A collateralized debt obligation (CDO) is a security backed by a pool of assets, such as mortgages, credit card debt, or other types of loans. The issuer of a CDO assembles different types of debt instruments and sells ownership stakes in the CDO to investors. Because the underlying assets are diverse, CDOs offer investors exposure to a wide range of risks. For this reason, some market observers believe that CDOs are risky investments. Others contend that for conservative investors, properly structured CDOs can be an attractive way to gain diversified exposure to the debt market.

Collateralized debt obligations are a collection of secured debts, which is where the “collateral” part comes in. With secured debts, borrowers are required to put up an asset as collateral. If they default, that asset can be seized.

They are typically taken on by institutional investors like pension funds, insurance companies, banks, investment managers and other financial institutions.

Different types of CDOs may be known by different names, based on the type of loans packaged in the CDO. For example, a CDO of mortgage loans is known as a “mortgage-backed security” (MBS), while other collections of debt like credit cards, student loans and corporate debt are known as “asset-backed securities.”

The advantage of CDOs is that, when the economy is strong, these high-risk investments can turn out better returns compared to other fixed-income products in their portfolio. For institutional investors like pension funds, insurance companies and hedge funds, that translates into higher profits.

Since CDOs aren’t tangible assets, their value is determined through a computer model. As those have become more complex, so has evaluating risk. Read more

What are your thoughts on collateralized debt obligations? Are they risky investments? Let us know in the comments below!

Article Source Here: Are Collateralized Debt Obligations Risky Investments?

Companies offer credit sales, allowing customers to pay for products and services later. Companies record sales made on credit as accounts receivable. Later, they account for any repayments from customers as a reduction in that account. Sometimes, however, customers may also fail to repay their suppliers. In those cases, companies must write off bad debts.

What is a Bad Debt?

Bad debt is an expense that represents receivable amounts no longer collectible. As mentioned, companies record these amounts when customers fail to repay their owed amounts. Several reasons may exist for their failure to reimburse the company. For example, some customers may be going through bankruptcy or experiencing financial issues.

A bad debt represents an amount that a company deems as irrecoverable. This amount relates to the sales made to customers at an earlier date. For most companies offering credit terms, bad debts are inevitable. These amounts fall under the general administrative expenses reported in the income statement. Writing off bad debts helps represent a true and fair picture of accounts receivable balances.

What is the accounting for Bad Debts?

Companies report bad debts in the financial statements under two methods. The first of these includes the direct write-off method. Under this approach, companies write off bad debts directly against the related receivable account. Usually, companies estimate these bad debts through the corresponding transaction. This method of writing off bad debts is more accurate.

The other approach to reporting bad debts is the allowance method. It does not include a specific bad debt or account. Instead, it estimates the bad debt expense at the end of each accounting period. On top of that, it does not reduce the accounts receivable balance directly.

What are the journal entries for Bad Debts?

The journal entries for bad debts depend on the approach that companies use. As mentioned, these include the direct write-off and allowance methods.

Direct write-off method

Under the direct write-off method, companies report bad debts for specific receivable accounts. This approach involves recording an expense for the irrecoverable amount. On the other hand, it also reduces the receivable balance for the customer account. The journal entries for writing off bad debts under this approach are below.

Dr	Bad debts
Cr	Accounts receivable

Allowance method

Under the allowance method, companies estimate doubtful debts based on past experiences. Usually, this approach involves creating an expense of those amounts. On the other hand, it also requires companies to record a provision for those amounts. The journal entries for writing off doubtful debts under the allowance method are below.

Dr	Doubtful debts
Cr	Allowance for doubtful debts

Example

A company, Green Co., provides credit sales to customers. During a financial year, the company sells goods worth $100,000. However, the company believes $5,000 of this balance to be irrecoverable. On top of that, Green Co. also estimates $3,000 to be doubtful. Therefore, the company must record these debts as bad and doubtful, respectively.

For the bad debts, Green Co. uses the following journal entries.

Dr	Bad debts	$5,000
Cr	Accounts receivable	$5,000

For the doubtful debts, Green Co. uses the following double-entries.

Dr	Doubtful debts	$3,000
Cr	Allowance for doubtful debts	$3,000

Conclusion

Bad debts are an expense in the income statement that relates to amounts owed by customers. When a customer fails to repay, the debt becomes irrecoverable. For that amount, the company must write off the bad debts. Similarly, companies must also estimate doubtful debts and record them in the income statement.

