Tag: Learn

Definition:

Equity is a part of a business or other assed, owned by its investors. Equity is calculated by deducting any outstanding obligations, such as taxes or bills,  from the asset’s overall worth.

‍

Equity appears on most companies’ balance sheets and is used to assess their condition. It can be divided among multiple owners, just as large corporations frequently have many shareholders.

‍

Equity is like a pizza you have bought with a friend. You don’t own the entire pizza, and you’re only allowed to eat a portion of it equal to the percentage of the pizza you paid for. Similarly, ownership in a company or other asset is determined by the percentage paid for. Subtracting the company’s liabilities from its assets and then multiplying by the person’s ownership percentage yields the dollar value of their equity.

‍

Calculating equity
‍

To calculate a company’s total ownership equity, use the following formula: owner’s equity = assets – liabilities.

If a company has more than one owner, the value of each person’s ownership stake can be calculated by identifying the total equity in the company and then multiplying it by the percentage of the company that each owner owns. Assume a fictitious company called Anna’s Burger has $1 million in assets, $0.5 million in liabilities, and five owners with equal shares. A single owner’s equity in the company would be equal to ($1M-$0.5M) * 20%, or $100,000.

‍

Types of equity
‍

– Common stock is a type of stock that typically includes voting rights, which allow shareholders to vote on important business decisions. It may also pay dividends if the company performs well.

‍

– Preferred stock frequently lacks voting rights but has other advantages that make it more desirable than common stock. In contrast to the variable, lower price paid to common stockholders, companies pay fixed dividends to preferred shareholders. Preferred shareholders also have first dibs on dividends.

‍

– Private equity refers to investments in non-publicly traded companies.

‍

– The funds raised by issuing shares at a price above par value are known as contributed surplus. The face value of each stock is determined by the corporate charter of the company and is known as par value. The corporation guarantees not to issue any shares below the par value price by fixing it. Par value is frequently listed quite low because of this.

‍

– Retained earnings are a company’s profits after any dividends or other payments to investors have been deducted. The business uses this money to finance capital investments, R&D, marketing, or even acquisitions in order to fuel its growth.

‍

– Treasury stock is stock that a business has sold and then bought back. The total number of outstanding shares on the market is decreased by these repurchases. Treasury stock lowers shareholders’ equity because these equities are no longer owned by shareholders.

‍

– Home equity is the portion of the property’s value that the owner personally owns. It can be estimated by deducting the total value of the house from the outstanding loans.

‍

The working process of equity financing
‍

A corporation has a number of choices if it needs to raise capital. Equity finance, or the sale of firm shares, is one of them.

Before they grow to be large enough to perform an IPO and sell their shares on the stock market, many businesses rely on private funding. The money obtained via the founders’ sale of a portion of their business in order to raise money is known as private equity.

Yes, the business owner must sell a portion of the property, but he can use the proceeds to grow the enterprise.

‍

The difference between stocks and equity
‍

Stock is one variety of equity. Because of this, not all equity is stocks; rather, not all stocks are equity.

An investor-owned stake in a business is referred to as equity. Stock shares, which are traded on the stock market, are the most popular kind of equity. Stock is the full ownership of a company. Each share of stock, which is divided into multiple pieces, has an equal stake in the company. However, as was said earlier, a company’s equity can also comprise different things like retained earnings and business equity.

‍

Why is investing in equities profitable?
‍

‍Equities have dangers like other investments do, but because of their advantages, many investors find them to be particularly alluring.

One is that the value of stocks may increase with time. Businesses that are run effectively typically grow more profitable over time. You could profit from the sale if you were to buy in one and then sell your shares years later.

Additionally, dividends from your investment may allow you to profit. Businesses that are successful distribute a percentage of their income to their shareholders. This implies that you might get a portion of your money back each quarter. By doing so, a profit could be made without having to sell the initial shares.

‍

Real estate consists of land, constructions built on that land, and also its natural resources, including minerals and crops.

‍

What is Real Estate?
‍

Real estate consists of land and anything that is permanently affixed to it, including residences, structures, and storage facilities. The residential, commercial, industrial, and vacant land segments of the real estate market are separated. Real estate investments can be made directly by purchasing real estate, such as a house, apartment complex, retail space, or open field, as well as through REITs, real estate mutual funds, real estate exchange-traded funds (ETFs), and real estate investment trusts (REITs). Real estate investing offers advantages and disadvantages.

‍

EXAMPLE
‍

When a young man decides to buy his first house, it is itself and the land it sits on – are residential estate. Then he decides to open a donut shop. When he buys a store, he gets commercial real estate. Two years later, he decides to open a donut factory – it is industrial real estate, including the land of the factory.

‍

Beginning a business is similar to investing in real estate. Both call for financial and time commitments. They are probably going to appreciate in value if you invest the right resources in them. But if you ignore them, they can disintegrate. Additionally, outside variables like the economy might have an impact on their worth in both situations.

‍

Types of real estate
‍

Real estate can be divided into four major categories:

‍

  1. Residential

Residential real estate includes homes for single people and small families. Residential real estate can be purchased to generate rental revenue. Residential real estate includes single-family homes, townhomes, holiday properties, etc.

