Understanding Forward Premiums is Important

From an economic standpoint, the forward premiums in foreign exchange markets and futures markets are based on overall changes in supply and level of exports. Essentially, the forward premium is a proxy for the supply curve, the spread between futures and spot rates known as carry yield.

If forward prices are greater than spot rates, markets are in contango. This means the cost of storing supply is increasing with time. There is an expected decrease in supply with a decreasing shift in the supply curve. If forward prices are less than the spot rates, markets are backwarded. This means that the cost of storing supply is decreasing with time, and there is an expected increase in supply with an increasing shift in the supply curve.

Assuming that eventually the forward price and the spot price will converge, there could be a trading opportunity afforded by major discrepancies between the two rates. For instance, if the euro has a major premium factored into the forward rate compared to the current spot rate, then there may be a good trading opportunity. In this instance, one can sell the forward contract and buy the spot rate currency to profit from converging prices, all else equal.

Wine Investing

Wine investing has many palpable benefits. Before investing in wine, however, you should be aware that there are difficulties in this type of investment as well. Make sure that you do your marketing research and speak to an experienced professional. One of the biggest benefits of wine investing is that it is a tangible asset. Its quality improves with age. Plus, wine investing is non-correlated to common financial investments.

Tangible asset

Anytime there are economic woes and market failures, investors across the board will turn to investing in tangible assets. One of the great features for wine investing is that it is a tangible asset. It can be enjoyed as it reaches its optimal maturity for consumption. In general, tangible assets have a higher demand when financial market prices are slashed. Therefore, it makes sense to include wine as a good way to diversity your portfolio.

Quality improves with age

Unlike financial investments, wine will invariably improve in quality with time. When adhering to all the recommended provisions for storage and upkeep, the investment will invariably improve with age. That is the nature of wine. Financial investments, on the other hand, are constantly subject to market perceptions in order to uphold and improve their quality. For example, a bond is subject to many risks that are inherent to the bond markets themselves. They are constantly scrutinized and perceived differently by market participants. Their quality grades are constantly changing.

Non correlated to other investments

The fact that wine investments are not correlated to the broader economy makes it another great means for diversification. When the market is experiencing a failing economy, investors flock to tangible assets. Some of the most common assets are  collectibles, fine art or precious metals. However, these assets are normally non correlated, and yet, wine collections are even more independent than many other popular tangible assets.

Investment funds have poured money into investing in wine for the broader pool of investors. Investing in wine funds can be a hedge investment for the carefree rich investor who does not want to worry about the marketing and up keeping of the wine collection. Although wine investing carries the major aforementioned benefits, there are certain factors to watch out for including the following:

• Storage efficiency
• Wine brand
• Economics

If the wine is not stored properly, it will instantly will lose its appeal for all marketing purposes. That’s why it is important to adhere to the auction houses’ recommendations in order to ensure the quality of the collection. The brand of wine and the year that it was bottled is also very important. Also, the wine should be a specific brand and year, to be profitable. The collection instantly loses its investment appeal if it is not quality because this asset class is so ethereal as a marketable investment. Also, you should be wary of the upcoming supply and demand of your vintage collection during the time it will be sold.

Avg. Returns Versus Compounded Returns

When comparing investments, you can use average return or compound return as a comparison method. Compound return is more suitable for comparison and can be plugged into a formula for growth because it uses the power rule. Average return is easier to calculate, but is not commonly used by analysts to review earnings growth.

The calculations

Applying these calculations to earnings is simple. First, you acquire the earnings data for all periods whether it be annual or quarterly earnings data. Then you calculate the rate of return for each period. You would then sum the rates of return and divide that number by the number of periods. This calculates the average earnings growth.

Compounded growth, on the other hand, is a little different. For a compounded growth calculation you get the first period and the last period, divide that number to find a ratio, and take the inverse of the power function by the number of periods.

Average return example

Take for example, company xyz. Let's assume their earnings per share is as follows: $1.00; $2.25; $2.50. The rates of earnings growth for each period would be as follows: (2.25/1-1);(2.5/2.25-1). That equals to 125% growth from current to year one and 11% growth from year one to year two. The average earnings growth, therefore, is equal to (1.25+.11)/2=68%. Notice, from looking at the numbers, you can see a deceleration of earnings growth from year two going into year three. The average earnings growth does not account for rate of change well which makes a big difference in estimation when analyzing many periods.

Compound return example

Now for compounded growth, formulate the problem as follows: (2.5/1)^(1/2)-1=1.58-1=58%. Note the calculation found the compounded growth rate to be 58%, and that it is less than the average growth rate of 68%. Notice that the compound return method intuitively takes into account the deceleration of earnings growth. This is very important when dealing with a many number of periods, especially when analyzing quarterly periods because of the acceleration and deceleration of growth involved and changing of trajectory.

