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How to calculate point price elasticity of demand with examples
Where (∆Q/∆P) is the derivative of the demand function with respect to P. You don’t really need to take the derivative of the demand function, just find the coefficient (the number) next to Price (P) in the demand function and that will give you the value for ∆Q/∆P because it is showing you how much Q is going to change given a 1 unit change in P. Finding the point elasticity solution is best demonstrated with examples.
To find the point price elasticity of demand we begin with an example demand curve:
Q = 15,000 – 50P
This gives us (∆Q/∆P)= -50
Next we need to find the quantity demanded at each associated price and pair it together with the price: (100; 10,000), (10; 14,500)
Then we plug those values into our point elasticity of demand formula to obtain the following:
e = -50(100/10,000) = -.5
e = -50(10/14,500) = -.034
How to find the point price elasticity of demand with the following demand function:
How To Price A Product: A Scientific 3-Step Guide (With Calculator)
Last Updated May 02, 2020
Product pricing is an essential element in determining the success of your product or service, yet eCommerce entrepreneurs and businesses often only consider pricing as an afterthought. They settle and use the first price that comes to mind, copy competitors, or (even worse) guess.
Humans are irrational. Product pricing strategy is just as much as an art form as it is a science.
Today, I’ll be breaking down the scientific side of how to price your product.
There are lots of resources out there on the art of pricing, but this step-by-step guide will provide you with the tools and strategies you need to create a reliable, data-backed pricing structure for your product.
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There are lots of product-pricing strategies out there based on the study of human psychology.
Ending your price with a 9 or a 5, for example, is called “Charm Pricing.” Millions of businesses have used charm pricing to price their products, and it’s proven to increase sales.
Or there’s “The Rule of 100,” a fantastic psychological hack to maximize the perceived magnitude of your discount, no matter the discount size. With The Rule of 100, businesses use percentage amount discounts for items under $100 and dollar amount discounts for items over $100. [*]
Without a doubt, psychology is an important part of pricing.
But let’s take a look at scientific approaches and strategies. Follow these steps to arrive at the optimal price for your product.
Step 1: Find A Base Price By Getting To Know Common Pricing Strategies In Your Industry
Thousands of entrepreneurs and decades of learning have paved the way for new businesses to craft a strategy that utilizes the most innovative pricing options available.
Knowing which pricing models work best in your industry can simplify how you price a product, and give you confidence knowing that you’re not simply guessing.
One of the most simple ways to price your product is called cost-plus pricing. [*]
Cost-based pricing involves calculating the total costs it takes to make your product, then adding a percentage markup to determine the final price.
For example, let’s say you’ve designed a product with the following costs:
Material costs = $20
Labor costs = $10
Total Costs = $38
You then add your markup percentage, let’s say 50% (retail industry standard), to the total costs to give you a final product price of $57.00 ($38 x 1.50). If you remember our “Charm Pricing” tactic from the beginning, you might mark this product at $57.99.
This method is simple, fast, and lets you quickly add a profit margin to any product you intend to sell.
Also referred to as a competition-based pricing strategy, market-oriented pricing compares similar products (competition) in the market.
The seller sets the price higher or lower than their competitors depending on how well their own product matches up. [*]
Price above market: Consciously pricing your product above the competition to brand yourself as having a higher-quality or better-performing item
Copy market: Selling your item at the same price as your competition to maximize profit while staying competitive
Price below market: Using data as a benchmark and consciously pricing a product below competitors, to lure customers into your store over theirs
Each of the above strategies in the market-oriented model has its pros and cons. With market-oriented pricing, it’s important to understand the costs of making your product, as well as the quality compared to competitors to accurately price your product.
Dynamic pricing, also referred to as demand pricing or time-based pricing, is a strategy in which businesses set flexible prices for a product or service based on current market demands. [*]
In other words, dynamic pricing is the act of changing a price multiple times throughout the day, week, or month to better match consumer purchasing habits.
Here’s how it might look for eCommerce businesses in action:
It’s not just services like Uber that take advantage of dynamic pricing to maximize profits. Amazon has long been using price surges on their most-competitive items for big eCommerce shopping days such as Black Friday and Cyber Monday. [*]
Amazon prices fluctuate so frequently that the price-tracking site camelcamelcamel checks prices for popular items several times per day. [*]
There are a ton of great software products out there that will help you to automatically apply dynamic pricing to your products, without breaking the bank or pulling your hair out.
Tool #1: Quicklizard
Tool #2: Omnia Retail
Tool #2: Profit Peak by Splitly (Amazon-Specific)
These tools allow you to set specific pricing guidelines by targeting certain margins that will help your eCommerce business to remain profitable.
Step 2: Capture More Market Share By Experimenting With Pricing (And Understanding Price Elasticity)
Lots of businesses fall into the trap of thinking if they lower product prices, more people will buy the product and their revenue will increase.
“The problem with the race to the bottom is that you might win. Even worse, you might come in second.” — Seth Godin [*]
Strategically lowering product costs does have benefits, and can lead to increased revenue. For one, it reduces the amount of money being left on the table (consumer surplus) for customers who are willing to buy at various price points.
Put simply, Consumer Surplus is the difference between what the consumer pays and what he would have been willing to pay. [*]
So how do you maximize profits while also capturing more market share?
