Definition of 'Financial Innovation'

Advances over time in the financial instruments and payment systems used in the
lending and borrowing of funds. These changes, which include innovations in
technology, risk transfer and credit and equity generation, have increased available
credit for borrowers and given banks new and less costly ways to raise equity capital.

Investopedia explains 'Financial Innovation'

As seen with the global credit crunch sparked in 2008, which was triggered at least in
part by innovative financial products such as exotic ARMs, there will always be a need
for careful scrutiny of innovative financial products and their risks

Financial innovation
From Wikipedia, the free encyclopedia
Jump to: navigation, search

There are several interpretations of the phrase financial innovation. In general, it refers to the
creating and marketing of new types of securities.
Contents

1 Why does financial innovation occur?

2 Academic literature

3 Historical examples of financial innovation

o

3.1 Examples of spanning the market

3.2 Examples of mathematical innovation

3.3 Examples of innovation to avoid taxes and regulation

4 The role of technology in financial innovation

5 Criticism

6 Notes

7 Bibliography

Why does financial innovation occur?

Economic theory has much to say about what types of securities should exist, and why some may
not exist (why some markets should be "incomplete") but little to say about why new types of
securities should come into existence.
One interpretation of the Modigliani-Miller theorem is that taxes and regulation are the only
reasons for investors to care what kinds of securities firms issue, whether debt, equity, or
something else. The theorem states that the structure of a firm's liabilities should have no bearing
on its net worth (absent taxes, etc.). The securities may trade at different prices depending on
their composition, but they must ultimately add up to the same value.
Furthermore, there should be little demand for specific types of securities. The capital asset
pricing model, first developed by Treynor and Sharpe, suggests that investors should fully
diversify and their portfolios should be a mixture of the "market" and a risk-free investment.
Investors with different risk/return goals can use leverage to increase the ratio of the market
return to the risk-free return in their portfolios. However, Richard Roll argued that this model
was incorrect, because investors cannot invest in the entire market. This implies there should be
demand for instruments that open up new types of investment opportunities (since this gets
investors closer to being able to buy the entire market), but not for instruments that merely
repackage existing risks (since investors already have as much exposure to those risks in their
portfolio).
If the world existed as the Arrow-Debreu model posits, then there would be no need for financial
innovation. The Arrow-Debreu model assumes that investors are able to purchase securities that
pay off if and only if a certain state of the world occurs. Investors can then combine these
securities to create portfolios that have whatever payoff they desire. The fundamental theorem of
finance states that the price of assembling such a portfolio will be equal to its expected value
under the appropriate risk-neutral measure

Definition of 'GDP Price Deflator'

An economic metric that accounts for inflation by converting output measured at current prices into
constant-dollar GDP. The GDP deflator shows how much a change in the base year's GDP relies
upon changes in the price level. Also known as the "GDP implicit price deflator."

Investopedia explains 'GDP

Price Deflator'
Because it isn't based on a fixed basket of goods
and services, the GDP deflator has an advantage
over the Consumer Price Index. Changes in
consumption patterns or the introduction of new
goods and services are automatically reflected in
the deflator.
How to pick your next hotel stay

GDP Deflator
The GDP deflator is an economic measure that tracks the cost of goods produced in an economy
relative to the purchasing power of the dollar.
It measures inflation over time, similar to the Consumer Price Index, with key differences.
GDP Deflator by year

GDP Deflator courtesy multpl.com

Official Measurement

The GDP Deflator is reported by the Bureau of Economic Analysis (BEA), using 2005 as the
base year meaning, the deflator for 2005 is set to 100 with other years reported relative to the
2005 dollar.

Examples

The GDP Deflator for 2010 was 110.99. On average the 2005 dollar could buy (10.99/100)
10.99% more than the 2009 dollar.
The GDP Deflator for 1950 was 14.65. On average the 1950 dollar could buy (100/14.65) 6.82
times as many goods as the 2005 dollar.

GDP deflator
From Wikipedia, the free encyclopedia
Jump to: navigation, search

In economics, the GDP deflator (implicit price deflator for GDP) is a measure of the level of
prices of all new, domestically produced, final goods and services in an economy. GDP stands for
gross domestic product, the total value of all final goods and services produced within that
economy during a specified period.
Like the Consumer Price Index (CPI), the GDP deflator is a measure of price inflation/deflation
with respect to a specific base year; the GDP deflator of the base year itself is equal to 100.
Unlike the CPI, the GDP deflator is not based on a fixed basket of goods and services; the
"basket" for the GDP deflator is allowed to change from year to year with people's consumption
and investment patterns.
Measurement in national accounts

In most systems of national accounts the GDP deflator measures the ratio of nominal (or currentprice) GDP to the real (or chain volume) measure of GDP. The formula used to calculate the
deflator is:

The nominal GDP of a given year is computed using that year's prices, while the real GDP of
that year is computed using the base year's prices.
The formula implies that dividing the nominal GDP by the GDP deflator and multiplying it by
100 will give the real GDP, hence "deflating" the nominal GDP into a real measure

Definition of 'Bank Run'

A situation that occurs when a large number of bank or other financial institution's customers
withdraw their deposits simultaneously due to concerns about the bank's solvency. As more people
withdraw their funds, the probability of default increases, thereby prompting more people to
withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the
withdrawals. A bank run is typically the result of panic, rather than a true insolvency on the part of
the bank; however, the bank does risk default as more and more individuals withdraw funds - what
began as panic can turn into a true default situation.
Also called a "run."

Investopedia explains 'Bank

Run'
Because banks typically keep only a small
percentage of deposits as cash on hand, they must
increase cash to meet depositors' withdrawal
demands. One method a bank uses to quickly
increase cash on hand is to sell off its assets,
sometimes at significantly lower prices than if it did
not have to sell quickly. Losses on selling the assets
at lower prices can cause a bank to become
insolvent. A "bank panic" occurs when multiple
banks endure runs at the same time.
In the United States, the Federal Deposit Insurance
Corporation (FDIC) is the agency that insures
banking deposits. It was established by Congress in
1933 in response to the many bank failures that
happened in the 1920s. Its mission is to maintain
stability and public confidence in the U.S. financial
system.
A run on a bank occurs when a large number of depositors, fearing that their bank will be unable
to repay their deposits in full and on time, simultaneously try to withdraw their funds
immediately. This may create a problem because banks keep only a small fraction of deposits on
hand in cash; they lend out the majority of deposits to borrowers or use the funds to purchase
other interest-bearing assets such as government securities. When a run comes, a bank must
quickly increase its cash to meet depositors demands. It does so primarily by selling assets, often
hastily and at fire-sale prices. As banks hold little capital and are highly leveraged, losses on
these sales can drive a bank into insolvency.

The danger of bank runs has been frequently overstated. For one thing, a bank run is unlikely to
cause insolvency. Suppose that depositors, worried about their banks solvency, start a run and
switch their deposits to other banks. If their concerns about the banks solvency are unjustified,
other banks in the same market area will generally gain from recycling funds they receive back
to the bank experiencing the run. They would do this by making loans to the bank or by
purchasing the banks assets at non-fire-sale prices. Thus, a run is highly unlikely to make a
solvent bank insolvent.
Of course, if the depositors fears are justified and the bank is economically insolvent, other
banks will be unlikely to throw good money after bad by recycling their funds to the insolvent
bank. As a result, the bank cannot replenish its liquidity and will be forced into default. But the
run would not have caused the insolvency; rather, the recognition of the existing insolvency
caused the run.
A more serious potential problem is spillover to other banks. The likelihood of this happening
depends on what the running depositors do with their funds. They have three choices:
1.
They can redeposit the money in banks that they think are safe, known as direct redeposit.
2.
If they perceive no bank to be safe, they can buy treasury securities in a flight to quality. But what do the sellers of the
securities do? If they deposit the proceeds in banks they believe are safe, as is likely, this is an indirect redeposit.
3.
If neither the depositors nor the sellers of the treasury securities believe that any bank is safe, they hold the funds as
currency outside the banking system. A run on individual banks would then be transformed into a run on the banking
system as a whole.

