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what are the different types of equity financing | companies use two primary methods to obtain equity financing the private placement of stock with investors or venture capital firms and public stock offerings it is more common for young companies and startups to choose private placement because it is more straightforward | |
is equity financing better than debt | the most important benefit of equity financing is that the money does not need to be repaid however the cost of equity is often higher than the cost of debt the bottom linecompanies often require outside investment to maintain their operations and invest in future growth any smart business strategy will include a consideration of the balance of debt and equity financing that is the most cost effective equity financing can come from various sources regardless of the source the greatest advantage of equity financing is that it carries no repayment obligation and provides extra capital that a company can use to expand its operations | |
what is an equity fund | an equity fund is a type of investment fund that pools money from investors to trade primarily a portfolio of stocks also known as equity securities fund managers aim to generate returns for the fund s investors because of their focus on stocks equity funds are also known as stock funds equity funds offer investors a professionally managed diversified approach to investing in stocks with the potential for attractive long term returns while investing in stocks carries more risk than some other investments a fund can diversify with stocks from many different companies thus offering some protection from the risk of one or more of the stocks underperforming their growth potential attracts investors with longer time horizons who can weather short term market changes with the patience to see higher returns over the long run equity mutual and exchange traded funds etfs are often categorized according to company size the type of companies whose stock is held and how actively they are managed types of equity fundsequity funds each have their own investment strategy and management style two primary categories of equity funds are actively managed funds and passive funds the choice between active and passive funds depends on your goals risk tolerance and investment philosophy some investors prefer the potential for outperformance offered by actively managed funds while others want lower costs and market matching returns of passive funds some funds offer a mix of the two to balance risk and potential returns historically passive funds have outperformed active funds on average after accounting for fees transaction costs and taxes 2market capitalization or market cap is the total market value of a company s outstanding shares equity funds are often categorized based on the size of the companies they invest in 3 companies with different sizes tend to have distinct characteristics and risk return profiles equity funds are also classified based on their investment strategy with two main categories being growth funds and value funds blend equity funds invest in a mix of both growth and value stocks aiming to provide investors with a balance between the two investment strategies equity funds are categorized based on their focus on specific sectors or geographic regions benefits and risks of investing in equity fundsinvesting in equity funds offers several potential benefits to investors including the opportunity for attractive returns diversification and professional management however it s essential to understand the risks associated with equity fund investing to make informed decisions and align investments with individual financial goals and risk tolerance historically stocks have given investors the potential for higher returns than other asset classes such as bonds and cash from 1928 through 2023 the s p 500 a broad measure of u s stock market performance delivered an average annual total return of about 11 67 compared with 6 95 for investment grade corporate bonds 6 below we provide a chart and table for rates of real returns over time for the s p 500 versus 10 year treasurys real estate investment grade corporate bonds and gold while there have been at times steep drops in equities it s typically ahead for more years than these other assets their long term growth potential makes equity funds attractive to those wanting to build wealth over time investopediaa major benefit of investing in equity funds is diversification a risk management strategy that involves spreading investments across a range of assets this helps minimize the impact of any single investment s performance on the overall portfolio by investing in various stocks across different industries and sectors equity funds help mitigate the risks of investing in individual stocks for example if you hold a single stock that experiences a significant decline in value your entire investment is at risk however if you hold an equity fund that includes that same stock with many others the impact of its decline on the overall fund performance is reduced it s important to note that historical returns are not guaranteed and past performance does not necessarily predict future results the stock market experiences short term fluctuations and periods of volatility which can impact the performance of equity funds in addition individual equity funds may perform differently than the broader market while equity funds offer prospects for attractive returns they also come with risks to consider the main one with equity funds is market risk which is that economic downturns geopolitical events or changes in investor sentiment can cause prices to decline during market turbulence equity fund prices can fluctuate significantly potentially leading to short term losses for investors you can manage this risk by maintaining a long term investment perspective regularly reviewing and rebalancing your portfolio as circumstances change and ensuring that your equity fund investments align with your risk tolerance and financial goals it s also essential to conduct thorough research and due diligence when selecting equity funds while considering the fund s investment strategy management team historical performance and fees management fees and loads commissions can eat into your returns over time higher expected returns over the long rundiversificationprofessional managementhigher volatility and risk of loss than bonds or cashactive funds can have high management feesequity funds generate returns through capital gains and dividends which are taxed differently short term capital gains resulting from the sale of securities held for one year or less are taxed at your ordinary income tax rate while long term capital gains from securities held for more than one year are taxed at a lower rate dividends can be qualified or non qualified with qualified dividends taxed at the lower long term capital gains rate and non qualified dividends taxed at the ordinary income tax rate 7you can employ several strategies to minimize the tax impact of your fund investments one is to hold equity funds in tax advantaged retirement accounts such as 401 k plans or individual retirement accounts which offer tax benefits like tax deferred growth or tax free withdrawals another is to invest in more tax efficient fund structures such as index funds or etfs which typically have lower turnover and generate fewer capital gains distributions consult with a tax professional or financial advisor for a personalized tax strategy that aligns with your financial goals and investment portfolio | |
how to invest in equity funds | investing in equity funds is straightforward but it requires careful consideration and research to select the right funds for your financial goals and risk tolerance the first step is determining your investment goals risk tolerance and time horizon your investment objectives should align with your financial goals such as saving for retirement funding a child s education or building long term wealth 8 risk tolerance refers to your ability and willingness to withstand market volatility and potential losses in pursuit of higher returns time horizon is the length of time you plan to hold your investments before needing to access the funds once you understand these factors you can narrow down your equity fund choices consider the different types of equity funds available such as actively managed passive index or sector specific funds and determine which best aligns with your goals and risk profile for instance a young professional with several decades before retirement might want a higher risk growth fund with active management while someone nearing retirement might want a more conservative value fund or broad based index fund conducting thorough research and analysis is always important for making informed investment decisions start by reviewing the fund s prospectus a legal document providing detailed information about the fund s investment objectives strategies risks and fees the prospectus can typically be found on the fund company s website or through financial news and research platforms in addition to the prospectus review the fund s annual and quarterly reports which provide updates on the fund s performance holdings and market commentary these reports offer valuable insights into the fund s management style and decision making process review financial news and research platforms like morningstar yahoo finance and investopedia to find fund performance data analyst ratings and comparisons to peer funds pay attention to key metrics such as the fund s returns over various periods volatility measures such as standard deviation or beta and risk adjusted returns consider the fund s expense ratio which is the annual fee charged by the fund expressed as a percentage of assets under management higher expense ratios can significantly impact long term returns so comparing a fund s fees to those in the same category is essential 9most brokerages have mutual fund screeners that help you narrow down the thousands of fund options available based on your criteria once you have selected an equity fund or funds to invest in the next step is to open an investment account you can typically open an account directly with the fund company or through a brokerage firm that offers access to a wide range of funds from multiple providers mutual fund trades are executed once a day at the close of trading priced at the fund s net asset value or nav | |