 2. Commercial

Commercial real estate comprises office buildings, hotels, shopping centers and so on. Compared to residential real estate, leases are often shorter and down payments are bigger. Commercial real estate frequently has a higher value than residential real estate. They are typically also more regulated.

  3. Industrial real estate is used for manufacturing processes (factory, warehouse).

  4. Vacant land includes empty land, unoccupied parcels and reclaimed sites.

‍

The working process of real estate industry
‍

The properties that are up for sale in a particular location make up the real estate market. Only residential properties are included in the housing market, a subsection of the real estate industry. Property values may increase (or decrease) as a result of economic factors in a market.

There are various segments of the real estate market:

‍

• Property management firms assist landlords in finding tenants for their properties. They manage tenants, show apartments, take care of repairs, and collect rent.
• Development: To create a finished product that can be sold or leased to end users, real estate developers must purchase undeveloped land, rezone it, build it, and restore it. By making enhancements to real estate, developers earn.
• Lending: Lenders of real estate, such banks and governmental organisations, are crucial. In fact, the majority of builders and developers use debt to finance their operations.
• Sales and marketing: These businesses work with property developers to market and sell their apartments through brokers. In addition, they produce marketing materials and are paid a commission.
• Professional services: The real estate sector is maintained by professionals, such as designers, lawyers.
• Brokerage: brokerage firms hire real estate agents to work on transactions between the seller and the buyer.

‍

Investing in real estate
‍

‍Real estate investing can be done in a variety of ways. Here are a few typical instances:

– Direct investment in real estate

– Real estate investment trusts (REITs)

– Real estate mutual funds

– Real estate ETFs

– Real estate investment groups

‍

Direct investment: Purchasing real estate or an interest in one constitutes a direct investment. The most typical direct real estate investment in the United States is homeownership. An additional direct investment is a rental property. When you purchase an investment property, your goals are to sell it for more money than you paid for it or to generate income through rent.

‍

A real estate investment trust (REIT) pools the funds of numerous investors to purchase and manage real properties. A REIT operates similarly to a mutual fund. It enables small investors to own a portion of the revenue generated by real estate assets, including retail spaces or storage facilities. Retail REITs, residential REITs, and industrial REITs are a few examples of specialised REITs in which you might invest. Since you may buy and sell REITs on major markets like stocks, they are relatively liquid investments. A REIT is required by law to distribute to investors at least 90% of its net income. Investments are risky by nature.

‍

Mutual funds that specialize in investing in assets sold by publicly traded real estate corporations are known as real estate mutual funds.

‍

ETFs that invest in real estate provide extensive exposure to the industry. Exchange-traded funds can be used to invest in REITs, real estate service providers, and real estate development companies (ETFs). Investments are risky by nature.

‍

Members of real estate investment groups pool their funds to purchase rental properties. In exchange for a portion of the monthly fee, the business managing the group oversees the apartments.

‍

The most obvious advantages of investing in real estate are leverage and a consistent stream of income from rent payments. However, there are some drawbacks, including the high risk of being a landlord and the fact that properties are not liquid (if you need to sell quickly, you may have to sell for less than the property’s value).

‍

Definition:

A balance sheet is an important financial statement that a company makes. This report provides its financial situation: the presence of assets liabilities and equity.

‍

For clarity, it is necessary to imagine the scales. Then, the balance sheet can be expressed as a financial equation that is in perfect equilibrium at any time. Balance sheet is one of the most common financial statements. It shows the amount of all assets a company owns and equates it to the amount of their liabilities (long-term debts, bills, loans) as well as the shareholders’ equity.

‍

This form of reporting is actively used by analysts and investors to examine information about the company, its funding sources, growth support and ordinary operations. The sum of assets in balance sheet always equals the sum of liabilities and equity of the company.

An asset is something a company possesses and that has worth, either in the form of cash or value, needed to operate the business.

A liability, which can be long-term or short-term, is the debt the company owes to third parties.

‍

Where to read a Balance Sheet?
‍

The regulator requires public companies to fill out financial statements and updates once a quarter and keep them publicly available. Balance sheets, as mentioned earlier, are one type of these financial statements. You can find them in quarter reports that are published on the company’s website.

Private companies are not required to reveal their financial position and usually do so only to a limited circle of people (the board of directors, the largest shareholders).

Balance sheets usually list assets and liabilities in order of how easily they can be converted into cash, which means how ‘liquid’ they are on financial jargon.

‍

How to analyze balance sheets?
‍

For example, you can plot the debt-to-equity ratio, this helps figure out the potential value of the stock if the company closes, sells its assets, or pays its debts.

‍

Using the ratio method:

– Activity ratios. These focus on current accounts and show how efficiently a company generates income using its own cash and resources: inventory, accounts payable and accounts receivable.

– Financial Strength Ratios. These ratios show the stability of a company in meeting its obligations (like payments to creditors). They can also be used to see how the company finances its operations; how easily it can meet its short-term obligations with available working (short-term) cash.

