Both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.
Corporate governance:
By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors). However, some well-documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some public companies. The dot-com bubble in the early 2000s, and the subprime mortgage crisis in 2007-08, are classical examples of corporate mismanagement. Companies like Pets.com (2000), Enron Corporation (2001), One.Tel (2001), Sunbeam (2001), Webvan (2001), Adelphia (2002), MCI WorldCom (2002), Parmalat (2003), American International Group (2008), Lehman Brothers (2008), and Satyam Computer Services (2009) were among the most widely scrutinized by the media.
Creating investment opportunities for small investors:
As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.
Tuesday, December 15, 2009
Thursday, October 8, 2009
Joint stock company
A joint stock company (JSC) is a type of business entity: it is a type of corporation or partnership involving two or more legal persons. Certificates of ownership (or stocks) are issued by the company in return for each financial contribution, and the shareholders are free to transfer their ownership interest at any time by selling their stockholding to others.
In most countries, a joint stock company offers the protection of limited liability; a shareholder is not liable for any of the company's debt beyond the face value of their shareholding.
There are two kinds of joint stock company; the private company kind and the public company. The shares of the former are usually only held by the directors and Company Secretary. The shares of the latter are bought and sold on the open market.
In Russia (the former Soviet Union) the term JSC is used for ex-State Enterprises that are now under a more free business regime. Their business conditions are somewhat different from Joint Stock Companies in western countries.
In most countries, a joint stock company offers the protection of limited liability; a shareholder is not liable for any of the company's debt beyond the face value of their shareholding.
There are two kinds of joint stock company; the private company kind and the public company. The shares of the former are usually only held by the directors and Company Secretary. The shares of the latter are bought and sold on the open market.
In Russia (the former Soviet Union) the term JSC is used for ex-State Enterprises that are now under a more free business regime. Their business conditions are somewhat different from Joint Stock Companies in western countries.
Exchange Alley
Exchange Alley or Change Alley is a narrow alleyway connecting shops and coffeehouses in an old neighbourhood of the City of London in England, bounded by Lombard Street, Cornhill and Birchin Lane. It served as a convenient shortcut from the Royal Exchange to the Post Office. The shops included ship chandlers, makers of instruments for navigation such as telescopes, and goldsmiths from Lombardy.
The coffee houses of Exchange Alley, especially Jonathan's and Garraway's, became an early venue for the lively trading of stocks and commodities. These activities were the progenitor of the London Stock Exchange. Similarly, Edward Lloyd's coffee house, at 16, Lombard Street but originally on Tower Street, was the forerunner of Lloyd's of London, Lloyd's Register and Lloyd's List.
The coffee houses of Exchange Alley, especially Jonathan's and Garraway's, became an early venue for the lively trading of stocks and commodities. These activities were the progenitor of the London Stock Exchange. Similarly, Edward Lloyd's coffee house, at 16, Lombard Street but originally on Tower Street, was the forerunner of Lloyd's of London, Lloyd's Register and Lloyd's List.
Monday, June 29, 2009
Manulife Financial
The Manufacturers Life Insurance Company, is a major Canadian insurance company and financial services provider. Although its global head office is located in Toronto, with its Canadian operations based out of Waterloo, Ontario, Manulife has worldwide operations, most notably in the United States (through its subsidiary, John Hancock Insurance) and in 10 unique Asian countries and territories.
Manulife Financial is the largest insurance company in North America and the world's fourth largest, based on market capitalization. Manulife ranks number 91 on the Forbes Global 2000 list (2008 edition); by that measure, it is the second largest company in Canada.
Manulife Financial was founded in 1887 as The Manufacturers Life Insurance Company. Its first president was the first Prime Minister of Canada, Sir John A. Macdonald. In 1897, Manulife Financial expanded its operations into Asia, including China and Hong Kong.
Manulife currently has 47,000 employees and agents. It also holds considerable political sway, through former President and CEO Dominic D'Alessandro, who sits as one of only ten Canadian members of the North American Competitiveness Council, the group that directs much of the policy of the Security and Prosperity Partnership of North America (SPP).
Dominic D’Alessandro was formerly an executive vice president at the Royal Bank of Canada, departing in 1988 when he was appointed President and Chief Executive Officer of the Laurentian Bank of Canada.
In 2004, D'Alessandro led Manulife's acquisition of John Hancock Insurance (D'Alessandro is unrelated to Hancock CEO David D'Alessandro) and Maritime Life.
In October 2008, Manulife Financial Corp. was named one of Greater Toronto's Top Employers by Mediacorp Canada Inc., which was announced by the Toronto Star newspaper.
Current members of the board of directors of Manulife Financial are: John M. Cassaday, Lino J. Celeste, Thomas P. d'Aquino, Dominic D’Alessandro, Richard B. DeWolfe, Robert E. Dineen, Jr., Pierre Y. Ducros,Scott M. Hand, Robert Harding, Luther S. Helms, Thomas E. Kierans, Lorna R. Marsden, Gail C.A. Cook-Bennett (Chair), Hugh W. Sloan, Jr., Gordon G. Thiessen. Former director Michael Wilson resigned as director after 11 years, on being appointed Canadian ambassador to the United States of America in March 2006. Former Chairman Arthur Sawchuk retired in October 2008.
Manulife Financial is the largest insurance company in North America and the world's fourth largest, based on market capitalization. Manulife ranks number 91 on the Forbes Global 2000 list (2008 edition); by that measure, it is the second largest company in Canada.
Manulife Financial was founded in 1887 as The Manufacturers Life Insurance Company. Its first president was the first Prime Minister of Canada, Sir John A. Macdonald. In 1897, Manulife Financial expanded its operations into Asia, including China and Hong Kong.
Manulife currently has 47,000 employees and agents. It also holds considerable political sway, through former President and CEO Dominic D'Alessandro, who sits as one of only ten Canadian members of the North American Competitiveness Council, the group that directs much of the policy of the Security and Prosperity Partnership of North America (SPP).
Dominic D’Alessandro was formerly an executive vice president at the Royal Bank of Canada, departing in 1988 when he was appointed President and Chief Executive Officer of the Laurentian Bank of Canada.
In 2004, D'Alessandro led Manulife's acquisition of John Hancock Insurance (D'Alessandro is unrelated to Hancock CEO David D'Alessandro) and Maritime Life.
In October 2008, Manulife Financial Corp. was named one of Greater Toronto's Top Employers by Mediacorp Canada Inc., which was announced by the Toronto Star newspaper.
Current members of the board of directors of Manulife Financial are: John M. Cassaday, Lino J. Celeste, Thomas P. d'Aquino, Dominic D’Alessandro, Richard B. DeWolfe, Robert E. Dineen, Jr., Pierre Y. Ducros,Scott M. Hand, Robert Harding, Luther S. Helms, Thomas E. Kierans, Lorna R. Marsden, Gail C.A. Cook-Bennett (Chair), Hugh W. Sloan, Jr., Gordon G. Thiessen. Former director Michael Wilson resigned as director after 11 years, on being appointed Canadian ambassador to the United States of America in March 2006. Former Chairman Arthur Sawchuk retired in October 2008.
John Hancock Insurance
John Hancock Financial is a loose term for a major United States insurance company which existed, in various forms, from its founding on April 21, 1862, until its acquisition in 2004 by the Canadian insurance company Manulife Financial. It was named in honor of John Hancock, a prominent patriot. The company continues to operate as a wholly owned subsidiary of Manulife.
April 21, 1862, the charter of the John Hancock Mutual Life Insurance Company was approved by John A. Andrew, governor of Massachusetts.John Hancock advertisements and newspaper articles from the 1930s refer to it as the "John Hancock Life Insurance Company."1940s source refer to it as the "John Hancock Mutual Life Insurance Company"A July 2, 1998, Boston Herald story, John Hancock Mutual Life Insurance Co chairman, is quoted: "We have always said quite clearly that we are not for sale," [Stephen L.] Brown said, moving to kill speculation about possible deals with BankBoston or Fleet Financial Group. "There are simply no merger talks going on."In 2000, the company "demutualized," meaning that "John Hancock Mutual Life Insurance Company" formally ceased to exist, and a new company named "John Hancock Financial Services Inc." came into existence. Policyholders received shares in the new company in exchange for giving up ownership in the old. Life insurance continued to be sold by an entity known as the "John Hancock Variable Life Insurance Company," a subsidiary of John Hancock Financial Services Inc. On January 27, 2000, shares of Hancock stock started to trade on the New York Stock Exchange under the symbol JHF.On September 29, 2003, it was announced that Manulife Financial Corp. was acquiring John Hancock Financial Services Inc. for $10.4 billion.On April 29, 2004, the existence of John Hancock Financial Services, Inc. as an independent company formally ended.During 2004, Manulife merged its original U.S. domiciled business units with the newly acquired company under the John Hancock name.As of 2006 Manulife continues to use the John Hancock brand name for the majority of its U.S. business. The 2005 Manulife Annual Report (pp.154–155) lists as subsidiaries the following companies and others (where the indentation indicates a hierarchy of ownership): "John Hancock Holdings (Delaware) LLC" (100% owned) "John Hancock Financial Services, Inc." (100% owned) "John Hancock Life Insurance Company" (100% owned) "John Hancock Variable Life Insurance Company" (100% owned)In addition the following companies are former Manulife subsidiaries renamed to John Hancock: "John Hancock Life Insurance Company (U.S.A.)" (100% owned) "John Hancock Life Insurance Company of New York" (100% owned)"John Hancock Investment Management Services, LLC" (95% owned)
April 21, 1862, the charter of the John Hancock Mutual Life Insurance Company was approved by John A. Andrew, governor of Massachusetts.John Hancock advertisements and newspaper articles from the 1930s refer to it as the "John Hancock Life Insurance Company."1940s source refer to it as the "John Hancock Mutual Life Insurance Company"A July 2, 1998, Boston Herald story, John Hancock Mutual Life Insurance Co chairman, is quoted: "We have always said quite clearly that we are not for sale," [Stephen L.] Brown said, moving to kill speculation about possible deals with BankBoston or Fleet Financial Group. "There are simply no merger talks going on."In 2000, the company "demutualized," meaning that "John Hancock Mutual Life Insurance Company" formally ceased to exist, and a new company named "John Hancock Financial Services Inc." came into existence. Policyholders received shares in the new company in exchange for giving up ownership in the old. Life insurance continued to be sold by an entity known as the "John Hancock Variable Life Insurance Company," a subsidiary of John Hancock Financial Services Inc. On January 27, 2000, shares of Hancock stock started to trade on the New York Stock Exchange under the symbol JHF.On September 29, 2003, it was announced that Manulife Financial Corp. was acquiring John Hancock Financial Services Inc. for $10.4 billion.On April 29, 2004, the existence of John Hancock Financial Services, Inc. as an independent company formally ended.During 2004, Manulife merged its original U.S. domiciled business units with the newly acquired company under the John Hancock name.As of 2006 Manulife continues to use the John Hancock brand name for the majority of its U.S. business. The 2005 Manulife Annual Report (pp.154–155) lists as subsidiaries the following companies and others (where the indentation indicates a hierarchy of ownership): "John Hancock Holdings (Delaware) LLC" (100% owned) "John Hancock Financial Services, Inc." (100% owned) "John Hancock Life Insurance Company" (100% owned) "John Hancock Variable Life Insurance Company" (100% owned)In addition the following companies are former Manulife subsidiaries renamed to John Hancock: "John Hancock Life Insurance Company (U.S.A.)" (100% owned) "John Hancock Life Insurance Company of New York" (100% owned)"John Hancock Investment Management Services, LLC" (95% owned)
London Stock Exchange
The London Stock Exchange or LSE is a stock exchange located in London, United Kingdom. Founded in 1801, it is one of the largest stock exchanges in the world, with many overseas listings as well as British companies. The LSE is part of the London Stock Exchange Group.
Its current premises are situated in Paternoster Square close to St Paul's Cathedral in the City of London.
The trade in shares in London began with the need to finance two voyages: The Muscovy Company's attempt to reach China via the White Sea north of Russia, and the East India Company voyage to India and the east.
Unable to finance these costly journeys privately, the companies raised the money by selling shares to merchants, giving them a right to a portion of any profits eventually made.
The Change Alley exchange thrived. However, it suffered a setback in 1720.
Much excitement was caused by the South Sea Company, stoked by brokers, the company's owner John Blunt and the government. Having set up the unprofitable company nine years previously, the government hoped to wipe out the large debts accumulated by offering shares to the public.
Shares in the company, which had started at £128 each at the start of the year, were soon fetching as much as £1,050 by June. The bubble inevitably burst, with share prices plunging to £175, then £124.
The incident caused outcry, forcing the government to pass legislation to prevent another bubble, and it took a long time for the stock exchange to recover.
Jonathan's burnt down in 1748, and this, plus dissatisfaction with the overcrowding in the Alley, made the brokers build a New Jonathan's on Threadneedle Street, as well as charging an entrance fee. The building was soon renamed the Stock Exchange, only to be renamed again as the Stock Subscription Room in 1801, with new membership regulations. Former LSE premises in Threadneedle Street
However, this too proved unsatisfactory, and the exchange moved to the newly built Capel Court in the same year. The exchange had recovered by the 1820s, bolstered by the growth of the railways, canals, mining and insurance industries (there were, however, problems with stags and dividend payments). Regional stock exchanges were formed across the UK. Bonds (or gilt-edged securities) also began to be traded.
In December 2005, the London Stock Exchange rejected a £1.6 billion takeover offer from Macquarie Bank. The London Stock Exchange described the offer as "derisory", a sentiment echoed by shareholders in the exchange. Shortly after Macquarie withdrew its offer, the LSE received an unsolicited approach from NASDAQ valuing the company at £2.4 billion. This too it duly rejected. NASDAQ later pulled its bid, and less than two weeks later on 11 April 2006, struck a deal with LSE's largest shareholder, Ameriprise Financial's Threadneedle Asset Management unit, to acquire all of that firm's stake, consisting of 35.4 million shares, at £11.75 per share. NASDAQ also purchased 2.69 million additional shares, resulting in a total stake of 15%. While the seller of those shares was undisclosed, it occurred simultaneously with a sale by Scottish Widows of 2.69 million shares. The move was seen as an effort to force LSE to the negotiating table, as well as to limit the Exchange's strategic flexibility.
Subsequent purchases increased NASDAQ's stake to 25.1%, holding off competing bids for several months. United Kingdom financial rules required that NASDAQ wait for a period of time before renewing its effort. On 20 November 2006, within a month or two of the expiration of this period, NASDAQ increased its stake to 28.75% and launched a hostile offer at the minimum permitted bid of £12.43 per share, which was the highest NASDAQ had paid on the open market for its existing shares. The LSE immediately rejected this bid, stating that it "substantially undervalues" the company.
NASDAQ revised its offer (characterized as an "unsolicited" bid, rather than a "hostile takeover attempt") on 12 December 2006, indicating that it would be able to complete the deal with 50% (plus one share) of LSE's stock, rather than the 90% it had been seeking. The U.S. exchange did not, however, raise its bid. Many hedge funds had accumulated large positions within the LSE, and many managers of those funds, as well as Furse, indicated that the bid was still not satisfactory. NASDAQ's bid was made more difficult because it had described its offer as "final", which, under British bidding rules, restricted their ability to raise its offer except under certain circumstances.