You need to understand the sales volume of a product at specific price points, and what allows you to remain profitable. In other words, you need to understand price elasticity.
Price Elasticity is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. If the quantity demanded of a product exhibits a large change in response to its price change, it is termed “elastic”. [*]
For a second, imagine you have 100 customers that purchase your product:
After testing pricing, you find customers convert at different rates depending on the price of the product. You also find that sales volume fluctuates with price:
Given this small amount of data, you can now easily calculate how much revenue is generated from each price point. Theoretically, this is a great way to improve upon the “base” product price that you calculated in step one:
But there’s one small problem…
What about the 65 customers that would have purchased at a $5 or $10 price point?
That’s $450 in revenue that you are losing out on. No sane business owner wants to do that, which is why you need a strategy to unlock that untapped gold mine.
There are lots of pricing strategies out there to do this, but my three favorites for profitably lowering prices are discount pricing, loss-leader pricing, and anchor pricing.
Discount pricing is a strategy where items are initially marked up artificially or start at a higher price, but are then offered for sale at what seems to be a reduced cost to the consumer.
An online retail store, such as Macy’s shown above, might offer discount pricing on all of its kitchen items for a limited time to attract new customers and boost sales.
This is a simple way to attract new customers that might not have bought a particular item at a higher price.
The key to ensuring that the discount pricing strategy remains profitable for your business is to keep the profit margins close to $0 or slightly positive. In other words, don’t sell your products at a discount just to get customers in the door, only to find out you’re losing money hand over fist.
Attract customers with discounts, keep your profit margin on discounted items close to $0, and then upsell or cross-sell other items in your store to turn a profit.
That is, unless you want to give loss-leader pricing a shot.
Similar to discount pricing in strategy, loss-leader pricing takes a slightly more risky approach to attracting purchasers.
According to Inc. “Loss-leader pricing is an aggressive pricing strategy in which a store sells selected goods below cost in order to attract customers who will, according to the loss-leader philosophy, make up for the losses on highlighted products with additional purchases of profitable goods.” [*]
Patagonia is a perfect example of loss-leader pricing done right. First, they start with a “Web Specials” page that they promote via email and social media: [*]
In examining their Web Special products, many items are sold at 25-75% below normal retail price:
The key difference with loss-leader pricing vs. standard discount pricing is businesses often know that they will not make a profit on items sold as loss-leaders. And that starts with a deep understanding of your product costs and profit margins.
Using this pricing strategy can help attract large numbers of customers who would otherwise shop elsewhere, and some of them will buy items with a higher profit margin.
There’s a great video of Steve Jobs announcing the iPad price on stage in 2020.
He rhetorically asks the attendees what they should price the iPad at.
“If you listen to the pundits, we’re going to price it at under $1000, which is code for $999,” says Jobs.
$999 appears on the screen before he continues…
“I am thrilled to announce to you that the iPad pricing starts not at $999, but at just $499.”
On the screen, the $999 price is shattered by a falling “$499.”
That’s anchor pricing at its absolute finest.
Anchor Pricing is where you display your “regular” price and then visibly lower the price of that item in stores or online. It works so well because it helps you to create an image in shoppers’ minds that they’re getting an incredible deal.
Little do they know that the regular price was made up in the first place!
Step 3: Make Sure Your Product Pricing Drives Long-Term Business Profit
At this point, you should have some idea of where you’re going to start with pricing your product.
But our work here isn’t done.
To ensure that you maintain long-term product profitability you must analyze your current business metrics, as well as design a plan to constantly experiment moving forward.
Analyzing Your Current Metrics
The pricing strategies covered above offer good guidance on how to price a product.
However, the mix of pricing strategies you implement must result in enough income to cover your overhead expenses, while also leaving you a bit of profit to spark continuous growth.
Overhead expenses that you should consider include:
Staff salary and related costs
Professional fees, licenses, or permits
Shipping supply costs
Website maintenance costs
I recommend calculating your overhead expenses on a monthly basis. That way you’ll have a running and accurate total at all times — allowing you to proactively price your product based on your findings.
If you find you’re operating at a month-over-month net loss, you can quickly make decisions to return to profitability.
Experiment With Pricing
There are many things that directly affect the pricing of a product. That’s why it’s important to not allow your pricing strategy to remain static.
Prices that fluctuate and move with the market will help to increase revenue and decrease consumer surplus.
Here are three great ways you can experiment with your pricing:
1. Raise Your Prices On Best-sellers
We’ve talked about how lowering product prices can lead to a reduction in consumer surplus, well raising your prices can have a similar positive effect.
If one or more of your products is selling at a high volume, experiment with raising its price. This will increase your gross revenue and allow you to make up for any other products that aren’t pulling their weight.
One way to offset the potential negative impacts of raising your prices is to experiment with pairing higher prices with free shipping. This will help to make your customers happy while also increasing your bottom line.
See below for more on “free shipping”.
2. Take Advantage Of Seasonal Discounts Or Promotions
Seasonal sales and promotions are one of the best ways to attract more customers to your website or physical store.
Even something as small as offering “free shipping” can help to increase customers and revenue.