‍

Why are balance sheets useful?
‍

Balance sheets can provide key information about how a company covers its expenses and how efficiently it operates. They can help investors understand a company’s situation and state of affairs relatively quickly, and they are also useful for creditors.

‍

Disadvantages of balance sheets
‍

– Historical limitations. Balance sheets provide information and reflect financial events that have already passed, But, of course, this type of reporting can help predict the future trajectory of the company.

– A limited list of assets. The balance sheet accounts consider only those assets that are acquired by the company as a result of transactions. Goodwill in the balance sheet is intangible assets (technology, patents, brand). However, it is quite difficult to quantify them.

– Assets valuation rules. Long-term assets, such as land or real estate, in the balance sheet are equal to the transaction price less accumulated depreciation. On the balance sheet, this is reported as an expense during a financial period, such as a year, over the period of use of that asset. For example, depreciation expense on a $10,000 smoothie machine with a 10-year best before date might look like a company expense of $1,000 each year for 10 years, even though the market value of the property or land has increased over time. As a result, the market value of the company’s land and buildings may be very different from what is reflected in the balance sheet equation. This is taken into account when assets are sold, and they are referred to as ‘gain or loss on sale of assets.

‍

‍Definition:

‍A security is a financial instrument like stocks or bonds, that has monetary value and indicates ownership in or money loaned to a business, government, or nonprofit organization. The owner of a security has a risk of losing money.

‍

What it is?
‍

A security is a general term for a type of investment that can be divided into two categories: equity (a stock) and debt (a bond). A security is one you’ve traded in, such as a stock. The Securities and Exchange Commission oversees the trading of publicly traded securities and the disclosure of information about them by the firms that issued the securities.

‍

Shares of common stock are an illustration of an equity security that a private business may distribute publicly for the first time as it becomes registered on the public market.

There is a wide range of securities: stocks, bonds, mutual funds, and ETFs, but there is a chance they won’t increase in value. They represent some of the most popular short- and long-term investments made on public marketplaces. They are also made available by both businesses and governments so that they can raise money  to finance their activities.

‍

Types of securities
‍

• Equity Securities(consider stocks). Ownership rights are included with equity securities. This indicates that a piece of the original entity is owned by the shareholder. However, the privileges that come with stock ownership have restrictions. Based on the company’s performance and the level of their ownership, equity investors don’t always get regular payments (known as dividends) from a corporation. Equity owners, however, would be able to make money from their investment in the form of capital gains, which happen when an investor sells a security for more money than they paid for it initially.

‍

• Debt securities. This category of security comprises cash borrowed from the investor and subject to strict terms of repayment. Bonds and certificates of deposit (CDs) are two popular types of debt securities. Regardless of how the company that produced the security performs, the owner of the asset frequently receives a regular interest payment. Typically, debt securities are issued for a set period of time, after which the issuer has the option to reclaim them.

‍

A third, less popular kind of securities is known as hybrid securities, which typically combine elements of both equity and debt instruments. A bright example is an  equity warrant (option that a business issues to allow shareholders to buy stock within a certain time).

‍

Securities can be beneficial for companies, municipalities, and governments to raise new capital used to achieve a particular goal. There are several ways companies can raise this money. One is going public, which allows companies to sell shares on the open market in IPO. In the meantime, county or state governments can raise funds for projects by issuing municipal bonds.

‍

Places for security trading
‍

Depending on whether the company is public or private, securities are traded in different places. On stock exchanges, publicly traded securities, such as shares of a public company, are traded on the secondary market. If the shares are not mentioned on one of the major stock exchanges, they can be traded directly among sides on special “over the counter” markets.

Private companies’ securities are typically more complicated as they are not available on public markets. In order to purchase or sell a security in a private company, an investor may need to transfer assets directly back to the company or to qualified investors.

‍

Who regulates securities?
‍

The Securities and Exchange Commission, or SEC, regulates publicly traded securities in the United States. It is an autonomous government agency tasked with protecting investors and ensuring the smooth operation of trading markets. The SEC also controls all initial public offerings (IPOs) in the United States.

‍

The SEC now works to increase market transparency by obtaining, examining, and sharing market-related data with the public. Its main goal is to protect consumers.

‍

Definition:

The Stock Market is the place of meeting sellers and buyers with quite a simple purpose – to trade company shares.

‍

What is a Stock Market?
‍

Stocks can be bought or sold on stock markets where sellers and buyers of public companies meet together. Stock markets work as well as auctions: potential buyers offer the highest price they are able to pay (“the bid”), and potential sellers offer the lowest price they are able to sell (“the ask”). The real price will be between the buyer’s offer and the seller’s offer.

Stockbrokers can provide trades and act in portfolio managers’ or individual investors’ (as you are) stead. In the USA the most famous between 13 stock exchanges are the New York Stock Exchange and Nasdaq.

‍

Stock Markets are diverse, but combined with the same concept. The primary goal of every stock market is to connect sellers and buyers, who trade according to a concerted list of rules.

‍

The main functions of the Stock Market
‍

The Stock Market is a place where the public can get access to the shares of public companies. There is a similarity between the stock market and a farmer’s market: buyers and sellers in both types of market gather in one place to swap things.

