recapitalisation

When a company changes its capital structure (the proportion of equity to debt), This may occur,
for instance, as part of a debt restructuring, when a creditor exchanges an outstanding loan for a
stake in the company (debt for equity swap). While the aim of a recapitalisation is normally to
improve a company's debt/equity ratio, it can also be used to fend off a hostile takeover - in
which case the company makes itself unattractive by increasing the level of debt in its capital and
using the funds to pay special dividends to shareholders.

dividend yield
The yield a company pays out to its shareholders in the form of dividends. It is calculated by
taking the amount of dividends paid per share over the course of a year and dividing by the
stock's price. For example, if a stock pays out $2 in dividends over the course of a year and
trades at $40, then it has a dividend yield of 5%. Mature, well-established companies tend to
have higher dividend yields, while young, growth-oriented companies tend to have lower ones,
and most small growing companies don't have a dividend yield at all because they don't pay out
dividends.

Derivatives 101
August 05 2010 | Filed Under » Alternative Investments , Derivatives , Investing Basics , Portfolio
Management

Email

Print

Reprints

Feedback

Investing has become much more complicated over the past decades as various types of derivative
instruments become created. But if you think about it, the use of derivatives has been around for a very
long time, particularly in the farming industry. One party agrees to sell a good and another party agrees
to buy it at a specific price on a specific date. Before this agreement occurred in an organized market,
the bartering of goods and services was accomplished via a handshake. The type of investment that
allows individuals to buy or sell the option on a security is called a derivative. Derivatives are types of
investments where the investor does not own the underlying asset, but he makes a bet on the direction
of the price movement of the underlying asset via an agreement with another party. There are many
different types of derivative instruments, including options, swaps, futures and forward contracts.
Derivatives have numerous uses as well as various risks associated with them, but are generally
considered an alternative way to participate in the market. (Follow this tale of a fictional chicken farm to
learn how derivatives work in the market. For more information, see The Barnyard Basics Of
Derivatives.)

A Quick Review of Terms

Derivatives are difficult to understand partly because they have a unique language. For instance, many
instruments have counterparty, who is responsible for the other side of the trade. Each derivative has an
underlying asset for which it is basing its price, risk and basic term structure. The perceived risk of the
underlying asset influences the perceived risk of the derivative.

Pricing is also a rather complicated variable. The pricing of the derivative may feature a strike price,
which is the price at which it may be exercised. When referring to fixed income derivatives, there may
also be a call price which is the price at which an issuer can convert a security. Finally, there are different
positions an investor can take: a long position means you are the buyer and a short position means you
are the seller.

How Derivatives Can Fit into a Portfolio

Investors typically use derivatives for three reasons: to hedge a position, to increase leverage or to
speculate on an asset's movement. Hedging a position is usually done to protect against or insure the
risk of an asset. For example if you own shares of a stock and you want to protect against the chance
that the stock's price will fall, then you may buy a put option. In this case, if the stock price rises you gain
because you own the shares and if the stock price falls, you gain because you own the put option. The
potential loss from holding the security is hedged with the options position.

Leverage can be greatly enhanced by using derivatives. Derivatives, specifically options are most
valuable in volatile markets. When the price of the underlying asset moves significantly in a favorable
direction, then the movement of the option is magnified. Many investors watch the Chicago Board
Options Exchange Volatility Index (VIX) which measures the volatility of the S&P 500 Index options. High
volatility increases the value of both puts and calls.

Speculating is a technique when investors bet on the future price of the asset. Because options offer
investors the ability to leverage their positions, large speculative plays can be executed at a low cost

Trading
Derivatives can be bought or sold in two ways. Some are traded over-the-counter (OTC) while others are
traded on an exchange. OTC derivatives are contracts that are made privately between parties such as
swap agreements. This market is the larger of the two markets and is not regulated. Derivatives that
trade on an exchange are standardized contracts. The largest difference between the two markets is
that with OTC contracts, there is counterparty risk since the contracts are made privately between the
parties and are unregulated, while the exchange derivatives are not subject to this risk due to the
clearing house acting as the intermediary.

NTRR On Verge of Breakout

Types
There are three basic types of contracts-options, swaps and futures/forward contracts- with variations
of each. Options are contracts that give the right but not the obligation to buy or sell an asset. Investors
typically will use option contracts when they do not want to risk taking a position in the asset outright,
but they want to increase their exposure in case of a large movement in the price of the underlying
asset. There are many different option trades that an investor can employ, but the most common are:

 Long Call
If you believe a stock's price will increase, you will buy the right (long) to buy (call) the stock. As
the long call holder, the payoff is positive if the stock's price exceeds the exercise price by more
than the premium paid for the call.
 Long Put
If you believe a stock's price will decrease, you will buy the right (long) to sell (put) the stock. As
the long put holder, the payoff is positive if the stock's price is below the exercise price by more
than the premium paid for the put.
 Short Call
If you believe a stock's price will decrease, you will sell or write a call. If you sell a call, then the
buyer of the call (the long call) has the control over whether or not the option will be exercised.
You give up the control as the short or seller. As the writer of the call, the payoff is equal to the
premium received by the buyer of the call if the stock's price declines, but if the stock rises more
than the exercise price plus the premium, then the writer will lose money.
 Short Put
If you believe the stock's price will increase, you will sell or write a put. As the writer of the put,
the payoff is equal to the premium received by the buyer of the put if the stock price rises, but if
the stock price falls below the exercise price minus the premium, then the writer will lose
money.

