Capital Structure - Forex Trading

In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. In reality, capital structure may be highly complex and include tens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a long term loan etc.

The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, how a firm is financed is irrelevant to its value. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs, taxes, information asymmetry, to name some. This analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm.
Contents
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* 1 Capital structure in a perfect market
* 2 Capital structure in the real world
o 2.1 Trade-off theory
o 2.2 Pecking order theory
o 2.3 Agency Costs
o 2.4 Other
* 3 Arbitrage
* 4 See also
* 5 Further reading
* 6 References
* 7 External links

[edit] Capital structure in a perfect market
Main article: Modigliani-Miller theorem

Assume a perfect capital market (no transaction or bankruptcy costs; perfect information); firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions. Modigliani and Miller made two findings under these conditions. Their first 'proposition' was that the value of a company is independent of its capital structure. Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk. That is, as leverage increases, while the burden of individual risks is shifted between different investor classes, total risk is conserved and hence no extra value created.

Their analysis was extended to include the effect of taxes and risky debt. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure, then would be to have virtually no equity at all.

[edit] Capital structure in the real world

If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model.

[edit] Trade-off theory
Main article: Trade-off theory of capital structure

Trade-off theory allows the bankruptcy cost to exist. It states that there is an advantage to financing with debt (namely, the tax benefit of debts) and that there is a cost of financing with debt (the bankruptcy costs of debt). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Empirically, this theory may explain differences in D/E ratios between industries, but it doesn't explain differences within the same industry.

[edit] Pecking order theory
Main article: Pecking Order Theory

Pecking Order theory tries to capture the costs of asymmetric information. It states that companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means “of last resort”. Hence: internal debt is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Thus, the form of debt a firm chooses can act as a signal of its need for external finance. The pecking order theory is popularized by Myers (1984)[1] when he argues that equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance.

[edit] Agency Costs

There are three types of agency costs which can help explain the relevance of capital structure.

* Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders.
* Underinvestment problem: If debt is risky (eg in a growth company), the gain from the project will accrue to debtholders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value.
* Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management.

[edit] Other

* The neutral mutation hypothesis—firms fall into various habits of financing, which do not impact on value.
* Market timing hypothesis—capital structure is the outcome of the historical cumulative timing of the market by managers.[2]
* accelerated investment effect- even in absence of agency costs, levered firms use to invest faster because of the existence of default risk[3]

[edit] Arbitrage

Similar questions are also the concern of a variety of speculator known as a capital-structure arbitrageur, see arbitrage.

A capital-structure arbitrageur seeks opportunities created by differential pricing of various instruments issued by one corporation. Consider, for example, traditional bonds and convertible bonds. The latter are bonds that are, under contracted-for conditions, convertible into shares of equity. The stock-option component of a convertible bond has a calculable value in itself. The value of the whole instrument should be the value of the traditional bonds plus the extra value of the option feature. If the spread, the difference between the convertible and the non-convertible bonds grows excessively, then the capital-structure arbitrageur will bet that it will converge.

[edit] See also

* Cost of capital
* Corporate finance
* Debt overhang
* Discounted cash flow
* Enterprise value
* Financial modeling
* Financial economics
* Pecking Order Theory
* Weighted average cost of capital

Investment Management - Forex

Investment management is the professional management of various securities (shares, bonds etc.) and assets (e.g., real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds or Exchange Traded Funds) .


The term asset management is often used to refer to the investment management of collective investments, (not necessarily) whilst the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services as wealth management or portfolio management often within the context of so-called "private banking".

The provision of 'investment management services' includes elements of financial analysis, asset selection, stock selection, plan implementation and ongoing monitoring of investments. Investment management is a large and important global industry in its own right responsible for caretaking of trillions of dollars, euro, pounds and yen. Coming under the remit of financial services many of the world's largest companies are at least in part investment managers and employ millions of staff and create billions in revenue.

Fund manager (or investment adviser in the U.S.) refers to both a firm that provides investment management services and an individual who directs fund management decisions.

Industry scope

The business of investment management has several facets, including the employment of professional fund managers, research (of individual assets and asset classes), dealing, settlement, marketing, internal auditing, and the preparation of reports for clients. The largest financial fund managers are firms that exhibit all the complexity their size demands. Apart from the people who bring in the money (marketers) and the people who direct investment (the fund managers), there are compliance staff (to ensure accord with legislative and regulatory constraints), internal auditors of various kinds (to examine internal systems and controls), financial controllers (to account for the institutions' own money and costs), computer experts, and "back office" employees (to track and record transactions and fund valuations for up to thousands of clients per institution).

[edit] Key problems of running such businesses

Key problems include:

* revenue is directly linked to market valuations, so a major fall in asset prices causes a precipitous decline in revenues relative to costs;
* above-average fund performance is difficult to sustain, and clients may not be patient during times of poor performance;
* successful fund managers are expensive and may be headhunted by competitors;
* above-average fund performance appears to be dependent on the unique skills of the fund manager; however, clients are loath to stake their investments on the ability of a few individuals- they would rather see firm-wide success, attributable to a single philosophy and internal discipline;
* analysts who generate above-average returns often become sufficiently wealthy that they avoid corporate employment in favor of managing their personal portfolios.

The most successful investment firms in the world have probably been those that have been separated physically and psychologically from banks and insurance companies. That is, the best performance and also the most dynamic business strategies (in this field) have generally come from independent investment management firms.

[edit] Representing the owners of shares

Institutions often control huge shareholdings. In most cases they are acting as fiduciary agents rather than principals (direct owners). The owners of shares theoretically have great power to alter the companies they own via the voting rights the shares carry and the consequent ability to pressure managements, and if necessary out-vote them at annual and other meetings.

In practice, the ultimate owners of shares often do not exercise the power they collectively hold (because the owners are many, each with small holdings); financial institutions (as agents) sometimes do. There is a general belief that shareholders - in this case, the institutions acting as agents—could and should exercise more active influence over the companies in which they hold shares (e.g., to hold managers to account, to ensure Boards effective functioning). Such action would add a pressure group to those (the regulators and the Board) overseeing management.

However there is the problem of how the institution should exercise this power. One way is for the institution to decide, the other is for the institution to poll its beneficiaries. Assuming that the institution polls, should it then: (i) Vote the entire holding as directed by the majority of votes cast? (ii) Split the vote (where this is allowed) according to the proportions of the vote? (iii) Or respect the abstainers and only vote the respondents' holdings?

The price signals generated by large active managers holding or not holding the stock may contribute to management change. For example, this is the case when a large active manager sells his position in a company, leading to (possibly) a decline in the stock price, but more importantly a loss of confidence by the markets in the management of the company, thus precipitating changes in the management team.

Some institutions have been more vocal and active in pursuing such matters; for instance, some firms believe that there are investment advantages to accumulating substantial minority shareholdings (i.e. 10% or more) and putting pressure on management to implement significant changes in the business. In some cases, institutions with minority holdings work together to force management change. Perhaps more frequent is the sustained pressure that large institutions bring to bear on management teams through persuasive discourse and PR. On the other hand, some of the largest investment managers—such as Barclays Global Investors and Vanguard—advocate simply owning every company, reducing the incentive to influence management teams. A reason for this last strategy is that the investment manager prefers a closer, more open and honest relationship with a company's management team than would exist if they exercised control; allowing them to make a better investment decision.

The national context in which shareholder representation considerations are set is variable and important. The USA is a litigious society and shareholders use the law as a lever to pressure management teams. In Japan it is traditional for shareholders to be low in the 'pecking order,' which often allows management and labor to ignore the rights of the ultimate owners. Whereas US firms generally cater to shareholders, Japanese businesses generally exhibit a stakeholder mentality, in which they seek consensus amongst all interested parties (against a background of strong unions and labour legislation).

[edit] Size of the global fund management industry

Assets of the global fund management industry increased for the fourth year running in 2007 to reach a record $74.3 trillion. This was up 14% on the previous year and double from five years earlier. Growth during the past three years has been due to an increase in capital inflows and strong performance of equity markets.

Pension assets totalled $28.2 trillion in 2007, with a further $26.2 trillion invested in mutual funds and $19.9 trillion in insurance funds. Together with alternative assets, such as those of sovereign wealth funds, hedge funds, private equity funds and funds of wealthy individuals, assets of the global fund management industry probably totalled around $110 trillion at the end of 2007.

The US was by far the largest source of funds under management in 2007 with nearly a half of the world total. It was followed by the UK with 9% and Japan with 6%. The Asia-Pacific region has shown the strongest growth in recent years. Countries such as China and India offer huge potential and many companies are showing an increased focus in this region.[1]

[edit] 15 Largest Asset Management Firms

A 1 October 2007 article published in Pensions and Investments details the top 15 (300 listed) asset managers by assets under management (AUM) as of 31 December 2008.[2]
Ranking Manager Assets under management
(US$ billion) Country
1. UBS AG - according to its website (31.03.09) 2059 Switzerland
2. Barclays Global Investors 1,400 UK
3. State Street Global Advisors 1,367 US
4. Fidelity Investments 1,299 US
5. The Vanguard Group 852 US
6. JPMorgan Chase 782 US
7. Capital Group 1200 US
8. Deutsche Bank 723 Germany
9. Northern Trust 598 US
10. AllianceBernstein 516 US
11. Wellington Management Company 484 US
12. Merrill Lynch & Co. 473 US
13. Credit Agricole 461 France
14. Goldman Sachs 452 US
15. Citigroup 437 US

1. ^ Fund Management: City Business Series. International Financial Services, London. 2008-10-14. http://www.ifsl.org.uk/upload/CBS_Fund_Management_2008.pdf. Retrieved on 2008-14-14.
2. ^ P&I/Watson Wyatt World 500: The world's largest managers

[edit] Philosophy, process and people

The 3-P's (Philosophy, Process and People) are often used to describe the reasons why the manager is able to produce above average results.