A bank run (also known as a run on the bank) occurs in a fractional reserve banking system
when a large number of customers withdraw their deposits from a financial institution at the
same time and either demand cash or transfer those funds into government bonds, precious
metals or stones, or a safer institution because they believe that the financial institution is, or
might become, insolvent. As a bank run progresses, it generates its own momentum, in a kind of
self-fulfilling prophecy (or positive feedback loop) as more people withdraw their deposits, the
likelihood of default increases, thus triggering further withdrawals. This can destabilize the bank
to the point where it runs out of cash and thus faces sudden bankruptcy.[1]
A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at
the same time, as people suddenly try to convert their threatened deposits into cash or try to get
out of their domestic banking system altogether. A systemic banking crisis is one where all or
almost all of the banking capital in a country is wiped out.[2] The resulting chain of bankruptcies
can cause a long economic recession as domestic businesses and consumers are starved of capital

as the domestic banking system shuts down.[3] According to Federal Reserve Chairman Ben
Bernanke, the Great Depression was caused by the Federal Reserve System,[4] and much of the
economic damage was caused directly by bank runs.[5] The cost of cleaning up a systemic
banking crisis can be huge, with fiscal costs averaging 13% of GDP and economic output losses
averaging 20% of GDP for important crises from 1970 to 2007
A bank run takes place when the customers of a bank fear that the bank will become insolvent.
Customers rush to the bank to take out their money as quickly as possible to avoid losing it.
Federal Deposit Insurance has ended the phenomenon of bank runs."
Bank Runs and how Banks Work
When you deposit money in a bank, you will generally make that deposit into a
demand deposit account such as a checking account. With a demand deposit
account you have the right to take your money out of the account on demand, that
is at any time. However banks do not keep all the money in demand deposit
accounts stored in a vault. Instead they take that money and give it out in the form
of loans or other invest it in other interest paying assets. Banks are required by law
to have a minimum level of deposits on hand, known as a reserve requirement. As
detailed on the website of the New York Federal Reserve the reserve requirements
are quite low, generally in the range of 10%. So at any given time a bank can only
pay out a small fractions of the deposits of its depositors.

The system of demand deposits works quite well unless a large number of people demand to take
their money out of the bank at the same time. This generally does not happen, unless people
think their money is not safe in the bank. So a bank run typically occurs when the depositors of a
bank believe that a bank may go insolvent and if they do not take their money out right away
they may lose that money forever.

Definition of 'Business Cycle'

The recurring and fluctuating levels of economic activity that an economy experiences over a long
period of time. The five stages of the business cycle are growth (expansion), peak, recession
(contraction), trough and recovery. At one time, business cycles were thought to be extremely
regular, with predictable durations, but today they are widely believed to be irregular, varying in
frequency, magnitude and duration.

Investopedia explains
'Business Cycle'
Since the World War II, most business cycles have

lasted three to five years from peak to peak. The

average duration of an expansion is 44.8 months
and the average duration of a recession is 11
months. As a comparison, the Great Depression which saw a decline in economic activity from
1929 to 1933 - lasted 43 months.

Business cycle
The term business cycle (or economic cycle or boom-bust cycle) refers to economy-wide
fluctuations in production, trade and economic activity in general over several months or years in
an economy organized on free-enterprise principles.[1]
The business cycle is the upward and downward movements of levels of GDP (gross domestic
product) and refers to the period of expansions and contractions in the level of economic
activities (business fluctuations) around its long-term growth trend. [2]
These fluctuations occur around a long-term growth trend, and typically involve shifts over time
between periods of relatively rapid economic growth (an expansion or boom), and periods of
relative stagnation or decline (a contraction or recession).
Business cycles are usually measured by considering the growth rate of real gross domestic
product. Despite being termed cycles, these fluctuations in economic activity can prove
unpredictable.
A basic illustration of economic/business cycles.

Loan commitment

Assurance by a lender to make money available to a borrower on specific terms in return for a
fee.
Copyright 2012, Campbell R. Harvey. All Rights Reserved.
Loan Commitment
The amount in loans that a bank will make or may be required to make in the near future, but
has not yet made. Loan commitments may be open-ended or closed-ended. Suppose a bank
approves two loans in a year; one is a revolving line of credit for $50,000 and the other is a
business loan for $100,000. One would say that this bank has an open-ended loan commitment
of $50,000 (because the principal amount in the loan, when repaid, may be borrowed again)
and a closed-ended loan commitment of $100,000 (because once its principal is repaid, it no
longer must be committed to that borrower). Banks must disclose their loan commitments.

Definition of 'Loan Commitment'

A loan amount that may be drawn down, or is due to be contractually funded in the future. Loan
commitments are found at commercial banks and other lending institutions and consist of both openend and closed-end loans. Open-end loan commitments act like revolving credit lines, whereby if a
portion of the loan is paid off, the principle repayment amount is added back to the allowable loan
limit. Closed-end loans are reduced once any repayments are made.
Banks and investment shops must account for the value of outstanding loan commitments so that
funds are available should the borrower request them. They represent a future obligation in full, even
though a percentage of the notional loan amounts will never be utilized by the borrowers themselves.
Also known as "unfunded loan commitments," because the total capital outlay is not provided by the
lender up front.

Investopedia explains 'Loan

Commitment'
The aggregate loan commitments of commercial
banks, savings & loans and investments banks
registered in the United States must be disclosed
on quarterly financial reports to regulators at the
FDIC. These reports are known as the "Call

Reports" and can be found either through the

FDIC or the lender's corporate website.
Loan commitments get increased attention during
times of economic weakness, as more borrowers
delay making repayments and may draw down the
max on their revolving credit lines. This decreases
the return the bank can earn on the capital
deployed. The same is true for many construction
loans, which are typically classified as closed-end
loan commitments.

loan commitment

DefinitionSave to FavoritesSee Examples

Binding promise from a lender that a specified amount of loan or line of credit will
be made available to the named borrower at a certain interest rate, during a certain
period and, usually, for a certain purpose. The commitment letter often also
specifies the terms and requirements under which the loan will be advanced.
Lenders charge a commitment fee (ranging generally from 0.5 percent to 2.5
percent of the loan amount) for giving a written commitment.
Read more: http://www.businessdictionary.com/definition/loancommitment.html#ixzz2pV6nnzvf

Definition of 'Fiat Money'

Currency that a government has declared to be legal tender, but is not backed by a
physical commodity. The value of fiat money is derived from the relationship between
supply and demand rather than the value of the material that the money is made of.
Historically, most currencies were based on physical commodities such as gold or
silver, but fiat money is based solely on faith. Fiat is the Latin word for "it shall be".

Investopedia explains 'Fiat Money'

Because fiat money is not linked to physical reserves, it risks becoming worthless due
to hyperinflation. If people lose faith in a nation's paper currency, like the dollar bill,
the money will no longer hold any value.
Most modern paper currencies are fiat currencies, have no intrinsic value and are used
solely as a means of payment. Historically, governments would mint coins out of a
physical commodity such as gold or silver, or would print paper money that could be
redeemed for a set amount of physical commodity. Fiat money is inconvertible and
cannot be redeemed. Fiat money rose to prominence in the 20th century, specifically
after the collapse of the Bretton Woods system in 1971, when the United States ceased
to allow the conversion of the dollar into gold.

