Marketable Securitites

Marketable Securities

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of marketable securities.

This read will help you get started with understanding marketable securities on the balance sheet of a business.

Introduction

Marketable securities are financial instruments that can be converted into cash easily by the firm. Marketable securities are recorded in the balance sheet along with other current assets because of their nature. You can find marketable securities on a firm’s balance sheet under the Cash and cash equivalents section.

Types of marketable securities:

There are various types of marketable securities available to the firm and that can appear in its balance sheet. The most common ones are:

Bankers acceptances

Bankers acceptance bills can be imagined as an instrument that functions like a post-dated cheque. The business which purchases a banker’s acceptance note can use this instrument to convert it into cash, with the bank guaranteeing the payment. The bank issues these cheques in exchange of a fee, i.e. issues it at a discount to a face value to the company.

Commercial paper

Commercial Paper (CP) bought by a company refers to a short-term and unsecured debt instrument issued by other companies. The maturity of commercial papers can be as short as a few days to 270 days typically. Again, just like banker’s acceptance, commercial papers are issued at a discount on the face value.

Certificate of Deposits

Certificate of Deposits (CD) are issued by banks that provide interest on their value. Most financial institutions offer these certificates with a blocked period in which the certificate holder keeps the certificate untouched. The institution also levies a penalty in case of early withdrawal.

Treasury Bills

Treasury Bills (T bills) are similar to certificates of deposits, but are issued by governments with maturity of one year or less. They are usually issued in fixed denomination at a discount on the face value. They are considered as one of the safest forms of investment and the discount rate is referred to risk free rate of the country.

 

Final Words:

Marketable securities are important as they can be sold on short notice to meet the financial obligation of the firm (to pay salaries to employees, to pay bills to providers, etc.).

 

Relevance to the SimTrade certificate

This post deals with Marketable Securities on the balance sheet, an important tool for investors to take investment decisions.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Liabilities

Liabilities

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of liabilities.

This read will help you get started with understanding the liability side of the balance sheet.

Introduction

A liability is an obligation that a company has in return of economic benefits that the company has received in the past. Any kind of obligation or risk that are due to a third party can be termed as liability.

Liabilities are recorded on the balance sheet can be short-term or long-term in nature.

Liability vs Expense

It is important to know that liability is not an expense for the business. An expense is the cost of operation for the business and is recorded on the income statement of a business. Liabilities on the other hand is what the business owes to another party already as the economic benefit has been transferred in the past. It is recorded in the balance sheet of the company.

Liabilities are very important for a business as they finance the daily operations of the business. For expansion activities, for instance if a business wants to expand overseas, liability in form of bank loans will help the business acquire assets to make the move to another location. This loan facilitated by a bank for example will be recorded in the liabilities section in the balance sheet.

Structure of the Liabilities part of the balance sheet

The Liabilities part of the balance sheet can be structured as follows.

Screenshot 2021-10-25 at 1.24.06 AM

Current Liabilities

These are the company’s short-term obligation (Usually financial in nature) that are to be paid within a period of one year. Most noteworthy examples of current liabilities include:

  1. Wages Payable: The total amount of salaries that the company owes to its employees.
  1. Interest Payable: The credit that the business takes to finance short term needs of business operations accrues an interest. This interest in payable by the business in the short term and is recorded in the interest payable section of the balance sheet.
  1. Dividends Payable: The total amount of dividends that the company owes to the investors against the stocks issued to them.

These items help the readers understand the level of obligations on the businesses due in a short period of time.

Non-current liabilities

These are obligations that are owed in a period longer than a year. Long term bonds, loans, etc. are a part of long-term/non-current liabilities. Companies usually issue bonds fulfil their long-term capital needs which are very common type of non-current liability. Other common examples of long-term liabilities include:

  1. Debentures: Type of bond or debt instrument issued by the company unsecured against a collateral.
  1. Bonds Payable: Long term debt instrument issued by companies and government which is a promise to pay at a future date and is issued at a discount in the current period.
  1. Deferred tax liabilities: All that the company owed the government in the form of tax obligation that hasn’t been met yet by the company.

Final Word

Liability section of the balance sheet helps investors to assess the risk profile of a business. It is an important tool to measure the leverage taken by a firm to assess the risk level of the company within the industry and compare it with competitors in the same industry.

Relevance to the SimTrade certificate

This post deals with Liability side of the balance sheet, an important tool for investors to take investment decisions.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance Sheet

   ▶ Shruti CHAND Long-Term Liabilities

   ▶ Shruti CHAND Accounts Payable

   ▶ Shruti CHAND Financial leverage

About the author

Article written by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Assets

Assets

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of assets.

This read will help you get started with understanding Assets side on the balance sheet of a company.

Introduction

An asset can be defined as anything that has an economic value or future benefit. Assets are an important part of the balance sheet of a firm as it reports all that a business owns at a given point of time. Assets are economic resources that will generate cash flows in the future. Examples of assets include machinery, building, accounts receivable, etc.

All the value of assets that one sees on the balance sheet are typically recorded on historical cost, adjusted from time to time based on depreciation. The Assets side of the balance sheet states all the assets in the order of their liquidity, i.e., ease with which they can be converted into cash. Hence, current assets such as cash or cash equivalents, short-term investments, etc. are listed first followed by fixed non-liquid assets at the end (with the US and international framework).

Structure of the Assets part of the Balance Sheet

Screenshot 2021-10-25 at 1.24.06 AM

 

Types of Assets on the Balance Sheet:

Current Assets:

Any asset that can be converted into cash with ease (Typically within a timeframe of 1 year) is known as Current Asset.

Most common current assets on a balance sheet include cash and cash equivalents, inventory, accounts receivable, and other prepaid expenses.