* Philosophy refers to the over-arching beliefs of the investment organization. For example: (i) Does the manager buy growth or value shares (and why)? (ii) Do they believe in market timing (and on what evidence)? (iii) Do they rely on external research or do they employ a team of researchers? It is helpful if any and all of such fundamental beliefs are supported by proof-statements.
* Process refers to the way in which the overall philosophy is implemented. For example: (i) Which universe of assets is explored before particular assets are chosen as suitable investments? (ii) How does the manager decide what to buy and when? (iii) How does the manager decide what to sell and when? (iv) Who takes the decisions and are they taken by committee? (v) What controls are in place to ensure that a rogue fund (one very different from others and from what is intended) cannot arise?
* People refers to the staff, especially the fund managers. The questions are, Who are they? How are they selected? How old are they? Who reports to whom? How deep is the team (and do all the members understand the philosophy and process they are supposed to be using)? And most important of all, How long has the team been working together? This last question is vital because whatever performance record was presented at the outset of the relationship with the client may or may not relate to (have been produced by) a team that is still in place. If the team has changed greatly (high staff turnover or changes to the team), then arguably the performance record is completely unrelated to the existing team (of fund managers).

[edit] Investment managers and portfolio structures

At the heart of the investment management industry are the managers who invest and divest client investments.

A certified company investment advisor should conduct an assessment of each client's individual needs and risk profile. The advisor then recommends appropriate investments.

[edit] Asset allocation

The different asset class definitions are widely debated, but four common divisions are stocks, bonds, real-estate and commodities. The exercise of allocating funds among these assets (and among individual securities within each asset class) is what investment management firms are paid for. Asset classes exhibit different market dynamics, and different interaction effects; thus, the allocation of monies among asset classes will have a significant effect on the performance of the fund. Some research suggests that allocation among asset classes has more predictive power than the choice of individual holdings in determining portfolio return. Arguably, the skill of a successful investment manager resides in constructing the asset allocation, and separately the individual holdings, so as to outperform certain benchmarks (e.g., the peer group of competing funds, bond and stock indices).

[edit] Long-term returns

It is important to look at the evidence on the long-term returns to different assets, and to holding period returns (the returns that accrue on average over different lengths of investment). For example, over very long holding periods (eg. 10+ years) in most countries, equities have generated higher returns than bonds, and bonds have generated higher returns than cash. According to financial theory, this is because equities are riskier (more volatile) than bonds which are themselves more risky than cash.

[edit] Diversification

Against the background of the asset allocation, fund managers consider the degree of diversification that makes sense for a given client (given its risk preferences) and construct a list of planned holdings accordingly. The list will indicate what percentage of the fund should be invested in each particular stock or bond. The theory of portfolio diversification was originated by Markowitz and effective diversification requires management of the correlation between the asset returns and the liability returns, issues internal to the portfolio (individual holdings volatility), and cross-correlations between the returns.

[edit] Investment styles

There are a range of different styles of fund management that the institution can implement. For example, growth, value, market neutral, small capitalisation, indexed, etc. Each of these approaches has its distinctive features, adherents and, in any particular financial environment, distinctive risk characteristics. For example, there is evidence that growth styles (buying rapidly growing earnings) are especially effective when the companies able to generate such growth are scarce; conversely, when such growth is plentiful, then there is evidence that value styles tend to outperform the indices particularly successfully.

[edit] Performance measurement

Fund performance is the acid test of fund management, and in the institutional context accurate measurement is a necessity. For that purpose, institutions measure the performance of each fund (and usually for internal purposes components of each fund) under their management, and performance is also measured by external firms that specialize in performance measurement. The leading performance measurement firms (e.g. Frank Russell in the USA) compile aggregate industry data, e.g., showing how funds in general performed against given indices and peer groups over various time periods.

In a typical case (let us say an equity fund), then the calculation would be made (as far as the client is concerned) every quarter and would show a percentage change compared with the prior quarter (e.g., +4.6% total return in US dollars). This figure would be compared with other similar funds managed within the institution (for purposes of monitoring internal controls), with performance data for peer group funds, and with relevant indices (where available) or tailor-made performance benchmarks where appropriate. The specialist performance measurement firms calculate quartile and decile data and close attention would be paid to the (percentile) ranking of any fund.

Generally speaking, it is probably appropriate for an investment firm to persuade its clients to assess performance over longer periods (e.g., 3 to 5 years) to smooth out very short term fluctuations in performance and the influence of the business cycle. This can be difficult however and, industry wide, there is a serious preoccupation with short-term numbers and the effect on the relationship with clients (and resultant business risks for the institutions).

An enduring problem is whether to measure before-tax or after-tax performance. After-tax measurement represents the benefit to the investor, but investors' tax positions may vary. Before-tax measurement can be misleading, especially in regimens that tax realised capital gains (and not unrealised). It is thus possible that successful active managers (measured before tax) may produce miserable after-tax results. One possible solution is to report the after-tax position of some standard taxpayer.

[edit] Risk-adjusted performance measurement

Performance measurement should not be reduced to the evaluation of fund returns alone, but must also integrate other fund elements that would be of interest to investors, such as the measure of risk taken. Several other aspects are also part of performance measurement: evaluating if managers have succeeded in reaching their objective, i.e. if their return was sufficiently high to reward the risks taken; how they compare to their peers; and finally whether the portfolio management results were due to luck or the manager’s skill. The need to answer all these questions has led to the development of more sophisticated performance measures, many of which originate in modern portfolio theory.

Modern portfolio theory established the quantitative link that exists between portfolio risk and return. The Capital Asset Pricing Model (CAPM) developed by Sharpe (1964) highlighted the notion of rewarding risk and produced the first performance indicators, be they risk-adjusted ratios (Sharpe ratio, information ratio) or differential returns compared to benchmarks (alphas). The Sharpe ratio is the simplest and best known performance measure. It measures the return of a portfolio in excess of the risk-free rate, compared to the total risk of the portfolio. This measure is said to be absolute, as it does not refer to any benchmark, avoiding drawbacks related to a poor choice of benchmark. Meanwhile, it does not allow the separation of the performance of the market in which the portfolio is invested from that of the manager. The information ratio is a more general form of the Sharpe ratio in which the risk-free asset is replaced by a benchmark portfolio. This measure is relative, as it evaluates portfolio performance in reference to a benchmark, making the result strongly dependent on this benchmark choice.

Portfolio alpha is obtained by measuring the difference between the return of the portfolio and that of a benchmark portfolio. This measure appears to be the only reliable performance measure to evaluate active management. In fact, we have to distinguish between normal returns, provided by the fair reward for portfolio exposure to different risks, and obtained through passive management, from abnormal performance (or outperformance) due to the manager’s skill, whether through market timing or stock picking. The first component is related to allocation and style investment choices, which may not be under the sole control of the manager, and depends on the economic context, while the second component is an evaluation of the success of the manager’s decisions. Only the latter, measured by alpha, allows the evaluation of the manager’s true performance.

Portfolio normal return may be evaluated using factor models. The first model, proposed by Jensen (1968), relies on the CAPM and explains portfolio normal returns with the market index as the only factor. It quickly becomes clear, however, that one factor is not enough to explain the returns and that other factors have to be considered. Multi-factor models were developed as an alternative to the CAPM, allowing a better description of portfolio risks and an accurate evaluation of managers’ performance. For example, Fama and French (1993) have highlighted two important factors that characterise a company's risk in addition to market risk. These factors are the book-to-market ratio and the company's size as measured by its market capitalisation. Fama and French therefore proposed three-factor model to describe portfolio normal returns (Fama-French three-factor model). Carhart (1997) proposed to add momentum as a fourth factor to allow the persistence of the returns to be taken into account. Also of interest for performance measurement is Sharpe’s (1992) style analysis model, in which factors are style indices. This model allows a custom benchmark for each portfolio to be developed, using the linear combination of style indices that best replicate portfolio style allocation, and leads to an accurate evaluation of portfolio alpha.

[edit] Education or Certification

Increasingly, international business schools are incorporating the subject into their course outlines and some have formulated the title of 'Investment Management' conferred as specialist bachelors degrees (e.g. Cass Business School, London). Due to global cross-recognition agreements with the 2 major accrediting agencies AACSB and ACBSP which accredit over 560 of the best business school programs, the Certification of MFP Master Financial Planner Professional from the American Academy of Financial Management is available to AACSB and ACBSP business school graduates with finance or financial services-related concentrations. For people with aspirations to become an investment manager, further education may be needed beyond a bachelors in business, finance, or economics. A graduate degree or an investment qualification such as theChartered Financial Analyst (CFA) designation may help in having a career in investment management.[citation needed]

There is no evidence that any particular qualification enhances the most desirable characteristic of an investment manager, that is the ability to select investments that result in an above average (risk weighted) long-term performance. The industry has a tradition of seeking out, employing and generously rewarding such people without reference to any formal qualifications.

[edit] See also

* Active management
* Alpha capture system
* Corporate governance
* Exchange fund
* Investment
* List of asset management firms
* Passive management
* Exchange Traded Funds
* Personal information managers
* Portfolio
* Separately managed account
* Transition Management

portfolio Fiance -Forex

Finance, a portfolio is an appropriate mix of collection of investments held by institutions or a private individual.

Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value.

In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services.

Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios of different asset bundles are compared.

The unique goals and circumstances of the investor must also be considered. Some investors are more risk averse than others.

Mutual fund have developed particular techniques to optimize their portfolio holdings. See fund management for details.

[edit] Portfolio formation

Many strategies have been developed to form a portfolio.

* equally-weighted portfolio
* capitalization-weighted portfolio
* price-weighted portfolio
* optimal portfolio (for which the Sharpe ratio is highest)
* It is most important for economic developments.

[edit] Models

Some of the financial models used in the process of Valuation, stock selection, and management of portfolios include:

* Maximizing return, given an acceptable level of risk.
* Modern portfolio theory—a model proposed by Harry Markowitz among others.
* The single-index model of portfolio variance.
* Capital asset pricing model.
* Arbitrage pricing theory.
* The Jensen Index.
* The Treynor Index.
* The Sharpe Diagonal (or Index) model.
* Value at risk model.

[edit] Returns

There are many different methods for calculating portfolio returns. A traditional method has been using quarterly or monthly money-weighted returns. A money-weighted return calculated over a period such as a month or a quarter assumes that the rate of return over that period is constant. As portfolio returns actually fluctuate daily, money-weighted returns may only provide an approximation to a portfolio’s actual return. These errors happen because of cashflows during the measurement period. The size of the errors depends on three variables: the size of the cashflows, the timing of the cashflows within the measurement period, and the volatility of the portfolio[1].