The compounded growth method is more commonly used. Unless the numbers are showing a linear pattern, the average return would function just fine. However, most of the time, growth accelerates and decelerates. When analyzing growth, it is not easy to factor this dimension in without first using the compounded growth method. Note that just a minor difference in growth rate may not seem like a big difference; however, the compounded growth method will estimate earnings or whatever financial measure much better than the average return method.

Be sure also to chart the growth figures to approximate the shape of the growth curve and also approximate a growth formula to best estimate future earnings. After all, most of this is for the purpose of predicting future earnings as well as gauging current growth patterns.

ETF Strategy for the Economic Cycle

With the ease of trading in exchange-traded funds, you can apply a number of strategies, among which is the ETF strategy of timing the economic cycle. ETFs are investment funds that track major indexes, investment styles and broad market sectors. This leaves a simple execution for an economic cycle strategy.

First make sure that you have the ETFs tracking the major sectors on your radar: consumer staples, consumer goods, machinery and financials. Keep in mind that the definition of those general sectors can be translated with different investment funds. You generally want to stick with the ETFs that have been introduced by the same investment company for the strategy.

Timing the economic cycle requires careful analysis of the current situation of the economy as well as a basic understanding of economic cycles. Here is the list in chronological order of which sector should be growing in each stage of the economic cycle: 1) consumer staples, 2) consumer goods, 3) machinery and 4) financials.

These market sectors tend to do well in the different stages of an economic growth pattern. If the financial sector has been exhibiting strength for an extended period, you can bet that the current economic cycle is in the late stages.

Understanding Liquidity Risk

If you are involved with bonds and you are still wanting to learn the basics, liquidity risk is something you're going to want to learn about. It's not something you need to know for investing but is handy when you want to understand the details. Stick to the causes of liquidity risk that will help you gain a deeper understanding of how and why professionals discuss it.

Liquidity risk is essentially the risk entailed with a lack of liquidity in the markets. This normally happens where there are markets that are scantly traded. Be aware that this risk is not too much of a concern for the average investor. This is due to the fact that market makers provide a built-in liquidity premium. The more liquidity risk there exists, the more liquidity premium there should be.

Applying this basic principle to bonds introduces the liquidity preference theory. This theory says ultimately that the bonds that are preferred are the most liquid ones. Since the most liquid bonds are the near-term maturities, such as the Treasury bills or U.K. gilts, these are the ones with the highest liquidity. Note also that, as time until maturity increases, the liquidity risk also increases. As mentioned before, this liquidity risk is normally compensated with a risk premium.

The types of liquidity risks could stem from the following: bid and ask spreads and low proportion of buyers and sellers.

Bid-Ask Spread

Look at the bid-ask spread to see what it is telling you. It could say a lot of things, but know for sure that when the bid-ask spread is tight, the risk is very low. And when the bid-ask spread moves sporadically, like leaves in the wind, then you should really start to worry about the liquidity risk. That all goes back to the concept of volatility, and volatility, you must remember, is one of the causes of risk. You can look at it as though it's a scientific corollary or just know that the markets are going to take it for a cause and so should you. All in all, you should be wary of the bid-ask spread.

Buyers and Sellers

Investing in bonds is not like investing in stocks. Think of what happened during the mortgage bond crisis of the late 2000s. It was one of the most voluminous chains of events in financial history. This is because the mortgage bond and CDOs (collateralized debt obligations) market was one of the largest markets in the world, monetarily speaking. It was even bigger than the Treasury market. Yet the market capsized because, when times got risky, the pools of investors all wanted to exit at the same time, and there was a serious lack of buyers in the market. You don't have to worry about CDOs. Just know that from a standpoint of how the markets actually function, the proportion of buyers and sellers needs to be consistent for there to be a liquid market.

What is a Bull Flattener?

A bull flattener effect occurs when long term rates decrease so that they converge with short term rates. Normally, the yield curve is humped, the effect of a bull flattener is a flattening of lthe yield curve.

What happens during a bull flattening cycle is long term bond yield decrease while short term bond yields increase. This produces a yield curve that is beneficial for the major bond investors. Imagine the yield curve to be a concave line on an x and y axis plane.

To understand this concept, imagine the yield curve as a connected line of points on the x and y axis plane where the x axis is time until maturity and the y axis is the interest rate. The less concave the line is the closer the short term rates are to the long term rates.

Experienced bond investors study the yield curve and trade the spread in between long term bonds and short term bonds with the intention of profiting from the difference between the two rates.