Post Source Here: Writing Off Bad Debts

Decentralized Finance (DeFi) Will Continue to Grow

DeFi, which stands for Decentralized Finance, is a growing sector in the world of finance. It refers to financial applications that are built on top of blockchain technology, and it offers a number of advantages over traditional finance. DeFi is still in its early days, but it is quickly gaining traction and there is no doubt that it will continue to grow in the years ahead.

Decentralised Finance (DeFi) will continue to grow driven by innovations in automated market-making and other liquidity-providing solutions leading to attractive yields on cryptocurrencies, according to Swapnil Pawar, Founder at blockchain startup ASQI told Financial Express Online. Moreover, with the emergence of platforms like Olympus decentralized autonomous organization (DAO) and subsequent forks like Wonderland, a new DeFi commonly known DeFi 2.0 is likely to gain momentum.  Read more

In a decentralized finance world, counterparties can create products and instruments without the need for a third party. While this may sound like a positive development, it has led to the creation of complex and innovative derivatives products that are difficult to understand and trade.

“Complex derivative products and innovative financial instruments are being created daily. Early participants are being rewarded with returns in the 1000s of percentage Moreover, with the DeFi 2.0, institutions can no longer ignore the returns and would look for safe methods to participate in the wild west of crypto,”

The growth of new technologies in the finance world is a testament to how dramatically the industry has changed over time. One area that this change has been felt most keenly is with Decentralized Finance, which brings new opportunities for investment but also more risks if they’re not properly understood and managed.

Post Source Here: Decentralized Finance (DeFi) Will Continue to Grow

Human psychological bias affects us in many different ways. We have recently discussed how recency bias influences our trading. In this post, we’re going to talk about selection bias.

Selection bias occurs when a statistical sample is not representative of the entire population. This situation arises, for example, when a study is based on a small number of people, and/or the subjects are not truly randomized. It can also happen when the researchers subconsciously project their own beliefs onto the experiment design, thus leading to inaccurate results. In trading and portfolio management, the selection bias often manifests itself in the form of cherry-picking, i.e. the tendency for the portfolio managers to present results using samples that validate their views.

A recent article [1] examined the selection bias in a larger context. Specifically, it studied how the success narratives affect people’s decision making,

In this paper, we complement and build upon these previous efforts by focusing on the extent to which popular and widely-read success narratives containing plainly biased examples affect people’s decision-making in terms of what choices they make, how confident they are in those choices, and the justifications they provide around them. In our experiment, we observed a strikingly large difference in participants’ decisions depending on which condition they were assigned to: while 87% of people shown examples of successful graduates bet that graduates are more likely to succeed, only 32% of people shown examples of successful dropouts bet on graduates, a difference of 55 percentage points. Far from discounting the small sets of examples they acknowledged as biased, participants were substantially swayed by them. This strong effect on beliefs is caused by a weak manipulation that involves no outright deception.

Briefly, our decision making can be manipulated without difficulty. In fact, the authors pointed out that even with factual accurate data, its selective presentation can still lead us to a wrong conclusion,

There are many examples of the selective presentation of factually accurate data in polarizing domains like climate science, gun control, immigration, police violence, and social insurance programs. Given the size of the effect that we found with a manipulation that would clearly pass a conventional fact check, our results suggest that more attention should be paid to the prevalence and impact of presenting biased selections of factually accurate examples.

We believe that with the increasing influence of social media, selection bias will have a bigger impact on our decision making. Therefore it’s more important than ever to conduct investment research that is based on statistically valid samples and techniques.

References

[1] G. Lifchits, A. Anderson, DG. Goldstein, JM. Hofman, DJ. Watts, Success stories cause false beliefs about success, Judgment and Decision Making, Vol. 16, No. 6, November 2021, pp. 1439–1463

Originally Published Here: Selection Bias: How It Affects Our Lives

In order for us to have a clear idea of our compound growth rate, we must first understand the Time-Weighted Rate Of Return (TWR). Remember, compound growth is simply paying yourself a percentage of your earnings and then reinvesting those earnings to generate a larger return.

In this article, we will be digging deep into the Time-Weighted Rate Of Return or TWR. We will be looking at what it is, how does it work, and why it is important for your investment portfolio. So, let's get started.

What Is Time-Weighted Rate Of Return

In finance, there are a few metrics that have been used to measure the performance of your investment portfolio. One of those rates is the TWR which stands for "Time-Weighted Rate Of Return." The TWR helps to measure the growth of your investment portfolio. It basically breaks up your investment portfolio into different intervals based on your deposits or withdrawals. The TWR also eliminates the distorting effects in growth rates created by the inflows and outflows of money. So it can also be used for comparing the returns of investment managers and various investment portfolios.