According to First Round Review, Amazon famously drove up its purchase volume by offering free shipping for all orders over $25 (after an increase to $35 and back down to $25 in 2020). Free shipping is an attractive incentive because it appeals to anyone who is getting something mailed to them. [*]
3. Model, Don’t Copy Your Competitors
As with any great business or pricing strategy, looking towards the market (particularly your competitors) is a great way to stay on top of current pricing trends.
Everything from stock market fluctuations and employment rates, to new laws and trends, can affect the price that people are willing to pay for your product.
That’s why it’s important to keep an eye on the market and your competitors.
But remember, you are operating on your terms with your overhead expenses and profit margins. So while it’s great to evaluate how they’re pricing their product, you need to put your business first.
According to PWC’s “2020 Global Consumer Insights Survey,” global retail eCommerce sales will reach $4.878 trillion by 2021. That’s an 18% increase in worldwide eCommerce sales, from $1.845 trillion in 2020 to $4.878 trillion in 2021! [*]
Millions of business are vying for customers’ attention.
One way to gain a competitive advantage in this wild marketplace is to have a product pricing strategy that is dynamic — one that moves with the market, and one that allows your business to remain profitable all at the same time.
The last thing you want is customers leaving your store because you fail to adapt, and update the value of your product.
Use this step-by-step guide constantly throughout the year. Save it to your bookmarks, add it to pocket, do whatever you have to do to keep yourself accountable for ensuring that your product pricing strategy remains competitive.
Текст книги “Английский для экономистов (учебник английского языка)”
Представленный фрагмент произведения размещен по согласованию с распространителем легального контента ООО “ЛитРес” (не более 20% исходного текста). Если вы считаете, что размещение материала нарушает чьи-либо права, то сообщите нам об этом.
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Автор книги: Денис Шевчук
Жанр: Иностранные языки, Наука и Образование
Текущая страница: 13 (всего у книги 19 страниц) [доступный отрывок для чтения: 13 страниц]
5.What are the goals of international banking regulation?
6.What do you know of the activities of the Central Bank of the Republic of Belarus? 7.Comment on the following: “A banker is a man who lends you umbrella when the weather is fair, and takes it away from you when it rains.”
8. Money is more convenient means of exchange, but barter still exists. Why?
9. Find the information about the development of banking industries in England, Germany, France, your country and prepare a 10-15 minute report.
10.“Money is a resource because a person who has money can put it to productive use. The same is true of a nation’s money.” Do you agree?
11.If you possess a large sum of money, what are the pros and cons of the following: -putting it into a sock; – buying a lottery ticket; – taking it to (local) Las Vegas; – putting it in a bank; – buying gold; buying a picture by Van Gogh; – investing in property; – buying shares?
12.What financial barriers might confront people who live in different societies with different monetary systems and who wish to trade with one another? Would it be advantageous if the entire world used a common currency? What do you think are some of the reasons we do not have a world currency?
13.Summarize the information of the unit to be ready to speak on “Money”. The first step to be done is to write the plan of your future report.
14.Choose any question (problem, topic) relating to Banking and make a 10-12 minute report in class. Refer to different additional sources to make your report instructive, interesting and informative.
What the government gives it must first take away.
Finance – management of money
– capital involved in a project
– loan of money for a particular purpose
– money resources of a state, company or person
Finance house (company)
– organization providing finance for hire-purchase agreements.
– accountant whose primary responsibility is the management of the finances of an organization and the preparation of its annual accounts.
– a person who offers financial advice to someone else, especially one who advises on investment.
– organization, usually a merchant bank, which advises the board of a company during a take-over.
– the liquid as opposed to physical assets of a company.
– futures contract in currencies or interest rates.
– an organization that collects funds from individuals, other organizations or government agencies and invest these funds or lends them on to borrowers.
– formal financial document.
– bank, building, society, finance house, insurance, company, investment trust etc. that holds funds borrowed from lenders in order to make loans to borrowers.
– person or organization that sells insurance but is not directly employed by an insurance company.
– any year connected with finance, e.g. a company’s accounting period or a year for which budgets are made up.
– specific period relating to corporation tax.
– ratios between particular groups of the assets or liabilities of an enterprise and corresponding totals of assets or liabilities; or between assets and liabilities and flows like turnover or revenue.
– person who uses his one money to finance a business deal or venture or who makes arrangements for such a deal.
You’ve studied the definitions taken from a dictionary. Refer to some other sources to find more information about the concepts mentioned above.
Ex. 1. Think of the nouns that are most commonly used with these verbs. Give your own sentences with the combinations of words.
to generate, to adopt, to utilize, to perform, to involve, to seek, to provide, to facilitate.
Ex. 2. Give Russian equivalents to the following.
Grant loans, accept deposits, facilitate securities transfers, raising corporate funds, obtain funds, dividend policies, merger and acquisition activities, leasing, the realm of the capital budget, the cash budget, security trading, portfolio managers, stocks, bonds, stock and index options, warrants, financial futures, bank teller, financial analyst, a loan officer, depository institution, mortgage servicing specialist, insurance company, accounts payable staff, treasurer, brokerage house, investment counselor.
Ex. 3. Match the word with its definition.
rate, portfolio, quotation, option, warrant, exchange rate, brokerage, deposit, merger, mortgage, counselor, interest rate.
