User rob - ourluckydime

Answer by Rob for What is a derivitive?

2009-10-16T23:13:45Z

I will attempt to add some nuance.

In all financial markets there is typically a spot market, the spot market is the market you go too if you want to buy something immediately, so if you want to buy a share of microsoft off the dow your essentially buying it off the spot dow market. This is fairly straight forward for things like stocks but what about oil? Say you know that in three months time you will need 100 barrels of oil, but you don't need it now, if you buy it now you've got to store it till you need it, bit of a waste of money that since it's going to cost you to store it. Well instead of going to the spot market and getting the oil immediately you buy on the futures market, which basically allows you to buy oil in the future but pay the price which is quoted now. When you actually come to get your oil in three months time the price on the spot market could be alot lower than what you paid three months ago, alternately it could be alot higher, it doesn't really matter, you locked in your price for good or ill three months ago.

Another important aspect of derivatives is that usually you can go short. That means you can sell something before you own it. How the hell does that work you ask? Well what your essentially doing is making a deal with your broker, your broker will lend you 100 barrels of oil and you'll sell them, BUT you have to buy them back later and return those 100 barrels to the broker, so if you borrow then sell and the price goes down, you can buy them back later, return them to the broker and pocket the difference, exactly the same as buying, waiting for the price to rise and selling but in reverse.

The third important thing to know about derivatives is that although they can be used to buy the physical item, be it oil or a share of microsoft you don't always have to take delivery of that item you could opt to take the cash value instead essentially betting on the price of the underlying commodity.

Finally, there are generally two classes of derivatives, those that are on an exchange and those that aren't. Futures are a good example of a derivative that are on an exchange, a single regulated place where buyers and sellers can come to deal with each other. The participants both buyers and sellers have to have a certain amount of cash in reserves to support their trading and all that is mandated by the exchange, this helps build trust between participants.

The other type of derivatives are called OTC or over the counter derivatives, these are basically just an agreement between two parties, probably in the form of a contract describing the underlying commodity, bet size e.t.c. The banks often made these OTC derivatives between each other and then they made more OTC derivatives with other banks about the derivatives they'd already bet on, multiply this by hundreds of banks and millions of different transactions and you can see where the OTC derivatives market can become a nightmare really fast. And that's essentially what happened and why you keep hearing about derivatives in the news alot.

Answer by Rob for How does investing in other currencies work?

2009-10-12T19:21:12Z

Essentially in a nut shell if the value of the dollar declines vs other currencies then it costs more dollars to buy the same basket of goods. For example six months from now it will cost more to buy the same goods as it does now, if the dollar continues to decline. Why? Well take oil for example, oil is priced in dollars but when the dollar declines vs the euro it also declines vs oil in other words the price of oil in dollars goes up. This has nothing to do with supply and demand, it just means that yesterday 1 barrel of oil was worth 67 dollars of oil, today the dollar weakened a little bit and so the barrel of oil is worth 68. But to a person holding euro's the barrel of oil costs exactly the same, because the dollar declined at roughly the same rate against both oil and the euro.

Essentially you have to understand that the dollar is not a fixed unit, if the value of the dollar declines then in essence the value of everything that the dollar can buy goes up!

And that is why you hear people worrying about the decline of the dollar because is slowly, ever so slowly devalues what you have in your pocket.

Let me give you a scarier example, from 2000-2007 your returns in the stock market were severely diluted because the dollar was declining, because stocks too are measured in dollars and if the dollar declines then it declines against stocks as well. So in an ideal world when investing in stocks you want to find a country that has both a strong stock market and a strong currency, then you get a double benefit, your stocks go up but also the currency does as well, so stocks might go up 10% in the currency they are denominated in but the currency also rose 5% against yours as well.

So currency investing is a lot more about maintaining your purchasing power and hedging against the decline of your currency. Since the dollar has been declining for almost 8 years now this perhaps is a fairly wise thing to do.

This leads onto a whole nightmare of topics including the loss of the dollars status as reserve currency, the evils of fiat money and the stupidity of politicians (aided and abetted by their populaces) but that is beyond the scope of your question.

Answer by Rob for Does diversification also mean who you have your portfolio with

2009-10-11T09:41:43Z

I would say there is something to be said for having what I would term emergency funds in a seperate bank account, I say this because while everything you have at your existing banks maybe fdic insured, the fdic process can take time, time when you might need money but can't access it because the bank is in administration e.t.c.

So the old proverb about not keeping all your eggs in one basket probably applies.

Answer by Rob for Why do stock prices go down when the jobless rate goes up?

2009-10-02T16:51:27Z

Fundamentally because the jobless rate is a barometer of the health of the economy, if the jobless rate increases then it's a sign that the economy is deteriorating and so companies are likely to make less profit in the future. Lower future profits means a lower stock price.

However there are instances when the opposite could happen, stocks could rise on a worse jobs number, this is because markets, the stock market included are a discounting mechanism, they take what available information there is before the fact and then discount that in the price. For example the consensus might be that 50,000 jobs will be lost, the market takes that information into account, when the jobs numbers are issued the number is as expected 50,000 that is what everyone was expecting and so the price does not move much, the information was factored in. On the otherhand say the number came in at -25,000 this is better than consensus the stock market would increase because the information that was factored in was incorrect, likewise a -75,000 print would be worse and the market would decline.

Answer by Rob for Why do currency rates fluctuate?

2009-10-02T15:25:08Z

The answers to your questions are somewhat complicated Alex but I'll try my best.