how do equity funds provide diversification | equity funds provide diversification by investing in a wide range of stocks across different sectors and industries by spreading investments among companies funds reduce the impact of any single stock s poor performance on the overall portfolio this diversification reduces the unsystematic risk associated with investing in individual stocks as the success or failure of one company has a limited effect on the fund as a whole | |
how can i choose an equity fund that aligns with my investment goals | to choose the right equity fund for your investment goals assess your risk tolerance time horizon and financial goals for example suppose you are a young investor with a long time horizon and a high risk tolerance in that case you may consider investing in an actively managed small cap growth fund that seeks to capitalize on the potential of emerging companies meanwhile if you are nearing retirement and prioritize income generation and capital preservation a large cap value fund focusing on mature dividend paying companies may be more appropriate look for funds with a proven track record experienced management teams and investment philosophies that align with your own for example if you value socially responsible investing you may want equity funds that incorporate esg criteria into their choice of investments | |
what was the first equity fund and does it still exist | the first modern equity fund was the massachusetts investors trust established in boston in 1924 by edward g leffler and ashton l carr 10 the fund was designed to allow smaller individual investors to pool resources and invest in diversified portfolio of stocks which was previously only available to wealthy individuals or institutions the massachusetts investors trust still exists and operates under the name mfs massachusetts investors trust and is managed by mfs investment management | |
what is the world s largest equity fund | as of the second quarter of 2024 the largest equity fund also the largest mutual fund is the vanguard total stock market index fund admiral shares vtsax this mutual fund tracks the performance of the entire u s stock market providing investors with broad exposure to large cap mid cap and small cap stocks as of april 2024 the fund held more than 1 5 trillion in assets under management 11the bottom lineequity funds offer a convenient way to gain exposure to a diversified portfolio of stocks with the potential for higher returns than bonds or cash investors can choose between actively managed and passive funds funds that invest in a range of company sizes growth vs value orientation and sector or geographic specific funds however investing in equity funds also carries risks primarily because of the stock market s higher volatility before investing in equity funds it s essential to consider your investment objectives risk tolerance and tax situation as with any potential investment consult with a financial advisor to help determine how equity funds may fit within your overall financial strategy and always conduct thorough research before making any investment decisions | |
what is an equity linked note eln | an equity linked note eln is an investment product that combines a fixed income investment with additional potential returns that are tied to the performance of equities equity linked notes are usually structured to return the initial investment with a variable interest portion that depends on the performance of the linked equity elns can be structured in many different ways but the vanilla version works like a strip bond combined with a call option on a specific security a basket of securities or an index like the s p 500 or djia in the case of a note linked to an equity index the security would typically be called an equity index linked note understanding equity linked notesequity linked notes provide a way for investors to protect their capital while also getting the potential for an above average return compared to regular bonds in theory the upside potential for returns in an equity linked note is unlimited whereas the downside risk is capped even in the worst case scenario most equity linked notes offer full principal protection that is what makes this type of a structured product appealing to risk averse investors who nevertheless have a bullish outlook on the market that said equity linked notes only pay on maturity so there is an opportunity cost for locking in that money if only the principal is returned in the end | |
how eln work | in the simplest form a 1 000 5 year equity linked note could be structured to use 800 of the fund to buy a 5 year strip bond with a 4 5 yield to maturity and then invest and reinvest the other 200 in call options for the s p 500 over the 5 year life of the note there is a chance that the options will expire worthless in which case the investor gets back the 1 000 initially put in if however the options appreciate in value with the s p 500 those returns are added to the 1 000 that will eventually be returned to the investor equity linked note caps participation rates and leveragein practice an equity linked note will have a participation rate which is the percentage amount that the investor in the note participates in the appreciation of the underlying equity 1 if the participation rate is 100 then a 5 increase in the underlying is a 5 increase for the eventual payout on the note however the cost of structuring the eln and managing it can lower the participation rate in the case of a 75 participation rate for example a 5 appreciation in the underlying is only worth 3 75 to the investor equity linked notes can also use different structures and features some will use an averaging formula to smooth out returns on the equity linked portion or a periodic cap that limits the eln s upside by realizing returns at a particular level on a regular basis there are also types of equity linked notes that use dynamic hedging instead of options deploying leverage to increase returns from the underlying equity overall equity linked notes can be a powerful tool for investors who want to protect their principle while still having the potential upside of an equity investment | |
what is an equity linked security elks | equity linked securities resemble both stocks and bonds so although they may be debt securities equity linked securities provide returns that are tied to some form of underlying equity hence the name this equity is normally a common stock this means the returns are linked to the upward and downward movements of the underlying stock elks normally mature within a one year period the yield they pay is normally higher than that of the underlying security they also make two payouts or distributions to investors before they mature which is why investors prefer these kinds of investments equity linked securities normally mature within one year understanding equity linked security elks an equity linked security offering provides corporations with an alternative way to structure interest payments to investors an issuer can base security interest payments on a range of equity market products including a stock a group of stocks or an equity index they may also cap or pay a specified portion of the benchmark s return a standard equity linked security structured as a bond would offer variable interest payments tied to an equity benchmark and the return of principal at maturity elks offer a controlled interest rate product for the issuer types of equity linked securitiesinvestors may be offered the opportunity to invest in elks from a few different issuers they may also find elks advertised as market linked the following are a few kinds of elks that are available on the market corporations typically work with investment banks for support to structure equity linked security offerings for capital financing the royal bank of canada rbc is a leading source of structured finance equity linked securities rbc works with companies to structure equity linked security offerings with various types of provisions retail investors may see equity linked security offerings from a bank alongside certificates of deposit an equity linked security can be any type of investment with interest payments tied to an equity benchmark us bank advertises equity linked cds as one component of their market linked cd offering the interest on the cds is linked to an equity index the minimum investment is 4 000 securities with payments linked to a market benchmark are offered across the investment industry a market linked security can have payments linked to any type of market benchmark an issuer could structure a market linked security to make payments based on an equity benchmark they can also use any other market benchmark such as gold or currency for the security issuer market linked products offer the opportunity to control the payment to the investor by choosing a specified benchmark for investors they can offer an easy alternative to investing in the benchmark itself an investor in a gold linked cd would generally seek to earn the same rate of return as gold issuers can structure market linked products in numerous ways market linked products are also known to be illiquid and not tradable or redeemable without penalty during the duration of the investment 1 | |
what are examples of equity linked securities | some examples of elks are corporate elks bank offered elks and market linked securities offered through certificates of deposit or other instruments that represent a basket of securities | |
how does an equity linked note eln work | elns are purchased at a strike price which is a discount to the spot price the eln issuer delivers the stock to the investor when or if the strike price is reached | |