In the end, NASDAQ's offer was roundly rejected by LSE shareholders. Having received acceptances of only 0.41 per cent of rest of the register by the deadline on 10 February 2007, Nasdaq's offer duly lapsed . Responding to the news, Chris Gibson-Smith, the LSE's chairman, said: "The Exchange’s strategy has produced outstanding results for shareholders by facilitating a structural shift in volume growth in an increasingly international market at the centre of the world’s equity flows. The Exchange intends to build on its exceptionally valuable brand by progressing various competitive, collaborative and strategic opportunities, thereby reinforcing its uniquely powerful position in a fast evolving global sector."
On Monday, 20 August 2007, NASDAQ announced that it was abandoning its plan to take over the LSE and subsequently look for options to divest its 31% (61.3 million shares) shareholding in the company in light of its failed takeover attempt. In September 2007, NASDAQ agreed to sell the majority of its shares to Borse Dubai, leaving the United Arab Emirates-based exchange with 28% of the LSE.
Its current premises are situated in Paternoster Square close to St Paul's Cathedral in the City of London.
The trade in shares in London began with the need to finance two voyages: The Muscovy Company's attempt to reach China via the White Sea north of Russia, and the East India Company voyage to India and the east.
Unable to finance these costly journeys privately, the companies raised the money by selling shares to merchants, giving them a right to a portion of any profits eventually made.
The Change Alley exchange thrived. However, it suffered a setback in 1720.
Much excitement was caused by the South Sea Company, stoked by brokers, the company's owner John Blunt and the government. Having set up the unprofitable company nine years previously, the government hoped to wipe out the large debts accumulated by offering shares to the public.
Shares in the company, which had started at £128 each at the start of the year, were soon fetching as much as £1,050 by June. The bubble inevitably burst, with share prices plunging to £175, then £124.
The incident caused outcry, forcing the government to pass legislation to prevent another bubble, and it took a long time for the stock exchange to recover.
Jonathan's burnt down in 1748, and this, plus dissatisfaction with the overcrowding in the Alley, made the brokers build a New Jonathan's on Threadneedle Street, as well as charging an entrance fee. The building was soon renamed the Stock Exchange, only to be renamed again as the Stock Subscription Room in 1801, with new membership regulations. Former LSE premises in Threadneedle Street
However, this too proved unsatisfactory, and the exchange moved to the newly built Capel Court in the same year. The exchange had recovered by the 1820s, bolstered by the growth of the railways, canals, mining and insurance industries (there were, however, problems with stags and dividend payments). Regional stock exchanges were formed across the UK. Bonds (or gilt-edged securities) also began to be traded.
In December 2005, the London Stock Exchange rejected a £1.6 billion takeover offer from Macquarie Bank. The London Stock Exchange described the offer as "derisory", a sentiment echoed by shareholders in the exchange. Shortly after Macquarie withdrew its offer, the LSE received an unsolicited approach from NASDAQ valuing the company at £2.4 billion. This too it duly rejected. NASDAQ later pulled its bid, and less than two weeks later on 11 April 2006, struck a deal with LSE's largest shareholder, Ameriprise Financial's Threadneedle Asset Management unit, to acquire all of that firm's stake, consisting of 35.4 million shares, at £11.75 per share. NASDAQ also purchased 2.69 million additional shares, resulting in a total stake of 15%. While the seller of those shares was undisclosed, it occurred simultaneously with a sale by Scottish Widows of 2.69 million shares. The move was seen as an effort to force LSE to the negotiating table, as well as to limit the Exchange's strategic flexibility.
Subsequent purchases increased NASDAQ's stake to 25.1%, holding off competing bids for several months. United Kingdom financial rules required that NASDAQ wait for a period of time before renewing its effort. On 20 November 2006, within a month or two of the expiration of this period, NASDAQ increased its stake to 28.75% and launched a hostile offer at the minimum permitted bid of £12.43 per share, which was the highest NASDAQ had paid on the open market for its existing shares. The LSE immediately rejected this bid, stating that it "substantially undervalues" the company.
NASDAQ revised its offer (characterized as an "unsolicited" bid, rather than a "hostile takeover attempt") on 12 December 2006, indicating that it would be able to complete the deal with 50% (plus one share) of LSE's stock, rather than the 90% it had been seeking. The U.S. exchange did not, however, raise its bid. Many hedge funds had accumulated large positions within the LSE, and many managers of those funds, as well as Furse, indicated that the bid was still not satisfactory. NASDAQ's bid was made more difficult because it had described its offer as "final", which, under British bidding rules, restricted their ability to raise its offer except under certain circumstances.
In the end, NASDAQ's offer was roundly rejected by LSE shareholders. Having received acceptances of only 0.41 per cent of rest of the register by the deadline on 10 February 2007, Nasdaq's offer duly lapsed . Responding to the news, Chris Gibson-Smith, the LSE's chairman, said: "The Exchange’s strategy has produced outstanding results for shareholders by facilitating a structural shift in volume growth in an increasingly international market at the centre of the world’s equity flows. The Exchange intends to build on its exceptionally valuable brand by progressing various competitive, collaborative and strategic opportunities, thereby reinforcing its uniquely powerful position in a fast evolving global sector."
On Monday, 20 August 2007, NASDAQ announced that it was abandoning its plan to take over the LSE and subsequently look for options to divest its 31% (61.3 million shares) shareholding in the company in light of its failed takeover attempt. In September 2007, NASDAQ agreed to sell the majority of its shares to Borse Dubai, leaving the United Arab Emirates-based exchange with 28% of the LSE.
Monday, April 27, 2009
Common stock
Common stock is a form of corporation equity ownership represented in the securities. It is a stock whose dividends are based on market fluctuations. It is dangerous in comparison to preferred shares and some other investment options, in that in the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than preferred shares or bonds over time.
Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering.
Additional benefits from common stock include earning dividends and capital appreciation.
Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering.
Additional benefits from common stock include earning dividends and capital appreciation.
Security (finance)
A security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt securities (such as banknotes, bonds and debentures), and equity securities; e.g., common stocks. The company or other entity issuing the security is called the issuer. What specifically qualifies as a security is dependent on the regulatory structure in a country. For example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions.
Securities may be represented by a certificate or, more typically, by an electronic book entry. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible.
Issuers of securities include commercial companies, government agencies, local authorities and international and supranational organizations (such as the World Bank). Debt securities issued by a government (called government bonds or sovereign bonds) generally carry a lower interest rate than corporate debt issued by commercial companies. Interests in an asset—for example, the flow of royalty payments from intellectual property—may also be turned into securities. These repackaged securities resulting from a securitization are usually issued by a company established for the purpose of the repackaging—called a special purpose vehicle (SPV). See "Repackaging" below. SPVs are also used to issue other kinds of securities. SPVs can also be used to guarantee securities, such as covered bonds.
Commercial enterprises have traditionally used securities as a means of raising new capital. Securities may be an attractive option relative to bank loans depending on their pricing and market demand for particular characteristics. Another disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants. Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, the governments may raise capital through the issuance of securities (see government debt).
The traditional economic function of the purchase of securities is investment, with the view to receiving income and/or achieving capital gain. Debt securities generally offer a higher rate of interest than bank deposits, and equities may offer the prospect of capital growth. Equity investment may also offer control of the business of the issuer. Debt holdings may also offer some measure of control to the investor if the company is a fledgling start-up or an old giant undergoing 'restructuring'. In these cases, if interest payments are missed, the creditors may take control of the company and liquidate it to recover some of their investment.
The last decade has seen an enormous growth in the use of securities as collateral. Purchasing securities with borrowed money secured by other securities is called "buying on margin." Where A is owed a debt or other obligation by B, A may require B to deliver property rights in securities to A. These property rights enable A to satisfy its claims in the event that B becomes insolvent. Collateral arrangements are divided into two broad categories, namely security interests and outright collateral transfers. Commonly, commercial banks, investment banks and government agencies are significant collateral takers.
Debt securities may be called debentures, bonds, deposits, notes or commercial paper depending on their maturity and certain other characteristics. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually "senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is "subordinated".
Corporate bonds represent the debt of commercial or industrial entities. Debentures have a long maturity, typically at least ten years, whereas notes have a shorter maturity. Commercial paper is a simple form of debt security that essentially represents a post-dated check with a maturity of not more than 270 days.
Money market instruments are short term debt instruments that may have characteristics of deposit accounts, such as certificates of deposit, and certain bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Commercial paper is also often highly liquid.
Euro debt securities are securities issued internationally outside their domestic market in a denomination different from that of the issuer's domicile. They include eurobonds and euronotes. Eurobonds are characteristically underwritten, and not secured, and interest is paid gross. A euronote may take the form of euro-commercial paper (ECP) or euro-certificates of deposit.
Government bonds are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a source of finance for governments. U.S. federal government bonds are called treasuries. Because of their liquidity and perceived low risk, treasuries are used to manage the money supply in the open market operations of non-US central banks.
Sub-sovereign government bonds, known in the U.S. as municipal bonds, represent the debt of state, provincial, territorial, municipal or other governmental units other than sovereign governments.
Supranational bonds represent the debt of international organizations such as the World Bank, the International Monetary Fund, regional multilateral development banks and others.
Securities may be represented by a certificate or, more typically, by an electronic book entry. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible.
Issuers of securities include commercial companies, government agencies, local authorities and international and supranational organizations (such as the World Bank). Debt securities issued by a government (called government bonds or sovereign bonds) generally carry a lower interest rate than corporate debt issued by commercial companies. Interests in an asset—for example, the flow of royalty payments from intellectual property—may also be turned into securities. These repackaged securities resulting from a securitization are usually issued by a company established for the purpose of the repackaging—called a special purpose vehicle (SPV). See "Repackaging" below. SPVs are also used to issue other kinds of securities. SPVs can also be used to guarantee securities, such as covered bonds.
Commercial enterprises have traditionally used securities as a means of raising new capital. Securities may be an attractive option relative to bank loans depending on their pricing and market demand for particular characteristics. Another disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants. Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, the governments may raise capital through the issuance of securities (see government debt).
The traditional economic function of the purchase of securities is investment, with the view to receiving income and/or achieving capital gain. Debt securities generally offer a higher rate of interest than bank deposits, and equities may offer the prospect of capital growth. Equity investment may also offer control of the business of the issuer. Debt holdings may also offer some measure of control to the investor if the company is a fledgling start-up or an old giant undergoing 'restructuring'. In these cases, if interest payments are missed, the creditors may take control of the company and liquidate it to recover some of their investment.
The last decade has seen an enormous growth in the use of securities as collateral. Purchasing securities with borrowed money secured by other securities is called "buying on margin." Where A is owed a debt or other obligation by B, A may require B to deliver property rights in securities to A. These property rights enable A to satisfy its claims in the event that B becomes insolvent. Collateral arrangements are divided into two broad categories, namely security interests and outright collateral transfers. Commonly, commercial banks, investment banks and government agencies are significant collateral takers.
Debt securities may be called debentures, bonds, deposits, notes or commercial paper depending on their maturity and certain other characteristics. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually "senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is "subordinated".
Corporate bonds represent the debt of commercial or industrial entities. Debentures have a long maturity, typically at least ten years, whereas notes have a shorter maturity. Commercial paper is a simple form of debt security that essentially represents a post-dated check with a maturity of not more than 270 days.
Money market instruments are short term debt instruments that may have characteristics of deposit accounts, such as certificates of deposit, and certain bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Commercial paper is also often highly liquid.
Euro debt securities are securities issued internationally outside their domestic market in a denomination different from that of the issuer's domicile. They include eurobonds and euronotes. Eurobonds are characteristically underwritten, and not secured, and interest is paid gross. A euronote may take the form of euro-commercial paper (ECP) or euro-certificates of deposit.
Government bonds are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a source of finance for governments. U.S. federal government bonds are called treasuries. Because of their liquidity and perceived low risk, treasuries are used to manage the money supply in the open market operations of non-US central banks.
Sub-sovereign government bonds, known in the U.S. as municipal bonds, represent the debt of state, provincial, territorial, municipal or other governmental units other than sovereign governments.
Supranational bonds represent the debt of international organizations such as the World Bank, the International Monetary Fund, regional multilateral development banks and others.
Business studies
Business studies is the name of an academic subject taught at higher level in Australia, Ireland, New Zealand, United Kingdom, India, and Canada (at both GCSE, AS Level and A Level in the UK), as well as at university level in many countries. Its study combines accounting, economics, finance, marketing and organisational behaviour, however these topics are taught somewhat differently depending on which board the examinations are sat on.
The General Certificate of Secondary Education in Business Studies is taken through a combination of a coursework project and an exam. Cambridge University considers Business Studies not to be a 'traditional academic subject', although taking Business Studies individually will not disadvantage students as long as it is identified as 'essential' or 'desirable' for the course being applied for. It is also suitable when applying for economics at University, if the college the candidate comes from does not offer the economics a-level individually.
New Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses (commonly called the North Island and the South Island), and numerous smaller islands, most notably Stewart Island/Rakiura and the Chatham Islands. The indigenous Māori named New Zealand Aotearoa, commonly translated as The Land of the Long White Cloud. The Realm of New Zealand also includes the Cook Islands and Niue (self-governing but in free association); Tokelau; and the Ross Dependency (New Zealand's territorial claim in Antarctica).
New Zealand is notable for its geographic isolation: it is situated about 2000 km (1250 miles) southeast of Australia across the Tasman Sea, and its closest neighbours to the north are New Caledonia, Fiji and Tonga. During its long isolation New Zealand developed a distinctive fauna dominated by birds, a number of which became extinct after the arrival of humans and the mammals they introduced.
The population of New Zealand is mostly of European descent; the indigenous Māori are the largest minority. Asians and non-Māori Polynesians are also significant minority groups, especially in the urban areas.
Elizabeth II, as the Queen of New Zealand, is the country's head of state and is represented by a non-partisan Governor-General. The Queen has no real political influence, and her position is essentially symbolic. Political power is held by the democratically elected Parliament of New Zealand under the leadership of the Prime Minister, who is the head of government.
The General Certificate of Secondary Education in Business Studies is taken through a combination of a coursework project and an exam. Cambridge University considers Business Studies not to be a 'traditional academic subject', although taking Business Studies individually will not disadvantage students as long as it is identified as 'essential' or 'desirable' for the course being applied for. It is also suitable when applying for economics at University, if the college the candidate comes from does not offer the economics a-level individually.
New Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses (commonly called the North Island and the South Island), and numerous smaller islands, most notably Stewart Island/Rakiura and the Chatham Islands. The indigenous Māori named New Zealand Aotearoa, commonly translated as The Land of the Long White Cloud. The Realm of New Zealand also includes the Cook Islands and Niue (self-governing but in free association); Tokelau; and the Ross Dependency (New Zealand's territorial claim in Antarctica).
New Zealand is notable for its geographic isolation: it is situated about 2000 km (1250 miles) southeast of Australia across the Tasman Sea, and its closest neighbours to the north are New Caledonia, Fiji and Tonga. During its long isolation New Zealand developed a distinctive fauna dominated by birds, a number of which became extinct after the arrival of humans and the mammals they introduced.
The population of New Zealand is mostly of European descent; the indigenous Māori are the largest minority. Asians and non-Māori Polynesians are also significant minority groups, especially in the urban areas.
Elizabeth II, as the Queen of New Zealand, is the country's head of state and is represented by a non-partisan Governor-General. The Queen has no real political influence, and her position is essentially symbolic. Political power is held by the democratically elected Parliament of New Zealand under the leadership of the Prime Minister, who is the head of government.