Before everything went to hell last year the worlds financial system was humming along quite nicely, people were borrowing money in one country and investing it in others, there was a commodity boom going on, oil was going to $140 a barrel and most other major commodities were similarly going stratospheric. This was good for Australia because oz is a major commodities producer so Australia was getting more money for its products. On the whole that's why Aussie dollar is considered a "Commodity Currency" aka a currency that tends to move in tandem with commodity prices.

Now in October everything went to hell and everyone panicked, people worldwide knew something was wrong, they didn't know how bad it was but they knew it was bad and more to the point half their investments were going sour (US Mortgages), so what did they do? They looked to see what they had a profit in, aka commodities and sold em, they sold everything they could in order to raise cash to pay off their debts, the consequence was a worldwide stock market crash and a crash in commodity prices and remembering that the Aussie dollar is corrolated to commodity prices, people sold investments in Australia and moved that money home, where they needed it. Consequently money flooded back to the UK (major financial hub) and New York (other major financial Hub). Meaning the oz dollar declined against the pound and dollar in that massive spike you see.

Now the spike deflated back to where it started and then bounced again a bit in January, that January spike was probably just technical (I'll explain that below) and then the pound continued to weaken against the oz dollar and has continued to do so for the remainder of the year the reason being that once people had caught their breath and realised that actually the world wasn't going to end, they looked at the worlds economies and realised that China was still going and if China was still going there would still be demand for commodities which oz would supply, they also realised that Australia wasn't even in recession yet and the UK and America were, so they decided there money would be safer and get a better rate of return in Australia because Australia had a better economy.

What it comes down too in the most part is that money is attracted to two things, higher interest rates and sound economies, OZ has a good economy and pays higher interest rates on balance than most other countries (historically) consequently people want Aussie dollars and to invest in Aussie companies e.t.c. Also the UK is particularly hard hit by the current recession and paying very little in terms of interest rates, we are also in the process of building up huge amounts of government debt, something that currency investors don't like. Consequently the exchange rate vs the oz dollar is going to be bad for the foreseeable future, if I were you I would be sending regular sums of money back to oz, I think your money is better off there than it is here.

Finally a note on the "technical" bit I mentioned. Currency traders in fact any kind of trader will look at the chart you posted and see alot more than a layman will, what technically happened in January was a dead cat bounce, currency traders in the end of december pushed the rate towards a major line of support while the markets were thin, in January when everyone came back to work they bought off that support line and we got a bounce but it obviously wasn't to last for the fundamental reasons I've given.

Probably alot of that bit didn't make sense but suffice to say it didn't rise for any particular fundamental reason it was mostly speculation.

If all this is leaving you bewildered there is one golden rule, the trend is your friend, look at the chart and see which direction the rate has been going, it will probably continue in that direction. As I said October was an abberation and not something you could really foresee so don't worry about it and just follow the trend, making decisions accordingly.

Answer by Rob for What is a bond?

2009-10-02T15:39:33Z

A bond is where you lend money to a company or government, unlike a stock where you are buying a piece of a company (becoming a partial owner).

When you lend money as a bond, you are guaranteed the full amount back once the term of the bond is up for example you might lend the US government money for 10 years by buying a 10 year US Treasury Note, the US government would pay you interest on that bond.

Now you are guaranteed to get your money back after 10 years when your bond matures, but in the meantime you may also sell your bond (you stop receiving interest when you do) but importantly if you sell your bond before it matures you may receive less or more than you originally invested. This is because you are not selling your bond back to the government, you are selling it to another private investor who wants a bond and they may not believe the bond is a good an investment as when you bought it. Consequently if you sell before the bond matures you may receive more or less than you invested originally but if you wait till maturity you are guaranteed to get your money back.

What are the good points about bonds?

Depending on the issuer, they are super secure, arguably US Treasury Bonds or other Bonds issued by AAA rated sovereign nations are as safe an investment as you can get, defaults (the issuer not paying the bond back) are rare but do happen and usually if a country is likely to default on it's debt then it will have a lower credit rating aka Russia might have an ABB rating (random made up example) meaning it has a higher risk of defaulting vs the US which has an AAA rating. The flip side of this coin is that Russia may well offer you a higher rate of interest in order to attract your money, the bond is riskier but the interest rate is better to compensate for the risk.

What are the bad points about bonds?

They don't do well during periods of stability or high inflation relative to stocks and other assets, you may get an interest rate of 4% on your bond, but if the inflation rate is 6% you are losing money.

Why buy bonds?

Because they move in the opposite direction to stocks and most other asset classes, so if the stock market crashes your bonds probably do very well.

Final note, as a general rule of thumb you should invest the same percentage of your portfolio in bonds as your age, aka if your 27 then 27%. This is a rough guide however your circumstances and investing situation may differ.

Hope that helps.

Answer by Rob for When should I diversify investments to other countries?

2009-09-28T11:47:09Z

To have a decent shot at answering that question I'd need to know some more information.

Is your local stock market in a developed or developing country?
How stable is the currency the stock market is denominated in? Is it the euro, dollar e.t.c. or a smaller currency?
What are you trying to achieve by this diversification? Are you worried that other markets might outperform yours?
Do you have investments in bonds, commodities e.t.c.?

I can give you a much better answer with answers to these questions.

Comment by Rob

2009-10-02T16:39:20Z

The principle behind it is that when your young you have more risk in your portfolio (more stocks) as you grow older and can less sustain damaging financial accidents (the stock market halving) you keep a higher percentage in bonds. The age = percentage rule is just a simple way of doing this. As for citations I'm afraid I have none, this was a tip picked up off various investors I have talked too. I think however it's a sound one.