are equity linked notes equity securities | equity linked notes pay returns linked to the performance of the underlying security while equity linked securities pay a fixed interest rate | |
what is an equity market | an equity market is a market in which shares of companies are issued and traded either through exchanges or over the counter markets also known as the stock market it is one of the most vital areas of a market economy it gives companies access to capital to grow their business and investors a piece of ownership in a company with the potential to realize gains in their investment based on the company s future performance understanding an equity marketequity markets are the meeting point for buyers and sellers of stocks the securities traded in the equity market can either be public stocks which are those listed on the stock exchange or privately traded stocks often private stocks are traded through dealers which is the definition of an over the counter market | |
when companies are born they are private companies and after a certain time they go through an initial public offering ipo which is a process that turns them into public companies traded on a stock exchange private stocks operate slightly differently as they are only offered to employees and certain investors | some of the largest equity markets or stock markets in the world are the new york stock exchange nasdaq tokyo stock exchange shanghai stock exchange and euronext europe companies list their stocks on an exchange as a way to obtain capital to grow their business an equity market is a form of equity financing in which a company gives up a certain percentage of ownership in exchange for capital that capital is then used for a variety of business needs equity financing is the opposite of debt financing which utilizes loans and other forms of borrowing to obtain capital trading in an equity marketin the equity market investors bid for stocks by offering a certain price and sellers ask for a specific price when these two prices match a sale occurs often there are many investors bidding on the same stock when this occurs the first investor to place the bid is the first to get the stock when a buyer will pay any price for the stock they are buying at market value similarly when a seller will take any price for the stock they are selling at market value | |
when a company offers its stock on the market it means the company is publicly traded and each stock represents a piece of ownership this appeals to investors and when a company does well its investors are rewarded as the value of their stocks rise | the risk comes when a company is not doing well and its stock value may fall stocks can be bought and sold easily and quickly and the activity surrounding a certain stock impacts its value for example when there is a high demand to invest in the company the price of the stock tends to rise and when many investors want to sell their stocks the value goes down stock exchangesstock exchanges can be either physical places or virtual gathering spots nasdaq is an example of a virtual trading post in which stocks are traded electronically through a network of computers electronic trading posts are becoming more common and a preferred method of trading over physical exchanges the new york stock exchange nyse on wall street is a famous example of a physical stock exchange however there is also the option to trade in online exchanges from that location so it is technically a hybrid market most large companies have stocks that are listed on multiple stock exchanges throughout the world however companies with stocks in the equity market range from large scale to small and traders range from big companies to individual investors most buyers and sellers tend to prefer trading at larger exchanges where there are more options and opportunities than at smaller exchanges however in recent years there has been an uptick in the number of exchanges through third party markets which bypass the commission of a stock exchange but pose a greater risk of adverse selection and don t guarantee the payment or delivery of the stock in a physical exchange orders are made in open outcry format which is reminiscent of depictions of wall street in the movies traders shout and display hand signals across the floor in order to place trades physical exchanges are made on the trading floor and filter through a floor broker who finds the trading post specialist for that stock to put through the order physical exchanges are still very much human environments although there are a lot of functions performed by computers brokers are paid commissions on the stocks they work this form of trading has become rare and replaced by electronic communication | |
what is the equity method | the equity method is an accounting technique used by a company to record the profits earned through its investment in another company with the equity method of accounting the investor company reports the revenue earned by the other company on its income statement this amount is proportional to the percentage of its equity investment in the other company paige mclaughlin investopediaunderstanding the equity methodthe equity method is the standard technique used when one company the investor has a significant influence over another company the investee when a company holds approximately 20 or more of a company s stock it is considered to have significant influence 1significant influence means that the investor company can impact the value of the investee company which in turn benefits the investor as a result the change in value of that investment must be reported on the investor s income statement companies with less than 20 interest in another company may also hold significant influence in which case they also need to use the equity method significant influence is defined as an ability to exert power over another company this power includes representation on the board of directors involvement in policy development and the interchanging of managerial personnel 2owning 20 or more of the shares in a company doesn t automatically mean that the investor exerts significant influence operating agreements ongoing litigation or the presence of other majority stockholders may indicate that the investor doesn t exert significant influence and that the equity method accounting is inappropriate 3recording revenue and asset changes under the equity methodthe equity method acknowledges the substantive economic relationship between two entities the investor records their share of the investee s earnings as revenue from investment on the income statement for example if a firm owns 25 of a company with a 1 million net income the firm reports earnings from its investment of 250 000 under the equity method | |
when the investor has a significant influence over the operating and financial results of the investee this can directly affect the value of the investor s investment the investor records their initial investment in the second company s stock as an asset at historical cost under the equity method the investment s value is periodically adjusted to reflect the changes in value due to the investor s share in the company s income or losses adjustments are also made when dividends are paid out to shareholders | using the equity method a company reports the carrying value of its investment independent of any fair value change in the market with a significant influence over another company s operating and financial policies the investor is basing their investment value on changes in the value of that company s net assets from operating and financial activities and the resulting performances including earnings and losses for example when the investee company reports a net loss the investor company records its share of the loss as loss on investment on the income statement which also decreases the carrying value of the investment on the balance sheet | |
when the investee company pays a cash dividend the value of its net assets decreases using the equity method the investor company receiving the dividend records an increase to its cash balance but reports a decrease in the carrying value of its investment other financial activities that affect the value of the investee s net assets should have the same impact on the value of the investor s share of investment the equity method ensures proper reporting on the business situations for the investor and the investee given the substantive economic relationship they have | example of the equity methodfor example assume abc co purchases 25 of xyz corp for 200 000 at the end of year one xyz corp reports a net income of 50 000 and pays 10 000 in dividends to its shareholders at the time of purchase abc co records a debit of 200 000 to investment in xyz corp an asset account and a credit in the same amount to cash at the end of the year abc co records a debit of 12 500 25 of xyz s 50 000 net income to investment in xyz corp and a credit in the same amount to investment revenue in addition abc co records a debit of 2 500 25 of xyz s 10 000 dividends to cash and a credit in the same amount to investment in xyz corp the debit to the investment increases the asset value while the credit to the investment decreases it the new balance in the investment in xyz corp account is 210 000 the 12 500 investment revenue figure will appear on abc s income statement and the new 210 000 balance in the investment account will appear on abc s balance sheet the net 197 500 cash paid out during the year 200 000 purchase 2 500 dividend received will appear in the cash flow from used in investing activities section of the cash flow statement alternative methods | |
when an investor company exercises full control generally over 50 ownership over the investee company it must record its investment in the subsidiary using a consolidation method all revenue expenses assets and liabilities of the subsidiary would be included in the parent company s financial statements | on the other hand when an investor does not exercise full control or have significant influence over the investee they would need to record their investment using the cost method in this situation the investment is recorded on the balance sheet at its historical cost | |
