The Vegvisir

Hedging is a means of mitigating risk that arises out of potential losses in investments by taking an opposite position in a related asset. This does not come without a come and can reduce potential profits. Hedging strategies typically employ the use of derivatives which can include options and futures contracts. The easiest way to understand hedging is by taking into example a personal asset that has high value, such as a house. To 'hedge' the risk of an unforeseen event incurring a high cost on this asset you may take out insurance; a position in a related asset. By investing in insurance you protect your own personal investment. In financial terms this is more complex and can involve the use of put options, call options and futures contracts. We will consider each of these in turn. Put options A put option is a derivative that enables its owners the right (but crucially not the obligation) to sell a specified amount of an underlying security at a specified pri

Foreign exchange risk is the risk of losses emerging in international financial transactions due to the fluctuation of currencies. It describes the possibility that an investment's value may decrease due to changes in foreign currencies. There are three types of foreign exchange risk; let us consider each in turn: 1.) Translation risk: This is the risk when foreign operations / investments need to be translated back the base currency. this can be considered through MNCP's who have foreign operations must have their revenues translated back to the parent company's base currency. This can also effected investors; let us consider an example. For example, if an investor in the UK has a lot of cash invested in different US equities and the dividends are returned in USD. It was assumed that the difference between the USD and GBP was 1:1. If the dollar appreciates against the pound that so that it is 0.9:1 the investor will experience a 10% lower return on investment d

Repurchase agreement (AKA Repo) A repo is the equivalent of a short term collateralized loan. The owner of a marketable security would sell these securities for cash - and then agree to purchase back the security at a later date, usually at a higher price than he/she sold it for. The spread between the two prices is equivalent to interest. These are used by institutions who look for quick easy ways to make additional cash  with their current cash at little to no risk. So if  a bank had a surplus cash of £1 million, it would buy a repo, put in x buyback date and pay y for this lending as it is the buyer. The owner of the securitised assets would be selling or borrowing the cash in exchange. y is considered the equivalent of interest. To avoid the risk of the seller being unable to buy back those assets repo agreements are usually collateralised with securities with a market value in excess of the amount paid for them. As a consequence of this agreement the goals of both partie

What is fixed income?   Fixed income is an umbrella term that refers to financial instruments that pay investors fixed interest or dividend payments until its maturity date - these rates are known in advance. These securities are typically of low risk which in turn pays back low reward. When the maturity date is reached investors are paid back the principal amount they had invested. This is in contrast to equities that may pay no return to investors, or variable-income securities, where payments can change based on some underlying measure like interest rates.  Government and corporate bonds - typically seen as much safer investments - are common examples of fixed income products. Were a company to become bankrupt, fixed income investors are often paid before common stockholders.  Fixed income instruments are typically recommended to those who are more conservative and tend to be more risk averse.  What are the types of fixed income products?  The list below prov

Bank capital Bank capital is the difference between a banks assets and its liabilities. It represents the new worth of the bank or its equity values to investors. The asset portion of a banks capital includes its cash, government securities, and interest earning loans (mortgages, letters of credit and inter-bank loans). The liabilities section of a bank's capital includes loan-loss reserves and any debt it owes. A bank's capital can be thought of as the margin to which creditors are covered if the bank would liquidate its assets. Basel I, Basel II and Basel III standards provides a definition of the regulatory bank capital that market and banking regulators closely monitor. A banks capital can be divided or structured into different tiers - with Tier 1 capital the primary indicator of the banks financial health. How does it work?  Bank capital indicates the financial health of the bank. If an external force was take a hit on the bank (such as coronavirus of the f

What is Forex?  Forex refers to the foreign exchange market - the trading of one currency to another. These trades take place on the foreign exchange market AKA the Forex market for short. This market is the most liquid market in the world with trillions changing hands each day. There is no physical centralized location but instead is a electronic network of banks, brokers, institutions and individual traders (mostly trading through brokers or banks).  Trades on the Forex markets take place for a multitude of reasons. It can be done for profit by financial traders who may bet on a currency appreciating or depreciating in value, it can be done by a treasury to ensure its business has the right amount of a currency for the right duration of time to ensure its financial health or it could be as simple as a tourist changing currencies at an airport.  What drives decisions behind Forex?  Interest rate decisions made by central banks  This is driven by hot mone

What is maturity?  Maturity refers to the date in which the financial instrument (be it a deposit, foreign exchange spot, forward transaction, interest rate and commodity swap, options, loans and fixed income instruments such as bonds) ends. At this point it must either be renewed or it will cease to exist. The end date will typically trigger the repayment of the financial instrument.  Some financial instruments, deposits and loans for example, require repayment of principal and interest at maturity; other, such as foreign exchange transactions provide for the delivery of a commodity. Interest rate swaps consist of a series of cash flows with the final one occurring at maturity.  What is a maturity date?  The maturity date refers to the moment within a period in which the principal of a fixed income instrument must be repaid to an investor. The maturity date is used to classify bonds into three main categories: short-term (one to three years), medium-term (10 or