The importance of Time-Weighted Rate Of Return

It is hard to calculate the rate of returns from an investment portfolio where there are multiple deposits and withdrawals. This is because when you add these transactions to your investment portfolio, there will be a significant change in the investment value and performance of your portfolio. This change is due to compounding which can be witnessed in both upward and downward movements in the value of your investments.

On the other hand, multiple investments and redemptions can distort the rate of returns over a period of time. It can be difficult to know how much each transaction has contributed to the total return.

So for these reasons, we need a metric that helps us eliminate or adjust for the inflows and outflows of money. That's where the TWR comes in. It helps us get a more accurate picture of the rate of returns for our portfolio.

How does Time-Weighted Rate Of Return work

TWR basically calculates the rate of return for your investment portfolio based on changes in cash flow. It is the calculation of the investment returns that managers generate over a specific time period that is geometrically connected or compounded. Here is the formula for calculating TWR or Time-Weighted Rate Of Return

TWR = [(1+HP1) x (1+HP2) x (1+HPn)] – 1

In this formula

1. n = the number of sub-periods
2. HP = (End Value - (Beginning Value + Cash Flow)) / (Beginning Value + Cash Flow)
3. HPn = Return for sub-period n

Conclusion

In conclusion, the TWR or Time-Weighted Rate Of Return is a metric that helps us get a better picture of our investment portfolio returns. In other words, it helps get rid of the distortion in growth rates due to inflows and outflows of money. This makes it easier for us to analyze how well we have been performing as investors.

Post Source Here: Time-Weighted Rate of Return

Could There Be a #Bitcoin Crash Next Year?#BTC #SPYhttps://t.co/tU4VpwLJKV

— Harbourfront Technologies (@DerivValuation) December 28, 2021

2021 was a meteoric year for crypto, with bitcoin looking to end the year almost 70% up from its January starting value, the first big crypto company (Coinbase) going public in April, and the launch of the first SEC-approved bitcoin futures ETF in October. This year experienced a lot of volatility in the crypto space, but overall, crypto assets are worth an astounding $2 trillion as the year draws to a close; looking ahead to next year, analysts anticipate some major movement for bitcoin, reports CNBC.

Bitcoin is best known for its volatility and the allure of the gains that it can provide. However, several analysts believe that the surge seen this year could be erased in a potentially massive crash next year, as has been the historical case for the most popular cryptocurrency. In 2018, bitcoin once reached a high of almost $20,000, only to crash down to around $3,000 within the space of a few months.

“Without question, Bitcoin’s price chart appears to track many historical asset bubbles and busts and is carrying a ‘this time it’s different’ narrative just like other bubbles,” said Todd Lowenstein, chief equity strategist of Union Bank’s private banking arm.

Carol Alexander, professor of finance at Sussex University, goes a step further, expecting bitcoin to fall as low as $10,000 next year, completely erasing any gains from this year on the bearish sentiment that bitcoin doesn’t have fundamental value.

Post Source Here: Could There Be a Bitcoin Crash Next Year?

Companies attract customers through their products and services. In addition to those, companies also provide other packages or incentives. These incentives come through the provision of credit terms and incentives. On top of these, companies also offer discounts that promote more sales. Usually, companies provide two forms of discounts, namely sales and trade discounts.

What is a Sales Discount?

A sales discount is a reduction in the amount owed by a customer. This discount does not relate to a company's operations, products, or services. Instead, they depend on the credit terms that companies offer. Sales discounts allow customers to pay a lower price for goods and services. However, this reduction is only valid if they pay promptly.

Another name used for sales discounts is cash discounts. These discounts allow companies to collect their receivables earlier. However, it depends on customers to utilize these discounts. Sales discounts usually fix a date or time for customers to repay. If they fail to reimburse the company until then, they will not receive the reduction in payment. Sales discounts are also crucial for cash and liquidity management.

How do Sales Discounts work?

When companies sell products or services, they may collect cash when the transaction occurs. However, some companies also offer credit terms, allowing customers to pay later. This strategy is crucial in allowing customers to purchase more products or services. However, companies may face an issue when collecting the owed amount. Usually, companies seek to receive these amounts as soon as possible.

It is where sales discounts can be helpful. With these discounts, companies offer customers the chance to reduce the owed amount. However, they also set an expiry time for it, which is before the credit term expires. It allows companies to collect cash earlier, providing more investment opportunities. On the other hand, the customer pays a lower price for the goods.

What is the accounting treatment of Sales Discount?

As mentioned, companies usually offer two types of discounts. A trade discount is a reduction in the price of goods or services. Accounting standards do not require an accounting treatment for those discounts. However, sales discounts are different. With these, companies must record the sold items at the agreed price.