Business
A business (also called a firm or an enterprise) is a legally recognized organization designed to provide goods and/or services to consumers. Businesses are predominant in capitalist economies, most being privately owned and formed to earn profit that will increase the wealth of its owners and grow the business itself. The owners and operators of a business have as one of their main objectives the receipt or generation of a financial return in exchange for work and acceptance of risk. Notable exceptions include cooperative businesses and state-owned enterprises. Socialist systems involve either government agencies, public, or worker ownership of most sizable businesses.
The etymology of "business" relates to the state of being busy either as an individual or society as a whole, doing commercially viable and profitable work. The term "business" has at least three usages, depending on the scope — the singular usage (above) to mean a particular company or corporation, the generalized usage to refer to a particular market sector, such as "the music business" and compound forms such as agribusiness, or the broadest meaning to include all activity by the community of suppliers of goods and services. However, the exact definition of business, like much else in the philosophy of business, is a matter of debate.
Business Studies, the study of the management of individuals to maintain collective productivity in order to accomplish particular creative and productive goals (usually to generate profit), is taught as an academic subject in many schools.
Although forms of business ownership vary by jurisdiction, there are several common forms:
Sole proprietorship: A sole proprietorship is a business owned by one person. The owner may operate on his or her own or may employ others. The owner of the business has total and unlimited personal liability of the debts incurred by the business.
Partnership: A partnership is a form of business in which two or more people operate for the common goal of making profit. Each partner has total and unlimited personal liability of the debts incurred by the partnership. There are three typical classifications of partnerships: general partnerships, limited partnerships, and limited liability partnerships.
Corporation: A business corporation is a for-profit, limited liability entity that has a separate legal personality from its members. A corporation is owned by multiple shareholders and is overseen by a board of directors, which hires the business's managerial staff.
Cooperative: Often referred to as a "co-op business" or "co-op", a cooperative is a for-profit, limited liability entity that differs from a corporation in that it has members, as opposed to shareholders, who share decision-making authority. Cooperatives are typically classified as either consumer cooperatives or worker cooperatives. Cooperatives are fundamental to the ideology of economic democracy.
For a country-by-country listing of legally recognized business forms, see Types of business entity.
There are many types of businesses, and, as a result, businesses are classified in many ways. One of the most common focuses on the primary profit-generating activities of a business:
Agriculture and mining businesses are concerned with the production of raw material, such as plants or minerals.
Financial businesses include banks and other companies that generate profit through investment and management of capital.
Information businesses generate profits primarily from the resale of intellectual property and include movie studios, publishers and packaged software companies.
Manufacturers produce products, from raw materials or component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers.
Real estate businesses generate profit from the selling, renting, and development of properties, homes, and buildings.
Retailers and Distributors act as middle-men in getting goods produced by manufacturers to the intended consumer, generating a profit as a result of providing sales or distribution services. Most consumer-oriented stores and catalogue companies are distributors or retailers. See also: Franchising
Service businesses offer intangible goods or services and typically generate a profit by charging for labor or other services provided to government, other businesses or consumers. Organizations ranging from house decorators to consulting firms to restaurants and even to entertainers are types of service businesses.
Transportation businesses deliver goods and individuals from location to location, generating a profit on the transportation costs
Utilities produce public services, such as heat, electricity, or sewage treatment, and are usually government chartered.
There are many other divisions and subdivisions of businesses. The authoritative list of business types for North America is generally considered to be the North American Industry Classification System, or NAICS. The equivalent European Union list is the NACE.
The etymology of "business" relates to the state of being busy either as an individual or society as a whole, doing commercially viable and profitable work. The term "business" has at least three usages, depending on the scope — the singular usage (above) to mean a particular company or corporation, the generalized usage to refer to a particular market sector, such as "the music business" and compound forms such as agribusiness, or the broadest meaning to include all activity by the community of suppliers of goods and services. However, the exact definition of business, like much else in the philosophy of business, is a matter of debate.
Business Studies, the study of the management of individuals to maintain collective productivity in order to accomplish particular creative and productive goals (usually to generate profit), is taught as an academic subject in many schools.
Although forms of business ownership vary by jurisdiction, there are several common forms:
Sole proprietorship: A sole proprietorship is a business owned by one person. The owner may operate on his or her own or may employ others. The owner of the business has total and unlimited personal liability of the debts incurred by the business.
Partnership: A partnership is a form of business in which two or more people operate for the common goal of making profit. Each partner has total and unlimited personal liability of the debts incurred by the partnership. There are three typical classifications of partnerships: general partnerships, limited partnerships, and limited liability partnerships.
Corporation: A business corporation is a for-profit, limited liability entity that has a separate legal personality from its members. A corporation is owned by multiple shareholders and is overseen by a board of directors, which hires the business's managerial staff.
Cooperative: Often referred to as a "co-op business" or "co-op", a cooperative is a for-profit, limited liability entity that differs from a corporation in that it has members, as opposed to shareholders, who share decision-making authority. Cooperatives are typically classified as either consumer cooperatives or worker cooperatives. Cooperatives are fundamental to the ideology of economic democracy.
For a country-by-country listing of legally recognized business forms, see Types of business entity.
There are many types of businesses, and, as a result, businesses are classified in many ways. One of the most common focuses on the primary profit-generating activities of a business:
Agriculture and mining businesses are concerned with the production of raw material, such as plants or minerals.
Financial businesses include banks and other companies that generate profit through investment and management of capital.
Information businesses generate profits primarily from the resale of intellectual property and include movie studios, publishers and packaged software companies.
Manufacturers produce products, from raw materials or component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers.
Real estate businesses generate profit from the selling, renting, and development of properties, homes, and buildings.
Retailers and Distributors act as middle-men in getting goods produced by manufacturers to the intended consumer, generating a profit as a result of providing sales or distribution services. Most consumer-oriented stores and catalogue companies are distributors or retailers. See also: Franchising
Service businesses offer intangible goods or services and typically generate a profit by charging for labor or other services provided to government, other businesses or consumers. Organizations ranging from house decorators to consulting firms to restaurants and even to entertainers are types of service businesses.
Transportation businesses deliver goods and individuals from location to location, generating a profit on the transportation costs
Utilities produce public services, such as heat, electricity, or sewage treatment, and are usually government chartered.
There are many other divisions and subdivisions of businesses. The authoritative list of business types for North America is generally considered to be the North American Industry Classification System, or NAICS. The equivalent European Union list is the NACE.
Undervalued stock
An undervalued stock is defined as a stock that is selling at a price significantly below what is assumed to be its intrinsic value (finance). For example, if a stock is selling for $50, but can be determined to be worth $100 based on predictable future cash flows, then it is an undervalued stock.
Numerous popular books discuss undervalued stocks. Examples are The Intelligent Investor by Benjamin Graham, also known as "The Dean of Wall Street," and The Warren Buffett Way by Robert Hagstrom.
The Intelligent Investor puts forth Graham's principles that are based on mathematical calculations such as the price/earning ratio. He was less concerned with the qualitative aspects of a business such as the nature of a business and its management. Graham's ideas had a significant influence on the young Warren Buffett, who later became a famous US billionaire.
Warren Buffett, also known as "The Oracle of Omaha," stated that the value of a business is the sum of the cash flows over the life of the business discounted at an appropriate interest rate. This is in reference to the ideas of John Burr Williams. Therefore, one would not be able to predict whether a stock is undervalued without predicting the future profits of a company and future interest rates. Buffett stated that he is interested in predicable businesses and he uses the interest rate on the 10-year treasury bond in his calculations.
Therefore, an investor has to be fairly certain that a company will be profitable in the future in order to consider it to be undervalued. For example, if a risky stock has a PE ratio of 5 and the company becomes bankrupt, this would not be an undervalued stock.
Some qualities of companies with undervalued stocks are:
1. The company's earning history is stable.
2. The company does not specialize in high-technology that can become obsolete overnight.
3. The company is not in the middle of some financial scandal.
4. The company's low PE ratio is not due to profits realized from capital gains.
5. The company's low PE ratio is not due to a major decline in profitability.
6. The company's PE ratio is below its average PE ratio for the last 10 years.
7. The company is selling at a price below its tangible asset value.
8. The company's trailing 3-years earnings has risen over the past 10 years.
9. The company's credit rating is AAA, AA, or A.
10. The company did not have a loss during the last recession.
A excellent stock at a fair price is more likely to be undervalued than to a poor stock at a cheap price, according to Charles Munger, the Harvard educated partner of Buffett. An excellent stock continues to rise in value over the long term, while a poor stock declines in value.
An undervalued stock will usually have a low PE ratio. For example, a PE ratio of 10 is much better than a PE ratio of 20. Some high-flying Internet stocks had a PE ratios of 30, 40, 50, 100, 200 or more in year 2000, prior to the bursting of the Internet stock bubble. Investors of these Internet stocks did not purchase undervalued stocks, as they later learned.
Numerous popular books discuss undervalued stocks. Examples are The Intelligent Investor by Benjamin Graham, also known as "The Dean of Wall Street," and The Warren Buffett Way by Robert Hagstrom.
The Intelligent Investor puts forth Graham's principles that are based on mathematical calculations such as the price/earning ratio. He was less concerned with the qualitative aspects of a business such as the nature of a business and its management. Graham's ideas had a significant influence on the young Warren Buffett, who later became a famous US billionaire.
Warren Buffett, also known as "The Oracle of Omaha," stated that the value of a business is the sum of the cash flows over the life of the business discounted at an appropriate interest rate. This is in reference to the ideas of John Burr Williams. Therefore, one would not be able to predict whether a stock is undervalued without predicting the future profits of a company and future interest rates. Buffett stated that he is interested in predicable businesses and he uses the interest rate on the 10-year treasury bond in his calculations.
Therefore, an investor has to be fairly certain that a company will be profitable in the future in order to consider it to be undervalued. For example, if a risky stock has a PE ratio of 5 and the company becomes bankrupt, this would not be an undervalued stock.
Some qualities of companies with undervalued stocks are:
1. The company's earning history is stable.
2. The company does not specialize in high-technology that can become obsolete overnight.
3. The company is not in the middle of some financial scandal.
4. The company's low PE ratio is not due to profits realized from capital gains.
5. The company's low PE ratio is not due to a major decline in profitability.
6. The company's PE ratio is below its average PE ratio for the last 10 years.
7. The company is selling at a price below its tangible asset value.
8. The company's trailing 3-years earnings has risen over the past 10 years.
9. The company's credit rating is AAA, AA, or A.
10. The company did not have a loss during the last recession.
A excellent stock at a fair price is more likely to be undervalued than to a poor stock at a cheap price, according to Charles Munger, the Harvard educated partner of Buffett. An excellent stock continues to rise in value over the long term, while a poor stock declines in value.
An undervalued stock will usually have a low PE ratio. For example, a PE ratio of 10 is much better than a PE ratio of 20. Some high-flying Internet stocks had a PE ratios of 30, 40, 50, 100, 200 or more in year 2000, prior to the bursting of the Internet stock bubble. Investors of these Internet stocks did not purchase undervalued stocks, as they later learned.
Technical analysis
Technical analysis is a security analysis technique that claims the ability to forecast the future direction of prices through the study of past market data, primarily price and volume. In its purest form, technical analysis considers only the actual price and volume behavior of the market or instrument. Technical analysts, sometimes called "chartists", may employ models and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, cycles or, classically, through recognition of chart patterns.
Technical analysis stands in distinction to fundamental analysis. Technical analysis "ignores" the actual nature of the company, market, currency or commodity and is based solely on "the charts," that is to say price and volume information, whereas fundamental analysis does look at the actual facts of the company, market, currency or commodity. For example, any large brokerage, trading group, or financial institution will typically have both a technical analysis and fundamental analysis team.
Technical analysis is widely used among traders and financial professionals, and is very often used by active day traders, market makers, and pit traders. In the 1960s and 1970s it was widely discredited by academic mathematics. In a recent review, Irwin and Park reported that 56 of 95 modern studies found it produces positive results, but noted that many of the positive results were rendered dubious by issues such as data snooping so that the evidence in support of technical analysis was inconclusive; it is still considered by many academics to be pseudoscience. Academics such as Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of the efficient market hypothesis. Users hold that even if technical analysis cannot predict the future, it helps to identify trading opportunities.In the foreign exchange markets, its use may be more widespread than fundamental analysis. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987, most academic work has focused on the nature of the anomalous position of the foreign exchange market.It is speculated that this anomaly is due to central bank intervention. Recent research suggests that combining various trading signals into a Combined Signal Approach may be able to increase profitability and reduce dependence on any single rule.
Technical analysts (or technicians) seek to identify price patterns and trends in financial markets and attempt to exploit those patterns. While technicians use various methods and tools, the study of price charts is primary.
Technicians especially search for archetypal patterns, such as the well-known head and shoulders or double top reversal patterns, study indicators such as moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants or balance days.
Technical analysts also extensively use indicators, which are typically mathematical transformations of price or volume. These indicators are used to help determine whether an asset is trending, and if it is, its price direction. Technicians also look for relationships between price, volume and, in the case of futures, open interest. Examples include the relative strength index, and MACD. Other avenues of study include correlations between changes in options (implied volatility) and put/call ratios with price. Other technicians include sentiment indicators, such as Put/Call ratios and Implied Volatility in their analysis.
Technicians seek to forecast price movements such that large gains from successful trades exceed more numerous but smaller losing trades, producing positive returns in the long run through proper risk control and money management.
There are several schools of technical analysis. Adherents of different schools (for example, candlestick charting, Dow Theory, and Elliott wave theory) may ignore the other approaches, yet many traders combine elements from more than one school. Technical analysts use judgment gained from experience to decide which pattern a particular instrument reflects at a given time, and what the interpretation of that pattern should be.
Technical analysis is frequently contrasted with fundamental analysis, the study of economic factors that influence prices in financial markets. Technical analysis holds that prices already reflect all such influences before investors are aware of them, hence the study of price action alone. Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.
Technical analysis stands in distinction to fundamental analysis. Technical analysis "ignores" the actual nature of the company, market, currency or commodity and is based solely on "the charts," that is to say price and volume information, whereas fundamental analysis does look at the actual facts of the company, market, currency or commodity. For example, any large brokerage, trading group, or financial institution will typically have both a technical analysis and fundamental analysis team.
Technical analysis is widely used among traders and financial professionals, and is very often used by active day traders, market makers, and pit traders. In the 1960s and 1970s it was widely discredited by academic mathematics. In a recent review, Irwin and Park reported that 56 of 95 modern studies found it produces positive results, but noted that many of the positive results were rendered dubious by issues such as data snooping so that the evidence in support of technical analysis was inconclusive; it is still considered by many academics to be pseudoscience. Academics such as Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of the efficient market hypothesis. Users hold that even if technical analysis cannot predict the future, it helps to identify trading opportunities.In the foreign exchange markets, its use may be more widespread than fundamental analysis. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987, most academic work has focused on the nature of the anomalous position of the foreign exchange market.It is speculated that this anomaly is due to central bank intervention. Recent research suggests that combining various trading signals into a Combined Signal Approach may be able to increase profitability and reduce dependence on any single rule.
Technical analysts (or technicians) seek to identify price patterns and trends in financial markets and attempt to exploit those patterns. While technicians use various methods and tools, the study of price charts is primary.
Technicians especially search for archetypal patterns, such as the well-known head and shoulders or double top reversal patterns, study indicators such as moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants or balance days.
Technical analysts also extensively use indicators, which are typically mathematical transformations of price or volume. These indicators are used to help determine whether an asset is trending, and if it is, its price direction. Technicians also look for relationships between price, volume and, in the case of futures, open interest. Examples include the relative strength index, and MACD. Other avenues of study include correlations between changes in options (implied volatility) and put/call ratios with price. Other technicians include sentiment indicators, such as Put/Call ratios and Implied Volatility in their analysis.