1. The value of a currency expressed in terms of another currency.
2. Numerical proportion between two sets of things.
3. Charge made for borrowing a sum of money, expressed as a percentage of the total sum loaned.
4. Indication of the price at which a seller might be willing to offer goods for sale.
5. Person giving professional guidance on personal problems.
6. Range of investments held by a person, company, etc.
7. Broker’s fee or commission, which is usually calculated as a percentage of the sum involved in the contract.
8. Combining of two or more commercial organizations into one in order to increase efficiency and to avoid competition.
9. Right in property created as security for loan.
10. Money left with a bank for safe keeping or to earn interest.
11. Finance security that offers the owner the right to subscribe for the ordinary shares of a company at a fixed price.
12. Right to buy or sell a fixed quality of a commodity, currency, or security at a particular date at a particular price.
Ex. 4. Match each word on the left with its opposite on the right hand side.
Ask your partner as many questions as you can using the words above.
Ex. 5. Insert prepositions.
Financial planning process
Financial planning is an important aspect … the firm’s operation and livelihood since it provides road maps … guiding, coordinating and controlling the firm’s actions in order to achieve its objectives. Two key aspects … the financial planning process are cash planning and profit planning. Cash planning involves the preparation of the firm’s cash budget; profit planning is usually done … means of proforma financial statements.
The financial planning process begins … long-run, or strategic, financial plans that in turn guide the formulation of short-run, or operating, plans and budgets. Generally, the short-run plans and budgets implement the firm’s long-run strategic objectives.
Long-run (strategic) financial plans are planned long-term financial actions and the anticipated financial impact of those action. Such plans tend to cover periods ranging … two … 10 years. Long-run financial plans consider proposed fixed-assets outlays, research and development activities, marketing and product developing actions and major sources of financing.
Short-run (operating) financial plans are planned short-term financial actions and the anticipated financial impact … those actions. These plans most often cover a one – to two-year period. Key inputs include the sales forecast and various forms of operating and financial data. Key outputs include a number … operating budgets, the cash budget and proforma financial statements.
Read the text once again and answer the following questions: What are two key aspects of financial planning? What do short-run and long-run plans include?
Ex. 6. Join the halves. Translate the sentences into Russian.
1. Financial markets provide the mechanism for
2. Investment analysis focuses on
3. When a company obtains capital from external sources
4. Equity financing and debt financing provide
5. Working capital refers to
6. Financial management is concerned with
7. Transactions is short-term debt instruments that
8. Major securities traded in the capital market
9. When prices rise,
10. Finance involves
11. More experienced individuals would be eligible for
a. the funds used to keep business working or operating.
b. carrying out the allocation of financial resources.
c. take place in the money market.
d. include bonds and both common and preferred stock.
e. the financing can be either on a short-term or a long-term arrangement.
f. how individuals or portfolio managers select appropriate financial and real assets.
g. important means by which a corporation may obtain its capital.
h. how firms acquire and allocate funds.
i. loan officer, branch manager, or senior analyst.
j. the securing of funds for all phases of business operations.
k. the same goods, cost more in terms of dollars, and the dollar’s value in term of those goods falls.
Ex. 7. Translate the text into Russian in written form.
Financial institutions and markets create the mechanism through which funds flow between savers (fund suppliers) and investors (fund demanders). The level of funds flow between suppliers and demanders can significantly affect economic growth. Growth results from the interaction of variety of economic factors, such as the money supply, trade balances, and economic policies, that affect the cost of money – the interest rate or required return. The level of this rate acts as regulating device that controls the flow of funds between suppliers and demanders. In general, the lower the interest rate, the greater the funds flow and therefore the greater the economic growth and vice versa.
The interest rate or required return represents the cost of money. It is the rent or level of compensation a demander of fund must pay a supplier. When funds are lent, the cost of borrowing the funds is the interest rate. When funds are invested to obtain an ownership (or equity) interest, the cost to the demander is commonly called the required return. In both cases the supplier is compensated for providing either debt or equity funds. Ignoring risk factors, the nominal and actual interest (cost of fund) result from the real rate of interest adjusted for inflationary expectations and liquidly preferences – general preferences of investors for shorter-term securities.
In a perfect world in which there is no inflation and in which funds suppliers and demanders are indifferent to the terms of loans or investment because they have no liquidity preference and all outcomes are certain, at a given point in time there would be one cost of money – the real rate of interest. The real rate of interest creates an equilibrium between the supply of savings and the demand for investment funds.
Ex. 8. Give the Russian equivalents to the following.
Tax, taxation, taxable income, taxation brackets, tax avoidance, tax base, tax burden, tax evasion, tax exemption, tax-free, tax haven, tax holiday, taxman, tax relief, tax return, tax shelter, lump-sum tax, excise tax, heavy tax, payroll tax.
Ex. 9. Match the following expressions with the correct definition.
Ex. 10. What is the English for?
Взимать налог; не платить налоги; облагать налогом; освобождать от налога; платить налоги; подлежать налогооблoжению; снижать налоги; удерживать налоги; уклоняться от уплаты налогов; до вычета налогов; после удержания налогов.
WHAT IS FINANCE?
The field of finance is broad and dynamic. It directly affects the lives of every person and every organization, fi–nancial and non-financial, private or public, large or small, profit -seeking or non-profit. Finance can be defined as the art and science of managing money. All individuals and organizations earn or raise money and spend or invest money. Finance is concerned with the process, institutions, markets, the instruments involved in the transfer of money among and between individuals, businesses and governments.