is an investment in another company the same as an acquisition | one company can invest in another at any amount and it is not always considered an acquisition it is considered an acquisition if a company buys most or all of another company s shares 50 or more because the investor has effectively gained control of the investment company however an investor company can still exert significant influence even if it owns less than 50 of the investee s shares | |
what is the difference between the equity method and the cost method | under the equity method of accounting dividends are treated as a return on investment they reduce the value of the investor s shares the cost method of accounting however treats dividends as taxable income | |
what are the advantages of using the equity method | using the equity method of accounting provides a more complete and accurate picture of the economic interest that one company the investor has in another the investee this allows for more complete and consistent financial reports over time and gives a more accurate picture of how the investee s finances can impact the investor s the bottom line | |
when one company holds a significant investment in another usually 20 or more the investor company must use the equity method of accounting to report that investment on its income statement this is done because holding significant shares in a company gives an investor company some degree of influence over the company s profit performance and decisions as a result any profit or loss from the investment is recorded as profit or loss to the company itself | the investment is first recorded at its historical cost then adjusted based on the percent ownership that the investor has in net income loss and any dividend payments net income increases the value on the investor s income statement while both loss and dividend payouts decrease it | |
what is the equity multiplier | the term equity multiplier refers to a risk indicator that measures the portion of a company s assets that is financed by shareholders equity rather than by debt the equity multiplier is calculated by dividing a company s total asset value by the total equity held in the company s stock a high equity multiplier indicates that a company is using a high amount of debt to finance its assets a low equity multiplier means that the company has less reliance on debt the equity multiplier is also known as the leverage ratio or financial leverage ratio and is one of three ratios used in the dupont analysis investopedia nez riazunderstanding the equity multiplierinvesting in new and existing assets is key to running a successful business companies finance the acquisition of assets by issuing equity or debt in some cases they resort to issuing a combination of both as an investor you may want to determine how much shareholders equity is being used to pay for and finance a company s assets this is where the equity multiplier comes into play as noted above the equity multiplier is a metric that reveals how much of a company s total assets are financed by shareholders equity essentially this ratio is a risk indicator used by investors to determine a company s position when it comes to leverage a company s equity multiplier is only high or low when compared to historical standards the averages for the industry or the company s peers because their assets are generally financed by debt companies with high equity multipliers may be at risk of default formula for the equity multiplierequity multiplier total assetstotal shareholders equitywhere total assets both current and long term assetstotal shareholders equity total assets total liabilities begin aligned text equity multiplier frac text total assets text total shareholders equity textbf where text total assets text both current and long term assets text total shareholders equity text total assets text total liabilities end aligned equity multiplier total shareholders equitytotal assets where total assets both current and long term assetstotal shareholders equity total assets total liabilities interpreting the equity multiplieran equity multiplier of two 2 means that half the company s assets are financed with debt while the other half is financed with equity the equity multiplier is an important factor in dupont analysis which is a method of financial assessment devised by the chemical company for its internal financial review the dupont model breaks the calculation of return on equity roe into three ratios if roe changes over time or diverges from normal levels for the peer group the dupont analysis can indicate how much of this is attributable to the use of financial leverage if the equity multiplier fluctuates it can significantly affect roe higher financial leverage such as a higher equity multiple drives roe upward as long as all other factors remain equal examples of equity multiplier analysisthe equity multiplier calculation is straightforward consider apple s aapl balance sheet at the end of the 2021 fiscal year the company s total assets were 351 billion and the book value of shareholders equity was 63 billion the company s equity multiplier was 5 57x 351 63 1now let s compare apple to verizon communications vz the company has a very different business model than apple the company s total assets were 366 6 billion for the fiscal year 2021 with 83 2 billion of shareholders equity the equity multiplier was thus 4 41x 366 6 83 2 based on these values 2apple s relatively high equity multiplier indicates that the business relies more heavily on financing from debt and other interest bearing liabilities meanwhile verizon s telecommunications business model is similar to utility companies which have stable predictable cash flows and typically carry high debt levels apple is thus more susceptible to changing economic conditions or evolving industry standards than a utility or a traditional telecommunications firm as a result apple carries more financial leverage | |
is a higher equity multiplier better | average equity multipliers vary from industry to industry in general investors look for companies with a low equity multiplier because this indicates the company is using more equity and less debt to finance the purchase of assets companies that have higher debt burdens could be financially riskier | |
what is a good equity multiplier | there is no ideal equity multiplier it will vary by the sector or industry a company operates within in general equity multipliers at or below the industry average are considered better | |
what does an equity multiplier of 5 mean | an equity multiplier of 5 0x would indicate that the value of its assets is five times larger than its equity in other words assets are funded 80 by debt and 20 by equity | |
what affects the equity multiplier | a company s equity multiplier varies if the value of its assets changes and or if the level of liabilities changes if assets increase while liabilities decrease the equity multiplier becomes smaller that s because it uses less debt and more shareholders equity to finance its assets the bottom linethe equity multiplier is a financial ratio that measures how much of a company s assets are financed through stockholders equity and is calculated by dividing total assets by shareholders equity in general lower equity multipliers are better for investors but this can vary between industries and companies with particular industries in some cases a low equity multiplier could actually indicate that the company cannot find willing lenders or it could also signal that a company s growth prospects are low on the other hand a high equity multiplier is not always a sure sign of risk high leverage can be part of an effective growth strategy especially if the company is able to borrow more cheaply than its cost of equity correction jan 19 2023 an earlier version of this article stated that a company s equity multiplier grows larger if its assets increase while its liabilities decrease this was corrected to show that the reverse is true that the equity multiplier becomes smaller because it uses less debt to finance its assets | |
what is the equity premium puzzle epp | the equity premium puzzle epp refers to the excessively high historical outperformance of stocks over treasury bills which is difficult to explain the equity risk premium which is usually defined as equity returns minus the return of treasury bills is estimated to be between 5 and 8 in the united states the premium is supposed to reflect the relative risk of stocks compared to risk free government securities however the puzzle arises because this unexpectedly large percentage implies an unreasonably high level of risk aversion among investors understanding the equity premium puzzle epp the equity premium puzzle epp was first formalized in a study by rajnish mehra and edward c prescott in 1985 it remains a mystery to financial academics to this day notably professor prescott won the nobel memorial prize in economics in 2004 for his work on business cycles and demonstrating that society could gain from a prior commitment to economic policy according to a statement by the prize organization some academics believe the equity risk premium is too large to reflect a proper level of compensation that would result from investor risk aversion therefore the premium should actually be much lower than the historical average of between 5 and 8 some of the mystery surrounding the equity premium puzzle involves the variance of the premium over time estimates for the first half of the 20th century put the equity risk premium at near 5 in the second half of that century the equity premium went up to over 8 the equity premium for the first half may be lower because the u s was still on the gold standard limiting the impact of inflation on government securities many measures of stock market valuation such as the p e 10 ratio also help to explain the different equity premiums u s stock valuations were above average in 1900 relatively low in 1950 and at record highs in 2000 