Definition
Money which has no intrinsic value and cannot be redeemed for specie or any commodity, but is
made legal tender through government decree. All modern paper currencies are fiat money, as are
most modern coins. The value of fiat money depends on the strength of the issuing country's
economy. Inflation results when a government issues too much fiat money.
Read more: http://www.investorwords.com/1928/fiat_money.html#ixzz2pV7EpBUM
Fiat money has been defined variously as:

any money declared by a government to be legal tender.[1]

state-issued money which is neither convertible by law to any other thing, nor fixed in
value in terms of any objective standard.[2]

money without intrinsic value.[3][4]

The term derives from the Latin fiat ("let it be done", "it shall be").[5]
While gold- or silver-backed representative money entails the legal requirement that the bank of
issue redeem it in fixed weights of gold or silver, fiat money's value is unrelated to the value of
any physical quantity. Even a coin containing valuable metal may be considered fiat currency if
its face value is defined by law as different from its market value as metal.
This was certainly the case in Rome, starting with the Civil War that ended the Republic. By
200CE, in less than a century, the silver content of the main "silver" coin, the Denarius, and that
of its official successor, went from 75% silver, down to 2%.

Definition of 'Monetary Base'

The total amount of a currency that is either circulated in the hands of the public or in the
commercial bank deposits held in the central bank's reserves. This measure of the money supply
typically only includes the most liquid currencies.
Also known as the "money base".

Investopedia explains
'Monetary Base'
For example, suppose country Z has 600 million
currency units circulating in the public and its central
bank has 10 billion currency units in reserve as part of
deposits from many commercial banks. In this case,
the monetary base for country Z is 10.6 billion
currency units.
For many countries, the government can maintain a
measure of control over the monetary base by buying
and selling government bonds in the open market.
Definition
Sum of a country's liquid financial assets comprising of currency (notes and coins) in
circulation held by public, and by financial institutions in their vaults and as reserve
requirement with the central bank.
Read more: http://www.businessdictionary.com/definition/monetarybase.html#ixzz2pV7jzfQU
Defining Base Money with floating fx- The Great Reframation

Posted by WARREN MOSLER on August 14th, 2013

With fixed fx/convertible currency base money doesnt include govt secs as those obligations
are claims on govt reserves (gold, fx, etc.), which are part of national savings as defined.

However, with todays floating fx/non convertible currency tsy secs (held outside of govt) are
logically additions to base money, as the notion of a reduction of govt reserves (again, gold, fx,
etc) is inapplicable to non convertible currency.
That is, with todays floating fx, I define base money as currency in circulation + $ balances in
Fed accounts. And $ balances in Fed accounts include both member bank reserve accounts and
securities accounts (tsy secs). And to me, its also not wrong to include any other govt
guaranteed debt as well, including agency paper, etc.
That is, with floating fx, base money can logically be defined as the total net financial assets of
the non govt sectors.
(Note, for example, that this means QE does not alter base money as thus defined, which further
fits the observation that QE in todays context is nothing more than a tax that removes interest
income from the economy.)
And deficit reduction is the reduction in the addition of base money to the economy, with the
predictable slowing effects as observed.
The point of this post is to reframe govt deficit spending away from going into debt as it
would be with fixed fx, to adding to base money as is the case with floating fx where net govt
spending increase the economys holdings of govt liabilities, aka tax credits.

Definition of M0, M1, M2, M3, M4

Different measures of money supply. Not all of them are widely used and the exact
classifications depend on the country. M0 and M1, also called narrow money, normally include
coins and notes in circulation and other money equivalents that are easily convertible into cash.
M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds. M3
includes M2 plus longer-term time deposits and money market funds with more than 24-hour
maturity. The exact definitions of the three measures depend on the country. M4 includes M3
plus other deposits. The term broad money is used to describe M2, M3 or M4, depending on the
local practice.

SDR Valuation
The currency value of the SDR is determined by summing the values in U.S. dollars, based
on market exchange rates, of a basket of major currencies (the U.S. dollar, Euro, Japanese
yen, and pound sterling). The SDR currency value is calculated daily (except on IMF

holidays or whenever the IMF is closed for business) and the valuation basket is reviewed
and adjusted every five years.

Definition of 'Special Drawing Rights - SDR'

An international type of monetary reserve currency, created by the International
Monetary Fund (IMF) in 1969, which operates as a supplement to the existing reserves
of member countries. Created in response to concerns about the limitations of gold and
dollars as the sole means of settling international accounts, SDRs are designed to
augment international liquidity by supplementing the standard reserve currencies.

Investopedia explains 'Special Drawing Rights SDR'

You can think of SDRs as an artificial currency used by the IMF and defined as a
"basket of national currencies". The IMF uses SDRs for internal accounting purposes.
SDRs are allocated by the IMF to its member countries and are backed by the full faith
and credit of the member countries' governments.

Definition of 'Yield Curve'

A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but
differing maturity dates. The most frequently reported yield curve compares the three-month, twoyear, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other
debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict
changes in economic output and growth.

Investopedia explains
'Yield Curve'
The shape of the yield curve is
closely scrutinized because it helps
to give an idea of future interest rate
change and economic activity.
There are three main types of yield
curve shapes: normal, inverted and
flat (or humped). A normal yield
curve (pictured here) is one in
which longer maturity bonds have a
higher yield compared to shorterterm bonds due to the risks
associated with time. An inverted
yield curve is one in which the
shorter-term yields are higher than
the longer-term yields, which can be
a sign of upcoming recession. A flat
(or humped) yield curve is one in
which the shorter- and longer-term
yields are very close to each other,
which is also a predictor of an
economic transition. The slope of
the yield curve is also seen as
important: the greater the slope, the
greater the gap between short- and
long-term rates.

A free rider, in economics, refers to someone who benefits from resources, goods, or services
without paying for the cost of the benefit. The term "free rider" was first used in economic theory
of public goods, but similar concepts have been applied in to other contexts, including collective
bargaining, antitrust law, psychology and political science.[citation needed] Free riding may be
considered as a free rider problem when it leads to under-provision of goods or services, or
when it leads to overuse or degradation of a common property resource.[1]
Although the term originated in economic theory, similar concepts have been cited in political
science, social psychology, and other disciplines. Some individuals in a team or community may
reduce their contributions or performance if they believe that one or more other members of the
group may free ride.[2]

Free Rider Problem

By Tejvan Pettinger on May 22, 2011 in economics

Definition of The Free Rider Problem. This occurs when people can enjoy a good service
without paying anything (or making a small contribution less than their benefit.) If enough
people can enjoy a good without paying for the cost then there is a danger that, in a free market,
the good will be under-provided or not provided at all.
More on Definition of Free Rider Problem
Public Good and a Free Rider Problem

A public good has a classic free rider problem because the good has two characteristics:
1. Non-excludability cant stop anyone from consuming good
2. Non-rivalry benefiting from good or service does not reduce the amount
available to others.

Therefore, public goods like national defence, street lighting, beautiful gardens may not be
provided in a free market.
A free rider problem is also said to occur when there is overconsumption of shared resources.
Also known as The Tragedy of the Commons. For example, a fisherman may take a high catch
and free ride on other fishermen who are more concerned to preserve sustainable fish stocks.
Solutions to Free Rider Problem

1. Tax.
One solution is to treat the many beneficiaries as one consumer and then divide the cost equally.
For example, UK national defence costs 31bn. This results in higher taxes for UK taxpayers.