Fixed Assets:

Fixed assets are resources that the business owns which cannot be converted into cash immediately. Most noteworthy fixed assets on a balance sheet include plants, buildings, machinery and equipment. There is a constant adjustment that is made to the value of these assets from time to time to reflect their current value.

Financial Assets:

This asset class represents the securities, corporate bonds, preferred equity and all other hybrid equity that is financial in nature that the business owns.

Intangible Assets:

These assets have no physical existence whatsoever, but since they still have value attached to it and generate benefit for the business, they are categorized as Intangible Assets. Examples of intangible assets include patents, copyrights, trademarks, goodwill and other intellectual property owned by the business.

Note that with the French presentation of the balance sheet, the least liquid assets appear in the top while the more liquid assets appear in the bottom of the balance sheet), and similarly the shareholders’ equity and the long-term liabilities appear in the top while the short-term liabilities appear in the bottom of the balance sheet.

Final Word:

Investors use the Assets side of the balance sheet to check the financial health of the business (profitability of the investments). One common way to assess the performance is to find out Asset turnover ratio which measures the revenues generated form the use of assets against sales.

The amount of which type of asset a business owns is dependent upon its area of operations. Some businesses are more capital intensive than others which might require them to have more fixed assets than others. Equipment manufacturers are going to have large number of fixed assets such as machinery while a tech business have almost no fixed assets (except intellectual property assessed over time accounted in intangibles).

Relevance to the SimTrade certificate

This post deals with Asset side of the balance sheet, an important tool for investors to take investment decisions.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Cash and Cash Equivalents

Cash and Cash Equivalents

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of cash equivalents

This read will help you get started with understanding the concept and its significance in determining financial health of a business.

Introduction

Cash and Cash Equivalents on the assets side of the balance sheet is the total amount of cash or assets that can be converted into cash on an immediate basis. Any bank accounts or marketable securities that a business owns can be categorized as cash equivalents.

What is included in Cash and Cash Equivalents?

Cash equivalents are the assets with short maturities typically 90 days or less. Examples of cash equivalents on a firm’s balance sheet include:

  • Treasury Bills
  • Money market mutual funds
  • Commercial Paper (bought from other firms)
  • Bank Certificates of deposit
  • Repurchase agreements
  • Other money market instruments

Cash on the other hand is not limited to the amount of money in checking and savings accounts (and coins and banknotes). It also includes assets such as cheques received but not deposited.

Cash and Cash Equivalents is recorded in the balance sheet in the “Current assets” section. Cash and Cash equivalents are related to other current assets that will transformed into cash later.

Measure of liquidity

Cash and Cash equivalents are used to measure the liquidity of the firm. For example, in financial analysis, it enters the computation of liquidity ratios.

Final Words

Cash and Cash equivalents may be a small part on the balance sheet of a firm but have a lot of impact as it is used to pay day-to-day operations of the firm on a very frequent basis.

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Current Assets

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Long-term securities

Long term securities

Shruti CHAND

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of long-term securities.

This read will help you get started with understanding long-term securities.

Introduction

Long-term assets on a balance sheet represent all the assets of a business that are not expected to turn into cash within one year. They are represented as the non-current part of the balance sheet. These are a set of assets that the company keeps for a long-term and is not likely to be sold in the coming years, in some cases, may never be sold.

Long-term assets can be expensive and require huge capital which might result in draining cash reserves or increasing debt for the firm.

The following category of long-term assets can be found in the balance sheet:

Investments

These are all the long-term investments by a company in securities, real estate and other asset classes. Even the bonds and other assets restricted for long-term value are treated as investments by the company.

Property, plant and equipment

Property that the company owns associated with the manufacturing process or other business operations. An important aspect about this asset class is the depreciation associated with the value of the asset over time.

Typically, you can find the following items disclosed as property, plant and equipment on the balance sheet:

  • Land
  • Land improvements
  • Buildings
  • Furniture
  • Machinery

(Less: Depreciation)

Intangible assets

Intangible assets are the assets without a physical existence. These items represent the intellectual property of a business acquired through their operations, marketing and other efforts to create value. The most notable intangible asset on a balance sheet is Goodwill.

Other intangible assets found in the financial statements are:

  • Copyrights
  • Trademarks
  • Patents

Other assets: All the assets of non-current nature that can not be liquidated easily.

Final words

Since a company holds the long-term assets for a long period of time, the changes in the long-term assets can be a sign of liquidation in some cases. When investors study the balance sheet of a company, they can see if the company often sells its long-term assets then it can be a sign of financial difficulty.

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance Sheet

   ▶ Shruti CHAND Assets

   ▶ Shruti CHAND Fixed Assets

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Intangible Assets

Intangible Assets

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of Intangible Assets

This read will help you get started with understanding intangible assets on the balance sheet of a company.

Meaning:

An intangible asset is an asset that has no physical existence. Such assets are identifiable when it is separable, or when it arises from contractual or other legal rights. These intangible assets can be sold, transferred or even licensed.

Most notable examples of intangible assets include:

  • Goodwill: Goodwill is an intangible asset that is the premium in excess to the purchase price of the company. Goodwill of a company can include intellectual property and brand value, which is not easily quantifiable.

 

  • intellectual property: The intellectual property owned by a company as a result of creativity, such as patents, copyrights, etc.

 

  • Patents: A license issued to a company conferring a right or title for a set period to exclude others from using, selling or making an invention.

 

  • Trademarks: Words, symbols legally registered by a company representing a product owner by them.

 

  • Copyrights: Rights that the creators of a product have created so that other makers don’t mimic/copy their work

Software and other computer-related assets outside of hardware also classify as intangible assets.

 Real life example: For instance, Company A purchases a patent from Company B for an agreed amount of 1 million, then Company A would record in its intangible assets 1 million under long term assets.

