Category Archives: Wall Street

What are the different types of Stocks?

Common Stocks

Common Stocks

The basic difference in stocks and bonds is that bonds are a debt while stocks are part ownership in a company. These are both valid and profitable ways to raise capital for a business. Effi Enterprises offers advice to companies which need to create value. They can help businesses achieve their financial goals and offer them many strategies for financial advancement to expand their marketing potential. There are many options for today’s business owners including stocks and bonds. There are two different types of stock options for investors to choose from.

Common Stocks

Common stocks are the most common and most of the stocks that are issued are common stocks. These stocks actually represent partial ownership in a company and therefore will receive dividends as a result. Those who purchase stocks are investing in the company so that the company can expand and realize profit. Each investor will also get one vote for each share that is purchased. With this vote they will elect board members who will make or oversee all the management’s major decisions.  This type of investment usually offers some of the highest returns over other investment options. Of course this is also associated with more risks as well. If the company is forced to liquidate those who hold common shares will not receive any money until after the creditors including bondholders have been paid.

Preferred Stock

The preferred stock also represents some ownership in a company, but without the same level of voting rights. Investors who purchase preferred shares are typically guaranteed a dividend which is fixed and ongoing. With common stock the dividends are not guaranteed at any time. And should the company be forced into liquidation, the preferred stock owner has a slight advantage over common stocks. They would be paid off after the debt holders, but before the common stockholders in this event. Preferred stock is also “callable.” This means that the company can choose to purchase the shares from the shareholders any time they decide to and for any reason. There are many who think that preferred stocks are more like a debt than equity. One way to classify them is to think of them as sitting between bonds and common shares in a company.

Different Classes of Stocks

Even though common and preferred stocks are the two basic types of stocks, companies always have the option of customizing their particular stocks into any package they feel will be appealing to their stockholders. Usually when stocks are customized it is because the company wants the voting power to be contained within a particular group. This way the company can classify the stocks so that they can manage their voters and still achieve the financial objectives. For instance they can set it up so that one group of stocks allows ten votes per share and another class of stocks only gets one vote per share. Berkshire Hathaway is an example of a business who offers more than one class of stocks. Usually they are assigned terms like Class A stocks and Class B stocks.

Advantages for Stockholders

Even though a person becomes a stockholder in a public company does not automatically mean that they have a large say in the day to day operations of the business. They will have the right to vote to elect a board of directors and thereby have some say in how the business is run. The goal is for it to all work together in the end so that the business benefits and can become more profitable from the investment; and the shareholder can profit from the company’s overall profits as well.

The Glass-Steagall Act

Glass-Steagall Act

Glass-Steagall Act

With recent computer glitches chipping away at investor’s confidence in the market, a repeat of the stock market crash of 1929 becomes a real fear. Investors such as Efraim Landa must continue to exercise caution in their investments. Effi Enterprises is a consulting business which offers counsel to emerging businesses and entrepreneurs regarding financial investments and how to increase the value of the company. They offer marketing strategies and assist in helping businesses get started with brokers, divestiture strategies, capital sources and IPOs. Because Effi Enterprises helps businesses create value it is important to stay up to date on various aspects of the market and note how changes can affect business on every level. One of the acts that helped shape the market as we know it today was the Glass-Steagall Act.

The Glass-Steagall Act (GSA) brought about a separation between commercial banking activities and the investment markets. This was due to the fact that most agreed that too much commercial bank involvement in market activities was behind the stock market crash of 1929. According to Congress banks were taking too large of risks with their depositors’ money. The GSA continued as established until it was repealed in 1999.

Just before the depression most feel that commercial banks were too careless in their investing practices. They did a lot of investing of their assets and became greedy by taking larger risks hoping to gain even larger financial rewards. The objectives of banking itself became somewhat blurred and many loans were made into companies that the bank had invested in. They encouraged their clients to invest in the same stocks. Many feel that this mismanagement of funds caused the stock market crash. Henry Steagall was chairman of the House Banking and Currency Committee and seated in the House of Representatives at the time. Senator Carter Glass founded the US Federal Reserve System. Steagall supported Glass after they added an amendment which would allow bank deposit insurance for the first time.