Technicians seek to forecast price movements such that large gains from successful trades exceed more numerous but smaller losing trades, producing positive returns in the long run through proper risk control and money management.
There are several schools of technical analysis. Adherents of different schools (for example, candlestick charting, Dow Theory, and Elliott wave theory) may ignore the other approaches, yet many traders combine elements from more than one school. Technical analysts use judgment gained from experience to decide which pattern a particular instrument reflects at a given time, and what the interpretation of that pattern should be.
Technical analysis is frequently contrasted with fundamental analysis, the study of economic factors that influence prices in financial markets. Technical analysis holds that prices already reflect all such influences before investors are aware of them, hence the study of price action alone. Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.
Fundamental analysis
Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis.
Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:
to conduct a company stock valuation and predict its probable price evolution,
to make a projection on its business performance,
to evaluate its management and make internal business decisions,
to calculate its credit risk.
When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies
Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.
Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.
Investors can use both these different but somewhat complementary methods for stock picking. Many fundamental investors use technicals for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies.
The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works". See the discussions at efficient market hypothesis, random walk hypothesis, Capital Asset Pricing Model, Fed model Theory of Equity Valuation, Market-based valuation, and Behavioral finance.
Investors may use fundamental analysis within different portfolio management styles.
Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out.
Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Even 'bad' companies' stock goes up and down, creating opportunities for profits.
Managers may also consider the economic cycle in determining whether conditions are 'right' to buy fundamentally suitable companies.
Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine". Fundamental analysis allows you to make your own decision on value, and ignore the market.
Value investors restrict their attention to under-valued companies, believing that 'it's hard to fall out of a ditch'. The value comes from fundamental analysis.
Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks.
Managers may also include fundamental factors along with technical factors into computer models (quantitative analysis).
The analysis of a business' health starts with financial statement analysis that includes ratios. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The earnings estimates and growth rate projections published widely by Thomson Reuters and others can be considered either 'fundamental' (they are facts) or 'technical' (they are investor sentiment) based on your perception of their validity.
The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future
dividends received by the investor, along with the eventual sale price. (Gordon model)
earnings of the company, or
cash flows of the company.
The amount of debt is also a major consideration in determining a company's health. It can be quickly assessed using the debt to equity ratio and the current ratio (current assets/current liabilities).
The simple model commonly used is the Price/Earnings ratio. Implicit in this model of a perpetual annuity (Time value of money) is that the 'flip' of the P/E is the discount rate appropriate to the risk of the business. The multiple accepted is adjusted for expected growth (that is not built into the model).
Growth estimates are incorporated into the PEG ratio but the math does not hold up to analysis. Its validity depends on the length of time you think the growth will continue.
Computer modelling of stock prices has now replaced much of the subjective interpretation of fundamental data (along with technical data) in the industry. Since about year 2000, with the power of computers to crunch vast quantities of data, a new career has been invented. At some funds (called Quant Funds) the manager's decisions have been replaced by proprietary mathematical models.
Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:
to conduct a company stock valuation and predict its probable price evolution,
to make a projection on its business performance,
to evaluate its management and make internal business decisions,
to calculate its credit risk.
When the objective of the analysis is to determine what stock to buy and at what price, there are two basic methodologies
Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.
Technical analysis maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.
Investors can use both these different but somewhat complementary methods for stock picking. Many fundamental investors use technicals for deciding entry and exit points. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies.
The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works". See the discussions at efficient market hypothesis, random walk hypothesis, Capital Asset Pricing Model, Fed model Theory of Equity Valuation, Market-based valuation, and Behavioral finance.
Investors may use fundamental analysis within different portfolio management styles.
Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out.
Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Even 'bad' companies' stock goes up and down, creating opportunities for profits.
Managers may also consider the economic cycle in determining whether conditions are 'right' to buy fundamentally suitable companies.
Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine". Fundamental analysis allows you to make your own decision on value, and ignore the market.
Value investors restrict their attention to under-valued companies, believing that 'it's hard to fall out of a ditch'. The value comes from fundamental analysis.
Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks.
Managers may also include fundamental factors along with technical factors into computer models (quantitative analysis).
The analysis of a business' health starts with financial statement analysis that includes ratios. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The earnings estimates and growth rate projections published widely by Thomson Reuters and others can be considered either 'fundamental' (they are facts) or 'technical' (they are investor sentiment) based on your perception of their validity.
The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future
dividends received by the investor, along with the eventual sale price. (Gordon model)
earnings of the company, or
cash flows of the company.
The amount of debt is also a major consideration in determining a company's health. It can be quickly assessed using the debt to equity ratio and the current ratio (current assets/current liabilities).
The simple model commonly used is the Price/Earnings ratio. Implicit in this model of a perpetual annuity (Time value of money) is that the 'flip' of the P/E is the discount rate appropriate to the risk of the business. The multiple accepted is adjusted for expected growth (that is not built into the model).
Growth estimates are incorporated into the PEG ratio but the math does not hold up to analysis. Its validity depends on the length of time you think the growth will continue.
Computer modelling of stock prices has now replaced much of the subjective interpretation of fundamental data (along with technical data) in the industry. Since about year 2000, with the power of computers to crunch vast quantities of data, a new career has been invented. At some funds (called Quant Funds) the manager's decisions have been replaced by proprietary mathematical models.
Active management
Active management (also called active investing) refers to a portfolio management strategy wherein the manager makes specific investments with the goal of outperforming an investment benchmark index. Investors or mutual funds that do not aspire to create a return in excess of the market benchmark index will often invest in an index fund that replicates as closely as possible the investment weighting and returns of that index. This is called passive management. Active management is the opposite of passive management, because the manager or passive management fund does not seek to outperform the benchmark index.
Ideally, the active manager exploits market inefficiencies by purchasing securities (stocks etc.) that are undervalued or by short selling securities that are overvalued. Either of these methods may be used alone or in combination. Depending on the goals of the specific investment portfolio, hedge fund or mutual fund, active management may also serve to create less volatility (or risk) than the benchmark index. The reduction of risk may be instead of, or in addition to, the goal of creating an investment return greater than the benchmark.
Active portfolio managers may use a variety of factors and strategies to construct their portfolio(s). These include quantitative measures such as price/earnings ratio P/E ratios and PEG ratios, sector investments that attempt to anticipate long-term macroeconomic trends (such as a focus on energy or housing stocks), and purchasing stocks of companies that are temporarily out-of-favor or selling at a discount to their intrinsic value. Some actively managed funds also pursue strategies such as merger arbitrage, short positions, option writing, and asset allocation.
The effectiveness of an actively-managed investment portfolio obviously depends on the skill of the manager and research staff. In reality, the majority of actively managed collective investment schemes rarely outperform their index counterparts over an extended period of time, assuming that they are benchmarked correctly. For example, the Standard & Poor's Index Versus Active (SPIVA) quarterly scorecards demonstrate that only a minority of actively managed mutual funds have gains better than the Standard & Poor's (S&P) index benchmark. As the time period for comparison increases, the percentage of actively-managed funds whose gains exceed the S&P benchmark declines further. Due to mutual fund fees and/or expenses, it is possible that an active or passively managed mutual fund could underperform compared to the benchmark index, even though the securities that comprise the mutual fund are outperforming the benchmark. However, since many investors are not satisfied with a benchmark return a demand for actively-managed continues to exist. In addition, many investors find active management an attractive investment strategy when investing in market segments that are less likely to be profitable when considered as whole. These kinds of sectors might include a sector such as small cap stocks.
The primary attraction of active management is that it allows selection of a variety of investments instead of investing in the market as a whole. Investors may have a variety of motivations for following such a strategy:
They may be skeptical of the efficient market theory, or believe that some market segments are less efficient in creating profits than others.
They may want to manage volatility by investing in less-risky, high-quality companies rather than in the market as a whole, even at the cost of slightly lower returns.
Conversely, some investors may want to take on additional risk in exchange for the opportunity of obtaining higher-than-market returns.
Investments that are not highly correlated to the market are useful as a portfolio diversifier and may reduce overall portfolio volatiity.
Some investors may wish to follow a strategy that avoids or underweights certain industries compared to the market as a whole, and may find an actively-managed fund more in line with their particular investment goals. (For instance, an employee of a high-technology growth company who receives company stock or stock options as a benefit might prefer not to have additional funds invested in the same industry.)
Several of the actively-managed mutual funds with strong long-term records invest in value stocks. Passively-managed funds that track broad market indices such as the S&P 500 have money invested in all the securities in that index ie. both growth and value stocks.
The use of managed funds in certain emerging markets has been recommended by Burton Malkiel, a proponent of the efficient market theory who normally considers index funds to be superior to active management in developed markets.
The most obvious disadvantage of active management is that the fund manager may make bad investment choices or follow an unsound theory in managing the portfolio. The fees associated with active management are also higher than those associated with passive management, even if frequent trading is not present. Those who are considering investing in an actively-managed mutual fund should evaluate the fund's prospectus carefully. Data from recent decades demonstrates that the majority of actively-managed large and mid-cap stock funds in United States fail to outperform their passive stock index counterparts.Active fund management strategies that involve frequent trading generate higher transaction costs which diminish the fund's return. In addition, the short-term capital gains resulting from frequent trades often have an unfavorable income tax impact when such funds are held in a taxable account.
When the asset base of an actively-managed fund becomes too large, it begins to take on index-like characteristics because it must invest in an increasingly diverse set of investments instead of those limited to the fund manager's best ideas. Many mutual fund companies close their funds before they reach this point, but there is potential for a conflict of interest between mutual fund management and shareholders because closing the fund will result in a loss of income (management fees) for the mutual fund company.
Ideally, the active manager exploits market inefficiencies by purchasing securities (stocks etc.) that are undervalued or by short selling securities that are overvalued. Either of these methods may be used alone or in combination. Depending on the goals of the specific investment portfolio, hedge fund or mutual fund, active management may also serve to create less volatility (or risk) than the benchmark index. The reduction of risk may be instead of, or in addition to, the goal of creating an investment return greater than the benchmark.
Active portfolio managers may use a variety of factors and strategies to construct their portfolio(s). These include quantitative measures such as price/earnings ratio P/E ratios and PEG ratios, sector investments that attempt to anticipate long-term macroeconomic trends (such as a focus on energy or housing stocks), and purchasing stocks of companies that are temporarily out-of-favor or selling at a discount to their intrinsic value. Some actively managed funds also pursue strategies such as merger arbitrage, short positions, option writing, and asset allocation.
The effectiveness of an actively-managed investment portfolio obviously depends on the skill of the manager and research staff. In reality, the majority of actively managed collective investment schemes rarely outperform their index counterparts over an extended period of time, assuming that they are benchmarked correctly. For example, the Standard & Poor's Index Versus Active (SPIVA) quarterly scorecards demonstrate that only a minority of actively managed mutual funds have gains better than the Standard & Poor's (S&P) index benchmark. As the time period for comparison increases, the percentage of actively-managed funds whose gains exceed the S&P benchmark declines further. Due to mutual fund fees and/or expenses, it is possible that an active or passively managed mutual fund could underperform compared to the benchmark index, even though the securities that comprise the mutual fund are outperforming the benchmark. However, since many investors are not satisfied with a benchmark return a demand for actively-managed continues to exist. In addition, many investors find active management an attractive investment strategy when investing in market segments that are less likely to be profitable when considered as whole. These kinds of sectors might include a sector such as small cap stocks.
The primary attraction of active management is that it allows selection of a variety of investments instead of investing in the market as a whole. Investors may have a variety of motivations for following such a strategy:
They may be skeptical of the efficient market theory, or believe that some market segments are less efficient in creating profits than others.
They may want to manage volatility by investing in less-risky, high-quality companies rather than in the market as a whole, even at the cost of slightly lower returns.
Conversely, some investors may want to take on additional risk in exchange for the opportunity of obtaining higher-than-market returns.
Investments that are not highly correlated to the market are useful as a portfolio diversifier and may reduce overall portfolio volatiity.
Some investors may wish to follow a strategy that avoids or underweights certain industries compared to the market as a whole, and may find an actively-managed fund more in line with their particular investment goals. (For instance, an employee of a high-technology growth company who receives company stock or stock options as a benefit might prefer not to have additional funds invested in the same industry.)
Several of the actively-managed mutual funds with strong long-term records invest in value stocks. Passively-managed funds that track broad market indices such as the S&P 500 have money invested in all the securities in that index ie. both growth and value stocks.
The use of managed funds in certain emerging markets has been recommended by Burton Malkiel, a proponent of the efficient market theory who normally considers index funds to be superior to active management in developed markets.
The most obvious disadvantage of active management is that the fund manager may make bad investment choices or follow an unsound theory in managing the portfolio. The fees associated with active management are also higher than those associated with passive management, even if frequent trading is not present. Those who are considering investing in an actively-managed mutual fund should evaluate the fund's prospectus carefully. Data from recent decades demonstrates that the majority of actively-managed large and mid-cap stock funds in United States fail to outperform their passive stock index counterparts.Active fund management strategies that involve frequent trading generate higher transaction costs which diminish the fund's return. In addition, the short-term capital gains resulting from frequent trades often have an unfavorable income tax impact when such funds are held in a taxable account.
When the asset base of an actively-managed fund becomes too large, it begins to take on index-like characteristics because it must invest in an increasingly diverse set of investments instead of those limited to the fund manager's best ideas. Many mutual fund companies close their funds before they reach this point, but there is potential for a conflict of interest between mutual fund management and shareholders because closing the fund will result in a loss of income (management fees) for the mutual fund company.
Real estate appraisal
Real estate appraisal, property valuation or land valuation is the practice of developing an opinion of the value of real property, usually its Market Value. The need for appraisals arises from the heterogeneous nature of property as an investment class: no two properties are identical, and all properties differ from each other in their location - which is one of the most important determinants of their value. So there cannot exist a centralised Walrasian auction setting for the trading of property assets, as there exists for trade in corporate stock. The absence of a market-based pricing mechanism determines the need for an expert appraisal/valuation of real estate/property.
Although some areas require no license or certification at all, a real estate appraisal is generally performed by a licensed or certified appraiser (in many countries known as a Property Valuer or Land Valuer and in British English as a "valuation surveyor"). If the appraiser's opinion is based on Market Value, then it must also be based on the Highest and Best Use of the real property. For mortgage valuations of improved residential property in the US, the appraisal is most often reported on a standardized form, such as the Uniform Residential Appraisal Report. Appraisals of more complex property (e.g. -- income producing, raw land) are usually reported in a narrative appraisal report.
It is important to distinguish between Market Value and Price. A price obtained for a specific property under a specific transaction may or may not represent that property's market value: special considerations may have been present, such as a special relationship between the buyer and the seller, or else the transaction may have been part of a larger set of transactions in which the parties had engaged. Another possibility is that a special buyer may have been willing to pay a premium over and above the market value, if his subjective valuation of the property (its investment value for him) was higher than the Market Value. An example of this would be the owner of a neighbouring property who, by combining his own property with the subject property, could thereby obtain economies-of-scale. Such situations often arise in corporate finance, as for example when a merger or acquisition is concluded at a price which is higher than the value represented by the price of the underlying stock. The usual rationale for these valuations would be that the 'sum is greater than its parts', since full ownership of a company entails special privileges for which a potential purchaser would be willing to pay. Such situations arise in real estate/property markets as well. It is the task of the real estate appraiser/property valuer to judge whether a specific price obtained under a specific transaction is indicative of Market Value.