A more accurate method for calculating portfolio returns is to use the true time-weighted method. This entails revaluing the portfolio on every date where a cashflow takes place (perhaps even every day), and then compounding together the daily returns.

[edit] Attribution

Performance Attribution explains the active performance (i.e. the benchmark-relative performance) of a portfolio. For example, a particular portfolio might be benchmarked against the S&P 500 index. If the benchmark return over some period was 5%, and the portfolio return was 8%, this would leave an active return of 3% to be explained. This 3% active return represents the component of the portfolio's return that was generated by the investment manager (rather than by the benchmark).

There are different models for performance attribution, corresponding to different investment processes. For example, one simple model explains the active return in "bottom-up" terms, as the result of stock selection only. On the other hand, sector attribution explains the active return in terms of both sector bets (for example, an overweight position in Materials, and an underweight position in Financials), and also stock selection within each sector (for example, choosing to hold more of the portfolio in one bank than another).

An altogether different paradigm for performance attribution is based on using factor models, such as the Fama-French three-factor model.

Outline of Finance

Essence of finance

The term finance may incorporate any of the following:

* The study of money and other assets
* The management and control of those assets
* Profiling and managing project risks
* As a verb, "to finance" is to provide funds for business.

[edit] Branches of finance

* Personal finance
* Corporate finance
* Public finance
* Project Finance
* Trade finance

[edit] Fundamental financial concepts

* Finance an overview
o Arbitrage
o Capital (economics)
o Capital asset pricing model
o Cash flow
o Cash flow matching
o Debt
+ Default
+ Consumer debt
+ Debt consolidation
+ Debt settlement
+ Credit counseling
+ Bankruptcy
+ Debt diet
+ Debt-snowball method
o Discounted cash flow
o Financial capital
+ Funding
o Financial modeling
o Entrepreneur
+ Entrepreneurship
o Fixed income analysis
o Gap financing
o Hedge
+ Basis risk
o Interest rate
+ Risk-free interest rate
+ Term structure of interest rates
o Short rate model
+ Vasicek model
+ Cox-Ingersoll-Ross model
+ Hull-White model
+ Chen model
+ Black-Derman-Toy model
o Interest
+ Effective interest rate
+ Nominal interest rate
+ Interest rate basis
+ Fisher equation
+ Crowding out
+ Annual percentage rate
+ Interest coverage ratio
o Investment
+ Foreign direct investment
+ Gold as an investment
+ Over-investing
o Leverage
o Locked-in value
o Long (finance)
o Liquidity
o Margin (finance)
o Mark to future
o Mark to market
o Market Impact
o Medium of exchange
o Microcredit
o Money creation
o Money
+ Currency
+ Coin
+ Banknote
+ Counterfeit
o Portfolio
+ Modern portfolio theory
o Reference rate
+ Reset
o Return
+ Absolute return
+ Investment performance
+ Relative return
o Right-financing
o Risk
+ Risk management
+ Risk measure
# Coherent risk measure
# Spectral risk measure
# Value at Risk
o Scenario analysis
o Short (finance)
o Speculation
+ Day trading
o Position trader
o Spread
o Standard of deferred payment
o Store of value
o Time horizon
o Time value of money
+ Discounting
+ Present value
+ Future value
+ Net present value
+ Internal rate of return
+ Modified internal rate of return
+ Annuity
+ Perpetuity
o Unit of account
o Volatility
o Yield
o Yield curve

[edit] History of finance

* Tulip mania 1620s/1630s
* South Sea Bubble & Mississipi Company 1710s; see also Stock market bubble
* Panic of 1837
* Railway mania 1840s
* Erie War 1860s
* Long Depression 1873 to 1896
* Post-WWI hyperinflation; see Hyperinflation and Inflation in the Weimar Republic
* Wall Street Crash 1929
* Great Depression 1930s
* Oil Shock 1973
* 1979 energy crisis
* Notable Bankrupts
* Savings and Loan Crisis 1980s
* Black Monday 1987
* Asian financial crisis 1990s
* Dot-com bubble 1995-2001
* Stock market downturn of 2002
* United States housing bubble 2001-

[edit] Finance terms, by field

[edit] Accounting (financial record keeping)

Main articles: Accounting and List of accounting topics

* Auditing
* Accounting software
* Book keeping
* FASB
* Financial accountancy
o Financial statements
+ Balance sheet
+ Cash flow statement
+ Income statement
* Management accounting
* Philosophy of Accounting
* Working capital

[edit] Banking

* Anonymous banking
* Automatic teller machine
* Deposit
* Deposit creation multiplier
* Loan
o Pre-qualification
o Pre-approval
o Subprime
* Withdrawal

[edit] Corporate finance
Main article: Corporate finance

* Balance sheet analysis
o Financial ratio
* Business plan
* Capital budgeting
o Capital investment decisions
o The investment decision
+ Business valuation
+ Stock valuation
+ Fundamental analysis
+ Real options
+ Valuation topics
+ Fisher separation theorem
o The financing decision
+ Capital structure
+ Cost of capital
+ Weighted average cost of capital
+ Modigliani-Miller theorem
o The Dividend Decision
+ Dividend
+ Dividend tax
+ Dividend yield
+ Modigliani-Miller theorem
* Corporate action
* Managerial finance
o Management accounting
* Mergers and acquisitions
o leveraged buyout
o takeover
o corporate raid
* Real options
* Return on investment
o Return on assets
o Return on equity
o Return on capital
* Working capital management
o cash conversion cycle
o Return on capital
o Economic value added
o Just In Time
o Economic order quantity
o Discounts and allowances
o Factoring (trade)

[edit] Investment management

* Fund management
o Active management
o Efficient market hypothesis
o Portfolio
o Modern portfolio theory
+ Capital asset pricing model
o Arbitrage pricing theory
o Passive management
+ Index fund
o Activist shareholder
o Mutual fund
+ Open-end fund
+ Closed-end fund
+ List of mutual-fund families
o Financial engineering
+ Long-Term Capital Management
o Hedge fund
o Hedge
* Visualization of Financial Implications

[edit] Personal finance
Main article: Personal finance

* 529 plan (college savings)
* Budget
* Coverdell Education Savings Account (Coverdell ESAs, formerly known as Education IRAs)
* Credit and debt
o Credit card
o Debt consolidation
o Mortgage loan
+ Continuous-repayment mortgage
* Debit card
* Direct deposit
* Employment contract
o Commission
o Employee stock option
o Employee or fringe benefit
o Health insurance
o Paycheck
o Salary
o Wage
* Financial literacy
* Insurance
* Predatory lending
* Retirement plan
o 401(a)
o 401(k)
o 403(b)
o 457 plan
o Keogh plan
o Individual Retirement Account
+ Roth IRA
+ Traditional IRA
+ SEP IRA
+ SIMPLE IRA
+ Conduit IRA
o Pension
* Social security
* Tax advantage
* Wealth
* Comparison of accounting software
* Personal financial management
o Comparison of personal financial management online tools
* Investment club
* Collective investment scheme
* Car financing

[edit] Public finance
Main article: Public finance

* Central bank
* Federal Reserve
* Fractional-reserve banking
o Deposit creation multiplier
* Tax
o Income tax
o Payroll tax
o Sales tax
o Tax advantage
o Tax, tariff and trade
* crowding out
* Industrial policy
* Agricultural policy
* Currency union
* Monetary reform

[edit] Insurance
Main article: Insurance

* Actuarial science
* Annuities
* Catastrophe modeling
* Earthquake loss
* Extended coverage
* Insurable interest
* Insurable risk
* Insurance
o Health insurance
+ Injury cover
+ Disability insurance
+ Flexible spending account
+ Health savings account
+ Long term care insurance
+ Medical savings account
o Life insurance
+ Life insurance tax shelter
+ Permanent life insurance
+ Term life insurance
+ Universal life insurance
+ Variable universal life insurance
+ Whole life insurance
o Property insurance
+ Auto insurance
+ Boiler insurance
+ Earthquake insurance
+ Home insurance
+ Title insurance
+ Pet insurance
o Casualty insurance
+ Business continuation insurance
+ Fidelity bond
+ Liability insurance
# Personal umbrella liability policy
# Commercial general liability policy
+ Political risk insurance
+ Surety bond
+ Terrorism insurance
o Credit insurance
o Reinsurance
o Self insurance
o Travel insurance
* Insurance contract
* Risk Retention Group

[edit] Economics and finance

* Economic growth
* Financial economics
* Mathematical economics
* Managerial economics
* Utility theory

[edit] Mathematics and finance

[edit] Time value of money
Main article: Time value of money

* Present value
* Future value
* Discounting
* Net present value
* Internal rate of return
* Annuity
* Perpetuity

[edit] Financial mathematics
Main article: Financial mathematics

[edit] Mathematical tools

* Probability
o Probability distribution
+ Binomial distribution
+ Log-normal distribution
+ Poisson distribution

* Expected value
* Value at risk
o CVaR
o Cash at risk
* Risk-neutral measure

* Stochastic calculus
o Markov process
o Brownian motion
o Itô's lemma
o Girsanov's theorem
o Radon-Nikodym derivative
o Martingale representation theorem
o Feynman-Kac formula
o Dynkin's formula
o Stochastic differential equations

* Monte Carlo methods in finance
o Monte Carlo methods for option pricing
o Quasi-Monte Carlo methods in finance

* Partial differential equations
o Heat equation
o Finite difference method

* Volatility
o ARCH model
o GARCH model

[edit] Derivatives pricing

Main article: Derivatives pricing

* Rational pricing assumptions
o Risk neutral valuation
o Arbitrage free pricing

* Futures
o Futures contract pricing

* Options (and Real options)
o Black-Scholes formula
o Black model
o Binomial options model
o Monte Carlo methods for option pricing
o The Greeks
o Volatility
+ Implied volatility
+ Historical volatility
+ Stochastic volatility
+ Volatility smile
# Volatility surface
# SABR Volatility Model