The GSA was in response to financial crisis and set up a sort of regulatory firewall between investment banks and other commercial activities. Banks were allowed a one year time frame in which to decide whether they wanted to specialize in investment banking or commercial banking. The Act allowed only 10 percent of the income for commercial banks to come from securities; but one exception was allowed in which commercial banks were allowed to underwrite government issued bonds. JP Morgan and other financial giants were forced to cut the services they provided which cut their income drastically as well. The goal of the GSA was to prevent banks from using deposits if an underwriting job failed. Many in the financial community felt like the GSA was too harsh and glass even moved for a repeal right after the Act passed claiming himself that it was an overreaction.

The Federal Reserve Board is the US bank regulator implemented the GSA but in 1956 Congress decided to regulate another bank sector. To keep any specific financial corporation from gaining too much power, they extended the GSA by adding the Bank Holding Company Act to create a wall between banking and insurance companies. This stopped banks from being able to underwrite insurance companies even though they could sell insurance.

There have been many debates over whether these restrictions were the healthiest option for the industry or not. Many felt like banks should be allowed to diversify to reduce risks and that the GSA restrictions had the adverse effect and made the banking industry riskier instead of safer. After the Enron market mistakes banks are more likely to be transparent and less likely of making risky or unsound decisions regarding investment procedures. Reputation is a key component in the market today and this in itself motivates banks to regulate their own activities.

In November, 1999, congress repealed the GSA and eliminated the restrictions prohibiting affiliations between investment and commercial banks. The Gramm-Leach-Bliley Act allows banks to engage in a wider range of services which include underwriting. The intent of the GSA was to prevent deposits from being lost if there were investment failures, the repeal and establishment of the Gramm-Leach-Bliley Act demonstrates that many times attempts to regulate can end up with adverse effects.

Stock Market Computer Glitches

Computer Glitches

Computer Glitches

Many people depend on the stability of the stock market from day to day. It is understood of course that there are times when it can have greater fluctuations than others. And there are times when the market becomes volatile which can be advantageous to some and a detriment to others depending on the types of trades occurring at the time. But for regular investors such as Effi Enterprises a glitch in the system can be disastrous. Efraim Landa helps business owners organize and maintain investments, offer IPOs, learn about brokers and dealers, and use many other aspects of financial resources to increase the value of their business or company. A glitch can mean real trouble for a business which is trying to achieve valuation. But we must remember that the market is primarily computer based and occasionally there are those times when a glitch will occur. Such was the case on May 6, 2010 when the Flash Crash occurred.

On this date the crisis occurred in a very short time frame of about 5 minutes just before 3 p.m. In this short amount of time the Dow Jones Industrial Average suddenly dropped almost 600 points. It was nick named the “flash crash.” Most blame it on a computer glitch of some sort while others tried to look at several trades which occurred shortly before the crash happened.

This year in May Facebook anticipated very good first day trades but on May 18 their jump into the market with their IPO ended up in chaos. A NASDAQ computer glitch delayed the opening by about 30 minutes which meant that investors were unable to purchase shares in the morning and then sell them later that day. They couldn’t even tell if their orders had gone through. NASDAQ is looking to pay nearly $62 million to different firms who suffered financial harm due to the glitch.

March of this year there was a glitch of some sort which affected at least one market which was trying to offer an IPO. Kansas City based BATS Global Markets, Inc. ended up canceling the IPO because a series of glitches never allowed the stock to open for trade. Later the CEO, Joe Ratterman, resigned as the chairman and offered a public apology.

Even though the specific details of what happened are sketchy, most of them seem to come from issues with the algorithms which keep high frequency trading afloat. These types of trades are conducted at a rate of millions in just nanoseconds. The large volume of stock trading is all computerized this means that the chance of malfunction is relatively high with the biggest problem being that a human cannot stop them before it’s too late and the damage is usually already done.