 

How can you value Intangible Assets?

 Businesses can create intangible assets in cases where it pays more than the book value of an asset and records it at a higher value on the Balance Sheet. This premium paid is an intangible asset on the books of the company.

 

Some important things to remember:

Financial assets are not intangible because they derive value from the contractual claims backing them.

Intangible assets contribute to the value of the company only through its presence on the balance sheet. Its measurement is essential to the company while assessing the state of the company’s resources.

Relevance to the SimTrade certificate

Intangible assets are an important factor to assess the value of companies investors want to invest in.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Fixed Assets

Fixed Assets

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of fixed assets.

Fixed Assets:

A fixed asset on a balance sheet is any asset that has a useful life greater than one year. Typically, a fixed asset is not intended to be resold within a short period of time. Fixed assets can also be understood as any non-current asset are recorded on the Balance Sheet with other assets.

Examples of Fixed assets on a company’s balance sheet:

  1. Property
  2. Building
  3. Machinery
  4. Land

The fixed assets are usually recorded at the net book value, which is nothing but the price at which it was acquired. Over time, all the lost value in the fixed assets arising out of holding these assets is recorded as impairment charges and depreciation in the balance sheet.

Out of intuition, it is fair to assume that Fixed costs are large assets which are immovable, but that is not true. An office equipment such as Office Computer can also be a fixed asset if it exceeds the capitalization limits of the concerned business.

Depreciation of fixed assets

Fixed assets can not be converted into cash easily. It is usually acquired by the company to produce more goods and services, hence the use that the fixed assets are put into can lead to its depreciation in value.

This decrease in value is recorded as depreciation in the books of accounts (Balance Sheet). Depending on the company, the depreciation methods vary. For instance, if the company uses a straight line method, the same amount of depreciation is recorded every year for a fixed period of time until the value of the asset is zero.

Example of depreciation

Let’s say a company purchases machinery and plants for $100000 and the useful life of the asset is fixed at 10 years, then every year $10000 will be recorded as depreciation in the books of accounts for the next 10 years and at the 10th year, the value of the asset in the book finally will be 0.

Relevance to the SimTrade certificate

This post deals with Fixed Assets on the Balance Sheet of the companies investors might be assessing to understand the financial health of the company.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance Sheet

   ▶ Shruti CHAND Assets

   ▶ Shruti CHAND Long-term securities

About the author

Article written by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Balance Sheet

Balance Sheet

Shruti CHAND

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of balance sheet

This read will help you get started with understanding balance sheet and what it indicates when studying a company.

What is a balance sheet?

Balance Sheet is one of the most important financial statement that states business’ assets, liabilities and shareholders’ equity at a specific point of time. It is a consolidated statement to explain what an entity owns and owes to the investors (both creditors and shareholders).

Balance sheet helps to understand the financial standing of the business and helps to calculate ratios which better explain the liquidity, profitability, financial structure and over all state of the business to better understand it.

Structure of the balance sheet

Screenshot 2021-10-25 at 1.24.06 AM

Use of the balance sheet in financial analysis

In financial analysis, the information from the balance sheet is used to compute ratios: liquidity ratios, profitability ratios (especially the return on investment (ROI) and the return on equity (ROE)) and ratios to measure the financial structure (the debt-to-equity ratio).

Final Word

Balance Sheet is one of the most important financial statement for fundamental analysis. Investors use Balance Sheet to get a sense of the health of the company. Various ratios such as debt-to-equity ratio, current ratio, etc can be derived out of the balance sheet. Fundamental Analyst also use the balance sheet as a comparison tool between companies in the same industry.

Relevance to the SimTrade certificate

This post deals with Balance Sheet and its importance in the books of accounts of a company that investors might want to assess.

About theory

  • By taking the SimTrade course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Assets

   ▶ Shruti CHAND Liabilities

   ▶ Shruti CHAND Assets

   ▶ Shruti CHAND Long-term securities

About the author

Article written by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Shareholder's Equity

Shareholder’s Equity

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of Shareholder’s equity.

This read will help you get started with understanding shareholder’s equity and its meaning on the books of accounts of companies.

Shareholders Equity:

Shareholders equity on the Balance Sheet is the amount that the owners of the company have invested into the business.

Shareholders equity = Money invested by owners + Retained earnings deferred over time.

The three categories of shareholders equity are:

  • Money invested by the shareholders:
  1. Common Shares: These shareholders are last in line when it comes to claims in case of dissolution of the company. They fall behind all the other dues of the company such as creditors, bond holders and preferred shareholders.
  2. Preferred Shares: These shareholders have a priority over the earnings of the company. What this means for the shareholders is that they are paid dividends before the common shareholders.
  3. Retained Earnings: is the percentage of net earnings that was not paid to the shareholders as dividends.

Owner’s claim:

One can further understand the shareholders equity by thinking of it as the difference between what the business owns and owes, i.e.: Total Assets – Total Liabilities. If one sums the total assets on a balance sheet and subtracts all types of liabilities, what remains is the sum of money that the business owes to its shareholders.

Understanding Shareholders equity:

If the value of Shareholders equity is positive, it means that business is in a healthy state and has enough assets to cover its liabilities. On the other hand, if the Shareholders equity is negative, then the business owes more in liabilities than the assets it holds to back the claims.

Relevance to the SimTrade certificate

Understanding shareholder’s equity structure of a company is an important indicator of the health of a company and can help investors make better investment decisions.

  • By taking the market orders course , you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Technical Analysis

Technical Analysis

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of technical analysis.

This read will help you get started with understanding technical analysis and how it is practiced in today’s world.

What is technical analysis?

Technical analysis is a tool used to predict future price movements and trends of security. This type of analysis is based on historical market data (both transaction prices and volumes) using various methods to help traders and investors in their decisions to buy and sell securities.