* Swaps
o Swap Valuation

* Interest rate derivatives
o Short-rate models (used in pricing bond options, swaptions and other interest rate derivatives)
+ Rendleman-Bartter model
+ Vasicek model
+ Ho-Lee model
+ Hull-White model
+ Cox-Ingersoll-Ross model
+ Black-Karasinski model
+ Black-Derman-Toy model
+ Longstaff-Schwartz model
+ Chen model

[edit] Constraint finance

* Creditary economics
* Environmental finance
* Feminist economics
* Green economics
* Islamic economics
* Uneconomic growth
* Value of Earth
* Value of life

[edit] Virtual finance

* Virtual finance

[edit] Financial markets

[edit] Market and instruments

* Capital markets
* Securities
* Financial markets
* Primary market
* Initial public offering
* Aftermarket
* Free market
* Bull market
* Bear market
* Bear market rally
* Market maker
* Dow Jones Industrial Average
* Nasdaq
* List of stock exchanges
* List of stock market indices
* List of corporations by market capitalization

[edit] Equity market
Main article: Equity market

* Stock market
* Stock
* Common stock
* Preferred stock
* Treasury stock
* Equity investment
* Index investing
* Private Equity
* Financial reports and statements
* Fundamental analysis
* Dividend
* Dividend yield
* Stock split

[edit] Equity valuation
Main article: Equity valuation

* Dow Theory
* Elliott Wave Theory
* Economic value added
* Gordon model
* Growth stock
* Mergers and acquisitions
* Leveraged buyout
* Takeover
* Corporate raid
* PE ratio
* Market capitalization
* Income per share
* Stock valuation
* Technical analysis
* Chart patterns
* V-trend

[edit] Investment theory
Main article: Investment theory

* Behavioral finance
* Dead cat bounce
* Efficient market hypothesis
* Market microstructure
* Stock market crash
* Stock market bubble
* January effect
* Mark Twain effect
* Quantitative behavioral finance
* Quantitative analyst
* Statistical arbitrage

[edit] Bond market
Main article: Bond market

* Bond (finance)
* Zero-coupon bond
* Junk bonds
* Convertible bond
* Accrual bond
* Municipal bond
* Sovereign bond
* Bond valuation
o Yield to maturity
o Bond duration
o Bond convexity
* Fixed income

[edit] Money market
Main article: Money market

* Repurchase agreement
* International Money Market
* Currency
* Exchange rate
* International currency codes
* Table of historical exchange rates

[edit] Commodity market
Main article: Commodity market

* Commodity
o Asset
o Commodity Futures Trading Commission
o Day trading
o Drawdowns
o Forfaiting
o Fundamental analysis
o Futures contract
o Fungibility
o Gold as an investment
o Hedging
o Jesse Lauriston Livermore
o List of traded commodities
o MACD
o Ownership equity
o Position trader
o Risk (Futures)
o Seasonal traders
o Seasonal spread trading
o Slippage
o Speculation
o Spread
o Technical analysis
+ Breakout
+ Bear market
+ Bottom (technical analysis)
+ Bull market
+ Moving average
+ Open Interest
+ Parabolic SAR
+ Point and figure charts
+ Resistance
+ RSI
+ Stochastic oscillator
+ Stop loss
+ Support
+ Top (technical analysis)
o Trade
o Trend

[edit] Derivatives market
Main article: Derivatives market

* Derivative (finance)
* (see also Financial mathematics topics; Derivatives pricing)
* Underlying instrument

[edit] Forward markets and contracts
Main article: Forward market

* Forward contract

[edit] Futures markets and contracts
Main article: Futures market

* Backwardation
* Contango
* Futures contract
o Currency futures
o Financial futures
o Interest rate futures
o Futures exchange

[edit] Option markets and contracts
Main article: Option market

* Options
o Stock option
+ Box spread
+ Call option
+ Put option
+ Strike price
+ Put-call parity
+ The Greeks
+ Black-Scholes formula
+ Black model
+ Binomial options model
+ Implied volatility
+ Option time value
+ Moneyness
# At-the-money
# In-the-money
# Out-of-the-money
+ Straddle
+ Option style
# Vanilla option
# Exotic option
# Binary option
# European option
* Interest rate floor
* Interest rate cap
# Bermudan option
# American option
# Quanto option
# Asian option
+ Employee stock option
o Warrants
o Foreign exchange option
o Interest rate options
o Bond options
o Real options
o Options on futures

[edit] Swap markets and contracts
Main article: Swap market

* Swap (finance)
o Interest rate swap
o Basis swap
o Asset swap
o Forex swap
o Stock swap
o Equity swaps
o Currency swap
o Variance swap

see: w:Swap (finance)

[edit] Derivative markets by underlyings

[edit] Equity derivatives
Main article: Equity derivative

* Accelerated Market Participation Securities (AMPS)
* Accelerated Return Equity Securities (ARES)
* Asset Return Obligation Securities (ASTROS)
* Automatic Common Exchange Securities (ACES)
* Basket Adjusting Structured Equity Securities (BASES)
* Basket Opportunity Exchangeable Securities (BOXES)
* Bifurcated Option Note Unit Securities (BONUSES)
* Broad Index Guarded Equity-Linked Securities (BRIDGES)
* Canadian Originated Preferred Securities (COPrS)
* Closed-end fund
* Commodity-Indexed Preferred Securities (ComPS)
* Common-Linked Higher Income Participation Securities (CHIPS)
* Common stock
* Convertible Contingent Debt Securities (CODES)
* Corporate-Backed Trust Securities (CorTS)
* Corporate Obligation Basket Listed Trust Securities (COBALTS)
* Currency Protected Notes (CPNS), (SPNS)
* Currency Protected Securities (CPS)
* Customized Upside Basket Securities (CUBS)
* Debt Exchangeable for Common Stock (DECS)
* Equity Growth Long-Term Strategy (EGLS)
* Enhanced Equity-Linked Debt Securities (ELKS)
* Enhanced Income Securities (EISs)
* Enhanced Stock Index Growth Notes (E-SIGNS)
* Equity Providing Preferred Income Convertible Securities (EPPICS)
* Exchange Preferred Income Cumulative Shares (EPICS)
* Exchange-traded fund (ETF)
* Exchangeable Capital Units (ExCaps)
* Foreign Currency Return Notes (FORENS)
* Global Bond Linked Securities (GLOBELS)
* Hybrid Income Securities Units (HITS)
* Income Deposit Securities (IDS)
* Inverse exchange-traded fund
* Leading Stockmarket Return Securities (LASERS)
* Leveraged Upside Indexed Accelerated Return Securities (LUNARS)
* Liquid Yield Option Notes (Zero Cupon) (LYONS)
* Mandatorily Exchangeable Debt Securities MEDS)
* Mandatory Adjustable Redeemable Convertible Securities (MARCS)
* Market Index Target Term Securities (MITTS)
* Market Participation Securities (MPS)
* Medium Term Equity Related Investment Securities (MERITS)
* Monthly Income Debt Securities (MIDS)
* Monthly Income Preferred Securities (MIPS)
* Participating Index Notes (PINS)
* Performance Equity-Linked Redemption Quarterly Pay Securities (PERQS)
* Performance Equity-Return Linked Securities (PERKS)
* Performance Leveraged Upside Securities (PLUS)
* Principal Accruing Enhanced Return Securities (PACERS)
* Preferred Equity Redemption Cumulative Stock (PERCS)
* Preferred Income Equity Redeemable Shares (PIERS)
* Preferred Redeemable Increased Dividend Equity Securities (PRIDES)
* Preferred stock
* Premium Equity Participating Securities (PEPS)
* Premium Income Equity Securities (PIES)
* Protected Exchangeable Equity-Linked Securities (PEEQS)
* Protected Growth Securities (ProGroS)
* Protected Performance Equity Linked Securities (PROPELS)
* Public Credit & Repackaged Securities (PCARS)
* Public Income Notes (PINES)
* Putable Automatic Rate Reset Securities (PARRS)
* Quarterly Income Capital Securities (QUICS)
* Quarterly Income Debt Securities (QUIDS)
* Quarterly Income Preferred Securities (QUIPS)
* Quarterly Interest Bond (QUIB)
* Real Estate Investment Trust (REIT)
* Reset Put Securities (REPS)
* Return Enhanced Convertible Securities (RECONS)
* Rights
* Risk Adjusting Equity Range Securities (RANGERS)
* Secure Principal Energy Receipts (SPERS)
* Select Equity Indexed Notes (SEQUINS)
* Senior Quarterly Income Debt Securities (SQUIDS)
* Shared Preference Redeemable Securities (SpuRS)
* Shares of Beneficial Interest (SBI)
* Step-Up Increasing Redeemable Equity Notes (SIRENS)
* Step-Up REIT Securities (StREITs)
* Stock Appreciation Income-Linked Securities (SAILS)
* Stock market Annual Reset Term (Notes) (SMART)
* Stock Participation Accreting Redemption Quarterly-pay Securities (SPARQS)
* Stock Return Income Debt Securities (STRIDES)
* Stock Upside Note Securities (SUNS)
* Structured Asset Trust Unit Repackaging (SATURNS)
* Structured Repackaged Asset-Backed Trust Securities (STRATS)
* Structured Yield Product Exchangeable for Common Stock (STRYPES)
* Subordinated Capital Income Securities (SKIS)
* Target Return Investment Growth Securities (TRIGGERS)
* Targeted Efficient Equity Securities (TEES)
* Targeted Growth Enhanced Terms Securities (TARGETS)
* Term Convertible Securities (TECONS)
* Threshold Appreciation Price Securities (TAPS)
* Trust Automatic Common Exchange Securities (TRACES)
* Trust Certificate (TRUC)
* Trust Investment Enhanced Return Securities (TIERS)
* Trust Issued Mandatory Exchange Securities (TIMES)
* Trust Originated Preferred Securities (TOPrS)
* Trust Preferred Stock (TruPs)
* Trust Units Exchangeable for Preference Shares (TrUEPrS)
* Warrants
* Warrants & Income Redeemable Equity Securities (WIRES)
* Yield Enhanced Equity-Linked Debt Securities (YEELDS)
* Yield Enhanced Stock (YES)