Finance can be defined at both the aggregate or macro le–vel and the firm or micro level. Finance at the macro level is the study of financial institutions and financial markets and how they operate within the financial systems. Finance at the micro level is the study of financial planning, asset management, and fund raising for business firms and financial institutions.
Finance has its origin in the fields of economics and accounting. Economists use a supply-and-demand framework to explain how the prices and quantities of goods and services are set in a free-enterprise or market-driven economic system.
Accountants provide the record-keeping mechanism for showing ownership of the financial instruments used to facilitate the flow of financial funds between savers and borrowers. Accountants also record revenues, expenses, and profitability of organizations involved in the production and exchange of goods and services.
Large-scale production and a high degree of specialization of labourcan function only if there exists an effective means of paying for productive resources and final products. Business can obtain the money it needs to buy capital goods such as machinery and equipment only if the institutions and markets have been established for making savings available for such investment. Similarly, the federal government and other governmental units can carry out their wide range of activities only if efficient means exist for raising money, for making payments, and for borrowing.
Financial markets, institutions orintermediaries, and business financial management are basic elements of well-developed financial systems. Financial markets provide the mechanism for carrying out the allocation of financial resources or funds from savers to borrowers. Financial institutions such as banks and insurance companies, along with other financial intermediaries, facilitate the flow of funds from savers to borrowers. Business financial management involves the efficient use of financial capital in the production and exchange of goods and services. The goal of the financial manager in a profit-seeking organisation is to maximize the owners’ wealth through effective financial planning and analysis, asset management, and of financial capital. The same financial management functions must be performed by financial managers in not-for-profit organizations, such as governmental units or hospitals, in order to provide the desired level of service at acceptable costs.
1. What is finance?
2. Where does finance have its origin?
3. What are the basic elements of financial system?
One of the primary considerations when going into business is money. Without sufficient funds a company cannot begin ope–rations. The money needed to start and continue operating a busi–ness is known as capital. A new business needs capital not only for ongoing expenses but also for purchasing necessary assets. These assets – inventories, equipment, buildings, and property – represent an investment of capital in the new business.
How this new company obtains and uses money will, in large measures determine its success. The process of managing this acquired capital is known as financial managing/management. In general finance is securing and utilizing capital to start up, operate, and expand a company.
To start up or begin a business, a company needs funds to purchase essential assets, support research and development, and buy materials for production. Capital is also needed for salaries, credit extension to customers, advertising, insurance, and many other day-to-day operations. In addition, financing is essential for growth and expansion of a company, because of competition in the market, capital needs to be invested in developing new product lines and productions techniques and in acquiring assets for future expansion.
In financing business operations and expansion, a business uses both short-term and long-term capital. A company, much like an individual, utilizes short-term capital to pay for items that last relatively short period of time. An individual uses credit cards for buying such things as clothing or food, while a company seeks short-term financing for salaries and office expenses. On the other hand, an individual uses long-term capital such as bank loan to pay for a home or car – goods that will last a long time. Similarly, a company seeks a long-term financing to pay for new assets that are expected to last many years.
When a company obtains capital from external sources the financing can be either on a short-term or a long-term arrangement. Generally, short-term financing must be repaid in less than one year, while long-term can be repaid over a longer period of time.
Finance involves the securing of funds for all phases of business operations. In obtaining and using this capital, the decisions made by managers affect the overall financial success of a company.
Read the text and be ready to speak on:
1. the funds the capital of a business consists of;
2. the classification of capital;
3. the types of financing.
The capital of a business consists of the funds used to start and run the business. The funds may be either the owner’s (equity capital) or creditor’s (debt capital). Equity capital consists of those funds provided to the business by the owner(s). These funds come from the personal savings of the owner. Debt capital consists of borrowed funds that the business owner owes to the lender. With debt capital the entrepreneur doesn’t have to share ownership, but has a legal obligation to repay the borrowed money (principal) plus interest at a future data even if the business does not make profit.
Capital is also classified, depending on it use, as fixed or working. Fixed capital refers to items bought once and used for a long period of time. These items include real estate, fixtures, equipment. With a grocery, for example, the real estate consists of the store itself and the land on which it is built. The fixtures include such objective as counters, refrigerators, shelves. Equipment covers such articles as cutting machines, knives, scales. Working capital refers to the funds used to keep a business working or operating. It pays for merchandise, inventory and operating expenses such as rent, utilities (light and heat), taxes, wages. Cash on hand and accounts receivable are also considered working capital. Therefore, working capital is cash, or anything that can easily and quickly be turned into cash.
Equity financing (obtaining owner funds) can be exemplified by the sale of corporate stock. In this type of transaction, the corporation sells units of ownership known as shares of stock. Each share entitles purchaser to a certain amount of ownership. For example, if someone buys 100 shares of stock from Ford Motor Company, that person has purchased 100 shares worth of Ford resources, material, plants, production and profits. The person who purchases shares of stock is known as a stockholder or shareholder.
All corporations, regardless of their size, receive their starting capital from issuing and selling shares of stock. The initial sales involve some risk on the part of the buyers because corporation has no record of performance. If the corporation is successful, the stockholder may profit through increased valuation of the shares of stock, as well as by receiving dividends. Dividends are proportional amounts of profit usually paid quarterly to stockholders. However, if the corporation is not successful, the stockholder may take losses on the initial stock investment.