since the introduction of the epp many academics attempted to solve or at least partly explain the equity premium puzzle the prospect theory by daniel kahneman and amos tversky the role of personal debt the value of liquidity the impact of government regulation and tax considerations have been applied to the puzzle regardless of the explanation the fact remains that investors have been rewarded handsomely for holding stocks instead of risk free treasury bills special considerationsgiven its variance and status as an anomaly there are substantial questions about the durability of the equity premium perhaps the real reason for the seemingly excessive equity risk premium is that investors did not realize how much more stocks returned a large portion of the market s returns come from dividends which are obscured by media coverage of daily price movements as people realized the long term benefits of stock ownership valuation levels generally trended up the end result could be lower returns for stocks which would solve the equity premium puzzle the risk free nature and value of treasury bills is another crucial consideration are treasury bills genuinely risk free of course not many governments have inflated their currencies and defaulted on their debts even the credibility of the u s government varies from one year to the next arguably gold is the risk free asset measured against gold the equity premium since 1970 is far less impressive from this point of view the high equity premium is explained by the decline of the u s dollar against gold rather than objectively high returns for stocks the aggregation of stocks may also play a part in the equity risk premium puzzle individual stocks are far riskier than the stock market as a whole in many cases investors were compensated for the higher risk of holding particular stocks rather than overall market risk the traditional idea was that an investor would directly buy shares in a few companies ideas about diversification mutual funds and index funds came later by diversifying investors can reduce risk without reducing returns potentially explaining the excessive equity risk premium at the heart of the equity premium puzzle finally demographics may play a significant role in stock market returns and explaining the equity premium puzzle intuitively businesses need more customers to grow when the population is rising the average business automatically gets new customers and grows during the 20th century populations in most countries were increasing which supported business growth and higher stock market returns empirically stock markets in japan and many european countries performed poorly as their populations started to decline perhaps rising populations created the equity premium puzzle | |
what is equity risk premium | equity risk premium refers to an excess return that investing in the stock market provides over a risk free rate this excess return compensates investors for taking on the relatively higher risk of equity investing the size of the premium varies and depends on the level of risk in a particular portfolio it also changes over time as market risk fluctuates understanding equity risk premiumstocks are generally considered high risk investments investing in the stock market comes with certain risks but it also has the potential for big rewards so as a rule investors are compensated with higher premiums when they invest in the stock market whatever return you earn above a risk free investment such as a u s treasury bill t bill or a bond is called an equity risk premium an equity risk premium is based on the idea of the risk reward tradeoff it is a forward looking figure and as such the premium is theoretical but there s no real way to tell just how much an investor will make since no one can actually say how well equities or the equity market will perform in the future instead an equity risk premium is an estimation as a backward looking metric it observes the stock market and government bond performance over a defined period of time and uses that historical performance to the potential for future returns the estimates vary wildly depending on the time frame and method of calculation because equity risk premiums require the use of historical returns they aren t an exact science and therefore aren t completely accurate | |
how to calculate equity risk premium | to calculate the equity risk premium we can begin with the capital asset pricing model capm which is usually written as ra rf a rm rf where so the equation for equity risk premium is a simple reworking of the capm which can be written as equity risk premium ra rf a rm rf if we are simply talking about the stock market a m then ra rm the beta coefficient is a measure of a stock s volatility or risk versus that of the market the market s volatility is conventionally set to 1 so if a m then a m 1 rm rf is known as the market premium and ra rf is the risk premium if a is an equity investment then ra rf is the equity risk premium if a m then the market premium and the equity risk premium are the same equity risk premium in realitythe equity risk premium isn t a generalizable concept even though certain markets in certain time periods may display a considerable equity risk premium economists argue that too much focus on specific cases has made a statistical peculiarity seem like an economic law several stock exchanges have gone bust over the years so a focus on the historically exceptional u s market may distort the picture this focus is known as survivorship bias 1the majority of economists agree though that the concept of an equity risk premium is valid over the long term markets compensate investors more for taking on the greater risk of investing in stocks the global equity risk premium historical average is 4 6 it is better in some countries than others e g 6 43 in australia and 6 38 in the u s the historical risk free rate has been lower than that for a little less than half of the last 60 years 23special considerationsthe equation noted above summarizes the theory behind the equity risk premium but it doesn t account for all possible scenarios the calculation is fairly straightforward if you plug in historical rates of return and use them to estimate future rates but how do you estimate the expected rate of return if you want to make a forward looking statement one method is to use dividends to estimate long term growth using a reworking of the gordon growth model k d p g | |
where | another is to use growth in earnings rather than growth in dividends in this model the expected return is equal to the earnings yield the reciprocal of the price to earnings ratio p e ratio k e p | |
where | the drawback of both of these models is that they do not account for valuation that is they assume the stocks prices are never correct since we can observe stock market booms and busts in the past this drawback is not insignificant finally the risk free rate of return is usually calculated using u s government bonds since they have a negligible chance of default this can mean t bills or t bonds to arrive at a real rate of return that is adjusted for inflation it is easiest to use treasury inflation protected securities tips as these already account for inflation it is also important to note that none of these equations account for tax rates which can dramatically alter returns | |
what is the equity risk premium in 2023 | the equity risk premium in the u s based on u s exchanges as of 2023 is 5 7 this is the market risk premium investors will achieve by investing in the stock markets the level has hovered between 5 3 and 5 7 since 2011 4can equity risk premium be negative yes equity risk premium can be negative this occurs when the returns expected from stock market investments are below the risk free rate in this scenario an investor would earn more from a risk free asset than they would by investing in the stock market | |
what does a high equity risk premium mean | the higher the equity risk premium the more you will earn from investing in stocks than you would by investing in risk free assets this makes investing in stocks more enticing however since the equity risk premium is based on historical data the returns are not guaranteed the bottom lineinvestors take risks to earn the highest possible return within their risk tolerances calculating the equity risk premium can indicate to investors how much more return they ll achieve than if they opted for a risk free rate however this is not a true mechanism to gauge potential returns as the calculation relies on historical data which is never indicative of future performance | |
what is an equity swap | an equity swap is an exchange of future cash flows between two parties that allows each party to diversify its income for a specified period of time while still holding its original assets an equity swap is similar to an interest rate swap but rather than one leg being the fixed side it is based on the return of an equity index the two sets of nominally equal cash flows are exchanged as per the terms of the swap which may involve an equity based cash flow such as from a stock asset called the reference equity that is traded for fixed income cash flow such as a benchmark interest rate swaps trade over the counter and are very customizable based on what the two parties agree to besides diversification and tax benefits equity swaps allow large institutions to hedge specific assets or positions in their portfolios equity swaps should not be confused with a debt equity swap which is a restructuring transaction in which the obligations or debts of a company or individual are exchanged for equity because equity swaps trade otc there is counterparty risk involved | |
