Nims

Successful trading of financial instruments requires one to be fully equipped with enough information before diving deep into investing. We covered two main types of brokerage accounts and here comes the other Types of brokerage accounts.

• Hypothecation

Pledging securities as a collateral against a loan, so that the securities can be sold by the broker if the customer is unwilling or unable to meet a margin call.

• Street name registration

An arrangement under which a broker is the registered owner of a security.

The account holder is the “beneficial owner.”

Trading accounts can also be differentiated by the ways they are managed.

• Advisory account – This is where an investor pays someone else to make buy and sell decisions on your behalf. The investor is not directly involved.
• Wrap account – All the expenses associated with your account are “wrapped” into a single fee. it is therefore expensed as one in a single transaction
• Discretionary account – You simply authorize your broker to trade for you. Almost similar to the advisory account but in this case, the broker is in charge of it all.
• Asset management account – Provide for complete money management, including check-writing privileges, credit cards, and margin loans.

You may be asking yourself, is it a must to  have a brokerage account for one to invest in financial securities? the simple answer is No. The long answer is that you do not need a brokerage account to invest in financial securities because a brokerage account is not a necessity. One can buy securities directly from the issuer or another alternative  is to invest in mutual funds.

We have discussed before what a margin account is. In a margin purchase, the portion of the value of an investment that is not borrowed is called the margin. The portion that is borrowed incurs an interest that is based on the broker’s call money rate, which is the rate brokers pay to borrow bank funds for lending to customer margin accounts. Here are a few case scenarios of margin accounts calculations:

Example 1: The Account Balance Sheet

You want to buy 1000 TechnologySage shares at $24 per share. You put up $18,000 and borrow the rest.

Solution

Amount borrowed = $24,000 – $18,000 = $6,000

Margin = $18,000 / $24,000 = 75%

ASSETS                                                 LIABILITIES AND ACCOUNT EQUITY

1000 WM shares  $24,000                     Margin loan  $  6,000

Account equity  18,000

 Total  $24,000                           Total  $24,000

In a margin purchase, the minimum margin that must be supplied is called the initial margin. The maintenance margin is the minimum margin that must be present at all times in a margin account. When the margin drops below the maintenance margin, the broker may demand for more funds. This is known as a margin call.

Read also: Choosing A Broker And The Broker Customer Relationships

Example: Margin Requirements

Your account requires an initial margin of 50% and a maintenance margin of 30%. Stock A is selling at $50 per share. You have $20,000, and you want to buy as much of stock A as you possibly can.

Solution:

You may buy up to $20,000 / 0.5 = $40,000 worth of shares.

ASSETS                                                 LIABILITIES AND ACCOUNT EQUITY

800 A shares  $40,000                                 Margin loan  $20,000

Account equity  20,000

Total  $40,000                                                Total  $40,000

Example: Margin Requirements

After your purchase, the share price of stock A falls to $35 per share.

ASSETS                                                 LIABILITIES AND ACCOUNT EQUITY

800 A shares  $28,000                                    Margin loan  $20,000

Account equity  8,000

Total  $28,000                                                    Total  $28,000

New margin = $8,000 / $28,000 = 28.6%  which is less than maintenance margin of  30% Therefore, you are subject to a margin call.

In conclusion, Margin is a form of financial leverage. It is important to bear in mind that when you borrow money to make an investment, the impact is to magnify both your gains and your losses. You should therefore deal with margin accounts with caution.

Who is a broker? Well, a broker is an individual or firm which charges a fee or commission for implementing a buy and sell order or orders submitted by an investor. Before diving into this, check out the basics of buying and selling shares. What is the best practice in choosing a Broker? Brokers are traditionally divided into three groups which are:

1. full-service brokers; A full–service broker is a licensed financial broker-dealer firm which offers extensive  services to its clients, including research and advice, retirement planning, tax tips, and much more.
2. ‚discount brokers; A discount broker is a stockbroker that charges its clients significantly lower fees compared to traditional brokerage firms but without providing financial advice.
3. ƒdeep-discount brokers: An agent that performs sales and exchanges between securities buyers and sellers at even lower commission rates than those offered by a regular discount broker. They do not offer investment advice.

These three groups can be distinguished by the level of service provided, as well as the resulting commissions charged. However, as the brokerage industry becomes more competitive, the differences among the broker types seem to be blurring. Another important change is the rapid growth of online brokers, also known as e-brokers or cyber brokers. Online investing has fundamentally changed the discount and deep-discount brokerage industry by slashing costs dramatically. The choice is therefore easy to make depending on the level of discount you prefer as an investor and the kind of investment advice you would wish to have.

Broker-Customer Relations

There are several important things to keep in mind when dealing with a broker. Note the following:

1. Any advice you receive is not guaranteed.
2. ‚Your broker works as your agent and has a legal duty to act in your best interest. On the other hand, brokerage firms are in the business of generating brokerage commissions.
3. ƒYour account agreement will probably specify that any disputes will be settled by arbitration and that the arbitration is final and binding.

Tha various Objectives and Constraints of Institutional Investors. Who are institutional investors? It is worth mentioning that the institutional investors include mutual funds, pension funds, endowment funds, insurance companies and banks.

1. Mutual Funds

The role of mutual funds is to pool together funds of investors who share a common investment goal or interest and invests them in financial assets as per its investment objective.

2. Pension Funds

Pension funds receive contributions from the firm, its employees, or both and invests those funds for the respective contributing parties.

• Defined Benefit – promise to pay retirees a specific income stream after retirement. Risk resides with the employer
• Defined Contribution – Employees contribute to a pension scheme while employed. No guarantee from the employer regarding the size of retirement income stream. Risk resides with the employee.