In the US, appraisals are performed to a certain standard of value (e.g. -- foreclosure value, fair market value, distressed sale value, investment value). The most commonly used definition of value is Market Value. While USPAP does not define Market Value, it provides general guidance for how Market Value should be defined:
a type of value, stated as an opinion, that presumes the transfer or sale of a property as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal.
Thus, the definition of value used in an appraisal or CMA analysis and report is a set of assumptions about the market in which the subject property may transact. It becomes the basis for selecting comparable data for use in the analysis. These assumptions will vary from definition to definition but generally fall into three categories:
There are three general groups of methodologies for determining value. These are usually referred to as the "three approaches to value":
The cost approach
The sales comparison approach and
The income approach
However, the recent trend of the business tends to be clining to the scientific methodology of appraisal which lies on the foundation of quantitative-data, risk and geographical based approaches .Pagourtzi et al. have provided a review on the methods used in the industry by comparison between conventional approaches and advanced ones .
The appraiser using three approaches will determine which one or more of these approaches may be applicable, based on the scope of work determination, and from that develop an appraisal analysis. Costs, income, and sales vary widely from one situation to the next, and particular importance is given to the specific characteristics of the subject.
Consideration is also given to the market for the property appraised. Appraisals of properties that are typically purchased by investors (e.g. - skyscrapers) may give greater weight to the income approach, while small retail or office properties, often purchased by owner-users, may give greater weighting to the sales comparison approach. While this may seem simple, it is not always obvious. For example, apartment complexes of a given quality tend to sell at a price per apartment, and as such the sales comparison approach may be more applicable. Single family residences are most commonly valued with greatest weighting to the sales comparison approach, but if a single family dwelling is in a neighborhood where all or most of the dwellings are rental units, then some variant of the income approach may be more useful.
The cost approach was formerly called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. The value of the improvements is often referred to by the abbreviation RCNLD (reproduction cost new less depreciation or replacement cost new less depreciation). Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials. In practice, appraisers use replacement cost and then deduct a factor for any functional disutility associated with the age of the subject property.
In most instances when the cost approach is involved, the overall methodology is a hybrid of the cost and sales comparison approaches. For example, while the replacement cost to construct a building can be determined by adding the labor, material, and other costs, land values and depreciation must be derived from an analysis of comparable data.
The cost approach is considered reliable when used on newer structures, but the method tends to become less reliable for older properties. The cost approach is often the only reliable approach when dealing with special use properties (e.g. -- public assembly, marinas).
The Comparitive Market Analysis (CMA) examines the price or price per unit/SF area of similar properties being sold in the marketplace. * Similar properties are of similar square footage, number of levels, age of the home, condition of the home, and area proximity of the subject home. Simply put, the sales of properties similar to the subject are analyzed and the sale prices adjusted to account for differences in the comparables to the subject to determine the value of the subject. This approach is generally considered the most reliable if adequate comparable sales exist. In any event, it is the only independent check on the reasonability of an appraisal opinion. Comparables used by appraisers are considered "worthy" or able to be used by the appraiser if they were sold within the last 12 months of the appraisal date of the subject property. Some appraiser are allowed sales only witin 6 months of the subject property. This differs with each company that is hired to appraise the subject property.
The above information holds true also when a Professional Licensed Real Estate Agent prepares a CMA ( comparitive market analysis) on the subject property.
When initially preparing a CMA, an agent will search back 12 months from the day of CMA preparation. Keep in mind, that when the subject home agrees to terms between buyer and seller or gets an "accepted offer", the lender of the BUYER will order the "Appraisal". Some comps that were originally used may not be "worthy comps" depending on the date the comparable was sold. Again, comps are worthy witin 12 months of the appraisal date of the subject property...........
Although some areas require no license or certification at all, a real estate appraisal is generally performed by a licensed or certified appraiser (in many countries known as a Property Valuer or Land Valuer and in British English as a "valuation surveyor"). If the appraiser's opinion is based on Market Value, then it must also be based on the Highest and Best Use of the real property. For mortgage valuations of improved residential property in the US, the appraisal is most often reported on a standardized form, such as the Uniform Residential Appraisal Report. Appraisals of more complex property (e.g. -- income producing, raw land) are usually reported in a narrative appraisal report.
It is important to distinguish between Market Value and Price. A price obtained for a specific property under a specific transaction may or may not represent that property's market value: special considerations may have been present, such as a special relationship between the buyer and the seller, or else the transaction may have been part of a larger set of transactions in which the parties had engaged. Another possibility is that a special buyer may have been willing to pay a premium over and above the market value, if his subjective valuation of the property (its investment value for him) was higher than the Market Value. An example of this would be the owner of a neighbouring property who, by combining his own property with the subject property, could thereby obtain economies-of-scale. Such situations often arise in corporate finance, as for example when a merger or acquisition is concluded at a price which is higher than the value represented by the price of the underlying stock. The usual rationale for these valuations would be that the 'sum is greater than its parts', since full ownership of a company entails special privileges for which a potential purchaser would be willing to pay. Such situations arise in real estate/property markets as well. It is the task of the real estate appraiser/property valuer to judge whether a specific price obtained under a specific transaction is indicative of Market Value.
In the US, appraisals are performed to a certain standard of value (e.g. -- foreclosure value, fair market value, distressed sale value, investment value). The most commonly used definition of value is Market Value. While USPAP does not define Market Value, it provides general guidance for how Market Value should be defined:
a type of value, stated as an opinion, that presumes the transfer or sale of a property as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal.
Thus, the definition of value used in an appraisal or CMA analysis and report is a set of assumptions about the market in which the subject property may transact. It becomes the basis for selecting comparable data for use in the analysis. These assumptions will vary from definition to definition but generally fall into three categories:
There are three general groups of methodologies for determining value. These are usually referred to as the "three approaches to value":
The cost approach
The sales comparison approach and
The income approach
However, the recent trend of the business tends to be clining to the scientific methodology of appraisal which lies on the foundation of quantitative-data, risk and geographical based approaches .Pagourtzi et al. have provided a review on the methods used in the industry by comparison between conventional approaches and advanced ones .
The appraiser using three approaches will determine which one or more of these approaches may be applicable, based on the scope of work determination, and from that develop an appraisal analysis. Costs, income, and sales vary widely from one situation to the next, and particular importance is given to the specific characteristics of the subject.
Consideration is also given to the market for the property appraised. Appraisals of properties that are typically purchased by investors (e.g. - skyscrapers) may give greater weight to the income approach, while small retail or office properties, often purchased by owner-users, may give greater weighting to the sales comparison approach. While this may seem simple, it is not always obvious. For example, apartment complexes of a given quality tend to sell at a price per apartment, and as such the sales comparison approach may be more applicable. Single family residences are most commonly valued with greatest weighting to the sales comparison approach, but if a single family dwelling is in a neighborhood where all or most of the dwellings are rental units, then some variant of the income approach may be more useful.
The cost approach was formerly called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. The value of the improvements is often referred to by the abbreviation RCNLD (reproduction cost new less depreciation or replacement cost new less depreciation). Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials. In practice, appraisers use replacement cost and then deduct a factor for any functional disutility associated with the age of the subject property.
In most instances when the cost approach is involved, the overall methodology is a hybrid of the cost and sales comparison approaches. For example, while the replacement cost to construct a building can be determined by adding the labor, material, and other costs, land values and depreciation must be derived from an analysis of comparable data.
The cost approach is considered reliable when used on newer structures, but the method tends to become less reliable for older properties. The cost approach is often the only reliable approach when dealing with special use properties (e.g. -- public assembly, marinas).
The Comparitive Market Analysis (CMA) examines the price or price per unit/SF area of similar properties being sold in the marketplace. * Similar properties are of similar square footage, number of levels, age of the home, condition of the home, and area proximity of the subject home. Simply put, the sales of properties similar to the subject are analyzed and the sale prices adjusted to account for differences in the comparables to the subject to determine the value of the subject. This approach is generally considered the most reliable if adequate comparable sales exist. In any event, it is the only independent check on the reasonability of an appraisal opinion. Comparables used by appraisers are considered "worthy" or able to be used by the appraiser if they were sold within the last 12 months of the appraisal date of the subject property. Some appraiser are allowed sales only witin 6 months of the subject property. This differs with each company that is hired to appraise the subject property.
The above information holds true also when a Professional Licensed Real Estate Agent prepares a CMA ( comparitive market analysis) on the subject property.
When initially preparing a CMA, an agent will search back 12 months from the day of CMA preparation. Keep in mind, that when the subject home agrees to terms between buyer and seller or gets an "accepted offer", the lender of the BUYER will order the "Appraisal". Some comps that were originally used may not be "worthy comps" depending on the date the comparable was sold. Again, comps are worthy witin 12 months of the appraisal date of the subject property...........
Bond valuation
Bond valuation is the process of determining the fair price of a bond. As with any security or capital investment, the fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the price or value of a bond is determined by discounting the bond's expected cash flows to the present using the appropriate discount rate.
The fair price of a straight bond (a bond with no embedded option; see Callable bond) is determined by discounting the expected cash flows:
Cash flows:
the periodic coupon payments C, each of which is made n times (n is usually 2) every year
the par or face value F, which is payable at maturity of the bond after T years.(NB final year payments will include the par value plus the coupon payments for the year). In some of the bonds, their Maturity Redemption Price might be more than par value, in this case the F is actually the Redemption Price.
Discount rate: the required (annually compounded) yield or rate of return r
r is the market interest rate for bonds with similar terms and risk ratings
m is the number of coupons to be paid over the remaining lifetime of the bond, ie n times T. (It is assumed that the previous coupon has just been paid.)
u is (1+r)^(1/n) ie an interest accumulation factor over one coupon period.
The yield to maturity (YTM) is the discount rate which returns the market price of the bond. It is thus the internal rate of return of an investment in the bond made at the observed price. YTM can also be used to price a bond, where it is used as the required return on the bond.
In other words, it is identical to r in the above equation.
To achieve a return equal to YTM, the bond owner must:
buy the bond at price P0,
hold the bond until maturity, and
redeem the bond at par.
The concept of current yield is closely related to other bond concepts, including yield to maturity, and coupon yield. The relationship between yield to maturity and coupon rate is as follows:
When a bond sells at a discount, YTM > current yield > coupon yield.
When a bond sells at a premium, coupon yield > current yield > YTM.
When a bond sells at par, YTM = current yield = coupon yield amt.
Here the bond will be priced relative to a benchmark, usually a government security. The yield to maturity on the bond is determined based on the bond's rating relative to a government security with similar maturity or duration. The better the quality of the bond, the smaller the spread between its required return and the YTM of the benchmark. This required return is then used to discount the bond cash flows as above to obtain the price.
In this approach, the bond price will reflect its arbitrage-free price (arbitrage=practice of taking advantage of a state of imbalance between two or more markets). Here, each cash flow is priced separately and is discounted at the same rate as the corresponding government issue Zero coupon bond. (Some multiple of the bond (or the security) will produce an identical cash flow to the government security (or the bond in question).) Since each bond cash flow is known with certainty, the bond price today must be equal to the sum of each of its cash flows discounted at the corresponding risk free rate - i.e. the corresponding government security. Were this not the case, arbitrage would be possible - see rational pricing.
The fair price of a straight bond (a bond with no embedded option; see Callable bond) is determined by discounting the expected cash flows:
Cash flows:
the periodic coupon payments C, each of which is made n times (n is usually 2) every year
the par or face value F, which is payable at maturity of the bond after T years.(NB final year payments will include the par value plus the coupon payments for the year). In some of the bonds, their Maturity Redemption Price might be more than par value, in this case the F is actually the Redemption Price.
Discount rate: the required (annually compounded) yield or rate of return r
r is the market interest rate for bonds with similar terms and risk ratings
m is the number of coupons to be paid over the remaining lifetime of the bond, ie n times T. (It is assumed that the previous coupon has just been paid.)
u is (1+r)^(1/n) ie an interest accumulation factor over one coupon period.
The yield to maturity (YTM) is the discount rate which returns the market price of the bond. It is thus the internal rate of return of an investment in the bond made at the observed price. YTM can also be used to price a bond, where it is used as the required return on the bond.
In other words, it is identical to r in the above equation.
To achieve a return equal to YTM, the bond owner must:
buy the bond at price P0,
hold the bond until maturity, and
redeem the bond at par.
The concept of current yield is closely related to other bond concepts, including yield to maturity, and coupon yield. The relationship between yield to maturity and coupon rate is as follows:
When a bond sells at a discount, YTM > current yield > coupon yield.
When a bond sells at a premium, coupon yield > current yield > YTM.
When a bond sells at par, YTM = current yield = coupon yield amt.
Here the bond will be priced relative to a benchmark, usually a government security. The yield to maturity on the bond is determined based on the bond's rating relative to a government security with similar maturity or duration. The better the quality of the bond, the smaller the spread between its required return and the YTM of the benchmark. This required return is then used to discount the bond cash flows as above to obtain the price.
In this approach, the bond price will reflect its arbitrage-free price (arbitrage=practice of taking advantage of a state of imbalance between two or more markets). Here, each cash flow is priced separately and is discounted at the same rate as the corresponding government issue Zero coupon bond. (Some multiple of the bond (or the security) will produce an identical cash flow to the government security (or the bond in question).) Since each bond cash flow is known with certainty, the bond price today must be equal to the sum of each of its cash flows discounted at the corresponding risk free rate - i.e. the corresponding government security. Were this not the case, arbitrage would be possible - see rational pricing.
Stock selection criteria
Stock selection criteria is a strategy in which an stock analyst or investor uses a systematic form of analysis to determine if a particular stock constitutes a good investment and should be added to their portfolio. The objective of stock selection criteria is to: (1) maximize the total return on investment (appreciation plus any dividends received) for the targeted holding period (2) limit risk (according to an individuals risks tolerance levels) (3) maintain an appropriate degree of portfolio diversification. The stock position can be either "long" (to benefit from a stock price increase) or "short" (to benefit from a decrease in a stocks price), depending on the analyst or investor's expectation of which way the stock is going to move. It is widely acknowledged that a disciplined stock selection approach is one of the primary factors behind the success of well-known investors like Warren Buffett and Peter Lynch. As a result several systematic stock picking approaches have been developed over the years by various stock market experts. In addition, automatic computer programs that query a stock database to select and rank stocks according to specified criteria are also commonly used by investors to aid in their stock selection process.
Stock picking can be an extremely difficult and complex endeavor because there is no foolproof method for reliably forecasting a stock’s future price movements. However, by carefully examining numerous factors, an investor may get a better sense of future stock prices rather than relying on unsubstantiated speculation such as advice from friends etc. The analytical components that are most commonly utilized by equity investors to select good investment prospects might include one or more of the following criteria.
Sector analysis involves identification and analysis of various industries or economic sectors that are likely to exhibit superior performance. Academic studies indicate that the health of a stock's sector is as important as the performance of the individual stock itself. In other words even the best stock located in a weak sector will often perform poorly because that sector is out of favor. Each industry has differences in terms of its customer base, market share among firms, industry growth, competition, regulation and business cycles. Learning how the industry operates provides a deeper understanding of a company's financial health. One method of analyzing a company's growth potential is examining whether the amount of customers in the overall market is expected to grow. In some markets, there is zero or negative growth, a factor demanding careful consideration. Additionally, market analysts recommend that investors should monitor sectors that are nearing the bottom of performance rankings for possible signs of an impending turnaround.