Investors perform technical analysis because sometimes, fundamental analysis may not always reflect the market price. In other words, the market may not be efficient from an informational point of view. Since technical analysis uses statistical and behavioral economics, it guides traders to what is most likely to happen. Hence, in real-life scenarios, investors usually use both technical and fundamental analysis to make decisions.

While fundamental analysis involves evaluating the intrinsic value of a company based on external events, market study, financial statement analysis, industry trends to name a few. Technical Analysis, on the other hand, relies on market movement more than the intrinsic value of the investment.

How is Technical Analysis different from Fundamental Analysis?

Unlike fundamental analyst, the overvaluation and undervaluation of a stock does not influence the behaviour of a technical analyst. Since Technical Analysis is concerned with price action, all decisions are based on the market movements rather than considering industry trends and company performance as technical analysts are really looking to
make money based on the stock market performance of a stock based on price trends.

Since technical analysis is statistical in nature, it is based on various
assumptions. It is very important to keep these assumptions in mind to
be able to perform technical analysis for investing:

  1. Market discounts itself: All the prices in the markets are a reflection of known and
    unknown information present with the investors in the stock
    market. The market takes into account all these factors and hence, price
    is always a reflection of this information.
  2. History repeats itself: Technical Analysis is a historic representation
    of price movements. It assumes that the history of the previous record
    of prices will be repeated in the future. It is based on the actions
    that investors take in an upward trending market, people tend to go
    long and vice versa.
  3. Trend influences price: Technical analysis studies and identifies
    trends in the market on the basis of which decisions are made.
    Since it is assumed that these trends will be reflected in the price,
    only then does technical analysis and its actions make sense.

How can you start Technical Analysis?

A lot of you all might wonder how can you start and eventually make money while practicing technical analysis. These simple steps can help any beginner:

There are various technical indicators that help technical analysts to identify market trends:

Charts:

While it is important to keep in mind that no technical analysis is perfect, there are some tried and tested common charts that Investors use various charts to help them predict future market movements, some of the most common ones are:

1.  Line Chart
2. Bar Chart
3. Candlestick Chart
4. Renko Chart etc
And many more…

Moving Averages:

Moving average is a technical analysis tool that helps investors smoothen the price movements data by a frequently updated average price. Since minor and major movements in stocks over a really brief period of time can influence technical analysis results, a moving average is calculated to better predict actions.

MA are customizable and the time frame is based on the discretion of the analyst. The most common time frames that investors use are 15, 20, 30, 50, 100, 200 days.

Relevance to the SimTrade certificate

With basic technical analysis, you can start trading in the markets through Online Brokers or through the Simtrade Platform to enhance your learnings.

About theory

  • By taking the market orders course , you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Long-Term Loans

Long-Term Loans

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on long-term loans.

This read will help you get started with understanding long-term loans and how it is used in today’s world.

Introduction

A term loan or long-term loan refers to a loan from a bank for a specific amount of
funds with a fixed interest rate or a floating interest rate payable over a specified
schedule. A company uses term loans to fund the purchase of fixed assets, for
instance, manufacturing equipment, property, etc.

The term loans are issued by banks for short-term as well as long-term periods of
time. Depending on the needs of the business, the banks usually have different
types of term loan offerings. These loans differ from each other in their repayment
schedule as well as the type of interest rates.

Main aspects behind facilitating a term loan

1. Collateral:
Nature of term loans are usually very risky for the lender, hence the banks
usually require collateral and a rigorous approval process to grant term loans
to businesses.

2. Repayment schedule:
The repayment schedule is fixed by the bank at the beginning of the term loan
grant process. This is based on various factors that the bank considers about
the risk profile behind the loan. Generally, term loans do not carry any
penalties if they are paid off ahead of schedule. If the company does not pay
the obligations in time based on a pre-decided repayment schedule, the
banks charge a penalty which can be hefty. These repayment schedules can
be monthly, quarterly, or yearly.

3. Interest rates: The term loan bears an interest rate charged by the bank which is pre-decided. This interest rate can be either fixed throughout the tenure of the
term loan period or be a floating rate that fluctuates throughout the period of
the term loan. Let’s understand the types of interest rates to get better
understanding:

● Fixed interest rate:
This is straightforward as it is fixed based on the nature of the loan and
the time period. If the loan is relatively risky, the interest rate fixed will be
higher than that for a loan with low levels of risk.

● Variable interest rates:
The interest rates that differ along the period of the term loan are
referred to as variable interest rate. They are usually attached to the
value of a benchmark rate such as LIBOR (London Interbank Offered
Rate).

This interest can be represented in the following way: LIBOR + 0.5%
Hence, as the value of LIBOR changes, the interest rate also increases
or decreases along with it.

 

Various types of term loans:

1. Short-term loans: These loans are usually taken by companies for a period of
less than 1 year.

2. Intermediate-term loans: These loans are usually for a period of more than 1
year but less than 3 years. The company usually pays for these loans monthly
through the cash flow it generates through its operations.

3. Long-term loans: Any term loan for a period of more than 3 years can be
defined as a long-term loan. These loans require collateral to be granted by
the bank. The repayment schedule can be monthly, quarterly based on the
agreed terms in the beginning.

Long-term loans are present on the non-current liabilities of the balance of every
firm. Long-term loans cannot be avoided by a company especially when it is starting
out as it is a primary source of funding

You can read more about other forms of liabilities on a firm’s balance sheet.

Relevance to the SimTrade certificate

This post deals with Long-Term loans, which are taken up by companies and indicate their financial health.

About theory

  • By taking the market orders course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Long-Term Liabilities

Long-Term Liabilities

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on long-term liabilities.