[edit] Interest rate derivatives
Main article: Interest rate derivative

* LIBOR
* Forward rate agreement
* Interest rate swap
* Interest rate cap
* Exotic interest rate option
* Bond option
* Forward rate agreement
* Interest rate future
* Money market instruments
* Interest rate swap
* Range accrual Swaps/Notes/Bonds
* In-arrears Swap
* Constant maturity swap (CMS) or constant treasury swap (CTS) derivatives (swaps, caps, floors)
* Interest rate Swaption
* Bermudan swaptions
* Cross currency swaptions
* Power Reverse Dual Currency note (PRDC or Turbo)
* Target redemption note (TARN)
* CMS steepener
* Snowball
* Inverse floater
* Strips of Collateralized mortgage obligation
* Ratchet caps and floors

[edit] Credit derivatives
Main article: Credit derivative

* Credit default swap
* Collateralized debt obligation
* Credit default option
* Total return swap
* Securitization

[edit] Foreign exchange derivative
Main article: Foreign exchange derivative

* Foreign exchange option
* Currency future
* Forex swap
* Foreign exchange hedge
* Binary option: Foreign exchange

[edit] Financial regulation

* Corporate governance
* Financial regulation
o Bank regulation
+ Banking license
* License

[edit] Designations and accreditation

* Certified Financial Planner
* Chartered Financial Analyst
o CFA Institute
* Chartered Financial Consultant
* Canadian Securities Institute
* Independent Financial Adviser
o Chartered Insurance Institute
* Financial Risk Manager
* Chartered Accountant

[edit] Fraud

* Forex scam
* Insider trading
* Legal origins theory
* Petition mill
* Ponzi scheme

[edit] Industry bodies

* International Swaps and Derivatives Association
* National Association of Securities Dealers

[edit] Regulatory bodies

* Autorité des marchés financiers
* Bank for International Settlements
* Canadian securities regulation

[edit] United Kingdom

* Financial Services Authority (UK)

[edit] European Union

* European Securities Committee (EU)
* Committee of European Securities Regulators (EU)

[edit] United States

* Commodity Futures Trading Commission (U.S.)
* Federal Reserve
* Federal Trade Commission
* Municipal Securities Rulemaking Board (US)
* Office of the Comptroller of the Currency (US)
* Securities and Exchange Commission

[edit] United States legislation

* Glass-Steagall Act (US)
* Gramm-Leach-Bliley Act (US)
* Sarbanes-Oxley Act (US)
* Securities Act of 1933 (US)
* Securities Exchange Act of 1934 (US)
* Investment Advisers Act of 1940 (US)
* USA PATRIOT Act


[edit] Actuarial topics

* Actuarial topics

[edit] Asset types

* Real Estate
* Securities
* Commodities
* Futures

[edit] Raising capital

* Debt
* Factor

* Securities
o Initial public offering

[edit] Valuation

* Value (economics)
* Fair value
* Intrinsic value
* "The Theory of Investment Value"

[edit] Discounted cash flow valuation
Main article: Discounted cash flow

* Cash flow
o Operating cash flow
* Time value of money
o Present value
o Future value
o Actualization
o Discounting
* Bond valuation
o Yield to maturity
o Duration
o Convexity
* Equity valuation
o Equivalent Annual Cost
o Net present value
o Discount rate
+ Capital Asset Pricing Model
+ Arbitrage pricing theory
+ Cost of capital
+ Weighted average cost of capital
o Fundamental analysis
o Stock valuation
o Business valuation
o The investment decision

[edit] Relative valuation

* Dividend yield
* Financial ratio
* Market-based valuation
* PE ratio
* Relative valuation
* Stock image
* Stock profile

[edit] Contingent claim valuation

See derivatives pricing below.


[edit] Financial software tools

* Straight Through Processing Software
* Technical Analysis Software
* Algorithmic trading
* List of numerical analysis software
* Comparison of numerical analysis software

[edit] Financial institutions

Financial institutions

* Bank
o List of banks
+ List of banks in Canada
+ List of banks in Hong Kong
+ List of banks in Singapore
+ List of bank mergers in United States
o Advising bank
o Central bank
+ List of central banks
o Commercial bank
o Community development bank
o Cooperative bank
o Custodian bank
o Depository bank
o Investment bank
o Islamic banking
o Merchant bank
o Microcredit
o Mutual bank
o Mutual savings bank
o National bank
o Offshore bank
o Private bank
o Savings bank
o Swiss bank
* Bank holding company
* Building society
* Clearing house
* Commercial lender
* Community development financial institution
* Credit rating agency
* Credit union
* Diversified financial
* Edge Act Corporation
* Export Credit Agencies
* Financial adviser
* Financial intermediary
* Financial planner
* Futures exchange
o List of futures exchanges
* Government sponsored enterprise
* Hard money lender
* Independent Financial Adviser
* Industrial loan company
* Insurance regulatory
* Insurance company
* Investment adviser
* Investment company
* Investment trust
* Large and Complex Financial Institutions
* Mutual fund
* Non-banking financial company
* Prime brokerage
* Retail broker
* Savings and loan association
* Stock broker
* Stock exchange
o List of stock exchanges
* Trust company

[edit] Persons influential in the field of finance

* List of corporate leaders

[edit] Finance scholars

* List of economists

Bond Market

The bond market (also known as the debt, credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. As of 2006, the size of the international bond market is an estimated $44.9 trillion, of which the size of the outstanding U.S. bond market debt was $25.2 trillion.

Nearly all of the $923 billion average daily trading volume (as of early 2007) in the U.S. bond market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges.

References to the "bond market" usually refer to the government bond market, because of its size, liquidity, lack of credit risk and, therefore, sensitivity to interest rates. Because of the inverse relationship between bond valuation and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve.
Contents
[hide]

* 1 Market structure
* 2 Types of bond markets
* 3 Bond market participants
* 4 Bond market size
* 5 Bond market volatility
* 6 Bond market influence
* 7 Bond investments
* 8 Bond indices
* 9 See also
* 10 References
* 11 External links

[edit] Market structure

Bond markets in most countries remain decentralized and lack common exchanges like stock, future and commodity markets. This has occurred, in part, because no two bond issues are exactly alike, and the number of different securities outstanding is far larger.

However, the New York Stock Exchange (NYSE) is the largest centralized bond market, representing mostly corporate bonds. The NYSE migrated from the Automated Bond System (ABS) to the NYSE Bonds trading system in April 2007 and expects the number of traded issues to increase from 1000 to 6000.[1]

[edit] Types of bond markets

The Securities Industry and Financial Markets Association classifies the broader bond market into five specific bond markets.

* Corporate
* Government & agency
* Municipal
* Mortgage backed, asset backed, and collateralized debt obligation
* Funding

[edit] Bond market participants

Bond market participants are similar to participants in most financial markets and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.

Participants include:

* Institutional investors
* Governments
* Traders
* Individuals

Because of the specificity of individual bond issues, and the lack of liquidity in many smaller issues, the majority of outstanding bonds are held by institutions like pension funds, banks and mutual funds. In the United States, approximately 10% of the market is currently held by private individuals.

[edit] Bond market size

Amounts outstanding on the global bond market increased 6% in 2008 to $83 trillion. Domestic bonds accounted for 71% of this and international bonds the remainder. Domestic bond market stocks increased 7% during the year, largely due to an increase in government bonds. The US was the largest market for domestic bonds in 2008 accounting for 43% of amounts outstanding followed by Japan with 16%. A quarter of amounts outstanding in the US were in mortgage backed bonds, a fifth in corporate debt and 18% in Treasury bonds with most of the remainder in Federal Agency securities and municipal bonds. In Europe, public sector debt is substantial in Italy (103% of GDP), Germany (61%), and France (58%) with government borrowing set to increase in the next few years. International bond issuance fell 19% in 2008 with international mortgage-backed bond issuance hitting record levels. The UK overtook the US in 2008 to become the leading centre globally for amounts issued with 30% of the global total. Amounts outstanding on the international bond market increased 5% in 2008 to $23.9 trillion. [2]

[edit] Bond market volatility

For market participants who own a bond, collect the coupon and hold it to maturity, market volatility is irrelevant; principal and interest are received according to a pre-determined schedule.

But participants who buy and sell bonds before maturity are exposed to many risks, most importantly changes in interest rates. When interest rates increase, the value of existing bonds fall, since new issues pay a higher yield. Likewise, when interest rates decrease, the value of existing bonds rise, since new issues pay a lower yield. This is the fundamental concept of bond market volatility: changes in bond prices are inverse to changes in interest rates. Fluctuating interest rates are part of a country's monetary policy and bond market volatility is a response to expected monetary policy and economic changes.

Economists' views of economic indicators versus actual released data contribute to market volatility. A tight consensus is generally reflected in bond prices and there is little price movement in the market after the release of "in-line" data. If the economic release differs from the consensus view the market usually undergoes rapid price movement as participants interpret the data. Uncertainty (as measured by a wide consensus) generally brings more volatility before and after an economic release. Economic releases vary in importance and impact depending on where the economy is in the business cycle.

[edit] Bond market influence

Bond markets determine the price in terms of yield that a borrower must pay in able to receive funding. In one notable instance, when President Clinton attempted to increase the US budget deficit in the 1990s, it led to such a sell-off (decreasing prices; increasing yields) that he was forced to abandon the strategy and instead balance the budget. [3][4]
“ I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody. ”

— James Carville, political advisor to President Clinton, Bloomberg [4]

[edit] Bond investments

Investment companies allow individual investors the ability to participate in the bond markets through bond funds, closed-end funds and unit-investment trusts. In 2006 total bond fund net inflows increased 97% from $30.8 billion in 2005 to $60.8 billion in 2006.[5] Exchange-traded funds (ETFs) are another alternative to trading or investing directly in a bond issue. These securities allow individual investors the ability to overcome large initial and incremental trading sizes.

[edit] Bond indices
Main article: Bond market index

A number of bond indices exist for the purposes of managing portfolios and measuring performance, similar to the S&P 500 or Russell Indexes for stocks. The most common American benchmarks are the Barclays Aggregate, Citigroup BIG and Merrill Lynch Domestic Master. Most indices are parts of families of broader indices that can be used to measure global bond portfolios, or may be further subdivided by maturity and/or sector for managing specialized portfolios.