Often equity financing does not provide the corporation with enough capital and it must turn to debt financing, or borrowing funds. One example of debts financing is the sale of corporate bonds. In this type of agreement, the corporation borrows money from investor in return for bond. The bond has maturity date, a deadline when the corporation must repay all of the money it has borrowed. The corporation must also make periodic interest payment to the bondholder during the time the money is borrowed. If these obligations are not met, the corporation can be forced to sell its assets in order to make payments to the bondholders.
All businesses need financial support. Equity financing (as in the sale of stock) and debt financing (as in the sale of bonds) provide important means by which a corporation may obtain its capital.
Read the text. Define the main idea of each paragraph. Underline the sentences expressing these ideas.
Financial markets provide a forum in which suppliers of funds and demanders of loans and investments can transact business directly. Whereas the loans and investments of institutions are made without the direct knowledge of the suppliers of funds (savers), suppliers in the financial markets know where their funds are being lent or invested. The two key financial markets are the money market and the capital market. Transactions in short-term debt instruments, or marketable securities, take place in the money market. Long-term securities (bonds and stocks) are traded in the capital market.
The money market is created by a financial relationship between suppliers and demanders of short-term funds, which have maturities of one year or less. The money market exists because certain individuals, businesses, governments and financial institutions have temporarily idle funds that they wish to put in some type of liquid assets or short-term, interest-earning instruments. At the same time, other individuals, businesses, governments and financial institutions find themselves in need of seasonal or temporary financing. The money market thus brings together these suppliers and demanders of short-term liquid funds.
The capital market is a financial relationship created by a number of institutions and arrangements that allows the suppliers and demanders of long-term funds – funds with maturities of more than one year – to make transactions. The backbone of the capital market is formed by the various securities exchanges that provide a forum for debt and equity transactions. Major securities traded in the capital market include bonds and both common and preferred stock.
All securities, whether in the money or capital markets, are initially issued in the primary market. This is the only market in which the corporate or government issuer is directly involved in the transaction and receives direct benefit from the issue – that is, the company actually receives the proceeds from the sale of securities. Once the security begins to trade among individuals, businesses, government or financial institutions, savers and investors, they become part of the secondary market. The primary market is the one in which «new» securities are sold; the secondary market can be viewed as an «issued» or «preowned» securities market.
During the last two decades the Euromarket – which provides for borrowing and lending currencies outside their country of origin – has grown quite rapidly. The Euromarket provides multinational companies with an «external» opportunity to borrow or lend funds with the additional feature of less government regulation.
1. What is a financial market?
2. What are the two key financial markets?
3. In what do they differ?
4. Differentiate between primary and secondary markets.
WHAT ARE DERIVATIVE INSTRUMENTS?
It may sound like a house of cards, but many financial instru–ments in the global economy are based on nothing more than the value of other financial instruments. Today it would be impossible to responsibly manage any significant international investment without an understanding of financial derivatives like options, financial futures, and interest rate swaps. A stock option, which allows an investor to purchase or sell a given stock at a fixed price sometime in the future, is called a derivative because its value is determined by the value of an underlying stock.
A financial future is an agreement to buy a financial instrument – such as a stock or bond – sometime in the future at a fixed price. A stock index future, for example, allows investors to benefit from the rise in a stock index by buying, in a sense, all the shares in the index. Just as a gold future goes up in value when gold’s price rises, a future on the Standard & Poor’s 500 will increase in value when the stock index rises.
The basic idea of a swap is to trade something you have for something you want. A swap is a trade agreement between two or more counterparties, usually banks, to exchange different assets or liabilities such as interest payments. Essentially, it allows both parties to obtain the right assets and cash flows for their own particular needs. In the case of banks, this most often means trading two loans with different interest rates or different foreign currencies. For example, a bank lending money to consumers at a fixed interest rate may be borrowing money at floating or periodically changing interest rates. In order to eliminate the risk of having borrowed and lent money at two different interest rates, the bank enters into an interest rate swap agreement with another institution to exchange one flow of interest rates for another.
1. What is ‘a financial instrument’?
2. What does a stock option allow?
3. What is ‘a financial future’?
4. What is the basic idea of a swap?
inflation A persistent rise in the general level of prices.
disinflation A falling inflation rate.
zero inflation No change in the general level of prices.
hyperinflation A rapidly rising inflation rate, often reaching hundreds of percentage points within a few months.
deflation The opposite of inflation, in which the general level of prices declines.
stagflation A simultaneous increase in both the inflation rate and the unemployment rate.
purchasing power of money The amount of goods and services a unit of money can command in the market.
price index A numerical device used to measure changes in prices.
consumer price index A measure of inflation based on a theoretical market basket of consumer goods.
Everyone is familiar with the way prices of goods and services behave in the mar–ketplace. They usually go up. The phenomenon of rising prices is calledinflation.Since the economy includes multitudes of prices, and all do not rise or fall at the same time, it is convenient to use the concept of an average price and describe inflation as a continuing rise in the level of the average price, or the general price level.