Swaps are derivatives where counterparties to exchange cash flows or other variables associated with
different investments. Many times a swap will occur because one party has a comparative advantage in
one area such as borrowing funds under variable interest rates, while another party can borrower more
freely as the fixed rate. . A "plain vanilla" swap is a term used for the simplest variation of a swap. There
are many different types of swaps, but three common ones are:

Advertisment - Article continues below.

  Interest Rate Swaps
Parties exchange a fixed rate for a floating rate loan. If one party has a fixed rate loan but has
liabilities that are floating, then that party may enter into a swap with another party and
exchange fixed rate for a floating rate to match liabilities. Interest rates swaps can also be
entered through option strategies. A swaption gives the owner the right but not the obligation
(like an option) to enter into the swap.

 Currency Swaps
One party exchanges loan payments and principal in one currency for payments and principal in
another currency.

 Commodity Swaps
This type of contract has payments based on the price of the underlying commodity. Similar to a
futures contract, a producer can ensure the price that the commodity will be sold and a
consumer can fix the price which will be paid.

Forward and future contracts are contracts between parties to buy or sell an asset in the future for a
specified price. These contracts are usually written in reference to the spot or today's price. The
difference between the spot price at time of delivery and the forward or future price is the profit or loss
by the purchaser. These contracts are typically used to hedge risk as well as speculate on future prices.
Forwards and futures contracts differ in a few ways. Futures are standardized contracts that trade on
exchanges whereas forwards are non-standard and trade OTC. (The futures markets can seem daunting,
but these explanations and strategies will help you trade like a pro. To learn more, check out Tips For
Getting Into Futures Trading.)

The Bottom Line

The proliferation of strategies and available investments has complicated investing. Investors who are
looking to protect or take on risk in a portfolio can employ a strategy of being long or short underlying
assets while using derivatives to hedge, speculate or increase leverage. There is a burgeoning basket of
derivatives to choose from, but the key to making a sound investment is to fully understand the risks -
counterparty, underlying asset, price and expiration - associated with the derivative. The use of a
derivative only makes sense if the investor is fully aware of the risks and understands the impact of the
investment within a portfolio strategy.

Read more: http://www.investopedia.com/articles/optioninvestor/10/derivatives-

101.asp?partner=pitm021412#ixzz1mZcns692
Appreciation and Depreciation

key terms

Mouse-over a link for a quick definition or click to read more in-depth!

currency

aggregate demand

appreciation

depreciation

net exports

 appreciation: An increase in the exchange rate.

o The home currency becomes relatively more expensive for foreigners to buy.
Appreciation also means that foreign currency becomes relatively cheaper for you to
buy.
 If prices in both countries remain the same, an appreciation will make foreign
goods relatively cheaper to you, leading to an increase in imports. It also means
that, even if prices remain the same, your goods will be more expensive to
foreigners. They will buy less of your goods and exports will fall. As a result, your
country's net exports will fall.
 This change to net exports causes a leftward shift of the aggregate demand
curve.
 Example
o Example: The exchange rate for the dollar with the euro on June 12, 2008 was e = 0.645
€/$. If the exchange rate today were e = 0.9 €/$ the dollar has appreciated.
 Let's say I was interested in importing Belgian chocolates that cost 1 € each.
 If I took $100 to the exchanger on June 12th I would have gotten 65 €
and could have bought 65 chocolates.
 If I took $100 to the exchanger today I would have gotten 90 € and
could have bought 90 chocolates!
 depreciation: A decrease in the exchange rate.
o The home currency becomes relatively cheaper for foreigners to buy. Depreciation also
means that foreign currency becomes relatively more expensive for you to buy.
 If prices in both countries remain the same, depreciation will make foreign
goods relatively more expensive to you, leading to a fall in imports. It also
means that, even if prices remain the same, your goods will be cheaper to
foreigners. They will buy more of your goods and exports will rise. As a result,
your country's net exports will increase.
 This change to net exports causes a rightward shift of the aggregate demand
curve curve.
o Example: The exchange rate for the dollar with the Euro on June 12, 2008 was e = 0.645
€/$. If the exchange rate today were e = 0.5 €/$ the dollar has depreciated.

 Let’s say I was interested in importing Belgian chocolates that cost 1 € each
 If I took $100 to the exchanger on June 12th I would have gotten 65 €
and could have bought 65 chocolates.
 If I took $100 to the exchanger today I would have gotten 50 € and
could have bought 50 chocolates!
 The price of Belgian chocolates did not change, but because the dollar
depreciated they become more expensive to you – so you import less.