Therefore the cost of national defence is paid indirectly by UK taxpayers. This ensures everyone
who benefits from the service pays towards the cost. Some may dislike this approach e.g. some
anti-war protesters have tried to withhold a certain % of their tax arguing they dont want to
make contributions to illegal wars. But, most people accept paying taxes.
2. Appealing To Peoples Altruism.
For some goods like visiting a garden, the garden may be able to raise funds by asking for
donations if you enjoy your visit. There will be probably be many free riders who dont make
donation. But, enough people may be willing to make a donation to fund the cost of the garden /
museum. This solution is only effective for services which have relatively low cost. People dont
mind paying 4 if others free ride. But, if there was a voluntary donation of 1,000 for national
defence, would anyone pay it?
3. Make A Public Good private.
A beautiful garden could be seen as a public good. However, if you erect a high barrier and limit
entrance to those willing to pay, it loses its feature as a public good and becomes a private good.
4. Legislation
To deal with the free rider problem associated with overconsumption of common resources. The
government have tried various options such as:

Quotes difficult to implement and difficult to monitor

Legislation on size of net size, number of fishing vessels

Compensation to move away from fishing.

Externality
From Wikipedia, the free encyclopedia
Jump to: navigation, search
"External" redirects here. For other uses, see External (disambiguation).

Air pollution from motor vehicles is an example of a negative externality. The costs
of the air pollution for the rest of society is not compensated for by either the
producers or users of motorized transport.

In economics, an externality is a cost or benefit that affects a party who did not choose to incur
that cost or benefit.[1]
For example, manufacturing activities that cause air pollution impose health and clean-up costs
on the whole society, whereas the neighbors of an individual who chooses to fire-proof his home
may benefit from a reduced risk of a fire spreading to their own houses. If external costs exist,
such as pollution, the producer may choose to produce more of the product than would be
produced if the producer were required to pay all associated environmental costs. If there are
external benefits, such as in public safety, less of the good may be produced than would be the
case if the producer were to receive payment for the external benefits to others. For the purpose
of these statements, overall cost and benefit to society is defined as the sum of the imputed
monetary value of benefits and costs to all parties involved.[2][3] Thus, it is said that, for goods
with externalities, unregulated market prices do not reflect the full social costs or benefit of the
transaction.
Positive externalities are benefits that are infeasible to charge to provide; negative
externalities are costs that are infeasible to charge to not provide. Ordinarily, as
ADAM SMITH explained, selfishness leads markets to produce whatever people want;
to get rich, you have to sell what the public is eager to buy. Externalities undermine
the social benefits of individual selfishness. If selfish consumers do not have to pay
producers for benefits, they will not pay; and if selfish producers are not paid, they
will not produce. A valuable product fails to appear. The problem, as David Friedman
aptly explains, is not that one person pays for what someone else gets but that

nobody pays and nobody gets, even though the good is worth more than it would
cost to produce (Friedman 1996, p. 278).

Definition of 'Externality'
A consequence of an economic activity that is experienced by unrelated third parties. An externality
can be either positive or negative.

Investopedia explains 'Externality'

Pollution emitted by a factory that spoils the surrounding
environment and affects the health of nearby residents is an
example of a negative externality. An example of a positive
externality is the effect of a well-educated labor force on the
productivity of a company.

What is an Externality?
Gene Callahan
British economist A.C. Pigou was instrumental in developing the theory of externalities. The
theory examines cases where some of the costs or benefits of activities "spill over" onto third
parties. When it is a cost that is imposed on third parties, it is called a negative externality. When
third parties benefit from an activity in which they are not directly involved, the benefit is called
a positive externality. The study of such situations, a part of welfare economics, has been an
active area of research since Pigou's efforts early in the twentieth century.
Government debt (also known as public debt and national debt)[1][2] is the debt owed by a
central government. (In the U.S. and other federal states, "government debt" may also refer to the
debt of a state or provincial government, municipal or local government.) By contrast, the annual
"government deficit" refers to the difference between government receipts and spending in a
single year, that is, the increase of debt over a particular year.
Government debt is one method of financing government operations, but it is not the only
method. Governments can also create money to monetize their debts, thereby removing the need
to pay interest. But this practice simply reduces government interest costs rather than truly
canceling government debt,[3] and can result in hyperinflation if used unsparingly.

Define Public Debt?

Answer
Public debt refers to the amount of money owed by a central government. The
operations of a government are normally financed through public debt. Another
term for public debt is government debt.

Definition of 'Federal Debt'

The total amount of money that the United States federal government owes to creditors. The
government's creditors include all individuals, businesses, governments and other organizations that
own U.S. government debt securities. The federal debt exists as a result of federal government
shortfalls, or deficit budgets in which the government's expenses exceed its revenues. The federal
debt does not include any debts in the name of individuals, corporations and state or municipal
governments.

Investopedia explains 'Federal

Debt'
In recent years, the federal debt has grown to
exorbitant amounts - as of April 2006, the total
federal debt was estimated to be $8.4 trillion.
Viewed as an absolute number, the federal debt
seems quite enormous, representing more than 20%
of total worldwide debt.
However, some economists point out that the
federal debt is only about two-thirds the size of the
U.S. GDP - a statistic that puts the U.S. well below
the debt-to-GDP levels of other industrialized
countries, such as Japan. Heated debate continues as
to whether the federal debt is too large and should
be paid down, or whether it is simply a necessary
catalyst for continued economic growth.

Fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection
(taxation) and expenditure (spending) to influence the economy. The two main instruments of
fiscal policy are changes in the level and composition of taxation and government spending in

various sectors. These changes can affect the following macroeconomic variables in an economy:
* Aggregate demand and the level of economic activity; * The distribution of income; * The
pattern of resource allocation within the government sector and relative to the.

What Is Fiscal Policy?

By Reem Heakal on October 09, 2013 A A A
Filed Under: Fiscal Policy, Government & Politics, Macroeconomics
Fiscal policy is the means by which a government adjusts its spending levels and
tax rates to monitor and influence a nation's economy. It is the sister strategy to
monetary policy through which a central bank influences a nation's money
supply. These two policies are used in various combinations to direct a country's
economic goals. Here we look at how fiscal policy works, how it must be
monitored and how its implementation may affect different people in an
economy.
Before the Great Depression, which lasted from Sept. 4, 1929 to the late 1930s
or early 1940s, the government's approach to the economy was laissez-faire.
Following World War II, it was determined that the government had to take a
proactive role in the economy to regulate unemployment, business cycles,
inflation and the cost of money. By using a mix of monetary and fiscal policies
(depending on the political orientations and the philosophies of those in power
at a particular time, one policy may dominate over another), governments are
able to control economic phenomena.

Definition of 'Fiscal Policy'

Government spending policies that influence macroeconomic conditions. Through fiscal policy,
regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and
influence interest rates in an effort to control the economy. Fiscal policy is largely based on the ideas
of British economist John Maynard Keynes (18831946), who believed governments could change
economic performance by adjusting tax rates and government spending.

Investopedia explains 'Fiscal

Policy'

To illustrate how the government could try to use

fiscal policy to affect the economy, consider an
economy thats experiencing a recession. The
government might lower tax rates to try to fuel
economic growth. If people are paying less in taxes,
they have more money to spend or invest. Increased
consumer spending or investment could improve
economic growth. Regulators dont want to see too
great of a spending increase though, as this could
increase inflation.
Another possibility is that the government might
decide to increase its own spending say, by
building more highways. The idea is that the
additional government spending creates jobs and
lowers the unemployment rate. Some economists,
however, dispute the notion that governments can
create jobs, because government obtains all of its
money from taxation in other words, from the
productive activities of the private sector.
One of the many problems with fiscal policy is that
it tends to affect particular groups
disproportionately. A tax decrease might not be
applied to taxpayers at all income levels, or some
groups might see larger decreases than others.
Likewise, an increase in government spending will
have the biggest influence on the group that is
receiving that spending, which in the case of
highway spending would be construction workers.
Fiscal policy and monetary policy are two major
drivers of a nations economic performance.
Through monetary policy, a countrys central bank
influences the money supply. Regulators use both
policies to try to boost a flagging economy,
maintain a strong economy or cool off an
overheated economy.

in economics and political science, fiscal policy is the use of government revenue collection
(taxation) and expenditure (spending) to influence the economy.[1] The two main instruments of
fiscal policy are changes in the level and composition of taxation and government spending in
various sectors. These changes can affect the following macroeconomic variables in an economy:

Aggregate demand and the level of economic activity;

The distribution of income;

The pattern of resource allocation within the government sector and relative to the private
sector.