Quantitative cumulative value analysis: This method is also commonly referred to as fundamental analysis. Fundamental analysts consider past records of assets, earnings, sales, products, management, and markets in predicting future trends in these indicators and how they may effect a company’s future success or failure. By appraising a firm’s prospects, these analysts determine a stock’s intrinsic value and assess whether a particular stock or group of stocks is undervalued or overvalued at the current market price. If the intrinsic value is more than the current share price, then this stock would appear to be undervalued and a possible candidate for investment. While there are several different methods for determining intrinsic value, the underlying premise is that a company is worth the sum of its discounted cash flows (DCF). The DCF is the value of future expected cash receipts and expenditures at a common date, which is calculated using net present value or internal rate of return. This means a company is worth the combined sum of its future profits, while at the same time being discounted in consideration of the time value of money. This value, as determined by the discounted cash flow analysis or its equivalents, consists of two components:
Current value ratios, such as the price-earnings (P/E) ratio and price-book (P/B) ratio. The PE ratio, also called the multiple, gives investors an idea of how much they are paying for a company’s earning power. The higher the PE, the more investors are paying, and therefore the more earnings growth they are expecting. High PE stocks – those with multiples over 20 – are typically young, fast-growing companies. P/B is the ratio of a stock’s price to its book value per share. A stock selling at a high PB ratio, such as 3 or higher, may represent a popular growth stock with minimal book value. A stock selling below its book value may attract value-oriented investors who think that the company’s management may undertake steps, such as selling assets or restructuring the company, to unlock hidden value on the company’s balance sheet.
Earnings growth which may be reflected in measures like the Prospective Earnings Growth (PEG) ratio. The PEG ratio is a projected one-year annual growth rate, determined by taking the consensus forecast of next year’s earnings, less the current year’s earnings, and dividing the result by the current year’s earnings.
Management issues: This involves examining perceptions about management and perceptions by management. It includes various qualitative judgments regarding the competence of current and prospective company management, as well as issues related to insider buying, future strategies to increase operations and market share. Most large companies compensate executives through a combination of cash, restricted stock and options. It is a positive sign when members of management are also shareholders. When management makes large purchases of their own stock with private funds, it may indicate that management insiders feel the company is undervalued, or that a favorable company event will occur soon. Another way to get a feel for management capability is to examine how executives performed at other companies in the past. Warren Buffett has several recommendations for investors who want to evaluate a company’s management as a precursor to possible investment in that company’s stock. For example, he advises that one way to determine if management is doing a good job is to evaluate the company's return on equity, instead of their earnings per share ( the portion of a company’s profit allocated to each outstanding share of common stock). "The primary test of managerial economic performance is achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." Buffett notes that because companies usually retain a portion of their earnings, the assets a profitable company owns, should increase annually. This additional cash allows the company to report increased earnings per share even if their performance is deteriorating. He also emphasizes investing in companies with a management team that is committed to controlling costs. Cost-control is reflected by a profit margin exceeding those of competitors. Superior managers "attack costs as vigorously when profits are at record levels as when they are under pressure." Therefore, be wary of companies that have opulent corporate offices, unusually large corporate staffs and other signs of bloat. Additionally, Buffett suggests investing in companies with honest and candid management, and avoiding companies that have a history of using accounting gimmicks to inflate profits or have mislead investors in the past.
Stock picking can be an extremely difficult and complex endeavor because there is no foolproof method for reliably forecasting a stock’s future price movements. However, by carefully examining numerous factors, an investor may get a better sense of future stock prices rather than relying on unsubstantiated speculation such as advice from friends etc. The analytical components that are most commonly utilized by equity investors to select good investment prospects might include one or more of the following criteria.
Sector analysis involves identification and analysis of various industries or economic sectors that are likely to exhibit superior performance. Academic studies indicate that the health of a stock's sector is as important as the performance of the individual stock itself. In other words even the best stock located in a weak sector will often perform poorly because that sector is out of favor. Each industry has differences in terms of its customer base, market share among firms, industry growth, competition, regulation and business cycles. Learning how the industry operates provides a deeper understanding of a company's financial health. One method of analyzing a company's growth potential is examining whether the amount of customers in the overall market is expected to grow. In some markets, there is zero or negative growth, a factor demanding careful consideration. Additionally, market analysts recommend that investors should monitor sectors that are nearing the bottom of performance rankings for possible signs of an impending turnaround.
Quantitative cumulative value analysis: This method is also commonly referred to as fundamental analysis. Fundamental analysts consider past records of assets, earnings, sales, products, management, and markets in predicting future trends in these indicators and how they may effect a company’s future success or failure. By appraising a firm’s prospects, these analysts determine a stock’s intrinsic value and assess whether a particular stock or group of stocks is undervalued or overvalued at the current market price. If the intrinsic value is more than the current share price, then this stock would appear to be undervalued and a possible candidate for investment. While there are several different methods for determining intrinsic value, the underlying premise is that a company is worth the sum of its discounted cash flows (DCF). The DCF is the value of future expected cash receipts and expenditures at a common date, which is calculated using net present value or internal rate of return. This means a company is worth the combined sum of its future profits, while at the same time being discounted in consideration of the time value of money. This value, as determined by the discounted cash flow analysis or its equivalents, consists of two components:
Current value ratios, such as the price-earnings (P/E) ratio and price-book (P/B) ratio. The PE ratio, also called the multiple, gives investors an idea of how much they are paying for a company’s earning power. The higher the PE, the more investors are paying, and therefore the more earnings growth they are expecting. High PE stocks – those with multiples over 20 – are typically young, fast-growing companies. P/B is the ratio of a stock’s price to its book value per share. A stock selling at a high PB ratio, such as 3 or higher, may represent a popular growth stock with minimal book value. A stock selling below its book value may attract value-oriented investors who think that the company’s management may undertake steps, such as selling assets or restructuring the company, to unlock hidden value on the company’s balance sheet.
Earnings growth which may be reflected in measures like the Prospective Earnings Growth (PEG) ratio. The PEG ratio is a projected one-year annual growth rate, determined by taking the consensus forecast of next year’s earnings, less the current year’s earnings, and dividing the result by the current year’s earnings.
Management issues: This involves examining perceptions about management and perceptions by management. It includes various qualitative judgments regarding the competence of current and prospective company management, as well as issues related to insider buying, future strategies to increase operations and market share. Most large companies compensate executives through a combination of cash, restricted stock and options. It is a positive sign when members of management are also shareholders. When management makes large purchases of their own stock with private funds, it may indicate that management insiders feel the company is undervalued, or that a favorable company event will occur soon. Another way to get a feel for management capability is to examine how executives performed at other companies in the past. Warren Buffett has several recommendations for investors who want to evaluate a company’s management as a precursor to possible investment in that company’s stock. For example, he advises that one way to determine if management is doing a good job is to evaluate the company's return on equity, instead of their earnings per share ( the portion of a company’s profit allocated to each outstanding share of common stock). "The primary test of managerial economic performance is achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." Buffett notes that because companies usually retain a portion of their earnings, the assets a profitable company owns, should increase annually. This additional cash allows the company to report increased earnings per share even if their performance is deteriorating. He also emphasizes investing in companies with a management team that is committed to controlling costs. Cost-control is reflected by a profit margin exceeding those of competitors. Superior managers "attack costs as vigorously when profits are at record levels as when they are under pressure." Therefore, be wary of companies that have opulent corporate offices, unusually large corporate staffs and other signs of bloat. Additionally, Buffett suggests investing in companies with honest and candid management, and avoiding companies that have a history of using accounting gimmicks to inflate profits or have mislead investors in the past.
Stock valuation
There are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices.
most theoretically sound stock valuation method, called income valuation or the discounted cash flow (DCF) method, involves discounting of the profits (dividends, earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition. The discounted rate normally includes a risk premium which is commonly based on the capital asset pricing model.
Average growth approximation: Assuming that two stocks have the same earnings growth, the one with a lower P/E is a better value. The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio.
Constant growth approximation: The Gordon model or Gordon's growth model is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula:
Limited high-growth period approximation: When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that the earnings growth rate will be sustained for a short time (say, 5 years), and then the growth rate will revert to the mean. This is probably the most rigorous approximation that is practical.
While these DCF models are commonly used, the uncertainty in these values is hardly ever discussed. Note that the models diverge for and hence are extremely sensitive to the difference of dividend growth to discount factor. One might argue that an analyst can justify any value (and that would usually be one close to the current price supporting his call) by fine-tuning the growth/discount assumptions.
Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis.
On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large.
Thus, in addition to fundamental economic criteria, market criteria also have to be taken into account market-based valuation. Valuing a stock is not only to estimate its fair value, but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price.
most theoretically sound stock valuation method, called income valuation or the discounted cash flow (DCF) method, involves discounting of the profits (dividends, earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition. The discounted rate normally includes a risk premium which is commonly based on the capital asset pricing model.
Average growth approximation: Assuming that two stocks have the same earnings growth, the one with a lower P/E is a better value. The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio.
Constant growth approximation: The Gordon model or Gordon's growth model is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula:
Limited high-growth period approximation: When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that the earnings growth rate will be sustained for a short time (say, 5 years), and then the growth rate will revert to the mean. This is probably the most rigorous approximation that is practical.
While these DCF models are commonly used, the uncertainty in these values is hardly ever discussed. Note that the models diverge for and hence are extremely sensitive to the difference of dividend growth to discount factor. One might argue that an analyst can justify any value (and that would usually be one close to the current price supporting his call) by fine-tuning the growth/discount assumptions.
Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis.
On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large.
Thus, in addition to fundamental economic criteria, market criteria also have to be taken into account market-based valuation. Valuing a stock is not only to estimate its fair value, but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price.
Tuesday, April 21, 2009
Industrial Revolution
The Industrial Revolution was a period in the late 18th and early 19th centuries when major changes in agriculture, manufacturing, mining, and transportation had a profound effect on the socioeconomic and cultural conditions in Britain. The changes subsequently spread throughout Europe, North America, and eventually the world. The onset of the Industrial Revolution marked a major turning point in human society; almost every aspect of daily life was eventually influenced in some way. Starting in the latter part of the 18th century there began a transition in parts of Great Britain's previously manual labour and draft animal–based economy towards machine-based manufacturing. It started with the mechanization of the textile industries, the development of iron-making techniques and the increased use of refined coal. Trade expansion was enabled by the introduction of canals, improved roads and railways. The introduction of steam power fuelled primarily by coal, wider utilization of water wheels and powered machinery (mainly in textile manufacturing) underpinned the dramatic increases in production capacity. The development of all-metal machine tools in the first two decades of the 19th century facilitated the manufacture of more production machines for manufacturing in other industries. The effects spread throughout Western Europe and North America during the 19th century, eventually affecting most of the world. The impact of this change on society was enormous.
The First Industrial Revolution, which began in the 18th century, merged into the Second Industrial Revolution around 1850, when technological and economic progress gained momentum with the development of steam-powered ships, railways, and later in the 19th century with the internal combustion engine and electrical power generation. The period of time covered by the Industrial Revolution varies with different historians. Eric Hobsbawm held that it 'broke out' in Britain in the 1780s and was not fully felt until the 1830s or 1840s, while T. S. Ashton held that it occurred roughly between 1760 and 1830. Some twentieth century historians such as John Clapham and Nicholas Crafts have argued that the process of economic and social change took place gradually and the term revolution is not a true description of what took place. This is still a subject of debate amongst historians. GDP per capita was broadly stable before the Industrial Revolution and the emergence of the modern capitalist economy. The Industrial Revolution began an era of per-capita economic growth in capitalist economies. Historians agree that the Industrial Revolution was one of the most important events in history. The most significant inventions had their origins in the Western world, primarily Europe and the United States.
The First Industrial Revolution, which began in the 18th century, merged into the Second Industrial Revolution around 1850, when technological and economic progress gained momentum with the development of steam-powered ships, railways, and later in the 19th century with the internal combustion engine and electrical power generation. The period of time covered by the Industrial Revolution varies with different historians. Eric Hobsbawm held that it 'broke out' in Britain in the 1780s and was not fully felt until the 1830s or 1840s, while T. S. Ashton held that it occurred roughly between 1760 and 1830. Some twentieth century historians such as John Clapham and Nicholas Crafts have argued that the process of economic and social change took place gradually and the term revolution is not a true description of what took place. This is still a subject of debate amongst historians. GDP per capita was broadly stable before the Industrial Revolution and the emergence of the modern capitalist economy. The Industrial Revolution began an era of per-capita economic growth in capitalist economies. Historians agree that the Industrial Revolution was one of the most important events in history. The most significant inventions had their origins in the Western world, primarily Europe and the United States.
Early modern period
The early modern period is a term used by historians to refer to the period approximately from AD 1500 to 1800, especially in Western Europe (Early modern Europe).[citation needed] It follows the Late Middle Ages period, and is marked by the first European colonies, the rise of strong centralized governments, and the beginnings of recognizable nation states that are the direct antecedents of today's states in what is called Modern times. This categorical era spans the two centuries between the Middle Ages and the Industrial Revolution that has created modern European and American society, and in subsequent years the term "Early modern" has evolved to be less euro-centric and more generally a semi-calendar era useful for tracking related historical events across vast regions, as the cultural influences and dynamics from one region impacting on distant others has become more appreciated.
The early modern period is characterized by the rise to importance of science, the shrinkage of relative distances through improvements in transportation and communications and increasingly rapid technological progress, secularized civic politics and the early authoritarian nation states.
Further, capitalist economies and institutions began their rise and development, beginning in northern Italian republics such as Genoa, and the oligarchy in Venice. The early modern period also saw the rise and beginning of the dominance of the economic theory of mercantilism.
As such, the early modern period represents the decline and eventual disappearance, in much of the European sphere, of Christian theocracy, feudalism and serfdom.
The period includes the Reformation, the disastrous Thirty Years' War, the Commercial Revolution, the European colonization of the Americas, the Golden Age of Piracy and the peak of the European witch-hunt craze.
The expression "early modern" is sometimes, and incorrectly, used as a substitute for the term Renaissance. However, "Renaissance" is properly used in relation to a diverse series of cultural developments that occurred over several hundred years in many different parts of Europe — especially central and northern Italy — and spans the transition from late medieval civilization to the opening of the early modern period.
Artistically, the early modern is not a common designation as the Renaissance is clearly distinct from what came later. Only in the study of literature is the early modern period a standard period. Music is generally divided between Renaissance and Baroque. Similarly, philosophy is divided between Renaissance philosophy and the Enlightenment. In other fields, there is far more continuity through the period such as warfare and science.
The early modern period is characterized by the rise to importance of science, the shrinkage of relative distances through improvements in transportation and communications and increasingly rapid technological progress, secularized civic politics and the early authoritarian nation states.
Further, capitalist economies and institutions began their rise and development, beginning in northern Italian republics such as Genoa, and the oligarchy in Venice. The early modern period also saw the rise and beginning of the dominance of the economic theory of mercantilism.
As such, the early modern period represents the decline and eventual disappearance, in much of the European sphere, of Christian theocracy, feudalism and serfdom.
The period includes the Reformation, the disastrous Thirty Years' War, the Commercial Revolution, the European colonization of the Americas, the Golden Age of Piracy and the peak of the European witch-hunt craze.
The expression "early modern" is sometimes, and incorrectly, used as a substitute for the term Renaissance. However, "Renaissance" is properly used in relation to a diverse series of cultural developments that occurred over several hundred years in many different parts of Europe — especially central and northern Italy — and spans the transition from late medieval civilization to the opening of the early modern period.