The inflation rate is the rate of change (or the percentage change) in the general price level over a specified time period, usually a year. An increase in the inflation rate means that prices are rising at a faster rate. A decrease in the inflation rate means that prices in general are not rising as quickly as before; it does not mean that prices are falling. The termdisinflation is often used to describe a declining inflation rate. If prices in general do not change, a situa–tion ofzero inflationexists.
Rapidly rising prices may lead to a situation called hyperinflation. Many countries have experienced hyperinflation, some very recently, with inflation rates reaching hundreds of percentage points in a matter of months.
The phenomenon of falling prices is known as deflation. It is the opposite of inflation.
Economies have also experienced a situation known asstagflation. This occurs when a high rate of inflation is accompanied by a high level of unemployment This presents a dilemma for policy makers, as attempts to cure one problem invariably make the other one worse. The cherished goal of every country has been to keep both problems under control to avoid the heavy costs they inflict on people.
Inflation and thepurchasing power of money are inversely related. Inflation causes the purchasing power of money to fall. The purchasing power of money (also known as the value of money) is the amount of goods and services that one unit of money can buy. When prices rise, the same goods cost more in terms of dollars, and the dollar’s value in terms of those goods falls.
Inflation is commonly measured with the aid of aprice index. A price index is a statistical device to measure price changes between a base period and a subse–quent period. Economists use many different price indices. Theconsumer price index (CPI) is the most popular index for tracking inflation in the United States. The CPI measures the average change in the prices paid by urban consumers for a fixed basket of goods and services. The statistics for this index are compiled by the Bureau of Labor Statistics of the U.S. Department of Labor, which publishes them monthly.
1. Sum up the text in 7-10 sentences and present your summary in class. Use the key-words given before the text.
When residents of one country trade with residents of another country, they must generally convert funds between the currencies of the two countries to facilitate payments. Currency conversion requires a rate to define the value of one curren–cy in terms of another currency. This rate is the exchange rate.
Since multinational companies trade in many different foreign markets, that’s why portions of their revenues and costs are based on foreign currencies. Among the currencies regarded as being major (or ‘Hard’) are the British pound, the Swiss franc, the Deutsche mark, the French franc, the Japanese yen, the Canadian dollar and the US dollar. The value of two currencies with respect to each other is foreign exchange rate.
For the major currencies, the existence of a floating relationship means that the value of any two currencies with respect to each other is allowed to fluctuate on a daily basis. On the other hand, many of the nonmajor currencies of the world try to maintain a fixed (or semi-fixed) relationship with the respect to one of the major currencies, or some type of an international foreign exchange standard.
On any given day, the relationship between two of the major currencies will contain two sets of the figures, one reflecting the spot exchange rate (the rate on the date), and the other indicating the forward exchange rate (the rate at some specified future date).
Two widely used systems of quoting exchange rates are known as European terms and American terms of quotation. In European terms, the value of the U.S dollar is expressed in terms of all other currencies. In American terms, the values of all foreign currencies are expressed in terms of U.S. dollars. American terms of quotation are commonly used in many retail currency transactions. In their dealings among themselves, banks use European terms of quotation except for quotes on the British pound, the Irish punt, the Australian dollar, and the New Zealand dollar. These currencies have been traditionally quoted in American terms. The Wall Street Journal reports daily exchange rates in both European terms and American terms.
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10 Ways to Avoid Losing Money in Forex
The global forex market is the largest financial market in the world and the potential to reap profits in the arena entices foreign-exchange traders of all levels: from greenhorns just learning about financial markets to well-seasoned professionals with years of trading experience. Because access to the market is easy—with round-the-clock sessions, significant leverage, and relatively low costs—many forex traders quickly enter the market, but then quickly exit after experiencing losses and setbacks. Here are 10 tips to help aspiring traders avoid losing money and stay in the game in the competitive world of forex trading.
Do Your Homework
Just because forex is easy to get into doesn’t mean due diligence should be avoided. Learning about forex is integral to a trader’s success. While the majority of trading knowledge comes from live trading and experience, a trader should learn everything about the forex markets, including the geopolitical and economic factors that affect a trader’s preferred currencies.
- In order to avoid losing money in foreign exchange, do your homework and look for a reputable broker.
- Use a practice account before you go live and be sure to keep analysis techniques to a minimum in order for them to be effective.
- It’s important to use proper money management techniques and to start small when you go live.
- Control the amount of leverage and keep a trading journal.
- Be sure to understand the tax implications and treat your trading as a business.
Homework is an ongoing effort as traders need to be prepared to adapt to changing market conditions, regulations, and world events. Part of this research process involves developing a trading plan—a systematic method for screening and evaluating investments, determining the amount of risk that is or should be taken, and formulating short-term and long-term investment objectives.
How Do You Make Money Trading Money?
Find a Reputable Broker
The forex industry has much less oversight than other markets, so it is possible to end up doing business with a less-than-reputable forex broker. Due to concerns about the safety of deposits and the overall integrity of a broker, forex traders should only open an account with a firm that is a member of the National Futures Association (NFA) and is registered with the U.S. Commodity Futures Trading Commission (CFTC) as a futures commission merchant. Each country outside the United States has its own regulatory body with which legitimate forex brokers should be registered.
Traders should also research each broker’s account offerings, including leverage amounts, commissions and spreads, initial deposits, and account funding and withdrawal policies. A helpful customer service representative should have the information and will be able to answer any questions regarding the firm’s services and policies.