Fiscal policy refers to the use of the government budget to influence economic activity
Laissez-faire ( i/lsefr-/, French: [lsef] ( listen)) (or sometimes laisser-faire)
is an economic environment in which transactions between private parties are free
from government restrictions, tariffs, and subsidies, with only enough regulations to
protect property rights.[1] The phrase laissez-faire is French and literally means "let
[them] do," but it broadly implies "let it be," "let them do as they will," or "leave it
alone."

Definition of 'Laissez Faire'

An economic theory from the 18th century that is strongly opposed to any government intervention
in business affairs.
Sometimes referred to as "let it be economics."

Investopedia explains 'Laissez

Faire'
People who support a laissez faire system are
against minimum wages, duties, and any other
trade restrictions.
Laissez faire is French for "leave alone.

Definition of 'Public Good'

A product that one individual can consume without reducing its availability to another
individual and from which no one is excluded. Economists refer to public goods as
"non-rivalrous" and "non-excludable". National defense, sewer systems, public parks
and basic television and radio broadcasts could all be considered public goods.

Investopedia explains 'Public Good'

One problem with public goods is the free-rider problem. This problem says that a
rational person will not contribute to the provision of a public good because he does
not need to contribute in order to benefit.

For example, if Sam doesn't pay his taxes, he still benefits from the government's
provision of national defense by free riding on the tax payments of his fellow citizens.

public good

Definition

An item whose consumption is not decided by the individual consumer but by the society as a
whole, and which is financed by taxation.
A public good (or service) may be consumed without reducing the amount available for others,
and cannot be withheld from those who do not pay for it. Public goods (and services) include
economic statistics and other information, law enforcement, national defense, parks, and other
things for the use and benefit of all. No market exists for such goods, and they are provided to
everyone by governments. See also good and private good.

Read more: http://www.businessdictionary.com/definition/publicgood.html#ixzz2pVFrzN9f

Definition of Public Good

A public good is often (though not always) underprovided in a free market because of its
characteristics of non-rivalry and non-excludability.

Public goods have two characteristics:

1. Non-rivalry: This means that when a good is consumed, it doesnt reduce
the amount available for others.
E.g. benefiting from a street light doesnt reduce light for others, but eating
an apple would.
2. Non-excludability: This occurs when it is not possible to provide a good
without it being possible for others to enjoy. E.g erecting a dam to stop
floodin, or providing law and order.

Definition of 'Tax Incidence'

An economic term for the division of a tax burden between buyers and sellers. Tax incidence is
related to the price elasticity of supply and demand. When supply is more elastic than demand, the
tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of
the tax.

Investopedia explains 'Tax

Incidence'
Tax incidence reveals which group, the consumers or
producers, will pay the price of a new tax. For
example, the demand for cigarettes is fairly inelastic,
which means that despite changes in price, the
demand for cigarettes will remain relatively constant.
Let's imagine the government decided to impose an
increased tax on cigarettes. In this case, the producers
may increase the sale price by the full amount of the
tax. If consumers still purchased cigarettes in the
same amount after the increase in price, it would be
said that the tax incidence fell entirely on the buyers.

Tax Incidence
Tax incidence is the degree to which a given tax is paid or borne by a particular economic unit
such as consumers, producers, employers, employees etc. When we say that the tax incidence of
a given tax falls on A, it means A ultimately pays or bears the burden of tax in greater proportion.
Tax incidence is of two types: statutory incidence and economic incidence.

Statutory incidence or nominal incidence of a given tax is the degree to which the tax is actually
paid by an economic unit in the form of cash, check etc. (Tax may be collected and deposited in
government's treasury by someone else). Statutory incidence is stated in tax law. For example, at
the time or writing, US tax laws require that tax on salary income of an employee must be borne
50% by employer and 50% by employee. In this case, statutory incidence of tax equally falls on
employer and employee.
Economic incidence of a given tax is the degree to which the burden of the tax is borne by an
economic unit in the form of reduced resources. Economic incidence of a tax does not
necessarily fall on the same economic unit on which its statutory incidence falls. Rather it
depends on the elasticity of demand and supply. When demand is inelastic and supply elastic, tax
burden is mainly on the consumer; in case of inelastic supply and elastic demand, tax incidence
falls mainly on producer. When both demand and supply are moderately elastic the tax incidence
is distributed between producers and consumers.

tax incidence
(noun)
Definition of tax incidence

The analysis of the effect of a particular tax on the distribution of economic welfare. Tax
incidence is said to "fall" upon the group that, at the end of the day, bears the burden of the tax.

Definition of 'Market Failure'

An economic term that encompasses a situation where, in any given market, the
quantity of a product demanded by consumers does not equate to the quantity supplied
by suppliers. This is a direct result of a lack of certain economically ideal factors,
which prevents equilibrium.

Investopedia explains 'Market Failure'

Market failures have negative effects on the economy because an optimal allocation of
resources is not attained. In other words, the social costs of producing the good or
service (all of the opportunity costs of the input resources used in its creation) are not
minimized, and this results in a waste of some resources.
Take, for example, the common argument against minimum wage laws. Minimum
wage laws set wages above the going market-clearing wage in an attempt to raise
market wages. Critics argue that this higher wage cost will cause employers to hire

fewer minimum-wage employees than before the law was implemented. As a result,
more minimum wage workers are left unemployed, creating a social cost and resulting
in market failure.

Market Failure
Definition of Market Failure

This occurs when there is an inefficient allocation of resources in a free market.

Types of market failure:
1. Positive externalities benefit to a third party, e.g. less congestion from
cycling
2. Negative externalities cost imposed on a third party, e.g. cancer from
passive smoking
3. Merit goods People underestimate benefit of good, e.g. education
4. Demerit goods People underestimate costs of good, e.g. smoking
5. Public Goods Goods which are non-rival and non-excludable e.g. police,
national defence
6. Monopoly Power when a firm controls market and can set higher prices
7. Inequality unfair distribution of resources in free market
8. Factor Immobility E.g. geographical / occupational immobility
9. Agriculture Agriculture is often subject to market failure

Key Terms in Market Failure

Externalities:
These occur when a third party is affected by the
decisions and actions of others.