Artistically, the early modern is not a common designation as the Renaissance is clearly distinct from what came later. Only in the study of literature is the early modern period a standard period. Music is generally divided between Renaissance and Baroque. Similarly, philosophy is divided between Renaissance philosophy and the Enlightenment. In other fields, there is far more continuity through the period such as warfare and science.
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often as mediated through a hypothesized maximization of income-constrained utility by individuals and of cost-constrained profits of firms employing available information and factors of production, in accordance with rational choice theory. Neoclassical economics dominates microeconomics, and together with Keynesian economics forms the neoclassical synthesis, which dominates mainstream economics today. There have been many critiques of neoclassical economics, often incorporated into newer versions of neoclassical theory as human awareness of economic criteria change.
The term was originally introduced by Thorstein Veblen in 1900, in his Preconceptions of Economic Science, to distinguish marginalists in the tradition of Alfred Marshall from those in the Austrian School. It was later used by John Hicks, George Stigler, and others who presumed that significant disputes amongst marginalist schools had been largely resolved to include the work of Carl Menger, William Stanley Jevons, John Bates Clark and many others. Today it is usually used to refer to mainstream economics, although it has also been used as an umbrella term encompassing a number of mainly defunct schools of thought, notably excluding institutional economics, various historical schools of economics, and Marxian economics, in addition to various other heterodox approaches to economics.
Classical economics, developed in the 18th and 19th centuries, included a value theory and distribution theory. The value of a product was thought to depend on the costs involved in producing that product. The explanation of costs in Classical economics was simultaneously an explanation of distribution. A landlord received rent, workers received wages, and a capitalist tenant farmer received profits on their investment. This classic approach included the work of Adam Smith and David Ricardo.
However, some economists gradually began emphasizing the perceived value of a goods to the consumer. They proposed a theory that the value of a product was to be explained with differences in "utility." This is called Utilitarianism and is associated with philosopher and economic thinker John Stuart Mill.
The third step from political economy to economics was the introduction of the "marginal theory of value" or marginalism. Marginal value means that economic actors make decisions based on the "margins". For example, a person decides to buy a second sandwich based on how full they are after the first one, a firm hires a new employee based on the expected increase in profits the employee will bring. This differs from the aggregate decision making of classical political economy in that it explains how vital goods such as water can be cheap, while luxuries can be expensive.
An important change in neoclassical economics occurred around 1933. Joan Robinson and Edward H. Chamberlin, with the near simultaneous publication of their respective books, The Economics of Imperfect Competition (1933) and The Theory of Monopolistic Competition (1933), introduced models of imperfect competition. Theories of market forms and industrial organization grew out of this work. They also emphasized certain tools, such as the marginal revenue curve.
Joan Robinson's work on imperfect competition, at least, was a response to certain problems of Marshallian partial equilibrium theory highlighted by Piero Sraffa. Anglo-American economists also responded to these problems by turning towards general equilibrium theory, developed on the European continent by Walras and Vilfredo Pareto. J. R. Hicks's Value and Capital (1939) was influential in introducing his English-speaking colleagues to these traditions. He, in turn, was influenced by the Austrian School economist Friedrich Hayek's move to the London School of Economics, where Hicks then studied.
These developments were accompanied by the introduction of new tools, such as indifference curves and the theory of ordinal utility. The level of mathematical sophistication of neoclassical economics increased. Paul Samuelson's Foundations of Economic Analysis (1947) contributed to this increase in formal rigor.
The interwar period in American economics has been argued to have been pluralistic, with neoclassical economics and institutionalism competing for allegiance. Frank Knight, an early Chicago school economist attempted to combine both schools. But this increase in mathematics was accompanied by greater dominance of neoclassical economics in Anglo-American universities after World War II.
Hicks' book, Value and Capital had two main parts. The second, which was arguably not immediately influential, presented a model of temporary equilibrium. Hicks was influenced directly by Hayek's notion of intertemporal coordination and paralleled by earlier work by Lindhal. This was part of an abandonment of disaggregated long run models. This trend probably reached its culmination with the Arrow-Debreu model of intertemporal equilibrium. The Arrow-Debreu model has canonical presentations in Gerard Debreu's Theory of Value (1959) and in Arrow and Hahn.
Many of these developments were against the backdrop of improvements in both econometrics, that is the ability to measure prices and changes in goods and services, as well as their aggregate quantities, and in the creation of macroeconomics, or the study of whole economies. The attempt to combine neo-classical microeconomics and Keynesian macroeconomics would lead to the neoclassical synthesis[14] which has been the dominant paradigm of economic reasoning in English-speaking countries since the 1950s. Hicks and Samuelson were for example instrumental in mainstreaming Keynesian economics.
Macroeconomics influenced the neoclassical synthesis from the other direction, undermining foundations of classical economic theory such as Say's Law, and assumptions about political economy such as the necessity for a hard-money standard. These developments are reflected in neoclassical theory by the search for the occurrence in markets of the equilibrium conditions of Pareto optimality and self-sustainability.
The term was originally introduced by Thorstein Veblen in 1900, in his Preconceptions of Economic Science, to distinguish marginalists in the tradition of Alfred Marshall from those in the Austrian School. It was later used by John Hicks, George Stigler, and others who presumed that significant disputes amongst marginalist schools had been largely resolved to include the work of Carl Menger, William Stanley Jevons, John Bates Clark and many others. Today it is usually used to refer to mainstream economics, although it has also been used as an umbrella term encompassing a number of mainly defunct schools of thought, notably excluding institutional economics, various historical schools of economics, and Marxian economics, in addition to various other heterodox approaches to economics.
Classical economics, developed in the 18th and 19th centuries, included a value theory and distribution theory. The value of a product was thought to depend on the costs involved in producing that product. The explanation of costs in Classical economics was simultaneously an explanation of distribution. A landlord received rent, workers received wages, and a capitalist tenant farmer received profits on their investment. This classic approach included the work of Adam Smith and David Ricardo.
However, some economists gradually began emphasizing the perceived value of a goods to the consumer. They proposed a theory that the value of a product was to be explained with differences in "utility." This is called Utilitarianism and is associated with philosopher and economic thinker John Stuart Mill.
The third step from political economy to economics was the introduction of the "marginal theory of value" or marginalism. Marginal value means that economic actors make decisions based on the "margins". For example, a person decides to buy a second sandwich based on how full they are after the first one, a firm hires a new employee based on the expected increase in profits the employee will bring. This differs from the aggregate decision making of classical political economy in that it explains how vital goods such as water can be cheap, while luxuries can be expensive.
An important change in neoclassical economics occurred around 1933. Joan Robinson and Edward H. Chamberlin, with the near simultaneous publication of their respective books, The Economics of Imperfect Competition (1933) and The Theory of Monopolistic Competition (1933), introduced models of imperfect competition. Theories of market forms and industrial organization grew out of this work. They also emphasized certain tools, such as the marginal revenue curve.
Joan Robinson's work on imperfect competition, at least, was a response to certain problems of Marshallian partial equilibrium theory highlighted by Piero Sraffa. Anglo-American economists also responded to these problems by turning towards general equilibrium theory, developed on the European continent by Walras and Vilfredo Pareto. J. R. Hicks's Value and Capital (1939) was influential in introducing his English-speaking colleagues to these traditions. He, in turn, was influenced by the Austrian School economist Friedrich Hayek's move to the London School of Economics, where Hicks then studied.
These developments were accompanied by the introduction of new tools, such as indifference curves and the theory of ordinal utility. The level of mathematical sophistication of neoclassical economics increased. Paul Samuelson's Foundations of Economic Analysis (1947) contributed to this increase in formal rigor.
The interwar period in American economics has been argued to have been pluralistic, with neoclassical economics and institutionalism competing for allegiance. Frank Knight, an early Chicago school economist attempted to combine both schools. But this increase in mathematics was accompanied by greater dominance of neoclassical economics in Anglo-American universities after World War II.
Hicks' book, Value and Capital had two main parts. The second, which was arguably not immediately influential, presented a model of temporary equilibrium. Hicks was influenced directly by Hayek's notion of intertemporal coordination and paralleled by earlier work by Lindhal. This was part of an abandonment of disaggregated long run models. This trend probably reached its culmination with the Arrow-Debreu model of intertemporal equilibrium. The Arrow-Debreu model has canonical presentations in Gerard Debreu's Theory of Value (1959) and in Arrow and Hahn.
Many of these developments were against the backdrop of improvements in both econometrics, that is the ability to measure prices and changes in goods and services, as well as their aggregate quantities, and in the creation of macroeconomics, or the study of whole economies. The attempt to combine neo-classical microeconomics and Keynesian macroeconomics would lead to the neoclassical synthesis[14] which has been the dominant paradigm of economic reasoning in English-speaking countries since the 1950s. Hicks and Samuelson were for example instrumental in mainstreaming Keynesian economics.
Macroeconomics influenced the neoclassical synthesis from the other direction, undermining foundations of classical economic theory such as Say's Law, and assumptions about political economy such as the necessity for a hard-money standard. These developments are reflected in neoclassical theory by the search for the occurrence in markets of the equilibrium conditions of Pareto optimality and self-sustainability.
Mainstream economics
Mainstream economics is a loose term used to refer to the non-heterodox economics taught in prominent universities. It is most closely associated with neoclassical economics. Mainstream economists are not generally separated into schools, but two major contemporary orthodox economic schools of thought are the Saltwater school of the US coastal universities, notably including MIT, Berkeley, and Harvard, and the Freshwater school of the University of Chicago, which is associated with the Chicago school of economics. The Saltwater school is associated with Keynesian ideas of government intervention into the free market, while the Freshwater schools are skeptical of the benefits of the government. Mainstream economists do not, in general, identify themselves as members of a particular school; they may, however, be associated with approaches within a field such as the rational-expectations approach to macroeconomics. Currently mainstream economics is dominated by the neoclassical synthesis, which combines neoclassical approach to microeconomics with Keynesian approach to macroeconomics. Some economists believe that the neoclassical "holy trinity" of rationality, greed, and equilibrium, is being replaced by the holy trinity of purposeful behavior, enlightened self-interest, and sustainability, considerably broadening the scope of what is mainstream.
Mainstream economics has also been defined as work which mainstream economists are willing to engage, which requires conforming to the mainstream language of mathematical models. Under this definition, schools which are typically thought of as heterodox because they do not work under the typical neoclassical assumptions, including econophysics, behavioral economics, and evolutionary economics, can be considered mainstream when they are engaged in the mainstream. Geoffrey Hodgson has stated that he believes that evolutionary economics and institutional economics are entering into the new mainstream.
The term came into common use in the late 20th century. It appears in the influential textbook by Samuelson and Nordhaus, on the inside back cover in the "Family Tree of Economics," which depicts arrows into it from J.M. Keynes (1936) and neoclassical economics (1860-1910). The term neoclassical synthesis itself also appears in Samuelson's influential 1955 textbook. Mainstream economics includes theories of market and government failure and private and public goods. These developments suggest a range of views on the desirability or otherwise of government intervention.
Some fields may be described as being partly within mainstream economics, partly within heterodox economics. Some of them are Austrian economics, institutional economics, neuroeconomics and non-linear complexity theory. They may use neoclassical economics as a point of departure. At least one institutionalist has argued that "neoclassical economics no longer dominates a mainstream economics."
A countervailing trend is the expansion of mainstream methods to such seemingly distant fields as crime the family, law, politics, and religion. The latter phenomenon is sometimes referred to as economic imperialism.
Mainstream economics has also been defined as work which mainstream economists are willing to engage, which requires conforming to the mainstream language of mathematical models. Under this definition, schools which are typically thought of as heterodox because they do not work under the typical neoclassical assumptions, including econophysics, behavioral economics, and evolutionary economics, can be considered mainstream when they are engaged in the mainstream. Geoffrey Hodgson has stated that he believes that evolutionary economics and institutional economics are entering into the new mainstream.
The term came into common use in the late 20th century. It appears in the influential textbook by Samuelson and Nordhaus, on the inside back cover in the "Family Tree of Economics," which depicts arrows into it from J.M. Keynes (1936) and neoclassical economics (1860-1910). The term neoclassical synthesis itself also appears in Samuelson's influential 1955 textbook. Mainstream economics includes theories of market and government failure and private and public goods. These developments suggest a range of views on the desirability or otherwise of government intervention.
Some fields may be described as being partly within mainstream economics, partly within heterodox economics. Some of them are Austrian economics, institutional economics, neuroeconomics and non-linear complexity theory. They may use neoclassical economics as a point of departure. At least one institutionalist has argued that "neoclassical economics no longer dominates a mainstream economics."
A countervailing trend is the expansion of mainstream methods to such seemingly distant fields as crime the family, law, politics, and religion. The latter phenomenon is sometimes referred to as economic imperialism.
Business cycle
The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession).
These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.
In 1860, French economist Clement Juglar identified the presence of economic cycles 8 to 11 years long, although he was cautious not to claim any rigid regularity.[2] Later, Austrian economist Joseph Schumpeter argued that a Juglar cycle has four stages: (i) expansion (increase in production and prices, low interests rates); (ii) crisis (stock exchanges crash and multiple bankruptcies of firms occur); (iii) recession (drops in prices and in output, high interests rates); (iv) recovery (stocks recover because of the fall in prices and incomes). In this model, recovery and prosperity are associated with increases in productivity, consumer confidence, aggregate demand, and prices.
In the mid-20th century, Schumpeter and others proposed a typology of business cycles according to its periodicity, so that a number of particular cycles were named after their discoverers or proposers: [3]the Kitchin inventory cycle of 3–5 years (after Joseph Kitchin);the Juglar fixed investment cycle of 7–11 years (often identified as 'the' business cycle);the Kuznets infrastructural investment cycle of 15–25 years (after Simon Kuznets);the Kondratieff wave or long technological cycle of 45–60 years (after Nikolai Kondratieff).
Interest in these different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles.
Business cycles after World War II were generally more restrained than the earlier business cycles. Economic stabilization policy using fiscal policy and monetary policy appeared to have dampened the worse excesses of business cycles. Automatic stabilization due to the aspects of the government's budget also helped defeat the cycle even without conscious action by policy-makers.
The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics. The most commonly used framework for explaining such fluctuations is Keynesian economics. In the Keynesian view, business cycles reflect the possibility that the economy may reach short-run equilibrium at levels below or above full employment. If the economy is operating with less than full employment, i.e., with high unemployment, then in theory monetary policy and fiscal policy can have a positive role to play rather than simply causing inflation or diverting funds to inefficient uses.
Keynesian models do not necessarily imply periodic business cycles. However, simple Keynesian models involving the interaction of the Keynesian multiplier and accelerator give rise to cyclical responses to initial shocks. Paul Samuelson's "oscillator model" is supposed to account for business cycles thanks to the multiplier and the accelerator. The amplitude of the variations in economic output depends on the level of the investment, for investment determines the level of aggregate output (multiplier), and is determined by aggregate demand (accelerator).
In the Keynesian tradition, Richard Goodwin accounts for cycles in output by the distribution of income between business profits and workers wages. The fluctuations in wages are the same as in the level of employment, for when the economy is at full-employment, workers are able to demand rises in wages, whereas in periods of high unemployment, wages tend to fall. According to Goodwin, when unemployment and business profits rise, the output rises.
Keynesian economist Hyman Minski has proposed a explanation of cycles founded on fluctuations in credit, interest rates and financial frailty. In an expansion period, interest rates are low and companies easily borrow money from banks to invest. Banks are not reluctant to grant them loans, because expanding economic activity allows business increasing cash flows and therefore they will be able to easily pay back the loans. This process leads to firms becoming excessively indebted, so that they stop investing, and the economy goes into recession.