Use a Practice Account
Nearly all trading platforms come with a practice account, sometimes called a simulated account or demo account, which allow traders to place hypothetical trades without a funded account. Perhaps the most important benefit of a practice account is that it allows a trader to become adept at order-entry techniques.
Few things are as damaging to a trading account (and a trader’s confidence) as pushing the wrong button when opening or exiting a position. It is not uncommon, for example, for a new trader to accidentally add to a losing position instead of closing the trade. Multiple errors in order entry can lead to large, unprotected losing trades. Aside from the devastating financial implications, making trading mistakes is incredibly stressful. Practice makes perfect: Experiment with order entries before placing real money on the line.
The average daily amount of trading in the global forex market.
Keep Charts Clean
Once a forex trader opens an account, it may be tempting to take advantage of all the technical analysis tools offered by the trading platform. While many of these indicators are well-suited to the forex markets, it is important to remember to keep analysis techniques to a minimum in order for them to be effective. Using multiples of the same types of indicators, such as two volatility indicators or two oscillators, for example, can become redundant and can even give opposing signals. This should be avoided.
Any analysis technique that is not regularly used to enhance trading performance should be removed from the chart. In addition to the tools that are applied to the chart, pay attention to the overall look of the workspace. The chosen colors, fonts, and types of price bars (line, candle bar, range bar, etc.) should create an easy-to-read-and-interpret chart, allowing the trader to respond more effectively to changing market conditions.
Protect Your Trading Account
While there is much focus on making money in forex trading, it is important to learn how to avoid losing money. Proper money management techniques are an integral part of the process. Many veteran traders would agree that one can enter a position at any price and still make money—it’s how one gets out of the trade that matters.
Part of this is knowing when to accept your losses and move on. Always using a protective stop loss—a strategy designed to protect existing gains or thwart further losses by means of a stop-loss order or limit order—is an effective way to make sure that losses remain reasonable. Traders can also consider using a maximum daily loss amount beyond which all positions would be closed and no new trades initiated until the next trading session.
While traders should have plans to limit losses, it is equally essential to protect profits. Money management techniques such as utilizing trailing stops (a stop order that can be set at a defined percentage away from a security’s current market price) can help preserve winnings while still giving a trade room to grow.
Start Small When Going Live
Once a trader has done their homework, spent time with a practice account, and has a trading plan in place, it may be time to go live—that is, start trading with real money at stake. No amount of practice trading can exactly simulate real trading. As such, it is vital to start small when going live.
Factors like emotions and slippage (the difference between the expected price of a trade and the price at which the trade is actually executed) cannot be fully understood and accounted for until trading live. Additionally, a trading plan that performed like a champ in backtesting results or practice trading could, in reality, fail miserably when applied to a live market. By starting small, a trader can evaluate their trading plan and emotions, and gain more practice in executing precise order entries—without risking the entire trading account in the process.
Use Reasonable Leverage
Forex trading is unique in the amount of leverage that is afforded to its participants. One reason forex appeals to active traders is the opportunity to make potentially large profits with a very small investment—sometimes as little as $50. Properly used, leverage does provide the potential for growth. But leverage can just as easily amplify losses.
A trader can control the amount of leverage used by basing position size on the account balance. For example, if a trader has $10,000 in a forex account, a $100,000 position (one standard lot) would utilize 10:1 leverage. While the trader could open a much larger position if they were to maximize leverage, a smaller position will limit risk.
Keep Good Records
A trading journal is an effective way to learn from both losses and successes in forex trading. Keeping a record of trading activity containing dates, instruments, profits, losses, and, perhaps most important, the trader’s own performance and emotions can be incredibly beneficial to growing as a successful trader. When periodically reviewed, a trading journal provides important feedback that makes learning possible. Einstein once said that “insanity is doing the same thing over and over and expecting different results.” Without a trading journal and good record keeping, traders are likely to continue making the same mistakes, minimizing their chances of becoming profitable and successful traders.
Know Tax Impact and Treatment
It is important to understand the tax implications and treatment of forex trading activity in order to be prepared at tax time. Consulting with a qualified accountant or tax specialist can help avoid any surprises and can help individuals take advantage of various tax laws, such as marked-to-market accounting (recording the value of an asset to reflect its current market levels).
Since tax laws change regularly, it is prudent to develop a relationship with a trusted and reliable professional who can guide and manage all tax-related matters.
Treat Trading as a Business
It is essential to treat forex trading as a business and to remember that individual wins and losses don’t matter in the short run. It is how the trading business performs over time that is important. As such, traders should try to avoid becoming overly emotional about either wins or losses, and treat each as just another day at the office.
As with any business, forex trading incurs expenses, losses, taxes, risk, and uncertainty. Also, just as small businesses rarely become successful overnight, neither do most forex traders. Planning, setting realistic goals, staying organized, and learning from both successes and failures will help ensure a long, successful career as a forex trader.
The Bottom Line
The worldwide forex market is attractive to many traders because of the low account requirements, round-the-clock trading, and access to high amounts of leverage. When approached as a business, forex trading can be profitable and rewarding, but reaching a level of success is extremely challenging and can take a long time. Traders can improve their odds by taking steps to avoid losses: doing research, not over-leveraging positions, using sound money management techniques, and approaching forex trading as a business.
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