For investors such as Efraim Landa these glitches can be very detrimental. They rely on the constant working of the market and place automatic orders expecting that their brokers will sell the stocks when they hit a particular price. Kevin Callahan, the spokesman for the Securities and Exchange Commission (SEC) made a statement in which he said that they “are closely monitoring the situation.” He also stated that they were in constant contact with the New York Stock Exchange and various other market participants. Many leading businessmen are asking for better oversight of some of the practices such as high frequency trading which seems to be the culprit leading to these types of glitches.

The most interesting thing about this recent glitch is that it occurred on the same day that the SEC published a rule which was set up to prevent glitches such as the “flash crash” of 2010. The goal of the rule was to establish one consolidated record of all the day’s trades. Many are calling for tighter regulations and closer monitoring to help prevent these glitches from occurring.

What is a Derivative?

Derivatives

Derivatives

Efraim Landa is president of Effi Enterprises which assists entrepreneurs and emerging companies create value. The company offers growing companies hands-on executive management and leadership and helps them discover various ways of securing finances. They offer options such as introducing businesses to angel money, marketing strategies and divestures among many other options. Effi Enterprises works with emerging companies to help find the best solution for their particular situation. This may include stock options for employees, future contracts or any number of other strategies. Future contracts, options, and warrants are all common derivatives.

What is a derivative?

A derivative’s value is based on a contract between parties who are agreeing on an underlying financial asset, security or index. Some of the most common underlying instruments are bonds, currencies, market indexes, stocks interest rates and commodities. Some common derivatives are warrants, swaps, options, forward contracts and futures contracts. Basically, a derivative is an instrument which derives its price from another variable or financial asset. A stock option derives its value from that of a stock; and a swap gets its value from the interest rate index. A derivative obtains its value form an underlying asset and the derivative’s price will rise or fall along with the underlying asset’s value. The derivative’s value is based off of the price of the instrument and the payoff will mirror that of the instrument that they are based on.

A derivative is a contract on an underlying asset. There are many different derivatives but options are the most common type. When an owner purchases an options contract they have the right to purchase or sell the asset at a certain price prior to a pre-set date. The most common underlying assets for which contracts are purchase are stocks, commodities, bonds, currencies, market indexes and interest rates.

Basically, a derivative is a contract between a buyer and a seller. Unlike traditional investments, there is a pre-set expiration date. This time is established at the time the contract is purchased. Payoff is typically determined at the expiry most of the time. Occasionally there is no exchange of money when the contract is made.

Some very well established exchanges trade derivatives. The New York stock Exchange, the Chicago Board of Trade and the French CAC are three. Trades such as these are called exchange-traded derivatives which mean that the terms and features are highly standardized. The advantage to these is that they are regulated which is just an extra safeguard for investors.

Other types of derivative instruments like swaps, forwards and other exotic derivatives are traded over-the-counter. These have very flexible terms and a large number of underlying assets and combinations which can be purchased. These types of financial dealers can customize the derivatives for specific clients and their needs.

Why Derivatives?

The largest thing that makes derivatives appealing to businesses is that they allow a certain amount of leverage. This is a financial term which refers to the increase that occurs when a small quantity of money is all that is used to control another item which is of a larger value. An example is a mortgage. A person can gain control of a highly priced piece of property for a smaller amount of money. Derivatives can give this same type of leverage, or multiplication as a mortgage can. An investor can actually control company stock which has a large value by using a small amount of money. An investor has the opportunity to make more money than the company who is reaping the benefit of the investment.

However, if derivatives take a turn for the worse they can be very costly for a business. In 1995, trader Nick Leeson traded derivatives but the trades were not profitable and because of the leverage the losses were so huge for the Barings Bank of England that they ended up in bankruptcy. Warren Buffet, who is a very successful investor, is against using derivatives and he sees them in a very negative light. However, just like any investment there are always risks involved. Derivatives are a form of investing which have been part of business finance for many years and will likely remain an integral part for many years to come.

What are Stock Options?

Stock Options

Stock Options

Effi Enterprises is a business which offers financial consulting to various types of businesses. Mr. Efraim Landa began as an entrepreneur and offers his expertise on how to secure financial revenue for emerging businesses. There are many options available and Effi Enterprises can help businesses sort through the plethora of options to find the most profitable and practical solution for an emerging business’ needs. One of the benefits top companies are offering top paid executives are stock options. The question is why are they being offered and are they profitable for the employee and the business?