However, the stock market has rapidly changing prices, so it can be considered as a more complex and orderly one.

‍

There are three key activities that you can find in the stock market:

– Shares buying: Ordinary retail investors can buy shares of companies as well as experienced institutional ones.

– Stock Selling: Every stock trade needs to have a buyer and a seller.

– Share Issue: When a private company wants to get money, it can sell pieces of its property on the stock market. This is called Initial Public Offering (“IPO”). But in cases when a public company wants to get money, it can make it on the secondary public offering. After the shares are issued by both companies, the public can easily buy or sell them.

‍

The stock market operates not only with shares. Exchange-traded funds (ETFs), REITs or other things called “securities” can also be traded on the stock market (although some details about the way they are valued or traded can differ).

‍

Are there any risks for the stock market?
‍

Definitely yes. It is very important to keep in mind that there are short-term and long-term risks. The stock prices can rise, but they can also plummet. The stock price can drop to $0 which means a complete loss of investment. That’s why investors should have a well-thought-out strategy which will help to manage their decisions.

‍

What does the phrase “the market has rose” mean?
‍

Thousands of companies trade their shares on stock markets. There are some stock market indices which are used to determine the stock price changes at any time.The best known index is the Dow Jones Industrial Index or the S&P 500 Index. The S&P 500 is an average of the 500 largest public companies listed in the United States by their market capitalization. Investors say that “the stock market rose” if the S&P 500 increased. But when the S&P 500 goes down, they say that “the stock market fell.”

‍

Stock market operating principle
‍

The stock market has the main purpose: to bring together buyers and sellers for negotiating stock trading. The stock market works like an auction to spot the prices.

 1. Buyers are pressing for paying the lowest possible price. Stockbrokers offer the price they want to pay for the stock. The highest price becomes the “Best Bid”.

 2. Sellers are pressing for selling at the highest possible price. The share owners or their stockbrokers propose the price they are ready to sell the shares. The lowest price becomes the “Best Asking Price”/Best Ask.

‍

The “Spread” is the difference between the Best Bid and the Best Ask. Both parties put in their best to make a deal by the average price, and the intermediary, who carries out the deal, gets the difference as a reward.

The stock prices are moving. The stock price can often change because of the number of investors willing to buy or sell shares and the number of transactions that take place on the stock market.

Shares are usually traded through negotiations between the bid and ask prices. The prices may change with the shares of other companies when many factors (political or economical) affect the changes of markets.

‍

Who uses the stock market?
‍

Here you can find some of the key players of the stock market:

– Retail investors (like you) can buy or sell stocks through your brokerage count. When you make an order, it is sent to the market where transactions are made.

– Stockbrokers (aka registered representatives) – they have been trained and passed a special exam. They can buy and sell securities in investors stead. They work for brokers who can be principals or agents in transactions, earning money from margins (as principals) or commissions (as agents) on transactions.

– Portfolio managers – they are like school owners – they order a big amount of books because they teach a lot of people. They make big orders to buy and sell stocks because they manage big portfolios of stocks which belong to other investors.The portfolio manager in many cases handles a package of underlying securities in the fund’s portfolio if you own shares here.

– Investment bankers – they help to place stocks on stock exchanges.

‍

Other participants in the stock market
‍

Investors can be considered as the moving power because they’re the ones who want to buy or sell shares. However between buyers and sellers there are important agents who earn money by providing services to investors. Here is a list of key ones:

‍

• Principals: This is a broker-dealer firm that has stocks they want to sell to investors. They also want to buy stocks from investors who are trying to sell them. Broker-dealers, who act as principals, earn money by adding a margin to the shares which were sold and the stocks which were bought by them.

• Agents: They are someones in the middle. They help to link the buying or sale request of one investor with the other side of the deal. They often charge a commission for their work.

• Stock Exchange: In the US the two most famous stock exchanges are the Nasdaq and the New York Stock Exchange, but the whole list consists of 13 exchanges. They charge a small commission for each deal that occurs there in exchange for their services. They also take a listing commission to companies that place their shares on the exchange.

• Custodians: They are the ones who hold your shares (mostly electronically, so you have a less risk of loss or theft). Brokerage houses usually pay them for this keeping service.

• Market-Makers: They are like your best friend who is ready for anything. These are firms that stand on the sidelines, ready to buy or sell shares at publicly quoted prices.

• Retail Investors: they are not professionals. They can buy or sell stocks by a personal brokerage account.

‍

Who regulates the stock markets?
‍

The Congress has granted the authority to regulate stock markets to the US Securities and Exchange Commission (US Security and Exchange Commission/SEC). Other countries have similar ways of regulation and agencies. These regulators have a broad mandate, and it is focused on customers. The main goals are investor protection, promoting justice and maintaining market efficiency.

‍

Key rules of the stock market
‍

The Securities and Exchange Commission sets principles and requirements for everybody who trades shares. Although these rules can be different in specifics for different stock markets in different countries, they are created to protect the investment with accuracy, transparency and consistency.

‍

 1. Price Transparency: Stock markets should guarantee that the best “bid” (the price the buyer is willing to pay) and the best “asking price” (the price the seller is willing to sell) are shown to participants to keep equity.

