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Randomly walking through financial jargons

May 5, 2009

Assets are goods that provide a flow of services over time. Assets can provide a flow of consumption services, like housing services, or can provide a flow of money that can be used to purchase consumption. Assets that provide a monetary flow are called financial assets.

Financial institutions
A market where people with convex consumption preferences, meet to swap a stream for a lump or vice versa. For instance, start-ups, private and quoted companies, with a steady stream of income but want a lump sum now, swap with those who have a lump sum now but prefer a steady stream of income over time eg, insurance companies, private equity firms, pensioners. Financial institutions eg, banks and the stock market, provide this service of intermediation.

A fact of life; to be alive at all involves some risk. Stock markets offer ways or are providers of mitigations (insurance) against some of these risks. In addition to providing exchange of consumption patterns, the stock market in effect helps investors and enterprises to invest their money in or sell their shares to myriad companies and shareholders respectively.

In this way they prevent putting all their eggs in one basket (either a company or single shareholder). Hence they spread their risks and can reallocate or transfer their wealth at will depending on their risk appetite. Other markets eg, trading in credit derivatives swaps (a sort of insurance market) also allow for spreading risk. Or muck? This is done over the counter (OTC), and was lightly regulated.

Risky assets
The value of an asset depends on how correlated it is with other assets ie, the level of risk it has is a function of its correlation with other assets. Assets that are negatively linked ie, when one increases the other decreases, are valuable since they reduce overall risk.

The riskiness of a stock relative to the risk of the stock market is measured by the beta of the stock. Beta of say stock A, equals riskiness of the stock divided by stock market’s riskiness.

Mutual funds
Mutual funds hold a portfolio of risky and riskless assets that help individual investors adjust for risk. They are professional money managers that pool the money of individual investors together.

They invest in quoted companies and distribute the profits accordingly, for a fee. Choice of mutual fund depends on your risk threshold and expected return. Compare your expected returns to the beta of a mutual fund. Note, higher returns denote reward for taking higher risks. If you can’t beat them, be close to them.

Compare by investing some money in an index fund ie, a mutual fund that mimics the daily average returns of a certain group of stocks (stock market indices) with lower fees to boot. Stock market indices eg, Footsie (UK stock market index), Dow Jones (US industrial index), Nasdaq (US technology index) are as risky as the market comes, since they hold assets representative of the markets riskiness.

Cash flow
Forecast your cash flow, funding sources, liquidity and working capital (wring cash out of your balance sheet). This way you increase liquidity in the short-term.

P.S: Talent
Intellectual capital; employers will be scurrying for it. It’s critical for their customer relations, and job know-how. They will seek to recruit good people (cash without talent equals fuel without a vehicle). Remember that “profit is an opinion, cash is fact.”

Sources: Hal Varian, Google’s chief economist and strategist and Ken Igbokwe, senior partner PWC Nigeria

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