Inflation is the term used in economics to describe the rate at which the price of a representative basket of goods is increasing. Some inflation is good, and central banks attempt to achieve a consistently inflation level of around 2%. However, if inflation becomes too high then purchasing power is reduced and consumer spending is reduced.
The typical response to undesirable inflation levels by central banks is to adjust interest rates; raise them to avoid high inflation to promote saving and reduce spending or lower them to encourage spending and lending.
An Initial Public Offering or IPO is the very first sale of stock to the public by a private company. This is also known as 'going public'. There are two kinds of companies who will undertake an IPO:
- Startup companies looking to raise capital and investors
- Large private companies looking to become publicly traded
A company looking to conduct an IPO will usually employ an investment bank to help with the IPO, with the advisory service provided including valuation and timing.
Investing in IPO companies is usually risky as there is no historical data on the performance of the stock and the stock of newly public companies typically tends to fluctuate wildly after and on the IPO date.
Insider trading is a financial crime which involves trading based on information which is not available to the general public. Insider trading is only illegal when the information being used is not available to the public, for example if a press statement has been made regarding the issue then anyone within the company is free to act on that information.
Giving advice or tips to a 3rd party in order for them to act on your behalf is also insider trading, and makes the 3rd party liable to the crime as well.
A company or government is deemed to be insolvent when it cannot pay its debts (i.e. is due to default). It is insolvency if it is due to not actually having enough money to pay off the debt, whereas simply not being able to access the money (which is a problem in itself) is a lack of liquidity.
When an entity is insolvent, some or all of its assets can be liquidated to pay off those with a claim on debt. Insolvency is usually undesirable for both the lender and the borrower as the assets are unlikely to be sold at face value, and therefore there is usually in the best interests of both parties to attempt to make alternative payment arrangements.
The rate of interest is the amount charged on any debt by the creditor to the borrower. An interest rate is expressed in percentage points (%) or in basis points (bps), and is usually charged on an annual rate.
The rate of interest charged will usually depend on the credit-worthiness or riskiness of the borrower. A high-risk borrower will be charged a higher rate of interest than a low risk borrower, all other things being equal.
An example of interest rates is as follows:
- An investor wishes to borrow $1,000,000 to invest in the stock market
- A bank loans the investor $1,000,000 for 5 years at an annual rate of 5%
- The investor has to pay $50,000 per year to the bank in interest as well as the $1,000,000 at the end of the 5 years
- If the investor earns more than 5% per year, he will make a profit, otherwise he will lose money or break-even
The IMF, or International Monetary Fund, is a global organisation which helps monitor and support the global economy. Its main responsibilities are:
- Providing funds and liquidity for countries in financial difficulties
- Monitor the global economy and stability
- Provide expertise and advice to those countries that need it
A Joint Venture (JV) is when a group of business collaborate on a business project, each taking a share of the profits, losses and control. A joint venture simply requires working together, no merger or any other kind of operations combination is required, allowing each business to keep its autonomy.
A junk bond is a high-risk bond that is rated BB or lower by one of the main ratings agencies. There is a reasonably high risk that the issuer of the bond will default on the payments, hence the low rating. Junk bonds usually pay a high rate of interest.
There are two reasons for purchasing junk bonds. The first option is for speculation purposes, going on the assumption that the issuer is more credit-worthy than they are being given credit for and that they will actually meet the high payments.
The other strategy is to purchase a large amount of diverse junk bonds and assume that only a few will default, but that the high return by the ones which succeed will more than outweigh the defaulting ones.
Junk bonds became very popular in the 1980s through the work of Drexel Burnham Lambert and Michael Milken.