 2. Confirmations: If you are a brokerage client trading stocks on the stock market, you have the rights to confirm the transaction with the main details of the transaction. These may be the time of the transaction, the real price you paid, and (if your broker charges a commission) the specific commission you charged.

 3. Qualification Exams: Stock traders have to be licensed by FINRA. This is a self-regulatory organization which consists of exchanges and financial institutions. The process of licensing includes taking some exams that, among other things, cover the principle of market work.

 4. Possibility of suspension:The exchange may be closed temporarily or for an entire day if trading in stocks or the whole market has certain price or volatility limits for a long time. This is a serious step (rarely used by exchanges) which helps to protect investors from trading in a panic and fix problems. The Securities and Exchange Commission or the exchange may also stop trading because of other important reasons.

‍

Providing real-time price data is the main trait of modern stock markets. Investment moves must rely on the most actual information, stock exchanges focus on faster and more relevant price information.

‍

Examples of the stock markets
‍

In the US the two largest stock exchanges are the Nasdaq and the New York Stock Exchange. There are many other well-known stock exchanges around the world, including Euronext (with markets in Amsterdam, Brussels, Dublin, Lisbon and Paris), TMX Group in Toronto, and many others. These stock markets are exchanges where companies in a particular region typically place their shares. But the local markets may also be accessible to traders around the world, so stocks listed on one exchange may sometimes be traded on others.

‍

DEFINITION:

Economies of scale occur when a company’s cost of producing a single product decreases as output increases.

‍

When do economies of scale arise?
‍

‍‍Economies of scale arise when a company’s average cost of producing a single product falls as production increases. Changes within or outside a firm might result in economies of scale. Internal economies of scale can occur when a company invests in new technology or hires less expensive personnel.

When resources become less costly or when a company’s transportation expenses decrease as roads improve, external economies of scale might emerge. The reverse can occur as well. Diseconomies of scale are when a company’s average cost per product rises due to internal or external changes. Constant returns to scale occur when the cost of producing each product remains constant as output increases.

‍

Henry Ford
‍

One of the most well-known instances of a person who achieved economies of scale through specialization and mass manufacturing is Henry Ford. For the typical person, his initial Model T Ford was prohibitively costly. Ford created machinery to produce enormous parts, but he also wanted to assemble vehicles more quickly. He enhanced productivity relative to labor cost by adapting the moving assembly line, which was utilized in food manufacturing at the time. As a result, he achieved economies of scale by producing more vehicles in less time. He was able to sell Model Ts for less money, and his moving assembly line revolutionized manufacturing.

‍

Takeaway
‍

In the long run, larger firms that can afford to acquire ingredients in bulk or invest in better gear can create more items for less money. You can build your economies of scale if you can afford to buy groceries in large quantities. In the long term, economies of scale occur when a business can manufacture more items for a lower average cost per product. As a company’s output grows, so does the cost of producing each product.

Large corporations frequently have a competitive edge (conditions that allow a company to do better than its rivals). As a result, they can save money by purchasing supplies in bulk at a discount or investing in robots for a manufacturing line. While the initial investment may increase expenses, firms will benefit from economies of scale in the long run, allowing them to produce more items for less money.

‍

What are the effects of economies of scale on production cost?
‍

All companies have fixed costs, for instance, lease payments and equipment. Fixed costs stay regardless of any specific business activities. However, once a company increases its number of products, its fixed costs would be spread out over more items. As a result, the average price to create each product would decrease.

A simple example of this is a shoe repair store with a replaced lazy worker, who could only fix five pairs of shoes a day, with an energetic worker, who would make 10. The shoe repairs store’s fixed costs — the wages of one full-time worker and rent for the shoe repairs — haven’t changed, but the number of fixed shoes has increased. As the fixed costs are spread through more shoes, the cost to make each pair of shoes falls.

Another type of cost all companies certainly have is variable costs. Those go up and down along with a company’s production. For example, if our shoe repairs want to get twice more shoes fixed, it has to buy more raw materials to do that, which increases variable costs. However, since the shoe repairs store is now buying more items at once, it may get a volume discount.

‍

What makes internal and external economies of scale different?
‍

Companies could achieve economies of scale because of either internal or external factors.

‍

Internal

‍There’re a few ways large companies can create internal economies of scale:

1. Invest in the specialization: A firm that invests in better machinery, technology, or personnel can create more at a faster rate.

2. Purchase resources or commodities at a discount: Purchasing in quantity is generally less expensive, resulting in reduced per-item pricing.

3. Obtain lower-cost financing: Larger businesses typically have stronger credit histories, allowing them to borrow money at lower interest rates than smaller businesses.

4. Expand facilities or relocate: A factory with more extensive facilities can produce more. In addition, transportation expenses can be reduced by relocating closer to the source of supplies and components.

‍

External

‍External economies of scale happen when changes outside of the company occur. For example, these External economies of scale could involve governmental subsidies or tax reductions where both factors could support the growth of businesses and reduce a company’s overall costs.

1. Improved transportation: By expanding or developing transportation networks, a firm may save money on transportation expenditures.