This read will help you get started with understanding long-term liabilities and how it is used in making investment decisions.

Introduction

Long-term liabilities are financial liabilities of the firm that are due in a period more than one year. These long-term obligations are also referred to as non-current liabilities.

You can find the long-term liabilities in the balance sheet including various items such as all long-term loans, bonds, and deferred tax liabilities.

While the current liabilities of a business represent the funds used by a company to cover its liquid assets, the non-current part of the liabilities are used to cover primary business operations and purchase of heavy long-term assets.

The current and non-current liabilities are separated from each other to help readers understand the financial prosperity of the businesses in different time scenarios.

The most common examples of long-term liabilities are as follows:

● Bonds payable
● Long term loans
● Pension liabilities
● Deferred income taxes
● Deferred revenues

Final Words

Understanding the level of long-term liabilities of the business helps the reader to assess the risk behind meeting the financial obligations of a business. To be able to measure this risk level, it is very important for the investor to understand the concept of leverage. It helps the reader understand how much capital comes from debt. This
helps one understand the position of a company towards its ability to meet its financial obligations. High levels of leverage can be risky for the business. You can measure this using various financial ratios. Common leverage ratios include debt-equity ratio and equity multiplier.

Relevance to the SimTrade certificate

Understanding long term liabilities and its significance in the books of accounts of a company will help you better understand the financial health of companies you would like to invest in.

About theory

  • By taking the market orders course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Liabilities

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Accounts Payable

Accounts Payable

Shruti Chand

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on the concept of accounts payable.

This read will help you get started with understanding accounts payable and its significance.

What are accounts payable?

Accounts Payable appears in the balance sheet of a company when the company purchases goods or services on credit that needs to be paid after a certain period.

Accounts payable arises when the payment for a purchase of goods or services has not been made upfront but will happen in the future at a given date determined at the time of the purchase by the client (sale by the firm). In this case, goods or services are purchased on credit. They are to to be paid back in the short term.

Example

The services that we consume monthly such as electricity or telephone usually must be paid at the end of the month even though the consumption of the month is done before the said payment. This in turn becomes accounts payable. And our failure to meet the payment at the end of the month could lead to default and hence an extra charge.

For businesses the account payable could be when for example they buy a product, but the payment is not done instantly. For instance, Company X buys an AC from company Y but agrees to make the payment after a month. This transaction for Company X will be recorded as accounts payable whereas for Company Y it will be recorded as accounts receivable.

Accounting Treatment

‘Accounts payable’ falls under Liability in the balance sheet under ‘Current Liability’. It is in current liability since it is a form of short-term debt. Failure to meet this payment by the company will lead to a default. For double entry of accounting, the debit of the same is recorded in the expense account as a purchase. For goods like raw materials, there is a variation in inventory in the revenues and an increase in the Asset side under ‘Inventory’.

The increase or decrease in the Accounts Payable of the prior period is recorded in the Cash Flow statement of the entity.

 

Final Words

Accounts payable are crucial to every economy and it differs based on various factors and is taken in control by policy makers whenever needed. As a student curious about Finance, learning about Repo Rate will go a long way in the future to understand better how liquidity and prices in the economy is maintained.

Relevance to the SimTrade certificate

This post deals with Accounts Payable and how it’s significance in the books of accounts of the companies you would like to invest in as an investor,

About theory

  • By taking the SimTrade course , you will learn more about the markets.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).

Inventory

Inventory

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of accounts receivable.

This read will help you get started with understanding inventory and its significance.

Definition

All the raw material that a business uses to produce goods and the ready for sale products that a business possesses is referred to as Inventory. It is a form of asset for a business.

All inventory is categorised and recorded as current asset on the balance sheet. The inventory mainly comprises of three types of goods:

1. Raw materials: The assets that a business uses in the production process to produce the final product.

2. Work-in progress: The unfinished product held by a business not ready to be sold yet.

3. Finished goods: Ready to sell products possessed by a business not sold yet. These products are usually held by a business in warehouses.

The value of inventory is important to be evaluated by a business as it is an asset stored by the business which incurs costs of storage. The value of the inventory can be evaluated in various ways though, depending on the accounting method followed by the business.

The three ways in which inventory can be valued are as follows

1. FIFO: First in first out method which calculates the cost of goods sold on the basis of the cost of earliest purchased materials.

2. LIFO: Last in first out method states that the cost of the goods sold are calculated based on the value of the raw materials purchased last.

3. Weighted average method: States that the value of inventory is calculated based on the average cost of the total raw material purchased by the business.

Final Words

Understanding inventory and calculating it well helps the business to plan the purchase of raw materials and production decisions better. Business can determine the level of purchases to be made and exercise stock control for better business performance.

Relevance to the SimTrade certificate

This post deals with inventory part of the books of accounts, which is an important indicator for investors to study the financial health of a company.

About theory

  • By taking the SimTrade course , you will learn more about the markets.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Accounts Receivable

   ▶ Shruti CHAND Current Assets

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Accounts Receivable

Accounts Receivable

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of accounts receivable.

This read will help you get started with understanding accounts receivable and its significance.

Introduction

Accounts Receivable appears in the balance sheet of a company when an entity (an individual or a company) purchases goods or services on credit from the company and the payment will be received later.

It is the amount of money owed by the customer for any purchase that is made on credit. Quite often, business sells products/services to its customers but the payment is made in the future and issues an invoice for this same in the meantime. This invoice signifies that the product has been sent but the payment is to be done within a specified future date. These are a form of short-term debt since they are to be paid back in a short span. The time for the payment is usually from about 30 days to a few months.

Example

Company A that sells broadband service usually provides the service for the month, but the payment is typically received at the end of the month. This means that even though the service has been provided, the payment is pending hence making it an accounts receivable.