Keynesian views have been challenged by real business cycle models in which fluctuations are due to technology shocks. This theory is most associated with Finn E. Kydland and Edward C. Prescott. They consider that economic crisis and fluctuations cannot stem from a monetary shock, only from an external shock, such as an innovation.
Following the tradition of Adam Smith and David Ricardo mainstream economists have usually viewed the departures of the harmonic working of the market economy as due to exogenous influences, such as the State or its regulations, labor unions, business monopolies, or shocks due to technology or natural causes (e.g. sunspots for S. Jevons, planet Venus movements for H. L. Moore). Contrarily, in the heterodox tradition of Sismondi, Juglar, and Marx the recurrent upturns and downturns of the market system are an endogenous characteristic of it.
These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.
In 1860, French economist Clement Juglar identified the presence of economic cycles 8 to 11 years long, although he was cautious not to claim any rigid regularity.[2] Later, Austrian economist Joseph Schumpeter argued that a Juglar cycle has four stages: (i) expansion (increase in production and prices, low interests rates); (ii) crisis (stock exchanges crash and multiple bankruptcies of firms occur); (iii) recession (drops in prices and in output, high interests rates); (iv) recovery (stocks recover because of the fall in prices and incomes). In this model, recovery and prosperity are associated with increases in productivity, consumer confidence, aggregate demand, and prices.
In the mid-20th century, Schumpeter and others proposed a typology of business cycles according to its periodicity, so that a number of particular cycles were named after their discoverers or proposers: [3]the Kitchin inventory cycle of 3–5 years (after Joseph Kitchin);the Juglar fixed investment cycle of 7–11 years (often identified as 'the' business cycle);the Kuznets infrastructural investment cycle of 15–25 years (after Simon Kuznets);the Kondratieff wave or long technological cycle of 45–60 years (after Nikolai Kondratieff).
Interest in these different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles.
Business cycles after World War II were generally more restrained than the earlier business cycles. Economic stabilization policy using fiscal policy and monetary policy appeared to have dampened the worse excesses of business cycles. Automatic stabilization due to the aspects of the government's budget also helped defeat the cycle even without conscious action by policy-makers.
The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics. The most commonly used framework for explaining such fluctuations is Keynesian economics. In the Keynesian view, business cycles reflect the possibility that the economy may reach short-run equilibrium at levels below or above full employment. If the economy is operating with less than full employment, i.e., with high unemployment, then in theory monetary policy and fiscal policy can have a positive role to play rather than simply causing inflation or diverting funds to inefficient uses.
Keynesian models do not necessarily imply periodic business cycles. However, simple Keynesian models involving the interaction of the Keynesian multiplier and accelerator give rise to cyclical responses to initial shocks. Paul Samuelson's "oscillator model" is supposed to account for business cycles thanks to the multiplier and the accelerator. The amplitude of the variations in economic output depends on the level of the investment, for investment determines the level of aggregate output (multiplier), and is determined by aggregate demand (accelerator).
In the Keynesian tradition, Richard Goodwin accounts for cycles in output by the distribution of income between business profits and workers wages. The fluctuations in wages are the same as in the level of employment, for when the economy is at full-employment, workers are able to demand rises in wages, whereas in periods of high unemployment, wages tend to fall. According to Goodwin, when unemployment and business profits rise, the output rises.
Keynesian economist Hyman Minski has proposed a explanation of cycles founded on fluctuations in credit, interest rates and financial frailty. In an expansion period, interest rates are low and companies easily borrow money from banks to invest. Banks are not reluctant to grant them loans, because expanding economic activity allows business increasing cash flows and therefore they will be able to easily pay back the loans. This process leads to firms becoming excessively indebted, so that they stop investing, and the economy goes into recession.
Keynesian views have been challenged by real business cycle models in which fluctuations are due to technology shocks. This theory is most associated with Finn E. Kydland and Edward C. Prescott. They consider that economic crisis and fluctuations cannot stem from a monetary shock, only from an external shock, such as an innovation.
Following the tradition of Adam Smith and David Ricardo mainstream economists have usually viewed the departures of the harmonic working of the market economy as due to exogenous influences, such as the State or its regulations, labor unions, business monopolies, or shocks due to technology or natural causes (e.g. sunspots for S. Jevons, planet Venus movements for H. L. Moore). Contrarily, in the heterodox tradition of Sismondi, Juglar, and Marx the recurrent upturns and downturns of the market system are an endogenous characteristic of it.
Development economics
Development economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example, through health and education and workplace conditions, whether through public or private channels. Thus, development economics involves the creation of theories and methods that aid in the determination of types of policies and practices and can be implemented at either the domestic or international level. This may involve restructuring market incentives or using mathematical methods like inter-temporal optimization for project analysis, or it may involve a mixture of quantitative and qualitative methods. Unlike in many other fields of economics, approaches in development economics may incorporate social and political factors to devise particular plans.
An early theory of development economics, the linear-stages-of-growth model was first formulated in the 1950s by W. W. Rostow in The Stages of Growth: A Non-Communist Manifesto. This theory modifies Marx's stages theory of development and focuses on the accelerated accumulation of capital, through the utilization of both domestic and international savings as a means of spurring investment, as the primary means of promoting economic growth and, thus, development. The linear-stages-of-growth model posits that there are a series of five consecutive stages of development which all countries must go through during the process of development. These stages are “the traditional society, the pre-conditions for take-off, the take-off, the drive to maturity, and the age of high mass-consumption” Simple versions of the Harrod-Domar Model provide a mathematical illustration of the argument that improved capital investment leads to greater economic growth.
Such theories have been criticized for not recognizing that, while necessary, capital accumulation is not a sufficient condition for development. That is to say that this early and simplistic theory failed to account for political, social and institutional obstacles to development. Furthermore, this theory was developed in the early years of the Cold War and was largely derived from the successes of the Marshall Plan. This has led to the major criticism that the theory assumes that the conditions found in developing countries are the same as those found in post-WWII Europe.
Structural-change theory deals with policies focused on changing the economic structures of developing countries from being composed primarily of subsistence agricultural practices to being a “more modern, more urbanized, and more industrially diverse manufacturing and service economy.” There are two major forms of structural-change theory; W. Lewis’ two-sector surplus model, which views agrarian societies as consisting of large amounts of surplus labor which can be utilized to spur the development of an urbanized industrial sector, and Hollis Chenery’s patterns of development approach, which is the empirical analysis of the “sequential process through which the economic, industrial and institutional structure of an underdeveloped economy is transformed over time to permit new industries to replace traditional agriculture as the engine of economic growth.”
Structural-change approaches to development economics have faced criticism for their emphasis on urban development at the expense of rural development which can lead to a substantial rise in inequality between internal regions of a country. The two-sector surplus model, which was developed in the 1950s, has been further criticized for its underlying assumption that predominantly agrarian societies suffer from a surplus of labor. Actual empirical studies have shown that such labor surpluses are only seasonal and drawing such labor to urban areas can result in a collapse of the agricultural sector. The patterns of development approach has been criticized for lacking a theoretical framework.
An early theory of development economics, the linear-stages-of-growth model was first formulated in the 1950s by W. W. Rostow in The Stages of Growth: A Non-Communist Manifesto. This theory modifies Marx's stages theory of development and focuses on the accelerated accumulation of capital, through the utilization of both domestic and international savings as a means of spurring investment, as the primary means of promoting economic growth and, thus, development. The linear-stages-of-growth model posits that there are a series of five consecutive stages of development which all countries must go through during the process of development. These stages are “the traditional society, the pre-conditions for take-off, the take-off, the drive to maturity, and the age of high mass-consumption” Simple versions of the Harrod-Domar Model provide a mathematical illustration of the argument that improved capital investment leads to greater economic growth.
Such theories have been criticized for not recognizing that, while necessary, capital accumulation is not a sufficient condition for development. That is to say that this early and simplistic theory failed to account for political, social and institutional obstacles to development. Furthermore, this theory was developed in the early years of the Cold War and was largely derived from the successes of the Marshall Plan. This has led to the major criticism that the theory assumes that the conditions found in developing countries are the same as those found in post-WWII Europe.
Structural-change theory deals with policies focused on changing the economic structures of developing countries from being composed primarily of subsistence agricultural practices to being a “more modern, more urbanized, and more industrially diverse manufacturing and service economy.” There are two major forms of structural-change theory; W. Lewis’ two-sector surplus model, which views agrarian societies as consisting of large amounts of surplus labor which can be utilized to spur the development of an urbanized industrial sector, and Hollis Chenery’s patterns of development approach, which is the empirical analysis of the “sequential process through which the economic, industrial and institutional structure of an underdeveloped economy is transformed over time to permit new industries to replace traditional agriculture as the engine of economic growth.”
Structural-change approaches to development economics have faced criticism for their emphasis on urban development at the expense of rural development which can lead to a substantial rise in inequality between internal regions of a country. The two-sector surplus model, which was developed in the 1950s, has been further criticized for its underlying assumption that predominantly agrarian societies suffer from a surplus of labor. Actual empirical studies have shown that such labor surpluses are only seasonal and drawing such labor to urban areas can result in a collapse of the agricultural sector. The patterns of development approach has been criticized for lacking a theoretical framework.
Potential output
In economics, potential output (also referred to as "natural gross domestic product") refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints. If actual GDP rises and stays above potential output, then (in the absence of wage and price controls) inflation tends to increase as demand exceeds supply. This is because of the limited supply of workers and their time, capital equipment, and natural resources, along with the limits of our technology and our management skills. Graphically, the expansion of output beyond the natural limit can be seen as a shift of production volume above the optimum quantity on the average cost curve. Likewise, if GDP is below natural GDP, inflation will decelerate as suppliers lower prices to fill their excess production capacity.
Potential output in macroeconomics corresponds to one point on the production possibilities frontier (or curve) for a society as a whole seen in introductory economics, reflecting natural, technological, and institutional constraints.
Potential output has also been called the "natural gross domestic product." If the economy is at potential, the unemployment rate equals the NAIRU or the "natural rate of unemployment."
Generally speaking, most central banks and other economic planning agencies attempt to keep GDP at or around the natural GDP level. This can be done in a number of ways: the two most common strategies are expanding or contracting the government budget (fiscal policy), and altering the money supply to change consumption and investment levels (monetary policy).
Potential output in macroeconomics corresponds to one point on the production possibilities frontier (or curve) for a society as a whole seen in introductory economics, reflecting natural, technological, and institutional constraints.
Potential output has also been called the "natural gross domestic product." If the economy is at potential, the unemployment rate equals the NAIRU or the "natural rate of unemployment."
Generally speaking, most central banks and other economic planning agencies attempt to keep GDP at or around the natural GDP level. This can be done in a number of ways: the two most common strategies are expanding or contracting the government budget (fiscal policy), and altering the money supply to change consumption and investment levels (monetary policy).
Economic growth
Economic growth is the increase in the amount of the goods and services produced by an economy over time.[1] It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment," which is caused by growth in aggregate demand or observed output.
As an area of study, economic growth is generally distinguished from development economics. The former is primarily the study of how countries can advance their economies. The latter is the study of the economic aspects of the development process in low-income countries.
As economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure. GDP per capita is not the same thing as earnings per worker. GDP includes all final goods and services in country in a year.
Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run.
The short-run variation of economic growth is termed the business cycle, and almost all economies experience periodical recessions. The cycle can be a misnomer as the fluctuations are not always regular. Explaining these fluctuations is one of the main focuses of macroeconomics. There are different schools of thought as to the causes of recessions but some consensus- see Keynesianism, Austrian Business Cycle Theory, Monetarism, New classical economics and New Keynesian economics. Oil shocks, war and harvest failure are obvious causes of recession. Short-run variation in growth has generally dampened in higher income countries since the early 1990s and this has been attributed, in part, to changes in macroeconomic management...
The long-run path of economic growth is one of the central questions of economics; in spite of the problems of measurement, an increase in GDP of a country is generally taken as an increase in the standard of living of its inhabitants. Over long periods of time, even small rates of annual growth can have large effects through compounding (see exponential growth). A growth rate of 2.5% per annum will lead to a doubling of GDP within 28 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 9 years. This exponential characteristic can exacerbate differences across nations. For example, the difference in the annual growth from country A to country B will multiply up over the years. A growth rate of 5% seems similar to 3%, but over two decades, the first economy would have grown by 165%, the second only by 80%.
In the early 20th century, it became the policy of most nations to encourage growth of this kind. To do this required enacting policies, and being able to measure the results of those policies. This gave rise to the importance of econometrics, or the field of creating measurements for underlying conditions. Terms such as "unemployment rate", "Gross Domestic Product" and "rate of inflation" are part of the measuring of the changes in an economy.
In mainstream economics, the purpose of government policy is to encourage economic activity without encouraging the rise in the general level of prices (in other words, increase GDP without creating inflation). This combination is seen as, at the macro-scale (see macroeconomics) to be indicative of an increasing stock of capital. The argument runs that if more money is changing hands, but the prices of individual goods are relatively stable, then it is proof that there is more productive capacity, and therefore more capital, because it is capital that is allowing more to be made at a lower cost per unit. See Economies of scale, Inflation, Hyperinflation, Price, Supply and demand.
As an area of study, economic growth is generally distinguished from development economics. The former is primarily the study of how countries can advance their economies. The latter is the study of the economic aspects of the development process in low-income countries.
As economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure. GDP per capita is not the same thing as earnings per worker. GDP includes all final goods and services in country in a year.
Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run.
The short-run variation of economic growth is termed the business cycle, and almost all economies experience periodical recessions. The cycle can be a misnomer as the fluctuations are not always regular. Explaining these fluctuations is one of the main focuses of macroeconomics. There are different schools of thought as to the causes of recessions but some consensus- see Keynesianism, Austrian Business Cycle Theory, Monetarism, New classical economics and New Keynesian economics. Oil shocks, war and harvest failure are obvious causes of recession. Short-run variation in growth has generally dampened in higher income countries since the early 1990s and this has been attributed, in part, to changes in macroeconomic management...
The long-run path of economic growth is one of the central questions of economics; in spite of the problems of measurement, an increase in GDP of a country is generally taken as an increase in the standard of living of its inhabitants. Over long periods of time, even small rates of annual growth can have large effects through compounding (see exponential growth). A growth rate of 2.5% per annum will lead to a doubling of GDP within 28 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 9 years. This exponential characteristic can exacerbate differences across nations. For example, the difference in the annual growth from country A to country B will multiply up over the years. A growth rate of 5% seems similar to 3%, but over two decades, the first economy would have grown by 165%, the second only by 80%.
In the early 20th century, it became the policy of most nations to encourage growth of this kind. To do this required enacting policies, and being able to measure the results of those policies. This gave rise to the importance of econometrics, or the field of creating measurements for underlying conditions. Terms such as "unemployment rate", "Gross Domestic Product" and "rate of inflation" are part of the measuring of the changes in an economy.
In mainstream economics, the purpose of government policy is to encourage economic activity without encouraging the rise in the general level of prices (in other words, increase GDP without creating inflation). This combination is seen as, at the macro-scale (see macroeconomics) to be indicative of an increasing stock of capital. The argument runs that if more money is changing hands, but the prices of individual goods are relatively stable, then it is proof that there is more productive capacity, and therefore more capital, because it is capital that is allowing more to be made at a lower cost per unit. See Economies of scale, Inflation, Hyperinflation, Price, Supply and demand.
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