2. Availability of higher-skilled labour: A firm may hire better workers for less money if more skilled people are accessible nearby.

3. An availability of raw materials: Resources become less expensive when they are simpler to obtain.

4. Industry-wide faster innovation: Companies that use technology to enhance output might profit from technological advancements.

External economies of scale can be realized by smaller firms in the same sector and area as larger enterprises by being in the right place at the right time. They could, for example, have access to a more specialized labour pool or wholesalers who can provide the supplies or components they require. Alternatively, they may be able to use a superior transportation network that arises as a result of the presence of more giant corporations.

‍

The limits of economies of scale?
‍

Economies of scale do not always continue indefinitely.

Increased production can lead to an increase in the average cost per product. Diseconomies of scale are what occur when this happens. Diseconomies of scale, like economies of scale, can occur due to internal or external factors.

‍
Internal scale inefficiencies can be caused by a variety of factors, including:

1. Issues with coordination: As a firm expands, it adds more employees and procedures to coordinate. A company’s efficiency might suffer as a result of its complexity.

2. Employee motivation: In large businesses, employees may feel insignificant and lose motivation, affecting productivity.

3. Communication: As a business grows, the chance of misunderstanding between departments, workers, or supply chain components increases.

‍

When events outside of a company cause costs to increase, it’s called external diseconomies of scale. Some of the most common are:

1. More costly materials: When resources or raw materials are scarce, prices might rise.

2. Higher import taxes or tariffs: Import taxes or tariffs can raise production expenses.

3. Increased transportation costs: As the cost of delivering a product rises, so does the cost of producing that product per unit.

4. Increasing supply chain costs: When the expenses of other companies with which a company does business rise, total production costs rise as well.

‍

Most businesses are constantly seeking methods to decrease costs without decreasing production in order to prevent diseconomies of scale. Outsourcing work to lower-wage locations, obtaining cheaper materials, and reducing manufacturing costs are all examples of this. There is generally a period of time between economies of scale and diseconomies of scale when the cost of producing each product remains constant. This is referred to as continuous economies of scale or constant returns to scale.

‍

What are economies of scope?
‍

Economies of scope and scale are two methods for a firm to reduce its average cost of production, but they function in distinct ways. The overall cost of producing a range of items is reduced when a firm creates new commodities that share the same fixed and variable resources as its initial product. This results in a scope economy.

For example, suppose a shoe repair store increases its product range. In that case, its fixed expenses will remain the same because they already have machines, employees, and a store. However, those expenses are now dispersed among a broader range of items.

While economies of scale lower the cost of manufacturing a single item, economies of scope reduce the cost of generating several items. Economies of scale allow businesses to create more of the same product with more efficient operations, but economies of scope enable enterprises to generate various goods with the same method.

DEFINITION:

The S&P 500 Index tracks the share prices of 500 of the largest publicly-traded companies in the U.S. This Index helps you to understand the current stock market performance.

 

Understanding the definition of S&P 500
‍

The Index is formally known as the Standard & Poor’s 500 Composite Stock Price Index, but conventionally is referred to as the S&P 500, with its ticker symbol is “SPX.” The signature stock market index created in 1957 appears to be the primary tool for answering the question “what’s happening in the stock market?”. It contains about 500 largest publicly traded companies in the U.S., including 11 different sectors of the economy.

‍

Company Weighting in S & P =  Total of all market caps/Company market cap​

‍

‍This Index’s formula confines the stock prices of 500 companies from various industries, and it’s weighted using each company’s value by market capitalization. Therefore, the most valuable and most prominent companies move the S&P index the most, thus, making it a more helpful reflection of the U.S. stock market. And by following the S&P 500 Index, you could easily identify whether the most significant stocks are gaining or losing value.

‍

About the members of the S&P 500
‍

Generally speaking, as it’s been mentioned above, the S&P 500 consists of the top 500 publicly traded U.S. companies by market capitalization. As of October 2021, a company’s cutoff for size is $13.1B in a market cap to be allocated in the Index. Indeed, the firms must be based in the U.S., have publicly traded stocks available for all, and be profitable in the past year. While highly valued but not profitable, companies aren’t allowed to join the S&P 500 even if their value would fit in the criteria of the top 500 companies. What is more, the final word about the membership in the S&P goes to the administrator of the Index, S&P Dow Jones Indices. Altogether, those approximately 500 members count for about 80% of all the publicly traded stock in the United States.

 

The calculation of the S&P 500
‍

As of December 20222, Apple, Microsoft, and Amazon are the first three companies in the Index and are reaching $1 trillion market caps. In addition, these three companies have the highest weight in the S&P 500, so their stock movements affect the Index more than the other companies. To calculate such a proportion of the weight a particular company has in the S&P 500, you have to divide the company’s market cap by the total market cap of the S&P 500.

‍

Why is the S&P 500 useful?
‍

Firstly, it depicts “how stocks are doing”: S&P includes about 80% of all currently available stocks in the U.S. market. Therefore, it gives you a holistic picture of how the market is doing in general.