Social benefit: is the total benefit to society =

Private Marginal Benefit (PMB) + External Marginal Benefit (XMB)

Social Cost: is the total cost to society =

Private Marginal Cost (PMC) + External Marginal Cost (XMC

Social Efficiency: This occurs when resources are utilised in the most
efficient way. This will occur at an output where social marginal cost (SMC) =
Social Marginal Benefit. (SMB)

Overcoming Market Failure

Tax on Negative Externalities

Carbon Tax

Subsidy on positive externalities

Laws and Regulations

Pollution Permits

Market failure is a concept within economic theory describing when the allocation of
goods and services by a free market is not efficient. That is, there exists another
conceivable outcome where a market participant may be made better-off without making
someone else worse-off. (The outcome is not Pareto optimal.) Market failures can be
viewed as scenarios where individuals' pursuit of pure self-interest leads to results that
are not efficient that can be improved upon from the societal point-of-view.[1][2] The first
known use of the term by economists was in 1958,[3] but the concept has been traced back
to the Victorian philosopher Henry Sidgwick.[4]

Market failures are often associated with time-inconsistent preferences,[5] information

asymmetries,[6] non-competitive markets, principalagent problems, externalities,[7] or
public goods.[8] The existence of a market failure is often the reason for government
intervention in a particular market.[9][10] Economists, especially microeconomists, are
often concerned with the causes of market failure and possible means of correction.[11]
Such analysis plays an important role in many types of public policy decisions and
studies. However, some types of government policy interventions, such as taxes,
subsidies, bailouts, wage and price controls, and regulations, including attempts to correct
market failure, may also lead to an inefficient allocation of resources, sometimes called
government failure.[12] Thus, there is sometimes a choice between imperfect outcomes,
i.e. imperfect market outcomes with or without government interventions. But either way,
if a market failure exists the outcome is not Pareto efficient. Mainstream neoclassical and
Keynesian economists believe that it may be possible for a government to improve the
inefficient market outcome, while several heterodox schools of thought disagree with this

Public Revenue is the income realized by the government for purposes of

financing public administration. Public revenue may be realized from taxation of the
various entities and activities within the country or from non-tax sources such as
revenue from government-owned corporations, public wealth funds, grants etc.
Government revenue is money received by a government. It is an important tool
of the fiscal policy of the government and is the opposite factor of government
spending. Revenues earned by the government are received from sources such as
taxes levied on the incomes and wealth accumulation of individuals and
corporations and on the goods and services produced, exported and imported from
the country, non-taxable sources such as government-owned corporations' incomes,
central bank revenue and capital receipts in the form of external loans and debts
from international financial institutions.

social safety net

DefinitionSave to FavoritesSee Examples
Social welfare services provided by a community of individuals at the state and local
levels These services are geared toward eliminating poverty in a specific area.
These services may include housing re-assignment, job placement, subsidies for
household bills, and other cash equivalents for food. Social safety net works in
conjunction with a number of other poverty reduction programs with the primary
goal of reducing/preventing poverty.
Read more: http://www.businessdictionary.com/definition/social-safetynet.html#ixzz2pVYWkRmk

Social safety net

From Wikipedia, the free encyclopedia
Jump to: navigation, search

Social safety nets, or "socioeconomic safety nets", are non-contributory transfer programs
seeking to prevent the poor or those vulnerable to shocks[disambiguation needed] and poverty from falling
below a certain poverty level. Safety net programs can be provided by the public sector (the state

and aid donors) or by the private sector (NGOs, private firms, charities, and informal household
transfers). Safety net transfers include:

Cash transfers

Food-based programs such as supplementary feeding programs and food

stamps, vouchers, and coupons

In-kind transfers such as school supplies and uniforms

Conditional cash transfers

Price subsidies for food, electricity, or public transport

Public works

Fee waivers and exemptions for health care, schooling and utilities

On average, spending on safety nets accounts for 1 to 2 percent of GDP across developing and
transition countries,[1] though sometimes much less or much more. In the last decade[when?], a
visible growing expertise in various areas of safety nets has taken place. However, even though
an increasing number of safety net programs are extremely well thought out, correctly
implemented, and demonstrably effective, many others face and create serious challenges.
Social Safety Net
Top
Home > Library > Miscellaneous > Oxford Articles
A system of available payments in cash or in kind which will keep people's incomes
from falling below some socially accepted minimum level. This needs to cover old
age, sickness and disability, and unemployment. It may include benefits in kind for
people with special requirements: for example, health care, and publicly provided
housing for those without the means or competence to house themselves privately.
Read more: http://www.answers.com/topic/social-safety-net#ixzz2pVZY0S91

What is SOCIAL SAFETY NET?

Community provided welfare services at local and state level geared towards reducing poverty in
the community. It can provide housing, jobs and money for utility bills and food coupons.

hedging
A risk management strategy used in limiting or offsetting probability of loss from
fluctuations in the prices of commodities, currencies, or securities. In effect, hedging
is a transfer of risk without buying insurance policies.

Hedging employs various techniques but, basically, involves taking equal and opposite positions
in two different markets (such as cash and futures markets). Hedging is used also in protecting
one's capital against effects of inflation through investing in high-yield financial instruments
(bonds, notes, shares), real estate, or precious metals.

Read more:
http://www.businessdictionary.com/definition/hedging.html#ixzz2pVa1GNgi

Definition of 'Hedge'
Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge
consists of taking an offsetting position in a related security, such as a futures contract.

Investopedia explains 'Hedge'

An example of a hedge would be if you owned a
stock, then sold a futures contract stating that you
will sell your stock at a set price, therefore
avoiding market fluctuations.
Investors use this strategy when they are unsure of
what the market will do. A perfect hedge reduces
your risk to nothing (except for the cost of the
hedge).

Definition of 'Liquidity'
1. The degree to which an asset or security can be bought or sold in the market without affecting the
asset's price. Liquidity is characterized by a high level of trading activity. Assets that can be easily
bought or sold are known as liquid assets.

2. The ability to convert an asset to cash quickly. Also known as "marketability."

There is no specific liquidity formula; however, liquidity is often calculated by using liquidity ratios.

Investopedia explains
'Liquidity'
1. It is safer to invest in liquid assets than
illiquid ones because it is easier for an
investor to get his/her money out of the
investment.
2. Examples of assets that are easily
converted into cash include blue chip and
money market securities.

Definition of 'Liquidity'

Definition: Liquidity means how quickly you can get your hands on your cash. In simpler terms,
liquidity is to get your money whenever you need it.
Description: Liquidity might be your emergency savings account or the cash lying with you that
you can access in case of any unforeseen happening or any financial setback. Liquidity also plays
an important role as it allows you to seize opportunities.
If you have cash and easy access to fund and a great deal comes along, then it's easier for you to
cease that opportunity. Cash, savings account, checkable account are liquid assets because they
can be easily converted into cash as and when required.

Definition of 'Price Risk'

The risk of a decline in the value of a security or a portfolio. Price risk is the biggest risk faced by all
investors. Although price risk specific to a stock can be minimized through diversification, market
risk cannot be diversified away. Price risk, while unavoidable, can be mitigated through the use of
hedging techniques.

Investopedia explains 'Price

Risk'
Price risk also depends on the volatility of the
securities held within a portfolio. For example, an
investor who only holds a handful of junior mining
companies in his or her portfolio may be exposed to a
greater degree of price risk than an investor with a
well-diversified portfolio of blue-chip stocks.
Investors can use a number of tools and techniques to
hedge price risk, ranging from relatively conservative
decisions such as buying put options, to more
aggressive strategies including short-selling and
inverse ETFs.

Price Risk What It Is:

Price risk is simply the risk that the price of a security will fall.
How It Works/Example:

Earnings volatility, unexpected financial performance, pricing changes, and bad management are
common factors in price risk. For example, assume that Company XYZ is trading at $4 per
share. The company is stable and doing well, but there is some uncertainty in the market about
Company XYZ's new model of widget that it coming out next year, and the economy looks like
it's headed for a recession. There is no certainty that the price of Company XYZ will stay at $4
per share or rise above $4, and thus investors in Company XYZ bear price risk when they hold
the stock.
Why It Matters:

Managing price risk is one of the fundamental tasks of portfolio management. Estimating,
predicting, and managing price risk are, in turn, primary objectives for nearly every investor. For
example, knowing that price risk is real and that some investments will indeed lost value,
investors hedge their portfolios via diversification, hedging, and/or trading strategically.