Definition of Stock Options

Employee stock options (ESO) are a type of reward in the form of equity in the company. Each company has different policies but most large scale companies offer equity compensation to their executives, and sometimes other employees as well. The employer gives the employee the option to purchase stock in the company by some very defined terms. Employers allow employees to purchase a specified number of company shares or stocks at a preset time and price. These are both specified by the employer. There can be several reasons why private and publicly held companies offer these options to their employees.

One reason is that the company wants to both attract and retain quality workers. They also want to allow employees to feel like they are partners or part owners of the business. Many companies offer stock options to employees to give them additional compensation above their salaries. Start-up companies such as those Effi Enterprises oversees are likely to make this available to employees as it allows them to hold on to more of their capital.

Benefits of Stock Options

When a company offers stock options to their employees the strike price is generally discounted and is close to the present market price. Options usually cannot be exercised for some amount of time so the hope is that the share’s price will increase so that later they can be sold for a profit. Offering stocks in the business can be beneficial for an employee as long as the business does well and stays in business. This is a way of allowing workers to invest in the business while reaping the benefit down the road. This is usually a nice incentive to help motivate workers to keep working and to perform satisfactorily. The financial condition of the business can have a direct influence on their investment.

When an employee purchases options they can convert them to stocks and then wait until the contract on the option expires and sell it off at a profit. They may also sell some of the stocks off for a profit when the contract is up; and save the rest of them for a later date. Lastly, the employee can choose to change all of the options for stock in the company in hopes that the price will continue to increase and they will realize a profit.

No matter which of the choices the employee decides on these options will have to be converted to stocks. The company usually offers a set amount of options and the employee can buy the amount that they want. Usually, the company will spread the vesting period out over 3, 5 or 10 years. Then they will allow employees to purchase a certain number of shares according to a set schedule. For instance perhaps a company offers options on 100 shares of stock in the company. The vesting schedule may be spread out over 4 years. The company may offer one-fourth of the options vested each of the next four years. For the employee that means that each year they can purchase 25 shares at the discounted price and then each year sell it at the current market price, or keep it. The hope is that the price will increase each year.

There is always an expiration date on options. This means that they can be exercised starting on a specified date and ending on a specified date. If they are not exercised according to the dates they are lost. And if the employee chooses to leave the company they only have the option of exercising their vested options and any future vesting is lost.

A company establishes a market or strike price on each of its shares of stock. They fix a price that is close to the share’s internal value and it is set by the board of directors by voting. These are not a risk free option because if the company loses the stock options will decrease in value as well. However, they can be beneficial to the employee and the employer alike.

How Does the Stock Market Work?

Efraim Landa and investment firms like Effi Enterprises are well acquainted with the workings of the stock market. They work with emerging businesses and help them gain value. One of the greatest steps for a company or a business is when they have become profitable enough to go public and make an Initial Public Offering (IPO) of their stocks. Typically a business idea begins with an entrepreneur who gets started and then outgrows their sources. This is when they look for a venture capitalist such as Efraim Landato help get them with funding options with the hope that there will be a day where they can make an IPO. This is when stocks in the company are available to the public through the stock market.

Stock Market

Stock Market

The stock market can be very confusing and those who are unsure about how it works can stand to lose a lot of money when they first start out. However, it is not as complex as it appears to be. Basically, you have the option of purchasing stocks in a company. Companies make these shares available as a way of funding their business. When someone purchases a company’s stock they do not own part of the company but are providing funds by which the company can grow. The more the company is worth, the more value their stocks become. Stocks are frequently traded back and forth on the “stock market.” There can be a few things that affect the price of stocks.

In one way it is as simple as the law of supply and demand. Stocks are available in a limited number and when there are a lot of people who want to buy stocks in a particular company the price will increase on their stocks. But when there is a decline in the number of buyers who want them, or there are a large number of people who want to sell the ones they have then the price on the stocks decreases. Theoretically the demand for stocks for a particular company will depend on how profitable the company is. However, what the company is expected to do in the future will also factor in to the value of the company’s stocks.