how an equity swap works | an equity swap is similar to an interest rate swap but rather than one leg being the fixed side it is based on the return of an equity index for example one party will pay the floating leg typically linked to libor and receive the returns on a pre agreed upon index of stocks relative to the notional amount of the contract equity swaps allow parties to potentially benefit from returns of an equity security or index without the need to own shares an exchange traded fund etf or a mutual fund that tracks an index most equity swaps are conducted between large financing firms such as auto financiers investment banks and lending institutions equity swaps are typically linked to the performance of an equity security or index and include payments linked to fixed rate or floating rate securities libor rates are a common benchmark for the fixed income portion of equity swaps which tend to be held at intervals of one year or less much like commercial paper according to an announcement by the federal reserve banks should stop writing contracts using libor by the end of 2021 the intercontinental exchange the authority responsible for libor will stop publishing one week and two month libor after december 31 2021 all contracts using libor must be wrapped up by june 30 2023 1 the stream of payments in an equity swap is known as the legs one leg is the payment stream of the performance of an equity security or equity index such as the s p 500 over a specified period which is based on the specified notional value the second leg is typically based on the libor a fixed rate or another equity s or index s returns example of an equity swapassume a passively managed fund seeks to track the performance of the s p 500 the asset managers of the fund could enter into an equity swap contract so it would not have to purchase various securities that track the s p 500 the firm swaps 25 million at libor plus two basis points with an investment bank that agrees to pay any percentage increase in 25 million invested in the s p 500 index for one year therefore in one year the passively managed fund would owe the interest on 25 million based on the libor plus two basis points however its payment would be offset by 25 million multiplied by the percentage increase in the s p 500 if the s p 500 falls over the next year then the fund would have to pay the investment bank the interest payment and the percentage that the s p 500 fell multiplied by 25 million if the s p 500 rises more than libor plus two basis points the investment bank owes the passively managed fund the difference since swaps are customizable based on what two parties agree to there are many potential ways this swap could be restructured instead of libor plus two basis points we could have seen one bp or instead of the s p 500 another index could be used | |
what is the equivalent annual annuity eaa approach | the equivalent annual annuity eaa approach is one of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives the eaa approach calculates the constant annual cash flow generated by a project over its lifespan if it were an annuity when used to compare projects with unequal lives an investor should choose the one with the higher eaa understanding the equivalent annual annuity eaa approachthe eaa approach uses a three step process to compare projects the present value of the constant annual cash flow is exactly equal to the project s net present value npv the first thing an analyst does is calculate each project s npv over its lifetime after that they compute each project s eaa so that the present value of the annuities is exactly equal to the project s npv lastly the analyst compares each project s eaa and selects the one with the highest eaa for example let s say a company with a weighted average cost of capital of 10 is comparing two projects a and b project a has an npv of 3 million and an estimated life of five years while project b has an npv of 2 million and an estimated life of three years using a financial calculator project a has an eaa of 791 392 44 and project b has an eaa of 804 229 61 under the eaa approach the company would choose project b since it has the higher equivalent annual annuity value calculating the equivalent annual annuity approach eaa often an analyst will use a financial calculator with the typical present value and future value functions to find the eaa an analyst can use the following formula in a spreadsheet or with a non financial calculator with exactly the same results | |
where | for example consider two projects project a has a seven year term and an npv of 100 000 project b has a nine year term and an npv of 120 000 both projects are discounted at a 6 percent rate the eaa of each project is project a is the better option | |
what is an annuity | an annuity is a contract between an investor and an insurance company typically used in retirement an annuity guarantees that you won t outlive your savings however they may come with high fees one fee is the surrender charge which you would need to pay if you withdrew a certain amount of funds from the annuity during the surrender period which can last up to two decades or so details vary from contract to contract so if you re considering an annuity be sure to read the fine print | |
what kinds of annuities are there | there are a few types of annuities fixed annuities offer a guaranteed interest rate which means a minimum amount of income on a periodic basis variable annuities allow you to invest in the market indexed annuities track a particular index such as the s p 500 annuities payouts can be immediate or deferred | |
what is the formula for the equivalent annual annuity approach | the formula for the equivalent annual annuity is c r x npv 1 1 r n | |
where | c equivalent annuity cash flownpv net present valuer interest rate per periodn number of periodsthe bottom linethe equivalent annual annuity approach is a method used to compare projects that will each last a specific amount of time you can use a financial calculator to help you determine which project is best or you can try your hand at these formulas | |
what is the equivalent annual cost eac | equivalent annual cost eac is the annual cost of owning operating and maintaining an asset over its entire life firms often use eac for capital budgeting decisions as it allows a company to compare the cost effectiveness of various assets with unequal lifespans in a process known as the replacement chain method investopedia mira norianunderstanding the equivalent annual cost eac equivalent annual cost eac is used for a variety of purposes including capital budgeting but it is used most often to analyze two or more possible projects with different lifespans where costs are the most relevant variable other uses of eac include calculating the optimal life of an asset determining if leasing or purchasing an asset is the better option determining the magnitude of which maintenance costs will impact an asset determining the necessary cost savings to support purchasing a new asset and determining the cost of keeping existing equipment the eac calculation factors in a discount rate or the cost of capital cost of capital is the required return necessary to make a capital budgeting project such as building a new factory worthwhile cost of capital includes the cost of debt and the cost of equity and is used by companies internally to judge whether a capital project is worth the expenditure of resources the formula for the equivalent annual cost eac asset price discount rate 1 1 discount rate n where discount rate return required to make project worthwhile n number of periods begin aligned text eac frac text asset price times text discount rate 1 1 text discount rate n textbf where text discount rate text return required to make project text worthwhile n text number of periods end aligned eac 1 1 discount rate nasset price discount rate where discount rate return required to make projectworthwhilen number of periods | |
how to calculate the equivalent annual cost | example of the equivalent annual costas stated earlier eac allows managers to compare npvs of different projects over different periods to accurately determine the best option consider two alternative investments in machinery equipment 1 machine a has the following 2 machine b has the following the cost of capital for the company making the decision is 5 next we calculate the eac which is equal to the net present value npv divided by the present value annuity factor or a t r while taking into account the cost of capital or r and the number of years in question or t the annuity factor is calculated as follows annuity factor 1 1 1 r t r where r cost of capital t number of periods begin aligned text annuity factor frac 1 frac 1 1 r t r textbf where r text cost of capital t text number of periods end aligned annuity factor r1 1 r t1 where r cost of capitalt number of periods using the formula above the annuity factor or a t r of each project must be calculated these calculations would be as follows machine a a t r 1 1 1 05 3 05 2 72 begin aligned text machine a a t r frac 1 frac 1 1 05 3 05 2 72 end aligned machine a a t r 051 1 05 31 2 72 machine b a t r 1 1 1 05 5 05 4 33 begin aligned text machine b a t r frac 1 frac 1 1 05 5 05 4 33 end aligned machine b a t r 051 1 05 51 4 33 next the initial costs must be divided by the annuity factor or a t r while adding in the annual maintenance cost the calculation for eac is eac machine a 105 000 2 72 11 000 49 557 begin aligned text eac machine a frac 105 000 2 72 11 000 49 557 end aligned eac machine a 2 72 105 000 11 000 49 557 eac machine b 175 000 4 33 8 500 48 921 begin aligned text eac machine b frac 175 000 4 33 8 500 48 921 end aligned eac machine b 4 33 175 000 8 500 48 921 by standardizing the annual cost a manager in charge of a capital budgeting decision where cost is the only issue would select machine b because it has an eac that is 636 lower than machine a the difference between the equivalent annual cost and the whole life costwhole life cost is the total expense of owning an asset over its entire life from purchase to disposal as determined by financial analysis it is also known as a life cycle cost which includes purchase and installation design and building costs operating costs maintenance associated financing costs depreciation and disposal costs whole life cost also takes into account certain costs that are usually overlooked such as those related to environmental and social impact factors the equivalent annual cost eac is the annual cost of owning operating and maintaining an asset over its entire life while the whole life cost is the total cost of the asset over its entire life limitations of using the equivalent annual costa limitation with eac as with many capital budgeting decisions is that the discount rate or cost of capital must be estimated for each project unfortunately the forecast can turn out to be inaccurate or variables can change over the life of the project or life of the asset that s be considered | |