The recording of sales has the same journal entries as traditional sales. However, the accounting for sales discount applies when customers avail the reduction in the owed amount. In that case, the company must record an expense for the reduced amount. Usually, companies use the following journal entries for sales discounts.

Dr	Discount allowed
Cr	Accounts receivable

Example

A company, Red Co., sells goods worth $1,000 to a customer on credit. The company records these sales as follows.

Dr	Accounts receivable	$1,000
Cr	Sales	$1,000

Red Co. requires the customer to repay within 30 days. However, the company also offers a sales discount of 10% if the customer pays within the next ten days. The customer avails of the sale discount and reimburses Red Co. within eight days. Red Co. receives a total of $900 from the customer. Therefore, the company will record the sales discount with the following journal entries.

Dr	Discount allowed	$100
Dr	Cash	$900
Cr	Accounts receivable	$1,000

Conclusion

A sales discount is a reduction of the money owed by a customer. This discount applies to products and services after the sales occur. Usually, it involves allowing customers to repay the company at an earlier date. Companies must record this discount as an expense in the accounts. Sales discounts help with cash management and can reduce bad debts.

Originally Published Here: Sales Discount: Accounting, Journal Entry, Example, Debit or Credit

Everyone is familiar with the term 'costs'. In business, there are all sorts of costs - from the cost of goods sold and the cost of marketing and sales to the cost of employee benefits and the cost of occupancy. But what about transaction costs?

Transaction costs are a unique type of cost that businesses incur whenever they exchange goods or services. Business owners need to be aware of these costs and take them into account when making decisions about exchanging goods or services. In this article, we'll take a look at transaction costs are some examples, and the different types of costs that fall under this category.

Definition of Transaction Cost

Transaction costs are an economic term that refers to the cost of participating in a market. It is a type of fee that is paid in order to engage in a transaction. Simply put, it is a payment that banks and brokers charge for their participation in a transaction. Even when you buy real estate or insurance and take assistance from an agent, you have to pay commission to him/her. That can also be considered as a transaction cost.

Examples of Transaction Cost

The following are examples of transaction costs

• Brokers' fees for buying or selling stocks on the stock market. A broker is an intermediary who helps you purchase, sell and manage your investment portfolio. The fee you pay the broker will be considered as a transaction cost.
• The average transaction cost for a mutual fund in the USA is around 1.45%. It is divided into many categories such as management fees, 12b-1 fees, and operating expenses.
• The cost of exchanging one currency for another is known as the foreign exchange rate or Forex rate. When you convert your British pounds into Euros, for example, you will be charged a fee by the bank. This fee is considered a transaction cost.

Different types of Transaction Costs

There are basically three different types of transaction costs that you might come across.

1. Search and Information Costs

These types of costs are associated with finding and obtaining information about a certain company or security. It may also include the cost of notarizing documents as well as the cost of getting opinions from experts such as legal counsel, tax consultants, and investment advisors.

2. Bargaining Costs

This includes all those expenses you incur while seeking to negotiate a deal including hiring legal representation if necessary. It also includes the costs associated with evaluating each competing bid.

3. Policing and Administration Costs

These types of costs are related to ensuring that all the rules and regulations are followed during the transactions like making sure there is no fraud involved, preventing embezzlement or theft. If you're buying a property on your own, you might need to hire a lawyer or an inspector. These types of costs fall into the category of policing and administration costs.

Conclusion

As you can see, there are a variety of different costs that fall under the category of transaction costs. Business owners need to be aware of these costs and factor them into their decisions whenever they're exchanging goods or services. By understanding transaction costs, you can make wiser choices and save yourself some money in the process.

Post Source Here: Transaction Costs

The income statement details a company's financial performance. This statement includes revenues and expenditures. Based on those items, it calculates several types of profits. However, it must categorize expenses into several categories depending on their nature. One of these classifications includes the cost of goods sold.

What is the Cost of Goods Sold?

The cost of goods sold (COGS) is an item that appears on the income statement. It includes all expenses related to manufacturing or purchasing goods. In essence, it consists of all the direct costs incurred in the process. COGS includes material and labour costs and other factory overheads. This cost also directly relates to the revenues generated during a period.

The cost of goods sold allows companies to calculate the gross profit. These profits include earnings from selling products only. Since it ignores indirect costs, the cost of goods sold indicates the expenses related to production or purchase. In some cases, companies may also refer to the cost of goods sold as the cost of sales. It is also directly proportional to the activity level during a specific period.

How does the Cost of Goods Sold work?

Companies combine expenses under one heading in the income statement based on their nature. These items help calculate different types of profits. The cost of goods sold accumulates direct expenses relating to the production process. In some cases, companies may sell manufactured goods purchased from other companies. The cost of goods sold covers the purchase expenses in those situations.