Mostly, businesses provide credit purchases to customers with whom they have frequent transactions. This enables them to avoid the hassle of payments every time a transaction occurs. It also helps build a good relationship with its clients by providing them an ease of payment.

Accounting Treatment

As discussed, since Accounts Receivables is like a short-term credit line to clients hence it is treated as a short-term asset in the balance sheet. It falls under ‘Current Assets’ since the payment is received in the short term. For double entry, the credit side of the same is recorded in the income account as a sale. Once, the payment is made the cash in the balance sheet will increase and the accounts receivable will decrease. For goods like raw materials, there is a variation in inventory in the revenues and a decrease in the Asset side under ‘Inventory’.

The increase or decrease in accounts receivable from the prior period is also recorded in the Cash Flow Statement.

Final Words

Accounts receivable are crucial to every economy and it differs based on various factors and is taken in control by policy makers whenever needed. As a student curious about Finance, learning about accounts receivable will go a long way in the future to understand better how liquidity and prices in the economy is maintained.

Relevance to the SimTrade certificate

This post deals with Accounts Receivable and its significance on the book of accounts of a company.

About theory

  • By taking the SimTrade course , you will learn more about the markets. It’s important to remember that accounts receivables are an important to assess it to understand the financial health of a company you would like to invest in.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Accounts Payable

   ▶ Shruti CHAND Current Assets

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Rise of SPAC investments as a medium of raising capital

Rise of SPAC investments as a medium of raising capital

Daksh GARG

In this article, Daksh GARG (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021) talks about the rise of SPAC investments as a medium of raising capital. Imagine someone famous asking you to invest in a company. Chances are, you will want to know more. As it turns out, there is no company, at least not yet. Will you invest in it with your money?

What are SPACs?

‘SPAC’ stands for Special Purpose Acquisition Companies. SPACs are a type of blank-check company that pools funds to finance mergers and acquisitions (M&A) transactions.

Once shunned by investors, SPACs have become an increasingly popular method in recent years to list companies on a stock exchange.

SPACs are shell companies with no actual commercial operations but are created solely for raising capital through an initial public offering – or IPO – to acquire later a private company. This is done by selling common stocks – with shares commonly sold at $10 a piece – and a warrant, which gives investors the preference to buy more stocks later at a fixed price.

Once the funds are raised, they will be kept in a trust until one of two things happen:

    The management team of the SPAC — also known as sponsors — identifies a company of interest, which will then be taken public through an acquisition, using the capital raised in the SPAC IPO.

    If the SPAC fails to merge or acquire a company within a deadline typically two years — the SPAC will be liquidated, and investors will get their money back.

SPACs have existed in one form or another as early as the 1990s, typically as a last resort for smaller companies to go public. The number of SPAC IPOs has waxed and waned over the years in tandem with the economic cycles. SPACs have been making a resurgence of late.

The timeline for SPAC

Figure 1 gives the typical timeline for a SPAC investment. Following the IPO, the proceeds for a SPAC are placed in a fund. In the meantime, the SPAC has to merge with a target company. If it is not able to do that in the time frame, the SPAC has to liquidate and the IPO proceeds are returned to the shareholders.

Figure 1. Typical SPAC timeline.

Typical SPAC timeline

Source: PWC accounting advisory

Difference between a traditional IPO and a SPAC

There are several ways a private company can go public (being quoted on the stock market). The most common route is through a traditional IPO, where the company is subject to regulatory and investor scrutiny of its audited financial statements.

An investment bank is usually hired by the company to underwrite the IPO, which usually takes 4-6 months to complete. This involves roadshows and pitch meetings between company executives and potential investors to drum up interest and demand in its shares. And not all IPOs succeed. A very famous example is that of a co-working-space company called WeWork withdrew its high-profile IPO in 2019 amid weak demand for its shares after massive losses and leadership controversies were revealed. Other companies such as Spotify and Slack went public through direct listings, saving on fees paid to middlemen such as investment banks, although there are more risks involved. And while private companies listed through SPACs are similar to reverse takeovers, such as the case for insolvent fintech company Wirecard, they are different in that SPACs start off on a clean slate and have lower risks. Because SPACs are nothing more but shell companies, their track records depend on the reputation of their management teams. By skipping the roadshow process, SPAC IPOs also typically are listed in a much shorter time. This leads to some investors to become wary of buying shares in companies listed through SPACs due to the lack of scrutiny compared to traditional IPOs.

SPAC sponsors also typically receive 20% of founder shares in the company at a heavily discounted price, also known as the “promote.” This essentially dilutes the ownership of public shareholders.

Performance of traditional IPOs compared to SPAC IPOs

According to Bloomberg, a study of 56 SPACs that completed acquisitions or mergers since the start of 2018 found that they tend to underperform the S&P 500 during a three, six and 12-month period after the transaction. A separate study of blank-check companies in the U.S. organized between 2015 and 2019 found that the majority are trading below the standard price of $10 per share. Between 2017 and the middle of 2019, there were slightly over 100 SPACs in the U.S., with an average return of a mere 2%.

Even before the pandemic, SPACs were already on the rise, buoyed by the equity boom and hot IPO market in 2019. While the pandemic has slowed the pipeline of traditional IPOs, SPACs have increased.

In fact, funds raised through SPACs outpaced traditional IPOs in August 2020 — a rarity on Wall Street. In the first ten months of 2020, there were 165 SPAC IPOs globally, of which 96% of them were listed in the U.S. While largely an American phenomenon, SPACs have caught the attention of investors in other jurisdictions.
In 2018, Antony Leung, the former finance secretary of Hong Kong, raised $1.5 billion on the New York Stock Exchange through his SPAC, which bought a mainland hospital chain a year later.

