Bonds are NOT Stocks!

     I recently asked my friend what he thought about bonds. He responded by saying, "I don't know what they are. Do you mean, like, a stock?" This prompted today's post- the true meaning of a bond. A bond is used when an investor loans money to an institution. The institution can then use that invested money for a certain period of time. The bond also states the interest (also known as a coupon) that needs to be paid on the returned money. Here is a more simple explanation:

If I want to purchase an iPad, but I do not have enough money, I can sell my "debt" to my friends. Let's say the bonds are worth $10 with a certain coupon attached to them. I will garner enough money from my friends to buy the iPad, but I will have to pay back the revenue generated from the interest rate. This is how my friends would make money off of the bonds.

There are many different types of bonds. US Treasuries are considered the most secure and stable because of the full faith in the credit of the United States government.
Treasury bills have extremely short maturities of 13 weeks, 26 weeks, or one year. These are bought at a discount to face value ($10,000) and the investor receives the full $10,000 maturity.
Treasury notes mature in 2 to 10 years. Depending upon the maturity, the investment is either $1,000 or $5,000.
Treasury bonds mature in 10 years and are distributed in denominations of $1000.
Zero-coupon bonds are sold at a very high discount and mature anywhere within 6 months to 30 years. Profits from interest rates are not received until the bond matures, but the investor still has to pay taxes on the interest rate profits that would be received normally.
Corporate bonds are much more risky than Treasury-backed securities because they depend on the profitability of the company, which is volatile and likely to change. Higher quality corporations are known as "investment-grade" bonds; they are less risky investments. Corporations with low credit are known as "high-yield" or "junk" bonds- these are very risks, but also very profitable.
Municipal bonds rarely interfere with taxes. While holding municipal bonds, the investor does not have to pay taxes on the money from interest rates to the federal government. Usually, if the muni is bought from a state or local government, taxes do not have to be paid to these governments either.

     Somebody can make money from investing in bonds by examining a bond's yield. The current, or running, yield can be determined by dividing the annual interest payment by the current cost of the bond in a market. The yield to maturity is a more accurate measure of profits from bonds. It takes into account not only the cost of the bond in the current market, but also the remaining coupons until maturity.


These are the basics on bonds. No, they are not stocks!

Fiscal Policy vs. Monetary Policy

     Fiscal and monetary policy are often used interchangeably; however, there are slight differences between the two.  Both fiscal and monetary policy can influence the economy, but they are implemented by different actors.  Monetary policy is implemented and altered by a central bank, whereas fiscal policy is implemented and altered by the government.  

     Monetary policy usually focuses on influencing the growth rate within a country.  Stimulative monetary policy should increase a country's growth rate.  Restrictive monetary policy slows down an economy to counterbalance inflationary factors.  In order to change monetary policy, the central bank can look towards interest rates or the amount of money in bank reserves.  The central bank in the United States is the Federal Reserve.  Once again, the chairwoman being the one and only Janet Yellen! (pictured below) 

Janet Yellen (chairwoman of the Federal Reserve)

The goal of monetary policy is to create maximum employment, which Janet Yellen has identified as one of her main goals as head of the Fed.  Monetary policy also works for instituting long-term moderate interest rates and stable prices.  The Federal Reserve uses three different methods of monetary policy.  These are 1) open market operations, 2) the discount rate, and 3) reserve requirements. Open market operations deal with the Fed buying and selling financial instruments, such as securities or enterprises.  When the Fed wants to increase the bank reserves, it buys securities and puts the deposit in the banks the Fed deals with.  When the Fed wants to decrease reserves, it sells those securities and takes out the deposit from the banks.  The discount rate is the interest rate banks use for short-term loans.  Reserve requirements are the amounts of deposits banks have to retain in reserves or with the Fed.

     Fiscal policy is how a government adjusts taxes and spending levels in order to make an effect on the economy.  Adam Smith introduced the idea of laissez-faire economics, in which the government plays a "hands-off" role in dealing with the economy.  However, after the Great Depression, the government began to play an increased role in our nation's economic status.  John Maynard Keynes engendered the idea of fiscal policy, which now follows Keynesian economics.  Keynesian economics explains that governments can play an active role by altering spending levels and tax rates.  Like anything else in life, a balance is necessary.  A common fiscal policy idea is decreasing taxes, which in turns puts more spending money into the economy.  By also increasing government spending, new businesses can arise, which can reduce unemployment levels.   
Shout out to Zachariah Chou for the request! #makingdollarsandsense 

Three of the Three Letter Acronyms

     Often, when reading a report on any country's economy, three letter acronyms are supposed to mean something.  However, if you do not know what the acronyms stand for, or even what they mean in totality, then the report is opaque- to say the least.  Therefore, today I will demystify THREE of the infamous THREE letter acronyms, as requested by Joshua Elkin!

     GDP- GDP is one of the most common acronyms used to analyze a country's financial standing.  GDP stands for Gross Domestic Product.  GDP can be measured in three ways, which all lead to the same result. It is measured by taking into account the market value of all goods produced within a certain country within a certain period of time (usually a year); it is equal to the accumulation of all profits after various stages of production, adding taxes but subtracting subsidies; and it is also equal to the sum of income generated from production.  The United States' GDP is currently around $16.24 trillion.  This type of GDP is the most common, and known as nominal GDP; however, there is also constant or real GDP, which adjusts for price changes.

     GNP- GNP is also very common; GNP stands for Gross National Product.  Gross National Product adds net income, but subtracts total payment outflow to foreign assets.  GNP is measured by considering the price of all production and services within a country, as well as production and services controlled by the country but on foreign lands.  The difference between GDP and GNP is where the money being counted comes from.  GDP takes into account any profits made inside the country's borders- regardless of the nationality of the worker.  GNP takes into account profits made from any resident of the country, regardless of where he or she lives. 

     PPP- PPP, or purchasing power parity, is used to determine the worth of a specific currency.  It is based on the concept of the law of one price, or how much everything in the world would cost if we used one currency.  This is useful in establishing an appropriate currency exchange rate between two countries.  Usually, the actual exchange rates do end up following the PPP exchange rates, so it helps to know possible future exchange rates. A really interesting example of how some people consider the differences in currencies is the Big Mac Index. The Big Mac Index compares the price around the world of- you guessed it- Big Macs!  Personally, I find this to be hilarious.  You are examining currencies based on the price of a cheeseburger!!! Unfortunately, the Big Mac Index is faulty when a country has to lower the price of the cheeseburger in order to increase competitiveness.  Oh well, it is still pretty awesome.  Anyways, back to PPP as a whole, PPP is difficult to measure because of the popularity of certain goods.  For example, the United States consumes an excess of bread (thanks, carbohydrate lovers)  whereas China consumes more rice.  This is not just a stereotype; it is factually correct.  Therefore, PPP would have to take into consideration these differences in demand.  PPP relates to GDP because GDP is usually measured with the global currency- the dollar.  If the PPP of the Japanese yen is reduced by 1/4th compared to the dollar, then the GDP of Japan will also be reduced by 1/4th.  This does not make Japan any worse off- it still has the same amount of money- it is just measured differently.

     All in all, GDP, GNP, and PPP are common terms.  Thanks for the request, Josh Elkin! Any other requests are welcomed in the comments section! #makingdollarsandsense