I know about bonds and public debt. I’ve basically only taken a basic economics class. I’m probably thinking it might be a good idea to take more economics class in the future so I can better understand economics. But… with the class I took I don’t think we really covered the stock market that much. We touched upon the basics about the markets, and what types of markets there are in theory… but we didn’t really talk in practica terms what the stock market did. I think it would be a great help if someone could explain it all to me. I’ve tried reading books on the stock market and I’ve looked at financial dictionaries and what not and I don’t understand it. I have questions and I would like answers.
What are derivatives? What are hedge funds… like I think people in the media have talked about how hedge funds have been toxic, or, something like that.
What is a toxic asset?
What do people mean when they are going to buy short or put up?
What is the prime market? What is the subprime market? What do people mean when they talk about quality of assets?
What is a bubble, and, how is it measured? I know that austrians don’t believe in graphs. But how do mainstream economists tell when a bubble is about to happen?
I don’t think my economics class I took really touched on the market place itself. Could someone explain the stock market to me in more detail? I understand the profit and loss mechanisms. But. I would like my question answered. I’m not looking to be converted to anarcho capitalism, or anything like that, so I just want straight answers… not talking points.
This is probably not the right board to learn about stocks. If you want to understand the jargon of puts, calls, moving averages, stochastics, you can visit Yahoo’s finance pages. If you want a website that forecasts the market, try http://www.elliottwave.com .
Derivatives are financial instruments that derive their value from some underlying asset. Options are a good example of this. If I pay you $3000 for the option (the right, but not the obligation) to buy your house at $100,000, then if I find out Elvis was born in the house and the value skyrockets to $3,000,000, I can purchase house from you for $100,000 and resell it to make a nice profit. The option is a derivative because the value of the financial instrument is tied to an underlying asset.
“What are hedge funds… like I think people in the media have talked about how hedge funds have been toxic, or, something like that.”
Think of hedge funds as actively managed funds that use advanced strategies to try to earn a greater return.
“What is a toxic asset?”
A worthless one
“What do people mean when they are going to buy short or put up?”
Selling short is to bet that the value of a stock is going to fall. You sell stock you do not yet own, hoping to buy it back and deliver it to the person you sold it to at a later date and a lower price. Example: I sell Walmart shares (that I do not own) to you for $50 and the stock drops to $40. I then use $40 of your $50 and purchase the stock and deliver it to you. I keep the $10 profit.
“What is the prime market? What is the subprime market?”
Prime market = mortgages home owners that have good credit, Subprime = mortgages of home owners that have bad credit
“What is a bubble, and, how is it measured? I know that austrians don’t believe in graphs. But how do mainstream economists tell when a bubble is about to happen?”
A bubble occurs when assets are bid up to astronomical levels by easy money. Mainstream economists can’t really tell when a bubble is about to happen. They blame bubbles on greedy speculators.
Permabear is essentially right, but you could probably benefit from some clarification.
A toxic asset is not necessarly worthless and is not well-defined. It is a term that the media uses for assets that are returning much less than their face value. For example, consider a bond that has a face value of $100 and is supposed to pay $5 per year in interest. A year after this bond issued, the borrower announces that they will only be paying $1 per year in interest. Assuming that the market still expects a 5% yield on this investment, the price of this bond will only be $20. Ordinarilly, the owner of the bond would either hold it to maturity, hoping that the borrower would make good on its obligation, or sell it for $20. In the current market, however, the owners are permitted to keep the bond on their books at $100. Because of this, there is no market for these assets.
Before shorting a stock, an investor has to borrow it from someone who already owns it. If the company that issued the stock pays a dividend while it is being borrowed by a short seller, the short seller has to pay the dividend to whoever he borrowed the stock from.
A put is one of two types of options, the other being a call. A put is the right to sell a stock for a certain price, while a call is the right to buy at a certain price. These instruments are created when someone writes them and offers them to the market. They have three elements, a strike price, an expiration date, and the price of the instrument. The strike price is the price of the underlying stock at which the option kicks in. For example, if a put option in XYZ company has a strike price of $50 and an option price of $10, I can buy the put option for $10. If the price of the stock is below $50 on the expiration date, the person who wrote the option will owe the buyer the difference between the price of the stock and $50. If the underlying stock price is equal to or above $50, the buyer loses his $10.
Regarding mortgages, the correct terms are actually conforming and non-conforming. A conforming mortgage conforms to the Federal National Mortgages Association (Fannie Mae) underwriting guidelines, so it can be sold to Fannie Mae. A non-conforming, or subprime, mortgage does not conform to these guidelines and must be held privately. Fannie Mae actually losened its underwriting guideline standards substantially between 2000 and 2008. Contrary to popular myth, the problems with the conforming mortgage market are much worse than those of the subprime market.