When a company goes public with their stock it is generally a way of increasing revenue. This is generally to be used for some form of expansion. Perhaps the business needs to add a new product or offer more services to their clientele. An IPO can be a way of raising those funds. The public can then invest in the company by purchasing the stocks.

The main goal of an investor is to make money on the stocks that are purchased. They will need to buy stock at a lower price and then when the price on the stocks goes up they will sell it off before it takes a downward turn. This will mean that stock holders will need to pay particular attention to the company’s value and the projected value of the company later on. Many times stock prices will go up before an earnings announcement but then decline if these earnings were much higher than what was generally expected.

A lot of novice investors think that when they purchase stocks they are going to receive from the company’s profits but this is not so. Some very large companies may pay a dividend and this is done a per share basis. But most companies hold on to their profits in order to pay for future growth. There are two schools of thought on this, some investors are interested in the company growing so that the stocks are worth more and others are more interested in investing in companies who are profitable enough to pay dividends. The type of stocks purchased will depend largely on a person’s investment goals.

The LIBOR Scandal

LIBOR

LIBOR

LIBOR has an influence on interest rates around the world; but recently there have been some questions raised about the rigging of interest rates. Barclays already had to pay over $45 million in fines and it looks like there may be many more fines, and possibly lawsuits to come. Many say that regulators should impose more fines on some of the other 16 banks that are members of the British Bankers Association in hopes that there will never be a repeat.

LIBOR is the London Interbank Offered Rate which is the rate which these 16 banks charge one another for short term deposits and loans. This rate becomes a benchmark for interest rates set worldwide. It influences literally hundreds of trillions of dollars. LIBOR has an influence on various financial contracts corporate loans such as those managed by companies such as Effi Enterprises, interest rate swaps and floating rate mortgages.

Presently, there is much talk about criminal charges and possible jail terms for those involved. Asia, Europe, Canada and the US are investigating what looks like a huge picture of deceit and avarice. Banks must submit their data to be used in calculating the LIBOR; but in order to hide their own institution’s financial problems, or to boost profits for traders, they have submitted falsified data. Remember, that the LIBOR influences interest rates around the world so the repercussions of these devious acts are felt worldwide. Because it affects interest rates, investment firms like Effi Enterprises have been affected by the lowered benchmark.

Lawsuits are pending but as they are pursued they can mean global financial disaster. Municipal governments and investment firms purchased bonds or have entered into financial contracts which were based on LIBOR. They are now asking for compensation from the banks since they intentionally manipulated the benchmark. If the suits take place as it is assumed they will we are talking about potentially tens of billions of dollars that will have to be paid out.

Just so we understand how large of an impact this could have let’s say that LIBOR was only 0.1 percent off for one year. In that time the incongruity on the $300 trillion of swaps could easily mean that the rates were off by up to about $300 billion. This is just one type of contract; it doesn’t even take into account all the other types of contracts or any punitive damages that might be sought. It’s big enough the entire banking system could be crippled.

One suggested option would be for the banks to set up a compensation fund for the victims of LIBOR so that all the banks could pool resources to pay out. An administrator would need to be independent but he could generate a transparent formula which could estimate and calculate the damages that have been done. If the banks at least attempt to right the wrong clients might be more willing to settle instead of pursuing litigation which would be much more costly.

Of course this would take much cooperation among these banks. They would need to decide how much LIBOR had been skewed because of the misreports. Then they would also have to decide how much of the financial liability each bank should be responsible for. Government involvement could help to expedite the process. There may be more regulations set by governments which could help improve the bank’s transparency. Had they maintained transparency this would have never happened in the first place. Perhaps this is a lesson for all of those who deal with financial institutions. Consumers and businesses can benefit from open and honest transparency.

What is LIBOR?