History of financial services

In the United States

The term "financial services" became more prevalent in the United States partly as a result of the Gramm-Leach-Bliley Act of the late 1990s, which enabled different types of companies operating in the U.S. financial services industry at that time to merge.[citation needed] Companies usually have two distinct approaches to this new type of business. One approach would be a bank which simply buys an insurance company or an investment bank, keeps the original brands of the acquired firm, and adds the acquisition to its holding company simply to diversify its earnings. Outside the U.S. (e.g., in Japan), non-financial services companies are permitted within the holding company. In this scenario, each company still looks independent, and has its own customers, etc. In the other style, a bank would simply create its own brokerage division or insurance division and attempt to sell those products to its own existing customers, with incentives for combining all things with one company.

[edit] Banks
Main article: Bank

A "commercial bank" is what is commonly referred to as simply a "bank". The term "commercial" is used to distinguish it from an "investment bank", a type of financial services entity which, instead of lending money directly to a business, helps businesses raise money from other firms in the form of bonds (debt) or stock (equity).

[edit] Banking services

The primary operations of banks include:

* Keeping money safe while also allowing withdrawals when needed
* Issuance of checkbooks so that bills can be paid and other kinds of payments can be delivered by post
* Provide personal loans, commercial loans, and mortgage loans (typically loans to purchase a home, property or business)
* Issuance of credit cards and processing of credit card transactions and billing
* Issuance of debit cards for use as a substitute for checks
* Allow financial transactions at branches or by using Automatic Teller Machines (ATMs)
* Provide wire transfers of funds and Electronic fund transfers between banks
* Facilitation of standing orders and direct debits, so payments for bills can be made automatically
* Provide overdraft agreements for the temporary advancement of the Bank's own money to meet monthly spending commitments of a customer in their current account.
* Provide Charge card advances of the Bank's own money for customers wishing to settle credit advances monthly.
* Provide a check guaranteed by the Bank itself and prepaid by the customer, such as a cashier's check or certified check.
* Notary service for financial and other documents

[edit] Other types of bank services

* Private banking - Private banks provide banking services exclusively to high net worth individuals. Many financial services firms require a person or family to have a certain minimum net worth to qualify for private banking services.[2] Private banks often provide more personal services, such as wealth management and tax planning, than normal retail banks.[3]

* Capital market bank - bank that underwrite debt and equity, assist company deals (advisory services, underwriting and advisory fees), and restructure debt into structured finance products.

* Bank cards - include both credit cards and debit cards. Bank Of America is the largest issuer of bank cards.[citation needed]

* Credit card machine services and networks - Companies which provide credit card machine and payment networks call themselves "merchant card providers".

[edit] Foreign exchange services

Foreign exchange services are provided by many banks around the world. Foreign exchange services include:

* Currency Exchange - where clients can purchase and sell foreign currency banknotes
* Wire transfer - where clients can send funds to international banks abroad
* Foreign Currency Banking - banking transactions are done in foreign currency

[edit] Investment services

* Asset management - the term usually given to describe companies which run collective investment funds.

* Hedge fund management - Hedge funds often employ the services of "prime brokerage" divisions at major investment banks to execute their trades.

* Custody services - Custody services and securities processing is a kind of 'back-office' administration for financial services. Assets under custody in the world was estimated to $65 trillion at the end of 2004.[4]

[edit] Insurance

* Insurance brokerage - Insurance brokers shop for insurance (generally corporate property and casualty insurance) on behalf of customers. Recently a number of websites have been created to give consumers basic price comparisons for services such as insurance, causing controversy within the industry.[5]

* Insurance underwriting - Personal lines insurance underwriters actually underwrite insurance for individuals, a service still offered primarily through agents, insurance brokers, and stock brokers. Underwriters may also offer similar commercial lines of coverage for businesses. Activities include insurance and annuities, life insurance, retirement insurance, health insurance, and property & casualty insurance.

* Reinsurance - Reinsurance is insurance sold to insurers themselves, to protect them from catastrophic losses.

[edit] Other financial services

* Intermediation or advisory services - These services involve stock brokers (private client services) and discount brokers. Stock brokers assist investors in buying or selling shares. Primarily internet-based companies are often referred to as discount brokerages, although many now have branch offices to assist clients. These brokerages primarily target individual investors. Full service and private client firms primarily assist execute trades and execute trades for clients with large amounts of capital to invest, such as large companies, wealthy individuals, and investment management funds.

* Private equity - Private equity funds are typically closed-end funds, which usually take controlling equity stakes in businesses that are either private, or taken private once acquired. Private equity funds often use leveraged buyouts (LBOs) to acquire the firms in which they invest. The most successful private equity funds can generate returns significantly higher than provided by the equity markets

* Venture capital - Venture capital is a type of private equity capital typically provided by professional, outside investors to new, high-potential-growth companies in the interest of taking the company to an IPO or trade sale of the business.

* Angel investment - An angel investor or angel (known as a business angel or informal investor in Europe), is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their investment capital.

* Conglomerates - A financial services conglomerate is a financial services firm that is active in more than one sector of the financial services market e.g. life insurance, general insurance, health insurance, asset management, retail banking, wholesale banking, investment banking, etc. A key rationale for the existence of such businesses is the existence of diversification benefits that are present when different types of businesses are aggregated i.e. bad things don't always happen at the same time. As a consequence, economic capital for a conglomerate is usually substantially less than economic capital is for the sum of its parts.

[edit] Financial crime

[edit] UK

Fraud within the financial industry costs the UK an estimated £14bn a year and it is believed a further £25bn is laundered by British institutions.[6]

[edit] Market share

The financial services industry constitutes the largest group of companies in the world in terms of earnings and equity market cap. However it is not the largest category in terms of revenue or number of employees. It is also a slow growing and extremely fragmented industry, with the largest company (Citigroup), only having a 3 % US market share.[7] In contrast, the largest home improvement store in the US, Home Depot, has a 30 % market share, and the largest coffee house Starbucks has a 32 % market share.

Brand Equity

Brand equity refers to the marketing effects or outcomes that accrue to a product with its brand name compared with those that would accrue if the same product did not have the brand name [1][2][3][4]. And, at the root of these marketing effects is consumers' knowledge. In other words, consumers' knowledge about a brand makes manufacturers/advertisers respond differently or adopt appropriately adept measures for the marketing of the brand [5][6]. The study of brand equity is increasingly popular as some marketing researchers have concluded that brands are one of the most valuable assets that a company has[7].
Contents
[hide]
• 1 Measurement
• 2 Positive Equity Only?
• 3 Examples
• 4 References
• 5 See also

[edit] Measurement
There are many ways to measure a brand. Some measurements approaches are at the firm level, some at the product level, and still others are at the consumer level.
Firm Level: Firm level approaches measure the brand as a financial asset. In short, a calculation is made regarding how much the brand is worth as an intangible asset. For example, if you were to take the value of the firm, as derived by its market capitalization - and then subtract tangible assets and "measurable" intangible assets- the residual would be the brand equity.[7] One high profile firm level approach is by the consulting firm Interbrand. To do its calculation, Interbrand estimates brand value on the basis of projected profits discounted to a present value. The discount rate is a subjective rate determined by Interbrand and Wall Street equity specialists and reflects the risk profile, market leadership, stability and global reach of the brand[8].
Product Level: The classic product level brand measurement example is to compare the price of a no-name or private label product to an "equivalent" branded product. The difference in price, assuming all things equal, is due to the brand[9]. More recently a revenue premium approach has been advocated [4].
Consumer Level: This approach seeks to map the mind of the consumer to find out what associations with the brand that the consumer has. This approach seeks to measure the awareness (recall and recognition) and brand image (the overall associations that the brand has). Free association tests and projective techniques are commonly used to uncover the tangible and intangible attributes, attitudes, and intentions about a brand[5]. Brands with high levels of awareness and strong, favorable and unique associations are high equity brands[5].
All of these calculations are, at best, approximations. A more complete understanding of the brand can occur if multiple measures are used.
[edit] Positive Equity Only?
An interesting question is raised- can brands have negative brand equity? From one perspective, brand equity cannot be negative. Positive brand equity is created by effective marketing including via advertising, PR and promotion. A second perspective is that negative equity can exist. Looking at a political "brand" example, the "Democrat" brand may be negative to a Republican, and vice versa.
The greater a company's brand equity, the greater the probability that the company will use a family branding strategy rather than an individual branding strategy. This is because family branding allows them to leverage the equity accumulated in the core brand. Aspects of brand equity includes: brand loyalty, awareness, association, and perception of quality .
[edit] Examples
In the early 2000s in North America, the Ford Motor Company made a strategic decision to brand all new or redesigned cars with names starting with "F". This aligned with the previous tradition of naming all sport utility vehicles since the Ford Explorer with the letter "E". The Toronto Star quoted an analyst who warned that changing the name of the well known Windstar to the Freestar would cause confusion and discard brand equity built up, while a marketing manager believed that a name change would highlight the new redesign. The aging Taurus, which became one of the most significant cars in American auto history would be abandoned in favor of three entirely new names, all starting with "F", the Five Hundred, Freestar and Fusion. By 2007, the Freestar was discontinued without a replacement. The Five Hundred name was thrown out and Taurus was brought back for the next generation of that car in a surprise move by Alan Mulally. "Five Hundred" was recognized by less than half of most people, but an overwhelming majority was familiar with the "Ford Taurus".

Product Lining

Product lining is the marketing strategy of offering for sale several related products. Unlike product bundling, where several products are combined into one, lining involves offering several related products individually. A line can comprise related products of various sizes, types, colors, qualities, or prices. Line depth refers to the number of product variants in a line. Line consistency refers to how closely related the products that make up the line are. Line vulnerability refers to the percentage of sales or profits that are derived from only a few products in the line.
The number of different product lines sold by a company is referred to as width of product mix. The total number of products sold in all lines is referred to as length of product mix. If a line of products is sold with the same brand name, this is referred to as family branding. When you add a new product to a line, it is referred to as a line extension. When you add a line extension that is of better quality than the other products in the line, this is referred to as trading up or brand leveraging. When you add a line extension that is of lower quality than the other products of the line, this is referred to as trading down. When you trade down, you will likely reduce your brand equity. You are gaining short-term sales at the expense of long term sales.
Image anchors are highly promoted products within a line that define the image of the whole line. Image anchors are usually from the higher end of the line's range. When you add a new product within the current range of an incomplete line, this is referred to as line filling.
Price lining is the use of a limited number of prices for all your product offerings. This is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.
There are many important decisions about product and service development and marketing. In the process of product development and marketing we should focus on strategic decisions about product attributes, product branding, product packaging, product labeling and product support services. But product strategy also calls for building a product line.