Usually, the cost of goods sold includes variable costs related to activity levels. For example, they will cover direct material and direct labour expenses. Apart from these, the cost of goods sold may also consist of fixed costs. For instance, factory overheads, holding costs, etc., fall into this category. However, it excludes selling and administrative expenses.

What is the accounting for the Cost of Goods Sold?

The accounting for the cost of goods sold is straightforward. Companies record expenses into their general ledgers. Usually, each account within the financial system has a type. Consequently, each expense account will become a part of a different heading in the income statement. Companies categorize direct expenses as the cost of goods sold.

Therefore, any amounts in those accounts will constitute the cost of goods sold in the income statement. The accounting process for those expenses will remain the same. Based on the classification, companies will present them under different headings. Through this process, companies separate expenses relating to the cost of goods.

Is the Cost of Goods Sold an income statement item or a balance sheet item?

As mentioned above, the cost of goods sold primarily relates to the income statement. Usually, it is the second line item on that statement. Since it includes expenses, it is crucial in calculating profits. Therefore, it becomes a part of the income statement. In contrast, the cost of goods sold does not appear on the balance sheet directly.

However, the cost of goods sold relates to the balance sheet indirectly. It requires opening and closing inventories, which come from the balance sheet. These items can increase or decrease the cost of sales reported in the income statement. Similarly, the cost of goods sold also impacts retained earnings in the balance sheet.

Conclusion

The cost of goods sold includes all direct costs related to producing or purchasing products. It appears on the income statement as an expense. Usually, companies account for the cost of sales by categorizing expenses into the cost of goods sold category. It is primarily a part of the income statement. However, the cost of goods sold can also indirectly impact the balance sheet.

Originally Published Here: Cost of Goods Sold: Accounting, Income Statement

Inflation is the scourge of the modern economy. In order for us to make wise decisions about where to allocate our precious resources, we need to have a good understanding of what inflation is and how it works.

On the other hand, there are a number of economic indicators that, when used properly, can help investors gain an insight into how the economy is going to behave in the future. The yield curve is one such indicator. In this article, we'll explore the relationship between the yield curve and inflation.

What is the Yield Curve?

Yield Curves are known as the lines that plot yields (interest rates) of bonds having the same credit quality but with differing maturities. The yield curve is meant to show investors the relationship between risk and return, and help them decide upon an optimal portfolio allocation based on their risk appetite and time horizon. An inverted yield curve occurs when long-term yields fall below short-term rates and signify a strong economic downturn.

How does Yield Curve work?

The yield curve works best when it comes to predicting deflationary or inflationary trends in an economy. It works as a benchmark to other debts in the market such as lending rates, and mortgage rates. It is also used to predict the changes in the economic landscape and growth.

What is Inflation?

Inflation is simply a rise in the prices of goods and services in an economy. This can be caused by a number of factors such as an increase in the money supply, higher taxes, or tariffs. Most economists agree that a little bit of inflation is good for an economy as it encourages people to spend money and helps businesses to grow. However, too much inflation becomes detrimental to economic growth as it makes goods and services expensive for consumers.

How does Inflation work?

Inflation works by decreasing the purchasing power of money. When prices for goods and services increase, people need more money to purchase the same amount of stuff. This can cause a lot of problems for people as they may not be able to afford the things that they need. In extreme cases, it can even lead to hyperinflation, which is a term used to describe an extremely high rate of inflation.

What can Yield Curve tell us about Inflation?

The yield curve can be used to tell us a lot about inflation. For example, if the yield curve is inverted, it usually means that there is an impending recession and that prices for goods and services are going to start increasing at a rapid rate. On the other hand, if the yield curve is steep, it usually means that there is a lot of economic activity in an economy, which usually leads to inflation.

How can Yield Curve be used to predict Inflation?

Investors can use the yield curve to help them make decisions about inflation. If an inverted yield curve is observed, it indicates that the economy is not doing well and there are low chances of price hikes for goods and services. Since the inverted yield curve is a signal of recession, investors should avoid purchasing stocks as they are likely to fall as an economy goes into a recession.

On the other hand, if the yield curve is steep, investors should consider putting their money in stocks as inflationary trends are likely to be observed. This usually means good business prospects for companies and that the prices for goods and services are likely to rise.

Conclusion

The yield curve is a powerful economic indicator that can be used to predict inflation. By understanding how the yield curve works, investors can make informed decisions about their investment portfolio and brace themselves for potential price hikes in the future.

Article Source Here: The Yield Curve and Inflation