Barclays Bank

Barclays Bank

LIBOR is an acronym for London Interbank Offered Rate. It is basically an interest rate used on the federal level. It’s the interest rate that is charged between banks for loans. As far as interest rates it is the busiest in the world of finance. There are a number of banks which participate in the money market in London and they offer short term deposits to each other. LIBOR is what is used to determine the price of several other financial derivatives. These include items such as futures for interest rates, Eurodollars and swaps. This is very influential throughout the world of finance as it affects more than just the Pound Sterling. It is also important to other currencies like the US Dollar, Canadian Dollar, Japanese Yen and the Swiss Franc.

Every morning in London at 11:00 am LIBOR is set. The exact rate is found by averaging the various interest rates which are being offered by the banks in membership with the British Bankers Association. It is calculated for different time frames from as short as a day to a full year. The banks may offer varying rates throughout each day but the rate set is fixed for a 24 hour time frame. Even when the instantaneous rate and LIBOR are different it is a very small increment and for a short time.

Eurodollar futures are the most important of the derivatives which are related to LIBOR. Eurodollars are basically US monies which are deposited in banks which are outside the United States, generally in Europe. These Eurodollars are traded in Chicago at the Chicago Mercantile Exchange. Depositors outside the country are not subjected to the margin requirements enforced by the Federal Reserve which gives the depositor more leverage over the funds. LIBOR determines the interest rate which is paid on these Eurodollars and these futures provide ways to bet or hedge against the changes in the future interest rate.

There are 16 member banks in the British Bankers Association and they control the rates on about $360 trillion worth in the financial markets and products around the world. This includes the adjustable rate mortgages (ARM), which is where it affects the average Joe. When the interest rates are stable it provides several decent options for those wishing to purchase homes. For these mortgages it means no negative amortization and usually there are fair rates in terms of repayment. Usually the ARM is guided by the 6 month LIBOR plus somewhere between 2 and 3 percent.

LIBOR’s influence affects more than just the homeowner it also affects the entrepreneur and loans for small businesses, students and credit cards. It is all good while the economic climate is stable and LIBOR is doing well. But when economic uncertainty looms, particularly in the developed countries then the rates become volatile. This makes it more difficult for the banks to exchange loans among themselves. This in turn makes it more difficult for others to obtain bank loans. The trouble is that when the system is volatile the bank simply raises its interest rates for the borrower, or offers fewer loans.

LIBOR can also affect Federal rate cuts. Usually investors such as Effi Enterprises enjoy it when the Federal government cuts rates. But when LIBOR rates soar it restricts people from obtaining loans. This means that the average person does not benefit from the discounted rate because fewer loans are being offered. For those with a subprime mortgage it is important to keep an eye on LIBOR rates.

Generally the LIBOR rates do not affect the US Dollar or have little effect. It mostly has an impact on the Euro, Japanese Yen and the British Pound. However, for monies from the US which are being held in foreign banks, it is a relevant issue.

The Dodd-Frank Wall Street Reform Act

Wall Street

Wall Street

There is no doubt that the world of finance needed an across the board overhaul from the small business to the entrepreneur all the way up to the largest of financial institutions. The Dodd-Frank Wall Street Reform Act was a broad piece of legislation which was created to help form and maintain financial stability. The intent was to create new organizations and rules on the federal level which will offer stricter oversight for most financial companies as well as the products that are sold by them. There are several key factors that are thought to be beneficial for the state of the financial world.

Safeguarding Consumers

The Wall Street Reform Act created the Consumer Financial Protection Bureau (CFPB) which is responsible for educating consumers by creating documents and financial curriculum and making them available to the general public. The CFPB operates under the Federal Reserve and is able to create and enforce applicable rules for various types of financial transactions that consumers may engage in. This includes things like credit cards, home or car loans, payday loans and bank accounts. The intent is to protect the public from various types of scams while assuring the consumer that they will still receive quality financial services which are available and priced in a fair manner in every community. The CFPB provides constant oversight of various organizations such as mortgage companies, debt collectors and credit unions.

The new educational documents help clear up definitions for consumers. The goal is to clearly define financial topics such as penalties, fees, risks and credit scores. This offers an extra layer of protection for consumers since it is less likely that one who is informed will fall victim to frauds and scams. Consumers will also likely experience some changes to their existing accounts. Many banks have stopped charging overdraft fees and not honor payments made which will overdraw the account. Guidelines for qualifying for loans are more stringent, but when you do qualify for a loan you will be able to afford it. This may put pressure on different types of financial institutions to be more creative in order to make a profit. This will mean some new services for their customers, for an additional fee of course.