Secondly, it could be a benchmark for your portfolio: An investor usually has a collection of stocks, which they call a portfolio (read more about investment portfolio in our library). To check if your portfolio is performing well or not, you could look at the raw percentage gain (up or down). Comparing your portfolio performance to the S&P 500 is an excellent way to check if your portfolio is outperforming or underperforming in the market.

Thirdly, it’s tracked by funds: Many investors prefer not to pick their stocks by themselves but to invest broadly in the U.S. stock market. An easy way to do so is to purchase shares of a mutual fund or ETF. In its turn, the mutual funds’ approach mimics the makeup of the S&P.

‍

S&P 500 vs. the Dow
‍

There are some critical differences between the two (a number of companies included):

The Dow is a very exclusive club – it gives prestige to the Dow’s 30 members, while it’s also not that representative to use it as a tool of measuring the stock market’s overall performance.

The S&P 500 is more inclusive — 500 companies. It’s way more objective than the Dow and could tell you more precisely on “what’s happening today?”

It’s important to note that: Companies with a higher share price influence the Dow the most, while the highest market cap companies affect the S&P 500 the most.

‍

Takeaway:
‍

S&P 500 = weighted by market capitalization = stock price and shares outstanding

Dow = weighted by stock price only.

DEFINITION:

‍The Dow Jones Industrial Average or simply “the Dow” is an index of the 30 largest and prestigious public companies — and it’s used to determine the overall direction of stock prices in general.

‍

Understanding the Dow
‍

The audience always wants to know how does “the market” does in general? Created in 1896 by Charles Dow and Edward Jones, the Dow consists of 30 large “blue chip” U.S. companies chosen by a selection committee. Such companies have to be big, profitable and have a long track record as publicly-traded companies. The Dow index is calculated using a weighted average of those 30 stock prices. So once people are saying that the markets go up, they’re usually making a reference to the Dow. Its ticker symbol is DJIA.

The Dow’s 30 companies are always the most prestigious and very well-known brands in the U.S. Investors always look at the Dow to check how markets are doing at the current moment. It’s important to note that the Dow is price-weighted, so it becomes a bit less useful tool than the S&P 500, which is value-weighted (read more about the S&P 500 in our library). As the Dow depicts only 30 companies, the index shouldn’t be used to evaluate a broader stock market.

‍

Who are the members of the Dow?
‍

If you become a member of the Dow 30, you’re officially a “blue chip” stock. Nowadays, despite its full name, the Dow’s 30 members include industrial and non-industrial companies to show a more inclusive mix of sectors. At the same time, previously, it was made of mainly industrial companies.

There are no quantitative criteria for the “blue chip” club or for those who’re willing to join them. However, there’s a tendency that a company should be U.S. based, have a strong reputation, and perform satisfactorily with sustained growth. In addition, their stock must be listed on the New York Stock Exchange or the Nasdaq. Finally, the selection committee could make changes to the index. |

Although there are no official quantitative criteria for “blue chip” or who gets to join the Dow’s 30-member club, the selection committee looks for US-based companies with an excellent reputation and who’ve demonstrated sustained growth. In addition, it’s a must for them to have their stock listed on the New York Stock Exchange or the Nasdaq. The selection committee changes the index from time to time – recently, as of August 2020, Amgen, Honeywell, and Salesforce.com replaced ExxonMobil, Pfizer, and Raytheon Technologies.

‍

Calculating the Dow
‍

Since it’s a price-weighted index, the stocks with the highest prices of all club members affect the index the most. So, the index is calculated by adding the stock prices and dividing that sum by the “Dow Divisor” number. Long ago, that Divisor was always a constant number. So, it was much easier to calculate the index by simply adding up all the stock prices and dividing by the number of companies included, only 12 at the time.
‍

Undoubtedly, today it gets a bit more complicated. The Dow Divisor appears to be way more complex. The administrator of the S&P Dow Jones Indices determines the Dow Divisor number. By that, ensuring the index remains appropriate and useful over time regardless of various corporate actions. Therefore, the index goes up and down based on the share prices of all 30 members. And the Dow Divisor number changes when there’s a need to adjust the corporate actions and remain more consistent. Nevertheless, one should always remember the main principle, that the companies with a higher share price move the market more.

‍

The differences between the Dow and the S&P 500?
‍

Both the Dow and the S&P 500, with their ticker symbol SPX are used to measure how the stock market is currently doing. However, there’re some crucial differences between the two:
‍

• The number of companies: The Dow is a very exclusive club – it gives prestige to the Dow’s 30 members, while it’s also not that efficient to use it as a tool of measuring the stock market’s overall performance. Of course, you can’t fully estimate the current situation in the market by looking only at the 30largest companies. The S&P 500’s brings it on— it includes 500 companies. Therefore, it’s way more objective than the Dow and could tell you more precisely on “what’s happening with the market today?”
  ‍
• The way the stocks are weighted: The number you see for the Dow is about 33,200 as of December 2022. That number is calculated by the index method and is based on the 30 stocks index weighted by the stock price. And a company with the highest dollar stock price affects the index the most. The S&P 500 is counted by a market capitalization. It accounts both for the stock price and the number of shares outstanding in the market.
  ‍

Companies with a higher share price affect the Dow the most, while companies with the highest market cap affect the S&P 500 the most.

