Money is not money unless it has all of the following defining characteristics: Money must have value, be durable, portable, uniform, divisible, in limited supply, and be usable as a means of exchange. Underlying all of these characteristics is trust — people must be confident that if they accept money, they can use it to pay for goods.
Karl Marx argued that the real price (or economic value) of goods should be determined not by the demand for those goods, but by the value of the labor that went into producing it.
A business may decide to capitalize a cost, and then spread it over a number of years. Capitalizing means recording an expense as an asset, and then allowing for its depreciation, or fall in value, over time. Accounting this way may be the difference between reporting a profit or a loss if the cost of expense is particularly large.
When to capitalize: For businesses wanting to have a smoother flow of reported income and for startups, it can be attractive to capitalize because it can report a higher income in its early years. However, there are tax implications if it is making a larger profit as a result.
Reading a company’s financial statement does not always give the full picture. Some of the world’s biggest corporate finance scandals have involved hidden losses, loans made to look like income, and misstated profits to make the company in question appear solvent when it is not.
We’re not managing profits, we’re managing businesses.
A financial instrument is something that has value and can be traded. This might be cash or currency, shares, assets, or debts and loans. It can include evidence of an ownership of interest in a company or other entity.
When shareholders buy a share, it is usually an “ordinary share” or “common share,” which means that they can vote in the election of the company’s executive team, approve or vote against new share issues and other money-raising activities, and in some cases receive payouts known as dividends.
“Stock” describes the ownership of shares in general. “Shares” refers to the ownership of shares in a particular company.
Referred to as financial weapons of mass destruction, derivatives can be volatile. Relying on debt leverage, they use complex mathematical models and not all traders clearly understand the risks they are taking. They can suffer large and catastrophic losses as a result.
A US-based airline company reviews its stock levels and decides that it will need to buy jet fuel for its fleet of planes in 3 month’s time.
To protect itself from potential future price increases, it can buy fuel at today’s prices from delivery and payment at a future date, known as a forward transaction. If the price of fuel then falls instead of rising, however, the company will be locked in to paying a higher price.
The primary market is where new shares are created and first issued, whereas the secondary market is where shares that have already been issued are traded between investors. When a company is preparing to float on the primary market, investment banks will set a price at which the new shares will be offered. They may also underwrite the IPO and guarantee to take on unsold shares. The issue price is fixed, but shares may be resold at a different price on the stock exchange (in the secondary market) from the first day of issue.
Hedging: A strategy that involves investors buying shares they think are likely to rise in price while also selling shares they think will fall, in order to maintain a market-neutral position.
60% of US equity trading was estimated to be High-Frequency Trading at its height in 2009.
Investment banks work with large companies, other financial institutions such as investment houses, insurance companies, pension funds, hedge funds, governments, and individuals who are very wealthy and have private funds to invest.
Investment banks have two distinct roles. The first is corporate advising, meaning that they help companies take part in mergers and acquisitions, creating financial products to sell, and bring new companies to market. The second is the brokerage division where trading and market-making — in which the investment bank provides mediation between those who want to buy shares and those who want to sell — take place. The two are supposed to be separate and distinct, so within an investment bank there is a so-called “wall” between these divisions to prevent conflict of interest.
Underwriting: The covering of a potential risk — in return for a fee or percentage.
Regulators monitor the insurance industry to make sure that insurers can pay claims made by insurees. They require insurance companies to buy their own insurance — called reinsurance — to ensure that they can meet their financial liabilities in full.
Investment companies pool investors’ funds to invest in different businesses and assets, potentially giving clients access to markets they could not afford to invest in alone. Fund managers analyze the market, deciding when to buy, sell, or hold. They respond to economic and world news, and try to anticipate movements in global stock markets to make money for clients.
Types of money in an economy are classified in “M” groups. The most liquid, or spendable, form of money is called “narrow” money, and include classes M0 and M1. The definition of “broad money” includes other less liquid, less convertible forms. These are classed as M2, M3, and also M4. How these classes are defined, and what they include or exclude, varies from country to country.
He who control the money supply of a nation controls the nation.
An asset is something that is owned that can be used to pay debts. Assets usually produce a return over time. A bank’s most important asset is its customer loan book, since customers pay interest on loans.
Banks increase money circulation when they issue a loan in the form of money deposited in a customer’s account. Although the loan and its repayment is an asset, the extra account money is a liability, because if the bank fails to make the money available on demand, it could collapse. To prevent this from occurring, banks maintain tight control of their balance sheets, making sure their liabilities always match their assets.