Definition of 'Floor Broker (FB)'

An independent member of an exchange who is authorized to execute trades on the exchange floor
on behalf of clients. A floor broker is a middleman who acts as an agent for clients, indirectly giving
them the best access possible to the exchange floor. A floor brokers clients typically include
institutions and wealthy people such as financial-service firms, pension funds, mutual funds, high net
worth individuals and traders. A floor brokers primary responsibility is best execution of client
orders, and to achieve this objective, he or she must continuously assess myriad factors including
market information, market conditions, prices and orders.
Also known as pit broker.

Investopedia explains 'Floor

Broker (FB)'
Once a floor broker receives a buy or sell order for a
specific stock, he or she will attempt to get the most
competitive market rate for the client. The floor
broker does this by proceeding to the trading post
on the exchange floor, where the specialist for the
stock is located, and bids against other brokers and
traders to get the best price for the stock purchase or
sale. Upon completing the transaction, the floor
broker notifies the client through the clients
registered representative.
A floor broker is different from a floor trader, who
trades as principal for his or her own account,
whereas the floor broker acts as an agent for clients.
A floor broker also differs from a commission
broker in that the latter is an employee of a member
firm, while the floor broker is an independent
member of the exchange.
A floor broker is an independent member of an exchange who can act as a broker
for other members who become overloaded with orders, as an agent on the floor of
the exchange. The floor broker receives an order via Teletype machine from his
firm's trading department and then proceeds to the appropriate trading post on the
exchange floor. There he joins other brokers and the specialist in the security being
bought or sold and executes the trade at the best competitive price available. On
completion of the transaction the customer is notified through his registered
representative back at the firm and the trade is printed on the consolidated ticker
tape which is displayed electronically around the country. A floor broker should not

be confused with a floor trader who trades as a principal for his or her own account,
rather than as a broker. Commission brokers are employees of a member firm.

A floor broker, also known as a pit broker, is a brokerage firm employee who executes orders on
the floor of a stock or commodity exchange on behalf of clients.

How It Works/Example:
A floor broker receives an order from a client through his or her brokerage firm and trades the
security with other brokers on the exchange floor. Based on interactions with specialists in the
specific securities being traded and bidding with other brokers or traders on the floor of the
exchange, the floor broker attempts to get the most competitive market rates available for his or
her client. When the floor broker executes a transaction on behalf of the client, he or she notifies
the client through the client's registered representative at the floor broker's firm.
A floor broker is different than a "floor trader" who, although he or she also works on the floor of
the exchange, makes trades as a principal for his or her own account. However, at times, floor
brokers also handle large volume trades on behalf of floor traders. The floor broker is licensed
by the relevant state authority and the US Securities and Exchange Commission. The floor
broker receives a fee for each securities trade.

Why It Matters:
Floor brokers act as agents for investor clients, giving them the closest thing possible to direct
access to the exchange floor. Floor brokers are responsible for assessing market information,
prices, competition, and using this information to make the best possible trades on behalf of their
clients.

credit union
See Examples Save to Favorites
Definition
A non-profit financial institution that is owned and operated entirely by its members.
Credit unions provide financial services for their members, including savings and
lending. Large organizations and companies may organize credit unions for their
members and employees, respectively. To join a credit union, a person must
ordinarily belong to a participating organization, such as a college alumni
association or labor union. When a person deposits money in a credit union, he/she
becomes a member of the union because the deposit is considered partial
ownership in the credit union.

Read more: http://www.investorwords.com/1214/credit_union.html#ixzz2pVnDZqcu

credit union

DefinitionSave to FavoritesSee Examples

Financial cooperative created for and by its members who are its depositors,
borrowers, and shareholders. Operated on non-profit basis, credit unions offer many
banking services, such as consumer and commercial loans (usually at lower than
market interest rates), time deposits (usually at higher than market interest rates),
credit cards, and guaranties. Credit unions are normally taxed at rates lower than
those applied to commercial banks and other financial institutions. Their members
often have a common-bond, such as employment in the same firm or domicile in the
same community. Credit unions are a type of mutual association.
Read more: http://www.businessdictionary.com/definition/creditunion.html#ixzz2pVnInWKg

Definition of 'Credit Union'

Member-owned financial co-operative. These institutions are created and operated by its members
and profits are shared amongst the owners.

Investopedia explains 'Credit

Union'
As soon as you deposit funds into a credit union account,
you become a partial owner and participate in the union's
profitability. Credit unions are formed by large corporations
and organizations for their employees and members.

mutual fund
See Examples Save to Favorites

Definition
An open-ended fund operated by an investment company which raises money from
shareholders and invests in a group of assets, in accordance with a stated set of
objectives.
Mutual funds raise money by selling shares of the fund to the public, much like any
other type of company can sell stock in itself to the public. Mutual funds then take
the money they receive from the sale of their shares (along with any money made
from previous investments) and use it to purchase various investment vehicles,
such as stocks, bonds and money market instruments. In return for the money they
give to the fund when purchasing shares, shareholders receive an equity position in
the fund and, in effect, in each of its underlying securities. For most mutual funds,
shareholders are free to sell their shares at any time, although the price of a share
in a mutual fund will fluctuate daily, depending upon the performance of the
securities held by the fund.
Benefits of mutual funds include diversification and professional money
management. Mutual funds offer choice, liquidity, and convenience, but charge fees
and often require a minimum investment.
Read more: http://www.investorwords.com/3173/mutual_fund.html#ixzz2pVnW3lGw
A mutual fund is a type of professionally managed collective investment scheme
that pools money from many investors to purchase securities.[1] While there is no
legal definition of the term "mutual fund", it is most commonly applied only to those
collective investment vehicles that are regulated and sold to the general public.
They are sometimes referred to as "investment companies" or "registered
investment companies."[2] Most mutual funds are "open-ended," meaning
stockholders can buy or sell shares of the fund at any time. Hedge funds are not
considered a type of mutual fund.

Definition of 'Mutual Fund'

An investment vehicle that is made up of a pool of funds collected

from many investors for the purpose of investing in securities such
as stocks, bonds, money market instruments and similar assets.
Mutual funds are operated by money managers, who invest the
fund's capital and attempt to produce capital gains and income for
the fund's investors. A mutual fund's portfolio is structured and
maintained to match the investment objectives stated in its

prospectus.
Investopedia explains 'Mutual Fund'

One of the main advantages of mutual funds is that they give small
investors access to professionally managed, diversified portfolios of
equities, bonds and other securities, which would be quite difficult (if
not impossible) to create with a small amount of capital. Each
shareholder participates proportionally in the gain or loss of the fund.
Mutual fund units, or shares, are issued and can typically be
purchased or redeemed as needed at the fund's current net asset
value (NAV) per share, which is sometimes expressed as NAVPS.
Are you interested in Mutual Funds? Check out How To Pick A Good
Mutual Fund and our Mutual Funds Tutorial for more information!

Leveraged buyout

A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or "bootstrap"

transaction) occurs when an investor, typically financial sponsor, acquires a controlling interest
in a company's equity and where a significant percentage of the purchase price is financed
through leverage (borrowing). The assets of the acquired company are used as collateral for the
borrowed capital, sometimes with assets of the acquiring company. Typically, leveraged buyout
uses a combination of various debt instruments from bank and debt capital markets. The bonds
or other paper issued for leveraged buyouts are commonly considered not to be investment
grade because of the significant risks involved.