Other players include Masayoshi Son’s SoftBank, and the investment arm of Chinese state-owned conglomerate CITIC Group. Despite having sponsors from Asia looking to acquire international companies, these SPACs are ultimately listed in the U.S.

One main reason is the different rules for SPACs across jurisdictions. In the U.S., investors can vote to approve the acquisition the SPAC proposes or redeem their funds if they do not support the proposed deal.

This, however, isn’t a requirement in some European jurisdictions, including the U.K. There is also a lock-in period for British investors once an acquisition is announced until the approval of the prospectus, which ties them into deals that they may not support in that indefinite period.

Future of SPACs

As SPAC activity reaches fever pitch in the U.S., regulators are putting these blank-check companies under the microscope. Competition to the IPO process is probably a good thing, but for good competition and good decision-making, you need good information. And one of the areas in the SPAC space that I’m particularly focused on is incentives and compensation to the SPAC sponsors. As more ordinary investors jump on the SPAC bandwagon, experts are concerned that this will overheat markets and affect any fragile economic recovery. While SPACs provide a straightforward route to invest through a trusted intermediary, its performance so far means that it is a dicey bet for ordinary investors.

Why should I be interested in this post?

If you are interested in how big companies are going public, SPAC is one of the most interesting phenomena which is going to transform the financial industry. So, if you are planning to work for top underwriting firms or big banks or on Wall Street, you should have in-depth knowledge on how SPACs work and what are some of their advantages and disadvantages.

Useful resources

PWC How special purpose acquisition companies (SPACs) work Accessed November 2, 2021.

PWC Analysis: De-SPACing Successes Refuel Hot SPAC IPO Market Accessed November 2, 2021.

Related posts on the SimTrade blog

   ▶ Suyue MA Expeditionary experience in a Chinese investment banking boutique

   ▶ Raphaël ROERO DE CORTANZE In the shoes of a Corporate M&A Analyst

About the author

The article was written in November 2021 by Daksh GARG (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021).

Pension Funds

Pension Funds

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of Pension Funds

This read will help you get started with understanding pension funds and its significance.

What are pension funds

Term pension liability refers to the amount that a company or government owes to the pension fund obligations due to retirees. A pension liability will only occur in defined benefit schemes.

The traditional pensions are pre-defined benefit schemes. These funds consist of contributions from employees and the company over a period of time. The employees agree to contribute a certain amount into the fund in return of a guaranteed source of fund flow upon retirement.

Not all pension funds have liabilities attached to them. Most common pension fund in this regard is 401k where the company is under no obligation to contribute towards the fund. It is pre-defined by the company and the employee to contribute towards the fund which may or may not guarantee obligation upon retirement.

So, what is pension fund liability?

Pension fund liability is the difference between the total amount due to retirees and the actual amount of money the company has in order to meet these fund obligations.

If the company or the government has more money than the future payment obligations, it is said to have a pension surplus, and if this is not the case, it is referred to as pension deficit which results in a pension fund liability.

Relevance to the SimTrade certificate

This post deals with Pension fund liability.

About theory

  • By taking the SimTrade course , you will learn more about the markets. It’s important to remember that pension funds has not much to do with investing directly. But, it is important to understand it as it’s an important activity for the companies investors invest in.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Liabilities

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Long-Term Assets

Long-Term Assets

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on long-term assets.

This read will help you get started with understanding long-term assets on the balance sheet of a business.

Introduction

Long-term assets on a balance sheet represent all the assets of a business that are not expected to turn into cash within one year. They are represented as the non- the current part of the balance sheet. These are a set of assets that the company keeps for the long-term and is not likely to be sold in the coming years, in some cases, may
never be sold.

Long-term assets can be expensive and require huge capital which might result in draining cash reserves or increasing debt for the firm.

The following category of long-term assets can be found in the balance sheet:

1. Investments:

These are all the long-term investments by a company in securities, real estate, and other asset classes. Even the bonds and other assets restricted for long-term value are treated as investments by the company.

2. Property, plant, and equipment:

Property that the company owns associated with the manufacturing process or other business operations. An important aspect about this asset class is the depreciation associated with the value of the asset over time.

Typically, you can find the following items disclosed as property, plant and equipment on the balance sheet:

● Land
● Land improvements
● Buildings
● Furniture
● Machinery
(Less: Depreciation)

3. Intangible assets

Intangible assets are the assets without a physical existence. These items represent the intellectual property of a business acquired through their operations, marketing and other efforts to create value. The most notable
intangible asset on a balance sheet is Goodwill.

Other intangible assets found in the financial statements are:

● Copyrights
● Trademarks
● Patents

4. Other assets: All the assets of non-current nature that can not be liquidated
easily.

Final Words

Since a company holds the long-term assets for a long period of time, the changes in the long-term assets can be a sign of liquidation in some cases. When investors study the balance sheet of a company, they can see if the company often sells its long-term assets then it can be a sign of financial difficulty.

Relevance to the SimTrade certificate

This post deals with Long-Term assets which are used by various  investors to study the financial health of a business.

Additional courses:

  • By taking the market orders course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance sheet

   ▶ Shruti CHAND Current Assets

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Current Assets

Current Assets

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on current assets.

This read will help you get started with understanding current assets and how it is used in today’s world.

Introduction

Current asset refers to all the assets of a business that can be converted into cash with ease, usually within 12 months or less. These assets are also referred to as
liquid assets based on their nature and include items such as cash and cash equivalents, short-term investments, etc.

Current assets are important as the company needs liquid assets to pay for ongoing operational expenses.

Current Assets = Cash + Cash Equivalents + Inventory + Accounts receivable +
Marketable securities + Prepaid expenses + Other liquid assets.