Government can issue their own money, either by printing it or by creating it electronically. However, creating money in this way carries a risk. Since money depends on trust, when a government issues increasing amounts of currency, people may have less confidence in the value of that currency. If their trust collapses completely, hyperinflation may occur.
$6.7T: the amount the US government spent in 2016.
As a healthy body depends on a good blood supply to receive nutrients, so a healthy economy requires a good money supply to keep the cycle of spending going: as one person spends, another earns, then spends, and so on. If this cycle slows, the economy may begin to decline. The government, via the central bank — which is like the beating heart of the economy — helps to keep money flowing.
A body may have optimal blood supply, but it is down to the cells to effectively utilize the nutrients. In the same way, while a government can improve money supply, economic growth then depends on how effectively individuals and businesses are able to convert this money into useful goods and services to raise living standards.
$21T is thought to be hidden in tax havens abroad.
Interest is effectively the price charged by a lender to borrower for the use of funds.
A pension is nothing more than deferred compensation.
It is possible for a government to fail financially, and there are two main ways this can happen. The first is when its loses the ability to meet is obligations to repay its debt, potentially leading to a default. The second is when it fails to reassure the public that the value of its currency, or money itself, can still be trusted, potentially leading to hyperinflation. Fundamentally both causes are due to a loss of public trust. So, if a government cannot be trusted, it is more likely to fail.
Trust is critical to making money and for governments to work properly. It is necessary for economic growth. If people do not believe a government’s financial promises, it may lose control of the economy. Trust is hard to win, and usually comes from political stability over a period of time.
Governments can trust in many different ways. A weak government might decide to issue more money to meet the demands made on it, instead of raising taxes. A government unable to repay it own debts, especially those owed to other countries, may decide that defaulting on the debt is easier than trying to levy taxes to pay. In both cases, trust in the government and its money will be undermined.
One controversial argument is that because hyperinflation results from weak governments, ending hyperinflation requires a strong government — even one that ends democracy. Economist Thomas Sargent has made this argument for central Europe in the 1920s, where a series of hyperinflationary episodes were halted by authoritarian governments.
Wealth is the value of a person’s assets, savings, and investments, while income is the money received regularly in return for work, from investments, or as a benefit or pension. Recognizing the difference between the two concepts is key to both building and protecting wealth. Income that is closely managed and carefully invested can create wealth over time.
Wealth is the value of assets already owned by a household or an individual. It can be savings alone if these are sufficient, or it can be amassed from savings, investments, and inheritance. Wealth is rarely used for day-to-day expenses unless income stops.
There is no formula to determine how much wealth is enough, or how much income is needed to build wealth. It depends on the individual. High earners tend to have higher lifestyle expectations than those on lower incomes. They must therefore save more, and invest more, to generate the wealth they need to maintain their lifestyle during retirement. The danger for this group is that high wags can lead to a false sense of affluence, resulting in big spending on lifestyle but little set aside in savings.
Shopping with a list to eliminate impulse buys, and buying in bulk in order to take advantage of cheaper prices or sales.
Risk comes from not knowing what you’re doing.
66M US adults have no savings.
Investments are something individuals buy or put money into in order to make a profit, or “return.” There are different types of investments — known as asset classes — each of which offers a different type of return. Investors may receive interest (from cash or bonds), dividends (from shares), rent (from property), or capital gains when they sell the asset.
Bankruptcy: This is a legal process that releases a person (or company) from almost all of their debts. People (and companies) can declare bankruptcy if they do not have a realistic chance of repaying their debts depending on the type of bankruptcy filled. Although it can offer a fresh start, the financial consequence can be that it adversely affects a person’s credit rating, and therefore their ability to borrow in the future.
Conventional money unique to a country or a region. Also called fiat currency, from the Latin word fiat meaning “let it be done,” a term used when making a government decree. Fiat currency is minted by the central banks of individual countries and its value is determined by supply and demand.
In 2015, the federal government spent $37T on services for the public. These services included Medicare and Medicaid programs, infrastructure improvements, and social security benefits.
According to the OMB, 47% of the 2015 revenue came from individual income tax. Payroll tax was next, at 33%, and corporate income tax came in at 11%. The remaining revenue, 9%, was from excise and other taxes.
A benefit for the investor who buys munis is that the interest is exempt from federal income tax.
The average credit card debt per household is $9.6K. In 2009, during the recession, 44% of Americans were carrying a balance. In 2014, the proportion was down to 34%.