what is erosion | erosion can include any negative impact on a company s associated assets or funds erosion can be experienced with regard to profits sales or tangible assets such as manufacturing equipment erosion is often considered a general risk factor within an organization s cash management system as the losses may be slow and occurring over time erosion can also occur with certain financial assets such as options contracts or warrants that decline in value as time passes known as time decay understanding the types of erosionerosion most often applies to longer term downward trends especially those that seem to be accelerating in other words erosion implies a permanent change in business conditions short term losses are not categorized as erosion but listed as one time charges or nonrecurrent losses standard anticipated depreciation or the cyclical nature of certain product sales are often considered a normal part of business functions these are more likely to be referred to as downward trends profit erosion can refer to the gradual redirection of funds from profitable segments or projects within a business to new projects and areas although managers almost always consider money flowing into new projects as investments in long term growth the short term effect is a slow erosion of cash flow cash flow is the amount of cash that flows in and out of a company as a result of its day to day business operations the risk involved in profit erosion is usually reflected in the company s profit margins as the monies are used to fund areas that may or may not be profitable in the future profit margin is the percentage of sales that has generated profits additionally profit erosion can occur even when sales numbers are comparable to previous levels this can occur when the cost of producing a particular product rises possibly due to increases in the costs of materials or labor but the sales price of the product is not raised to compensate certain assets lose value over time a process often referred to as depreciation though much asset depreciation is accounted for within the business s figures unexpected asset erosion can still occur these losses can materialize due to the general use of equipment or technological advances that make the current assets less valuable or obsolete asset erosion can lower the perceived value of the business as a whole as it lowers the book value of the assets associated with the company intangible assets such as patents or trademarks which have an expiration date also have their value eroded over time especially as that date nears for pharmaceuticals companies generic producers entering the market can lead to erosion of their offerings and be a real issue of concern amortization is the regular accounting process whereby intangible assets values are reduced over time options contracts are derivatives meaning their value is determined by an underlying asset options on stocks that have been issued to company managers or employees can erode in value over time options contracts typically come with an expiration date where the rights embedded in those contracts must be exercised prior to expiration as the expiration date approaches the time value in those contracts erodes in a process known as time decay in other words as time passes there s less chance to earn a profit from the option if it s not already profitable as a result the value of options decreases or erodes over time employee stock options have become a large balance sheet item for many large companies and so this form of value loss is important in analyzing financial statements sales erosion refers to the process of steady long term declines in overall sales numbers these differ from temporary sales declines because these losses are often considered fairly widespread possibly qualifying as a long term trend within the business s activities sales erosion can be experienced due to a number of factors including new entries into that particular product s market or price undercutting on behalf of the competition technology advances in the field can also lead to sales erosion if newer product developments make the current company offering seem obsolete | |
what is an error term | an error term is a residual variable produced by a statistical or mathematical model which is created when the model does not fully represent the actual relationship between the independent variables and the dependent variables as a result of this incomplete relationship the error term is the amount at which the equation may differ during empirical analysis the error term is also known as the residual disturbance or remainder term and is variously represented in models by the letters e or u understanding an error terman error term represents the margin of error within a statistical model it refers to the sum of the deviations within the regression line which provides an explanation for the difference between the theoretical value of the model and the actual observed results the regression line is used as a point of analysis when attempting to determine the correlation between one independent variable and one dependent variable error term use in a formulaan error term essentially means that the model is not completely accurate and results in differing results during real world applications for example assume there is a multiple linear regression function that takes the following form y x where constant parametersx independent variables error term begin aligned y alpha x beta rho epsilon textbf where alpha beta text constant parameters x rho text independent variables epsilon text error term end aligned y x where constant parametersx independent variables error term | |
what do error terms tell us | within a linear regression model tracking a stock s price over time the error term is the difference between the expected price at a particular time and the price that was actually observed in instances where the price is exactly what was anticipated at a particular time the price will fall on the trend line and the error term will be zero points that do not fall directly on the trend line exhibit the fact that the dependent variable in this case the price is influenced by more than just the independent variable representing the passage of time the error term stands for any influence being exerted on the price variable such as changes in market sentiment the two data points with the greatest distance from the trend line should be an equal distance from the trend line representing the largest margin of error if a model is heteroskedastic a common problem in interpreting statistical models correctly it refers to a condition in which the variance of the error term in a regression model varies widely linear regression error term and stock analysislinear regression is a form of analysis that relates to current trends experienced by a particular security or index by providing a relationship between a dependent and independent variables such as the price of a security and the passage of time resulting in a trend line that can be used as a predictive model a linear regression exhibits less delay than that experienced with a moving average as the line is fit to the data points instead of based on the averages within the data this allows the line to change more quickly and dramatically than a line based on numerical averaging of the available data points the difference between error terms and residualsalthough the error term and residual are often used synonymously there is an important formal difference an error term is generally unobservable and a residual is observable and calculable making it much easier to quantify and visualize in effect while an error term represents the way observed data differs from the actual population a residual represents the way observed data differs from sample population data | |
errors and omissions e o insurance is a type of liability insurance that covers claims against your business for mistakes you made or services you failed to provide e o insurance protects your business from claims by clients for negligence malpractice errors or omissions you allegedly made while providing a professional service the insurance helps pay for your legal fees and any owed damages or settlements | understanding e o insurancee o insurance also known as professional liability coverage protects your business from claims by clients for errors or mistakes faulty advice or failure to provide the level of service your client expected it also covers claims based on your failure to do the work meet a deadline or otherwise fulfill the terms of a contract for example suppose a furniture manufacturer hires your it consulting company to upgrade its computer aided manufacturing software several months later the client sues your company for 50 000 claiming you provided inadequate advice on using the new software because of your faulty instructions their machinery malfunctioned and they were unable to fill two large orders an e o policy might pay for damages or settlements arising from those claims it may also cover attorneys fees court costs and other legal expenses your insurer incurs to defend your business against the lawsuit whether or not the claim is valid or your business is found liable 2if you do business outside the u s look for an e o policy that applies worldwide avoid any policy that restricts coverage to incidents occurring in the u s who needs e o insurance you should consider buying an e o policy if your business involves giving advice or providing a professional service for a fee many types of businesses fit this description including accountants architects real estate agents consultants financial advisors wedding planners fitness instructors and physical therapists some types of professionals may be required by state or federal law to buy e o insurance before going into business such as attorneys contractors and medical professionals some businesses may need e o insurance to get or renew a professional license or to comply with the terms of a client contract 3 | |
