of a hostile takeover, if there are multiple offers for the company at different prices, if company insiders are involved in the transaction, or if board members or shareholders have concerns about the fairness of the transaction.

Example of a Fairness Opinion

ABC Company has made an offer to purchase XYZ Corp. for $10 million. XYZ Corp.’s board of directors is interested to know whether this is a fair offer from ABC Company. They have no other offers on the table at this time. XYZ Corp, as the target company in this scenario, hires an advisor at Independent Investment Bank to conduct an analysis and weigh in on the fairness of this offer.

The advisor reviews three comparable transactions. In line with best practice, the three comps involve companies in the same industry with a similar business model to XYZ Corp., and all transactions have taken place recently, within the last six months. The advisor calculates the EV-to-EBITDA multiple for the three comps. In this formula, EV is enterprise value and EBITDA is earnings before interest, taxes, depreciation, and amortization; a 12-month period is used for EBITDA.

As a result of the analysis, the advisor informs XYZ Corp. that $10 million is a fair value for this transaction. XYZ Corp.’s board of directors then approves the sale of the company for this amount.

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Term: Register

What Is Register?

Register has several different definitions. In finance the term often pertains to the recording of a financial event, an aggregation of stored data, or a record of charges.

Understanding Register

While the word “register” can convey many different meanings, in the finance industry, it usually refers to the process of inputting information into a record, or an official list, that creates a document of various useful data in an organized fashion.

In most cases, register refers to the act of recording an event, transaction, name, or other information, or an aggregation of stored data, usually containing past events, transactions, names or other information. Alternatively, the term can denote a record of all charges to a debit account.

KEY TAKEAWAYS

  • Register has several different definitions, including the recording of a financial event, an aggregation of event data, or a record of charges to a debit account.
  • Registering occurs any time information is filed from one party to another, including when public traded companies submit financial reports to the Securities and Exchange Commission (SEC).
  • A register can also be an authoritative list of one kind of information, such as a shareholder register, loan register, or register of deeds.

Filing Information

Registering occurs any time information is filed from one party to another. This includes registering for a membership, applying for a type of license, or filing a tax return with the government. Publicly traded companies are required to register with the Securities and Exchange Commission (SEC) and periodically file forms such as the 10-Q, 10-K, and 8-K.

Aggregation of Stored Data

A register can also be an authoritative list of one kind of information. One of the more common usages involves a shareholder register—a regularly updated list of active owners of a company’s shares. This particular register includes each person’s name, address, and the number of shares held. In addition, the register can detail the holder’s occupation and the price they paid.

Shareholder Register

The shareholder register is fundamental to the examination of the ownership of a company, enabling investors to keep tabs on who is buying into and selling out of a stock, as well as determine the size of each stake held. The shareholder register differs from a shareholder list. The former is updated only once per year, while the latter is tasked with keeping regular track of the current partial owners of a company.

Some shareholder registers even detail all issues of shares to each individual shareholder in the last 10 years, along with the date of any and all transfers of shares.

Loan Register

Registers are also commonly used by lenders. The loan register or maturity ticker, an internal database of maturity dates on loans belonging to a servicer, shows when the loans are due and lists them in chronological order, by maturity date.

In-house loan officers use this important tool to create follow-up leads. Most loan servicers have dedicated teams for retention business, and use loan registers to determine which borrowers to target in mass mailings or phone campaigns.

Register of Deeds

Another prevalent and significant kind of register is the register of deeds. A local government–generally at the county, town or state level–maintains a list of all real estate deeds and other land titles. The register of deeds will be used in conjunction with a grantor-grantee index that lists the owner of record and any transfers of property.

While the register of deeds is available for public viewing, it generally requires some time and government assistance to access particular mortgage records or deeds. In the U.S., the register of deeds will usually be maintained on the county, town, or state level. In this case, the term “register of deeds” also refers to an individual, sometimes publicly elected, who oversees the records, or the register, itself.

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