All the current asset’s values are added up and recorded under the current assets the section on the balance sheet. Let us understand the following items represent the part of the current assets:

Cash, and cash equivalents

Are all the cash and its equivalents such as marketable securities, short term treasury bills/bonds.

Accounts receivable

It is the money due to a company for goods/services already delivered but not yet paid for. It is treated as current assets because they are expected to be received within a year. In case the money is never received/collected by the company, such entries are noted down as bad debts and are still recorded in the current assets section of the balance sheet.

Stock Inventory

This represents all the finished products or the lying raw materials with a firm. The company holds them until they are sold and is expected to be sold in the near future. There can be instances though, when inventory is not sold and the company’s inventory can be backlogged.

Prepaid Expenses

These represent the advance payments made by a firm for goods/services that it will receive in the future. Since the payment is already made, it allows the firm to free up capital for other uses, which is why they are recorded as current assets. These expenses usually include payments to insurance companies or service providers.

Marketable securities

These are liquid financial instruments that can be easily converted into cash. These short-term securities can be bought or sold on public stock exchanges. It includes common stock, treasury bills, and money market instruments.

Final Words

It isn’t necessarily a good thing to have a lot of cash on the balance sheet. If the company has debt and is sitting on a large amount of cash, it can portray an the unhealthy state of business or bad financial management.

Current assets allow the management of the company to make necessary arrangements to continue business operations. As an investor, one needs to keep an eye on the current assets to assess the risk in the business operations of the firm. You can use a variety of financial ratios related to liquidity to do the same, for example, current ratio, quick ratio, and cash ratio.

Related posts on the SimTrade blog

   ▶ Shruti CHAND Balance Sheet

   ▶ Shruti CHAND Accounts Receivable

   ▶ Shruti CHAND Current Assets

Relevance to the SimTrade certificate

This post deals with Current Assets which are used by various investors to study the financial health of a business:

About theory

  • By taking the market orders course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Robinhood

Robinhood

Shruti Chand

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on Robinhood Markets.

This read will help you get started with understanding Robinhood and how it is used in today’s world.

Introduction

‘Investing for everyone’ – these are the first words you’d read if you were to visit Robinhood’s website. And that’s exactly what it stands for. Robinhood Markets, Inc is an American financial services company that offers commission-free trading through its website and mobile app. Its name is justified by their mission i.e. to ‘provide everyone with access to the financial markets, not just the wealthy.’

Since it was founded in 2013, this Silicon Valley-based firm has tried to disrupt the trading industry. It facilitated buying of fractions of a share, no minimum balance requirement for opening an account, and the best of all – free trades. Free trades weren’t a norm back in the day as it is today. With the onset of the pandemic, and the rise of new-age traders, zero-commission brokerage firms became immensely popular, and Robinhood stole the spotlight.

Homepage of Robinhood’s website
Capture

‘With great power comes great responsibility’

Its immense popularity made it face strong backlash too. Many believed that this app is giving great power in the hands of young inexperienced traders along with huge responsibility regarding their trading activity (as they are not assisted by a professional). It’s like giving the keys to a sports car to a 12-year-old boy or girl. In a statement to the Wall Street Journal, a Robinhood spokesperson wrote how they fully realize that their company has become synonymous with retail investing in America, leading to millions of young investors making their first investment through their app and that they do not take this responsibility lightly.

Suicide of a Robinhood trader

In June 2020, a 20-year-old trader on Robinhood died by suicide as he misinterpreted his Robinhood account statement, which temporarily showed a negative balance of $730,000. His suicide note also stated that he had no clue as to what he was doing and that he had no intention of taking so much risk. The company expressed its devastation while expanding its educational resources on options trading and increasing customer support in reaction to this incident.

Roll in 2021 short squeeze

In January 2021, Robinhood restricted the trading access to certain stocks such as GameStop, AMC Entertainment, Nokia, and others during the market frenzy surrounding the r/wallstreetbets subreddit (discussion forum on the Reddit platform) and its members’ attempted short squeeze on the stocks mentioned earlier. This move attracted condemnation from users on Reddit and Twitter, and it was also termed as ‘market manipulation’ to protect hedge funds. One of Robinhood’s primary market makers has some ownership in the hedge fund Melvin Capital which was one of the largest short sellers of GameStop and other stocks. This led many to suspect a conflict of interest, inducing class action lawsuits and the attention of few members of the US Congress.

How does Robinhood make money?

As most fees for equity and options trading evaporate, brokers do have to make money somehow. Robinhood generates income from a broad range of sources including Gold membership fees, stock loans, and rebates from market-makers and trading venues.

The company generates significant revenue from payments for order flow (PFOF). It is a common although controversial practice whereby brokers receive payment from market-makers in form of compensation and other benefits for directing their customers’ orders to those trading venues. While the payments might be negligible for small trades, a company that directs billions of dollars in trades can earn substantial amounts. A study suggested that in 2018, PFOF accounted for more than 40% of Robinhood’s overall revenue.

Other sources of revenue include a $5 monthly fee for optional membership to Robinhood Gold, which provides client access to margin loans and investing tools; interest on uninvested cash; lending stocks for short selling; and fees on purchases made using the company’s debit card.

Related posts on the SimTrade blog

   ▶ Shruti CHAND WallStreetBets

   ▶ Raphaël ROERO DE CORTANZE Gamestop: how a group of nostalgic nerds overturned a short-selling strategy

   ▶ Akshit GUPTA Short Selling

   ▶ Alexandre VERLET The GameStop saga

Relevance to the SimTrade certificate

This post deals with Robinhood Markets which is used by various traders and investors in different instruments. This can be learned in the SimTrade Certificate:

About theory

  • By taking the market orders course, you will know more about how investors can use various strategies to invest in order to trade in the market.

Take SimTrade courses

About practice

  • By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).