Resource-Based View

The resource-based view (RBV) is an economic tool used to determine the strategic resources available to a firm. The fundamental principle of the RBV is that the basis for a competitive advantage of a firm lies primarily in the application of the bundle of valuable resources at the firm’s disposal (Wernerfelt, 1984, p172; Rumelt, 1984, p557-558). To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources are heterogeneous in nature and not perfectly mobile (Barney, 1991, p105-106; Peteraf, 1993, p180). Effectively, this translates into valuable resources that are neither perfectly imitable nor substitutable without great effort (Hoopes, 2003, p891; Barney, 1991, p117). If these conditions hold, the firm’s bundle of resources can assist the firm sustaining above average returns. The VRIN model also constitutes a part of RBV.
Contents
[hide]
• 1 Concept
• 2 Definitions
o 2.1 What constitutes a "resource"?
o 2.2 What constitutes "competitive advantage"?
• 3 History of the resource-based view
o 3.1 Barriers to imitation of resources
o 3.2 Developing resources for the future
o 3.3 Complementary work
• 4 Criticisms
• 5 Further reading
• 6 See also
• 7 References

[edit] Concept
The key points of the theory are:
1. Identify the firm’s potential key resources.
2. Evaluate whether these resources fulfill the following (VRIN) criteria:
o Valuable - A resource must enable a firm to employ a value-creating strategy, by either outperforming its competitors or reduce its own weaknesses (Barney, 1991, p99; Amit and Shoemaker, 1993, p36). Relevant in this perspective is that the transaction costs associated with the investment in the resource cannot be higher than the discounted future rents that flow out of the value-creating strategy (Mahoney and Prahalad, 1992, p370; Conner, 1992, p131).
o Rare - To be of value, a resource must be by definition rare. In a perfectly competitive strategic factor market for a resource, the price of the resource will be a reflection of the expected discounted future above-average returns (Barney, 1986a, p1232-1233; Dierickx and Cool, 1989, p1504; Barney, 1991, p100).
o In-imitable - If a valuable resource is controlled by only one firm it could be a source of a competitive advantage (Barney, 1991, p107). This advantage could be sustainable if competitors are not able to duplicate this strategic asset perfectly (Peteraf, 1993, p183; Barney, 1986b, p658). The term isolating mechanism was introduced by Rumelt (1984, p567) to explain why firms might not be able to imitate a resource to the degree that they are able to compete with the firm having the valuable resource (Peteraf, 1993, p182-183; Mahoney and Pandian, 1992, p371). An important underlying factor of inimitability is causal ambiguity, which occurs if the source from which a firm’s competitive advantage stems is unknown (Peteraf, 1993, p182; Lippman and Rumelt, 1982, p420). If the resource in question is knowledge-based or socially complex, causal ambiguity is more likely to occur as these types of resources are more likely to be idiosyncratic to the firm in which it resides (Peteraf, 1993, p183; Mahoney and Pandian, 1992, p365; Barney, 1991, p110). Conner and Prahalad go so far as to say knowledge-based resources are “…the essence of the resource-based perspective” (1996, p477).
o Non-substitutable - Even if a resource is rare, potentially value-creating and imperfectly imitable, an equally important aspect is lack of substitutability (Dierickx and Cool, 1989, p1509; Barney, 1991, p111). If competitors are able to counter the firm’s value-creating strategy with a substitute, prices are driven down to the point that the price equals the discounted future rents (Barney, 1986a, p1233; Conner, 1991, p137), resulting in zero economic profits.
3. Care for and protect resources that possess these evaluations because doing so can improve organizational performance (Crook, Ketchen, Combs, and Todd, 2008).
The characteristics mentioned under 2 are individually necessary, but not sufficient conditions for a sustained competitive advantage (Dierickx and Cool, 1989, p1506; Priem and Butler, 2001a, p25). Within the framework of the resource-based view, the chain is as strong as its weakest link and therefore dependent on the resource displaying each of the four characteristics to be a possible source of a sustainable competitive advantage (Barney, 1991, 105-107).
[edit] Definitions
[edit] What constitutes a "resource"?
Jay Barney (1991, p101) referring to Daft (1983) "citation needed" says: "...firm resources include all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc; controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness (Daft,1983)."
A subsequent distinction made by Amit & Schoemaker (1993, p35) is that the encompassing construct previously called resources can be split up into resources and capabilities. In this respect resources are tradable and non-specific to the firm, while capabilities are firm-specific and used to utilize the resources within the firm, such as implicit processes to transfer knowledge within the firm (Makadok, 2001, p388-389; Hoopes, Madsen and Walker, 2003, p890). This distinction has been widely adopted throughout the resource-based view literature (Conner and Prahalad, 1996, p477; Makadok, 2001, p338; Barney, Wright and Ketchen, 2001, p630-31).
[edit] What constitutes "competitive advantage"?
A competitive advantage can be attained if the current strategy is value-creating, and not currently being implemented by present or possible future competitors (Barney, 1991, p102). Although a competitive advantage has the ability to become sustained, this is not necessarily the case. A competing firm can enter the market with a resource that has the ability to invalidate the prior firm's competitive advantage, which results in reduced (read: normal) rents (Barney, 1986b, p658). Sustainability in the context of a sustainable competitive advantage is independent with regards to the time-frame. Rather, a competitive advantage is sustainable when the efforts by competitors to render the competitive advantage redundant have ceased (Barney, 1991, p102; Rumelt, 1984, p562). When the imitative actions have come to an end without disrupting the firm’s competitive advantage, the firm’s strategy can be called sustainable. This is contrary to other views (e.g. Porter) that a competitive advantage is sustained when it provides above-average returns in the long run. (1985).
[edit] History of the resource-based view
Some aspects of theories are thought of long before they are formally adopted and brought together into the strict framework of an academic theory. The same could be said with regards to the resource-based view.
While this influential body of research within the field of Strategic Management was named by Birger Wernerfelt in his article A Resource-Based View of the Firm (1984), the origins of the resource-based view can be traced back to earlier research. Retrospectively, elements can be found in works by Coase (1937), Selznick (1957), Penrose (1959), Stigler (1961), Chandler (1962, 1977), and Williamson (1975), where emphasis is put on the importance of resources and its implications for firm performance (Conner, 1991, p122; Rumelt, 1984, p557; Mahoney and Pandian, 1992, p263; Rugman and Verbeke, 2002). This paradigm shift from the narrow neoclassical focus to a broader rationale, and the coming closer of different academic fields (industrial organization economics and organizational economics being most prominent) was a particular important contribution (Conner, 1991, p133; Mahoney and Pandian, 1992).
Two publications closely following Wernerfelt’s initial article came from Barney (1986a, 1986b). Even though Wernerfelt was not referred to, the statements made by Barney about strategic factor markets and the role of expectations can, looking back, clearly be seen within the resource-based framework as later developed by Barney (1991). Other concepts that were later integrated into the resource-based framework have been articulated by Lippman and Rumelt (uncertain imitability, 1982), Rumelt (isolating mechanisms, 1984) and Dierickx and Cool (inimitability and its causes, 1989). Barney’s framework proved a solid foundation for other to build on, which was provided with a stronger theoretical background by Conner (1991), Mahoney and Pandian (1992), Conner and Prahalad (1996) and Makadok (2001), who positioned the resource-based view with regards to various other research fields. More practical approaches were provided for by Amit and Shoemaker (1993), while later criticism came from among others from Priem and Butler (2001a, 2001b) and Hoopes, Madsen and Walker (2003).
The resource based view has been a common interest for management researchers and numerous writings could be found for same. Resource based view explains a firms ability to reach sustainable competitive advantage when different resources are employed and these resources can not be imitated by competitors which ultimately creates a competitive barrier (Mahoney and Pandian 1992 cited by Hooley and Greenley 2005, p.96 , Smith and Rupp 2002, p.48). RBV explains that a firm’s sustainable competitive advantage is reached by virtue of unique resources which these resources have the characteristics of being rare, valuable, inimitable, non-tradable, non-substitutable as well as firm specific (Barney 1999 cited by Finney et al.2004, p.1722, Makadok 2001, p. 94). These authors write about the fact that a firm may reach a sustainable competitive advantage through unique resources which it holds, and these resources can not be easily bought, transferred, copied and simultaneously they add value to a firm while being rare. It also highlights the fact that all resources of a firm may not contribute to a firm’s sustainable competitive advantage. Varying performance between firms is a result of heterogeneity of assets (Lopez 2005, p.662, Helfat and Peteref 2003, p.1004) and RBV is focused on the factors that cause these differences to prevail (Grant 1991, Mahoney and Pandian 1992, Amit and Shoemaker 1993, Barney 2001 cited by Lopez 2005, p.662).
Fundamental similarity in these writings is that unique value creating resources will generate a sustainable competitive advantage to the extent no competitor has the ability to use same type of resources either through acquisition or imitation. Major concern in the RBV is focused on the ability of the firm to maintain a combination of resources that can not be possessed or build up in a similar manner by competitors. Further such writings provide us the base to understand that the sustainability strength of competitive advantage depends on the ability of competitors to use identical or similar resources that makes the same implications on a firm’s performance. This ability of a firm to avoid imitation of their resources should be analysed in depth to understand the sustainability strength of a competitive advantage.
[edit] Barriers to imitation of resources
Resources are the inputs or the factors available to a company which helps to perform its operations or carry out its activities (Amit and Shoemaker 1993, Black and Boal 1994, Grant 1995 cited by Ordaz et al.2003, p.96). Also these authors state that resources, if considered as isolated factors doesn’t result in productivity hence coordination of resources is important. The ways a firm can create a barrier to imitation is known as “isolating mechanisms” and are reflected in the aspects of corporate culture, managerial capabilities, information asymmetries and property rights (Hooley and Greenlay 2005, p.96, Winter 2003,p. 992). Further, they mention that except for legislative restrictions created through property rights, other three aspects are direct or indirect results of managerial practises.