‍

Has the Dow changed over time?
‍

Industrial roots:

Back in time, when the Dow was created in 1896, it was fully industrial. It only had 12 members selected to reflect the big and bold American companies at the time. Among them were tobacco companies, leather, oil, animal feed, and rubber industries. The Dow has changed its membership 55 times within 125 years of its existence.
‍

Now it’s becoming more inclusive:

The index has expanded to today’s 30 members. And its club has also changed to reflect the changing of the American economy. For example, a few years ago, the Bureau of Economic Analysis declared that manufacturing made up just 11% of the American economy. Therefore, the Dow had to adjust to the changing trends and become more inclusive to give a more holistic picture of the economy of the United States.
‍

As of December 2022, the Dow includes companies from a variety of different industries.

If the VIX is high, it’s time to buy. When the VIX is low, look out below!

DEFINITION:

The CBOE Volatility Index (VIX) is a real-time index, an indicator that estimates the degree of volatility the stock market may be in the near term and could gauge the fear among market participants.

‍

Understanding the CBOE Volatility Index or simply “the VIX.”
‍

The VIX helps gauge the volatility of the stock market. It is often called the fear index as it depicts the level of either fear or optimism in the market. Once people are too optimistic or fearful, there would always be a chance that the market would behave chaotically. The Chicago Board Options Exchange (CBOE) calculating the VIX Index. So, when the VIX gets higher, there’s more fear. The option prices from the S&P 500 are used to calculate the Index. In its turn, a stock option is an agreement that provides an owner with the right to buy or sell some stocks but does not oblige him to do so. It’s important to note that there is the CBOE EFA ETF Volatility Index for the international stocks.

If the weather concerns you, you could always check the forecast and decide the best time to go on vacation. The same principle works with the VIX. So if you’re concerned about the time for the investments, you could check the VIX and explore how other investors consider the nearest future of the stock market. ‍

‍

What is the CBOE Volatility Index (VIX)?
‍

Let’s have a look more deeply into the Index. The Chicago Board Options Exchange made the CBOE Volatility Index to estimate volatility over the next 30 days. It measures market risk and expresses a general feeling of investors towards the market.

As it’s been mentioned above, the prices of the S&P 500 index options provide the groundings for the VIX: where buyers and sellers determine option prices. The current price of an option contract is called the option premium. And in case they’re more buyers, the option premium goes up. But if there were more sellers, the option premium would go down respectively.

The calculation of the VIX is made in a manner where the average of those prices is counted, giving a sense of what investors are ready to sacrifice for their opportunity to buy or to sell the S&P 500 index. Thus, the VIX provides a holistic picture of whether there is optimism or fear in the stock market. Generally speaking, if the VIX goes above 30, the market is considered to be volatile. And when the Index goes below 20, investors see the market as stable and calm.

‍

How does the Index work?
‍

The VIX goes up when more investors are purchasing the put options. And it falls when more investors are buying the call options on the S&P 500 index. Put and call options are to give the buyer the right, but not the obligation, to sell and purchase stocks at certain prices during a certain period of time. And more market volatility leads to the higher option prices. The volatility reflects the fear in the market.

‍

What does the VIX actually measure?
‍

The VIX rises when investors buy put options on the S&P 500, and it goes down when more call options are in higher demand. Thus, the VIX is used by investors as an indicator of instability in the market. And the Index provides a forecast of the future market volatility in the S&P 500. Also, it gives an understanding of how much people are willing to pay for the call or put options.

However, the VIX doesn’t measure the precise volatility but the market’s expectations of the volatility. Once there is more risk, more people are about to buy options. As investors often see the option prices as the degree of the risk in the market.

‍

The VIX calculation formula
‍

Option prices are part of the VIX calculation, but the CBOE does not use an option pricing model. Instead, CBOE uses a formula that looks at the variance of options prices with the same expiration date. To calculate the VIX, CBOE selects options for the Index. It includes a series of call and put strikes on two successive expiration dates. Then the CBOE will calculate each option’s influence on the total variance.

CBOE will then calculate the total variance for the first and second expiration dates. They then calculate the 30-day variance by interpolating the two variances. The standard deviation is the square root of the 30-day variance. Finally, the CBOE multiplies that standard deviation by 100 to get the VIX.

‍

‍The importance of the VIX
‍

The VIX is important for both traders and investors:
‍
For the investors – it could guide them with predicting the market movements; the VIX is rising when the market goes down and decreases once the market is up.
For the traders – the higher the VIX Index means the higher option prices.

‍

Is there a “normal’ VIX value?
‍

The simple answer is no; there’s no “normal” value of the VIX. However, there are some numbers that investors or traders can consider. A calm marker would have the VIX level below 20. The volatile number would increase the VIX above 30. Of course, such numbers are just preliminary and subject to change. The VIX isn’t a perfect tool for the market assessment, and it appears to be only one mechanism of forecasting and a tool for the investors to stay aware of the volatility. One could never predict the stock market trends precisely, and all of the prediction tolls carry a risk, so the investments do.