Leveraged buyout
From Wikipedia, the free encyclopedia
Jump to: navigation, search

A leveraged buyout (LBO) is when a company or single asset (e.g., a real estate property) is
purchased with a combination of equity and significant amounts of borrowed money, structured
in such a way that the target's cash flows or assets are used as the collateral (or "leverage") to
secure and repay the money borrowed to purchase the target-company/asset. Since the debt (be it

senior or mezzanine) has a lower cost of capital (until bankruptcy risk reaches a level threatening
to the lender[s]) than the equity, the returns on the equity increase as the amount of borrowed
money does until the perfect capital structure is reached. As a result, the debt effectively serves
as a lever to increase returns-on-investment.
LBOs are a very common occurrence in today's "Mergers and Acquisitions" (M&A)
environment. The term LBO is usually employed when a financial sponsor acquires a company.
However, many corporate transactions are partially funded by bank debt, thus effectively also
representing an LBO. LBOs can have many different forms such as Management Buyout
(MBO), Management Buy-in (MBI), secondary buyout and tertiary buyout, among others, and
can occur in growth situations, restructuring situations and insolvencies. LBOs mostly occur in
private companies, but can also be employed with public companies (in a so-called PtP
transaction Public to Private).

Definition of 'Leveraged Buyout - LBO'

The acquisition of another company using a significant amount of borrowed money
(bonds or loans) to meet the cost of acquisition. Often, the assets of the company being
acquired are used as collateral for the loans in addition to the assets of the acquiring
company. The purpose of leveraged buyouts is to allow companies to make large
acquisitions without having to commit a lot of capital.

Investopedia explains 'Leveraged Buyout - LBO'

In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high
debt/equity ratio, the bonds usually are not investment grade and are referred to as junk
bonds. Leveraged buyouts have had a notorious history, especially in the 1980s when
several prominent buyouts led to the eventual bankruptcy of the acquired companies.
This was mainly due to the fact that the leverage ratio was nearly 100% and the
interest payments were so large that the company's operating cash flows were unable
to meet the obligation.
One of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by
Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. The three
companies paid around $33 billion for the acquisition.
It can be considered ironic that a company's success (in the form of assets on the
balance sheet) can be used against it as collateral by a hostile company that acquires it.
For this reason, some regard LBOs as an especially ruthless, predatory tactic.

Institutional investors are organizations which pool large sums of money and invest those sums
in securities, real property and other investment assets. They can also include operating
companies which decide to invest their profits to some degree in these types of assets.
Typical investors include banks, insurance companies, retirement or pension funds, hedge funds,
investment advisors and mutual funds. Their role in the economy is to act as highly specialized
investors on behalf of others. For instance, an ordinary person will have a pension from his
employer. The employer gives that person's pension contributions to a fund. The fund will buy
shares in a company, or some other financial product. Funds are useful because they will hold a
broad portfolio of investments in many companies. This spreads risk, so if one company fails, it
will be only a small part of the whole fund's investment.
An institutional investor can have some influence in the management of corporations because it
will be entitled to exercise the voting rights in a company. Thus, it can actively engage in
corporate governance. Furthermore, because institutional investors have the freedom to buy and
sell shares, they can play a large part in which companies stay solvent, and which go under.
Influencing the conduct of listed companies, and providing them with capital are all part of the
job of investment management.
A graduated payment mortgage loan, often referred to as GPM, is a mortgage
with low initial monthly payments which gradually increase over a specified time
frame. These plans are mostly geared towards young men and women who cannot
afford large payments now, but can realistically expect to do better financially in the
future. For instance a medical student who is just about to finish medical school
might not have the financial capability to pay for a mortgage loan, but once he
graduates, it is more than probable that he will be earning a high income. It is a
form of negative amortization loan.

Definition of 'Graduated Payment Mortgage'

A type of fixed-rate mortgage in which the payment increases gradually from an initial low base
level to a desired, final level. Typically, the payments will grow 7-12% annually from their initial
base payment amount until the full payment is reached.

Investopedia explains
'Graduated Payment Mortgage'
In a graduated payment mortgage, only the low initial
rate is used to qualify the buyer, which allows many

people who might not otherwise qualify for a mortgage

to own a home. This type of mortgage payment system
may be optimal for young homeowners as their income
levels gradually rise to meet higher mortgage
payments.
Decision Tree offers Strategic Content Management solutions across diverse fields
ranging from Education to Executive Profile Development, Marcom to Project
Reports. Our dedicated team has a cumulative experience of thousands of hours of
innovative writing, be it technical or rhetorical.

A decision tree is a diagram that a decision maker can create to help select the best of several
alternative courses of action. The primary advantage of a decision tree is that it assigns exact
values to the outcomes of different actions, thus minimizing the ambiguity of complicated
decisions. Because they map out an applied, real-world logical process, decision trees are
particularly important to building "smart" computer applications like expert systems. They are
also used to help illustrate and assign monetary values to alternative courses of action that
management may take.
A decision tree represents a choice or an outcome with a fork, or branch. Several branches may
extend from a single point, representing several different alternative choices or outcomes. There
are two types of forks: (1) a decision fork is a branch where the decision maker can choose the
outcome; and (2) a chance or event fork is a branch where the outcome is controlled by chance or
external forces. By convention, a decision fork is designated in the diagram by a square, while a
chance fork is usually represented by a circle. It is the latter category of data, when associated
with a probability estimate, that makes decision trees useful tools for quantitative analysis of
business problems.
A decision tree emanates from a starting point at one end (usually at the top or on the left side)
through a series of branches, or nodes, until two or more final results are reached at the opposite
end. At least one of the branches leads to a decision fork or a chance fork. The diagram may
continue to branch as different options and chances are diagrammed. Each branch is assigned an
outcome and, if chance is involved, a probability of occurrence.

A decision tree is a decision support tool that uses a tree-like graph or model of decisions and
their possible consequences, including chance event outcomes, resource costs, and utility. It is
one way to display an algorithm.

Decision trees are commonly used in operations research, specifically in decision analysis, to
help identify a strategy most likely to reach a goal.

Redundant Constraints
Adding redundant constraints to a constraint model is probably the most widely
used improvement technique for finite domain constraints. Redundant constraints
are constraints which are declaratively implied by the other constraints of the
model. But, due to the incomplete constraint propagation, these redundant
constraint can contribute a lot to the propagation and help us to avoid infeasible
assignments.

The real problem with redundant constraints is not finding such constraints, but finding those
which will really help with the propagation. Often it is a good idea to add some redundant global
constraints, as these constraints include powerful propagation methods.
payoff table
a table showing the financial returns minus costs for each of the strategies under consideration.

Decision analysis tool that summarizes pros and cons of

a decision in a tabular form. It lists payoffs (negative or
positive returns) associated with all possible combinations of
alternative actions (under the decision maker's control) and
external conditions (not under decision maker's control).
Also called payoff matrix.
payoff table
See also decision theory

Related Terms:
decision theory
systematic approach to making decisions especially under uncertainty. Although statistics such
asexpected valueand standard deviationare essential for choosing the best course of action, the
decision problem can best be approached, using what is referred to as a payoff table(ordecision
matrix), which is characterized by: (1) the row representing a set of alternativeavailable to the
decision maker; (2) the columnrepresenting the or conditions that are likely to occur and over which
the decision maker has no control; and (3) the entries in the body of the table representing the
outcome of the decision, known as payoffs,which may be in the form of costs, revenues, profits, or
cash flows. By computing expected value of each action, we will be able to pick the best one.

What is PAYOFF TABLE?

A tool used for decision analysis which lists down all the pros and cons of any decision.
It makes use of payoffs, and provides various combinations or alternatives, giving a
better idea of the situation. Known as a payoff matrix too.

Law Dictionary: http://thelawdictionary.org/payoff-table/#ixzz2pXD4L0Hx