Insurance, Securitized Investments and Derivatives

Some of the complex financial products are regulated more uniformly for various risks. Financial and safety organizations are held responsible for risks. This means there is additional reviews conducted by the government to ensure product safety but this should make insurance more available in communities which have been underserved. Since the passing of the Dodd Frank Act, derivatives are treated closer to securities which require full disclosure of any involved risks as well as exchange trading which is centralized. Mortgage-backed securities and other creators of various securitized investments are required to maintain what is termed an equity stake.

New Indicators for the Economy

The government guarantees no bailout and those acquisition industries and traditional mergers must have a growth strategy and are now required to have an exit strategy. This restricts the size as well as the complexity of financial institutions. There are several new evaluation measures in place which prevent financial upheaval in larger companies which of course, has a wide range of economic repercussions.

Economic Impact

This is simply a brief overview of the economic benefits that have been realized from the passing of the Dodd Frank Act. In one way it makes consumers be more hands-on with their own finances and for some this means that they now must hire a financial expert. The goal of this legislation was to provide protection for consumers by requiring higher standards of financial institutions. It puts much more information into the hands of consumers and makes financial institutions more accountable for their products and services.

What is a Hedge Fund?

Hedge Funds

Hedge Funds

Hedge Funds are types of partnership investment opportunities. Sometimes these are formed as a limited partnership or a limited liability company just in case the company goes under or bankrupt, creditors will not be able to try to get more money from the investors than the amounts they contributed to the hedge fund. These are a very risky type of investment which many shy away from while others flock to it. Some feel that the greater the risk the higher the return can be in the end. A hedge fund manager will use money that has been deposited with his company by investor and use it to invest in another company looking for a profitable return on the funds.

The main purpose of a hedge fund is to capitalize on the market and be able to make money whether the market is increasing or decreasing.  This type of private investing is a way to sort of outperform the market. This type of private investing is not like mutual funds which are run by large public corporations; therefore they are not regulated by entities such as the Securities and Exchange Commission (SEC). This lack of regulations is what makes them be so risky, but is also one thing that makes them more attractive to investors. This is just one type of private investing opportunities which companies such as Effi Enterprises helps locate for start up businesses or struggling companies.

What does a manager do?

Managers of a hedge fund get compensated by earning a percentage of the returns. This is more appealing to many investors since they do not get just a “fee” as a return on their investment. The managers stand to make a lot more profit since the compensation structure can yield a return that is above market value. Without the standard types of regulations, hedge funds can yield a very high return; even though much of the investment is based on speculative results initially. Managers are excellent at using derivatives, like futures contracts or options. These allow a manager to bring in a profit whether or not the stock market goes up or down. Many times they have the option of selling the stocks short which basically means they can use a small amount of money as leverage and remain in control of large quantities of commodities or stocks. And they can select a particular time frame in which they will pay out. This means that they can use timing along with leverage to make a huge return if they correctly predict if the market is going to rise or fall.

New Regulations on Hedge Funds

Recently, there were some new regulations put into place regarding hedge funds. If the hedge fund is valued over $150 million it must be registered with the SEC. The Dodd-Frank Wall Street Reform Act which was enacted in 2010 set up a Financial Stability Oversight Council which watches for this type of private investing that begins to grow too large. Once it is deemed that they are “too large to fail” the Council may recommend the regulating of these funds by the Federal Reserve. The Dodd-Frank Act also set limits for how much a bank can invest in a hedge fund. Hedge funds can only be used by banks on behalf of customers and not simply to boost the corporate profits of the bank.

What happens if the investment is lost?

The hedge fund is very risky for investors. If the investment pays off everyone gets paid, but what happens if the fund loses money? Does the manager still get paid? Absolutely not; they will not get paid if there is a loss. The manager is somewhat protected while it is the investor that stands to lose. However this type of investment is protected from fraudulent activity but many feel that there are not enough regulations in place that can help protect the private investor.