Defining terms for the amateur investor.
Introduction
The majority of developed countries across the world have a developed financial centre for conducting international business. With London, New York, and Tokyo being at the forefront of this. A competitive financial centre provides employment and opportunities for growth in a national economy and is therefore often its status is enhanced by governments[1].
The New York Stock exchange (credit: creative commons)
The Role of the Financial Centre
Financial Centre: A firm that both borrows and lends in the market for gains in financial capital. [2]
The roles of the financial centre are important for the success of an economy. One such role includes the recycling of surplus funds and replacing deficit funds, in other words balancing the economy. These funds pass through financial intermediaries such as banks; the financial deficits are then loaned money. This is then turned into profits and surplus funds[1]
Regulation
Government intervention is required in financial markets to avoid market failure, there are four main types of market failure the government intervenes in.
Externalities: Financial institutions are key to linking lenders and users of funds. Because of this disruptions and issues in financial institutions can wreak havoc in an economy. [2]
Asymmetric information: higher roles of people in financial institutions have access to private information in their companies, this information is unfair on the investor with less information and can lead to issues such as insider trading. Governments often have laws such as disclosure requirements and regulated insider trading to avoid market failure occurring.[1]
Moral Hazard: The Moral hazard implies that when investors believe they are insured against an event occurring they are more likely to take larger risks, ultimately these risks lead to larger losses, both by the investor and those insuring them.[1]
Principal Agent: Directors and managers of financial institutions become agents for investors in their institutions, this means they can often be motivated by personal gains rather than an investor's best interest; therefore they are obligated to disclose the financial performance of a company to its investors.[1]
Options
Options are a type of financial asset giving the holder the right but not the obligation to buy or sell an asset at a predetermined price; there are two main types of option contracts, put options and call options. The contract involves two parties, the writer or seller of the option and the holder who buys the option. The holder can sell or buy an asset at a predetermined price in the future although they are not obligated to do so. Call options are defined when the holder has the right to buy the asset at a predetermined price, put options are known when the holder has the right to sell at a predetermined price. [1]
Using a call option is useful when the price of a share rises above the option price. When a market price rises above the option price, standard strategy would suggest that the holder would purchase the shares at option pricing, and then sell them at the market price, their profit being the difference between the two prices. Buying a call option is known as a long call, selling it is known as a short call.[1]
In contrast, we can approach the usefulness of a put option. A put option is useful when the potential holder believes the price of the asset will fall, the writer of the option sells the option at a premium. If the assets price rises above the initial price then the holder will not sell, if the price falls but does not fall more than the cost of the option premium the holder will sell but still make a minor loss, if the price falls more than the difference of the premium price then the holder will make a profit.[1]
Cryptocurrency
Physical representations of cryptocurrencies (credit: creative commons)
Cryptocurrencies are decentralized digital currencies; they are not controlled by a person or institution and they do not rely on physical materials[3]. One interesting point made about cryptocurrencies is the consideration that they are only used as a store of value, despite there being an infrastructure in place to transfer them the value of such currencies could be negated completely if they are not used as currency in the future and equally if countries decide to ban them completely based on the legality of them.[3]
References
[1] Pilbeam, K., 2018. Finance & financial markets Fourth.,
[2] Parkin, M., 2018. Economics. Thirteenth edition / Michael Parkin.; Global.,
[3] Franco, P., 2015. Understanding bitcoin: cryptography, engineering and economics. 1st ed.,
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