Read Also: Role of Short Term Investment Vehicles, advantages and disadvantages

3. Endowment Funds: 

Endowment funds represent contributions made to charitable or educational institutions. it is an investment fund set up by a foundation which periodically makes withdrawals from the invested capital.

4. Insurance Companies

An insurance company is that which pools together clients’ risks to make payments more affordable for the insured in the event of losses due to the insured peril. the types of insurance cover include:

• Life Insurance Companies

–Earn rate in excess of actuarial rate

–Growing surplus if the spread is positive

–Fiduciary principles limit the risk tolerance

–Liquidity needs have increased

• Nonlife Insurance Companies

–Cash flows less predictable

–Fiduciary responsibility to claimants

–Risk exposure low to moderate

–Liquidity concerns due to uncertain claim patterns

–Regulation more permissive

Read On: How Interest Rates affect Investment Decisions

Banks

A bank can be defined as a financial institution licensed to accept customer deposits and advance loans too. Banks can also offer financial services which include wealth management, safe deposit boxes and  currency exchange. They;

• Must attract funds in a competitive interest rate environment
• Try to maintain a positive spread between their cost of funds and their return on assets
• Need substantial liquidity to meet withdrawals and loan demands
• Face regulatory constraints

In our quest to discover how interest rates affect investment decisions we did a little research. Have you ever stopped to ask yourself what drives the investment decisions of rational investors with a longer time horizon? Well, worry less. Research has shown that majority of these investors generally do not take a keen look at the differences in the market interest rates among countries in making investment decisions.

It has been found out that the factors they do consider in making the investment decisions are good and stable growth prospects, low country risks—including political and economic stability—and a stable exchange rate. This all makes good sense for long-term investors such as pension funds and insurance companies. So why all this talk about how low interest rates in advanced economies are “pushing” investment flows to emerging countries. Additionally, it is in these economies where interest rates are generally higher. Does it really matter what the interest rates are? Let us find out.

Read Also: five Steps of the Investment Process

Interest rate can defined as the proportion of a loan that is charged as interest to the borrower. It can typically be expressed as an annual percentage of the loan outstanding. Interest rates are the single most important variable in determining returns to investors for bonds and fixed-income securities. Let us figure out how Interest Rates affect Investment Decisions.

Read also: Investing Decisions Over Investor Life Cycle

Interest rates and bond prices move in opposite directions. This is to say that, when interest rates go up, bond prices go down and when interest rates go down, bond prices go up. Investors therefore have to need to put this into consideration before investing in bonds. For example, if the market interest rates rise, then the price of the bond with the 3% coupon rate will fall more than that of the bond with the 6% coupon rate. Investors have to therefore purchase bonds in a low-interest rate environment. This means they have to do the vice versa in the case of high interest rates. A bond’s maturity refers to the specific date in the future at which the face value of the bond will be repaid to the investor.

The economic environment in business terms is the environment in which a business operates and it has a great influence upon it. For any successful investment the economic environment has to be studied and fully analysed. A rational investor has to be well versatile when it comes to Market timing. Market Timing is the process of identifying the current state of the economy/market and assessing the likelihood of its continuing on its present course. It is the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis. It is important to note that the investment occurs in an economy and therefore the economic conditions of the state can affect the returns.

There are two Conditions of the Economy that are important in the investment environment.

Recovery or expansion; This is the phase of the business cycle when the economy moves from a trough to a peak. It is a period when the level of business activity surges and gross domestic product (GDP) expands until it reaches a peak. During this phase, the Corporate profits are up and this helps stock prices. This phase is growth-oriented and speculative stocks do well.

Decline or recession; This is the phase of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. During this phase, the values and returns on common stocks tend to fall.

Read also: Five Steps Of The Investment Process

Different Stages of an Economic/ Market Cycle

A peak is the highest point between the end of an economic expansion and the start of a contraction in a business cycle. The peak of the cycle refers to the last month before several key economic indicators, such as employment and new housing starts, begin to fall. In economics, a trough is a low turning point or a local minimum of a business cycle.

Investing Decisions Over Investor Life Cycle vary as a in accordance with the age bracket. Investors tend to follow different investment philosophies as they move through different stages of the life cycle. Investment decisions are made by investors and investment managers. Investors commonly perform investment analysis by making use of fundamental analysis, technical analysis and gut feel. Investment decisions are often supported by decision tools. The investor life cycle refers to the different stages of investment ownership, from the initial purchase, to the sale of the investment. The most commonly used investor life cycle includes the accumulation phase, the consolidation phase and the spending and gifting phases. These phases if put into ages refer to the youth stage, the Middle-Aged and the Retirement Stage respectively.

1. Youth Stage: accumulation phase

–Twenties and thirties

–Growth-oriented investments

–Higher potential growth; Higher potential risk

–Stress capital gains over current income

• What are some examples of age-appropriate investments?

–Common stocks, options or futures

2. Middle-Aged Consolidation Stage

Include people of aged between 45 to 60

–Family demands & responsibilities become important (education expenses, retirement savings)

–Move toward less risky investments to preserve capital

–Transition to higher-quality securities with lower risk

• What are some examples of age-appropriate investments?

–Low-risk growth and income stocks, preferred stocks, convertible stocks, high-grade bonds

 3. Retirement Stage; gifting phase

A gifting phase is when a person begins planning for or actively begins giving away wealth as part of his or her estate planning. Happens with ages of 60 years and older

–Preservation of capital becomes primary goal

–Highly conservative investment portfolio

–Current income needed to supplement
retirement income

• What are some examples of age appropriate investments?

–Low-risk income stocks and mutual funds, government bonds, quality corporate bonds, bank certificates of deposit

Checkout what you need to know when Investing in Different Market Economic Environments