King (2007, p.156) mentions inter-firm causal ambiguity may results in sustainable competitive advantage for some firms. Causal ambiguity is the continuum that describes the degree to which decision makers understand the relationship between organisational inputs and outputs (Ghinggold and Johnson 1998,p.134,Lippman and Rumlet 1982 cited by King 2007, p.156, Matthyssens and Vandenbempt 1998, p.46). Their argument is that inability of competitors to understand what causes the superior performance of another (inter-firm causal ambiguity), helps to reach a sustainable competitive advantage for the one who is presently performing at a superior level. What creates this inability to understand the cause for superior performance of firm? Is it the intended consequence of a firm’s action? Holley and Greenley (2005, p.96) state that social context of certain resource conditions act as an element to create isolating mechanisms and further mentions that three characteristics of certain resources underpins the causal ambiguity scenario which are tacitness (accumulated skill-based resources acquired through learning by doing) complexity (large number of inter-related resources being used) and specificity (dedication of certain resources to specific activities) and ultimately these three characteristics will consequent in a competitive barrier.
Referring back to the definitions stated previously regarding the competitive advantage that mentions superior performance is correlated to resources of the firm (Christensen and Fahey 1984, Kay 1994, Porter 1980 cited by Chacarbaghi and Lynch 1999, p.45) and consolidating writings of King (2007, p.156) stated above we may derive the fact that inter-firm causal ambiguity regarding resources will generate a competitive advantage at a sustainable level. Further, it explains that the extent to which competitors understand what resources are underpinning the superior performance, will determine the sustainability strength of a competitive advantage. In a scenario that a firm is able to overcome the inter-firm causal ambiguity it does not necessarily result in imitating resources. As to Johnson (2006, p.02) and Mahoney (2001, p.658), even after recognising competitors valuable resources, a firm may not imitate due to the social context of these resources or availability of more pursuing alternatives. Certain resources like company reputation are path dependent that are accumulated over time and a competitor may not be able to perfectly imitate such (Zander and Zandre 2005, p.1521 , Santala and Parvinen 2007, p.172).
They argue on the base that certain resources, even imitated may not bring the same impact since the maximum impact of same is achieved over longer periods of time. Hence, such imitation will not be successful. In consideration of the reputation fact as a resource, does this imply that a first mover to a market always holds a competitive advantage? Can a late entrant exploit any opportunity for a competitive advantage? Kim and Park (2006, p.45) mentions three reasons new entrants may be outperformed by early entrants. First, early entrants have a technological know how which helps them to perform at a superior level. Secondly, early entrants have developed capabilities with time that enhances their strength to perform above late entrants. Thirdly, switching costs incurred to customers if decided to migrate, will help early entrants to dominate the market evading the late entrants opportunity to capture market share. Customer awareness and loyalty is a rational benefit early entrants enjoy (Liberman and Montgomery 1988, Porter 1985, Hill 1997, Yoffie 1990 cited by Ma 2004, p.914, Agrawal et al. 2003, p. 117).
However, first mover advantage is active in evolutionary technological transitions which are technological innovations based on previous developments (Kim and Park 2006, p, 45, Cottam et al. 2001, p. 142). Same authors further argue that revolutionary technological changes (changes that significantly disturb the existing technology) will eliminate the advantage of early entrants. Such writings elaborate that though early entrants enjoy certain resources by virtue of the forgone time periods in the markets, rapidly changing technological environments may make those resources obsolete and curtail the firm’s dominance. Late entrants may comply with the technological innovativeness and increase pressure of competition, hence, seek for a competitive advantage through making the existing competences and resources of early entrants invalid or outdated. In other words innovative technological implications will significantly change the landscape of the industry and the market, making early mover’s advantage minimum. However, in a market where technology does not play a dynamic role, early mover advantage may prevail.
Analysing the above developed framework for Resource Based View, it reflects a unique feature which is, sustainable competitive advantage is achieved in an environment where competition doesn’t exist. According to the characteristics of the Resource based view rivalry firms may not perform at a level that could be identified as a considerable competition for the incumbents of the market since they do not possess the required resources to perform at a level that creates a threat hence create competition. Through barriers to imitation incumbents ensure that rivalry firms do not reach a level to perform in a similar manner to them. In other words, the sustainability of the winning edge is determined by the strength of not letting other firms compete in the same level. The moment competition becomes active competitive advantage becomes ineffective since two or more firms begins to perform at a superior level evading the possibility of single firm dominance hence no firm will enjoy a competitive advantage. Ma (2003, p.76) agrees stating that by definition, the sustainable competitive advantage discussed in the Resource based view is ant-competitive. Further such sustainable competitive advantage could exist in the world of no competitive imitation (Barney 1991, Petref 1993 cited by Ma 2003, p.77, Ethiraj et al., 2005, p. 27).
For further discuission of causal ambiguity see causal ambiguity.
[edit] Developing resources for the future
Based on the empirical writings stated above RBV provides us the understanding that certain unique existing resources will result in superior performance and ultimately build a competitive advantage. Sustainability of such advantage will be determined by the ability of competitors to imitate such resources. However, the existing resources of a firm may not be adequate to facilitate the future market requirement due to volatility of the contemporary markets. There is a vital need to modify and develop resources in order to encounter the future market competition. An organisation should exploit existing business opportunities using the present resources while generating and developing a new set of resources to sustain its competitiveness in the future market environments, hence an organisation should be engaged in resource management and resource development (Chaharbaghi and Lynch 1999, p.45, Song et al., 2002, p.86). Their writings explain that in order to sustain the competitive advantage, it’s crucial to develop resources that will strengthen their ability to continue the superior performance. Any industry or market reflects high uncertainty and in order to survive and stay ahead of competition new resources becomes highly necessary. Morgan (2000 cited by Finney et al.2004, p.1722) agrees stating that, need to update resources is a major management task since all business environments reflect highly unpredictable market and environmental conditions. The existing winning edge needed to be developed since various market dynamics may make existing value creating resources obsolete. (" Achieving a sustainable competitive advantage in the IT industry through hybrid business strategy:A contemporary perspective"- Tharinda Jagathsiri (MBA-University of East London)
[edit] Complementary work
Building on the RBV, Hoopes, Madsen & Walker (2003) suggest a more expansive discussion of sustained differences among firms and develop a broad theory of competitive heterogeneity. “The RBV seems to assume what it seeks to explain. This dilutes its explanatory power. For example, one might argue that the RBV defines, rather than hypothesizes, that sustained performance differences are the result of variation in resources and capabilities across firms. The difference is subtle, but it frustrates understanding the RBV’s possible contributions (Hoopes et al., 2003: 891).
“The RBV’s lack of clarity regarding its core premise and its lack of any clear boundary impedes fruitful debate. Given the theory’s lack of specificity, one can invoke the definition-based or hypothesis-based logic any time. Again, we argue that resources are but one potential source of competitive heterogeneity. Competitive heterogeneity can obtain for reasons other than sticky resources (or capabilities)” (Hoopes et al. 2003: 891). Competitive heterogeneity refers to enduring and systematic performance differences among close competitors (Hoopes et al., 2003: 890).
[edit] Criticisms
Priem and Butler (2001) made four key criticisms:
• The RBV is tautological, or self-verifying. Barney has defined a competitive advantage as a value-creating strategy that is based on resources that are, among other characteristics, valuable (1991, p106). This reasoning is circular and therefore operationally invalid (Priem and Butler, 2001a, p31). For more info on the tautology, see also Collins, 1994
• Different resource configurations can generate the same value for firms and thus would not be competitive advantage
• The role of product markets is underdeveloped in the argument
• The theory has limited prescriptive implications
However, Barney (2001) provided counter-arguments to these points of criticism.
Further criticisms are:
• It is perhaps difficult (if not impossible) to find a resource which satisfies all of the Barney's VRIN criterion.
• There is the assumption that a firm can be profitable in a highly competitive market as long as it can exploit advantageous resources, but this may not necessarily be the case. It ignores external factors concerning the industry as a whole; Porter’s Industry Structure Analysis ought also be considered.
• Long-term implications that flow from its premises: A prominent source of sustainable competitive advantages is causal ambiguity (Lippman & Rumelt, 1982, p420). While this is undeniably true, this leaves an awkward possibility: the firm is not able to manage a resource it does not know exists, even if a changing environment requires this (Lippman & Rumelt, 1982, p420). Through such an external change the initial sustainable competitive advantage could be nullified or even transformed into a weakness (Priem and Butler, 2001a, p33; Peteraf, 1993, p187; Rumelt, 1984, p566).
• Premise of efficient markets: Much research hinges on the premise that markets in general or factor markets are efficient, and that firms are capable of precisely pricing in the exact future value of any value-creating strategy that could flow from the resource (Barney, 1986a, p1232). Dierickx and Cool argue that purchasable assets cannot be sources of sustained competitive advantage, just because they can be purchased. Either the price of the resource will increase to the point that it equals the future above-average return, or other competitors will purchase the resource as well and use it in a value-increasing strategy that diminishes rents to zero (Peteraf, 1993, p185; Conner, 1991, p137).
• The concept ‘rare’ is obsolete: Although prominently present in Wernerfelt’s original articulation of the resource-based view (1984) and Barney’s subsequent framework (1991), the concept that resources need to be rare to be able to function as a possible source of a sustained competitive advantage is unnecessary (Hoopes, Madsen and Walker, 2003, p890). Because of the implications of the other concepts (e.g. valuable, inimitable and nonsubstitutability) any resource that follows from the previous characteristics is inherently rare.
• Sustainable: The lack of exact definition with regards to the concept sustainable makes its premise difficult to test empirically. Barney’s statement (1991, p102-103) that the competitive advantage is sustained if current and future rivals have ceased their imitative efforts is versatile from the point of view of developing a theoretical framework, but a disadvantage from a more practical point of view as there is no explicit end-goal.