what e o insurance doesn t cover | many e o policies exclude claims resulting from any of the following your policy may contain additional exclusions read it carefully so you understand what it does and doesn t cover | |
how to choose an e o policy | the right choice for an e o policy depends on the nature of your business and the risks you want to insure many e o policies are designed to cover a specific occupation such as attorneys accountants or real estate agents when choosing a policy be sure it covers the kind of business you operate some e o policies cover additional risks common to businesses in many occupations an example is employment practices liability insurance which covers claims against businesses that result from workplace violations such as discrimination and wrongful termination like any insurance your e o policy will be a tradeoff between cost and the amount of protection policies that offer more coverage typically cost more when comparing policies check both the per occurrence limit and aggregate limit the per occurrence limit is the most the policy will pay per lawsuit claim and the aggregate limit is the most the policy will pay total for example an e o policy might offer 250 000 per incident and up to 1 million aggregate 5 | |
when you compare insurers on cost make sure it s an apples to apples comparison of total coverage you should also check the policy deductible this is the amount you must pay out of pocket first before the insurance kicks in policies with a higher deductible usually charge a lower premium | most e o policies are claims made meaning they cover claims made against your business during the term of the policy a claims made policy won t cover claims filed against your business after your policy expires some insurers offer e o insurance on occurrence policies which cover claims arising from incidents that occur during the policy term no matter when the claim is filed because occurrence policies provide broader coverage they are more expensive than their claims made counterparts 6 | |
how to buy e o insurance | if you need e o insurance a logical place to start is your general liability insurer many insurers that sell business insurance offer e o coverage some will add e o coverage to a general liability or business owners policy via an endorsement if your liability insurer doesn t offer e o insurance you can ask your business insurance agent for quotes or get quotes yourself online the cost of e o insurance varies by industry a building design company will likely pay more than a hair salon or massage therapist other factors that affect your premium are the size of your business your claim history and the limits you choose many small businesses can buy an e o policy for about 735 per year 1the bottom lineerrors and omissions insurance also called e o or professional liability insurance protects your business from claims arising from negligence faulty advice errors or omissions e o insurance covers damages settlements and legal costs that result from covered claims you likely need e o insurance if you or your employees give professional advice or provide a service to customers for a fee | |
why is e o insurance so important | if a client sues your business for errors or mistakes you made or faulty advice you gave your general liability policy won t cover the claim errors and omissions claims can be very expensive especially for a small company if you don t have e o insurance you ll have to pay for any damages settlements and legal fees out of pocket one large claim could put your company out of business | |
what is an example of e o insurance | medical malpractice insurance is a type of e o coverage that protects doctors and other medical practitioners against claims by patients for professional negligence it covers claims against healthcare professionals for negligence medical errors or accidental oversights state laws may require some medical practitioners to buy malpractice insurance before they can get a license to practice | |
is e o insurance the same as general liability coverage | no they are not the same thing a general liability policy covers claims by customers and other third parties for bodily injury or property damage that occurs on your premises is caused by your product or arises from your business operations e o insurance covers claims by clients for mistakes you made or faulty advice you gave when providing a professional service | |
what is escheat | escheat is the right of a government to take ownership of estate assets or unclaimed property in the event that there are no heirs or beneficiaries escheat rights can also be granted when assets are unclaimed for a prolonged period these situations can also be referred to as bona vacantia or simply unclaimed property the concept of escheat is that property always has a recognized owner which would be the state or federal government if no other claimant to ownership exists or is readily identified in the u s each state jurisdiction has its own laws and regulations governing escheat rights and related matters understanding escheatescheat is a government s right to property if it remains unclaimed for any reason after some period time escheat rights can be granted by a court of law or given following a standard period of time in the case of death with no will or heirs escheat rights may be granted to a state in a probate decision each state in the u s has rules and regulations governing escheat rights often property that has been escheated may later be reclaimed some states may incorporate a statute of limitations which creates an expiration date after which reclaiming property is no longer allowed escheatment is the process of transferring assets to the state escheat rights are often revocable reclamation rights can extend into perpetuity if no statute of limitations exists this means that ownership of an estate or property assets could revert to a lawful heir or owner should one turn up u s states also have processes and procedures for granting escheat rights when property has been unclaimed for a prolonged period these processes vary by the type of asset and usually by state some of the financial accounts that can become escheated are escheat and deathin the case of death estate assets with no will are considered intestate all deaths and death wishes usually go through a probate court for final determination intestate deaths also go through probate which involves researching heirs who may be given property assets heirs eligible to inherit assets intestate may include spouses siblings aunts uncles nieces nephews cousins and potentially more distant relatives if a probate court finds no heirs to unclaimed assets in death then a judge would grant escheat rights to the state escheat may also occur if a will or trust is deemed defective and legal heirs to an estate cannot be readily identified generally identifying heirs in most intestate deaths foregoes the need for escheatment however escheat can also kick in if an individual s legal heirs are deemed incompetent to manage the inheritance and no other rightful heirs can be identified if a rightful heir comes forward after escheat rights have been granted property can be given to such heirs as outlined by laws laws vary widely from state to state and may include a statute of limitations that can make asset ownership rights irrevocable escheatment of unclaimed assetsescheat rights can be granted to the government for different types of assets assets may include real estate bank deposits and unclaimed securities in accounts that have been dormant for a prolonged period financial institutions and brokerages keep records of inactivity labeling inactive accounts dormant after a specified period financial institutions keep records of dormant accounts these accounts are usually required to be turned over to the government after a specified period typically determined by each state by law financial institutions with dormant accounts are usually required to make efforts such as sending reminders and issuing notices to locate the owners of these assets before finally transferring them to the state through escheatment escheatment for financial accounts often occurs automatically after a specified amount of time has elapsed each state determines the time frame for granting escheat rights to the government and the process for doing so this table provides each u s state s escheatment timing for checking and savings accounts bank checks and wages or salaries your state may have additional specifics pertaining to the data below so be sure to review the latest information by visiting its official website or the national association of unclaimed property administrators 1escheat reclamationsome states maintain online registries of unclaimed assets and dormant accounts and register this information with the national association of unclaimed property administration you can find unclaimed property on its website 2however reclamation is ultimately subject to state law and states can institute a statute of limitations that restricts claims after a specified period statutes of limitation usually help protect states that sell assets or spend funds for their own use making these assets less recoverable | |
what does it mean when an account is escheat | an account is in escheat when there are no identifiable heirs to an account or no one claims it the government then takes ownership if a legal owner is identified it can be reclaimed | |
what does escheat mean in law | escheat is the right of a government to take ownership of an account if no one claims it or has a claim to it after the owner s death | |
what is escheat example | imagine that you had assets in a brokerage account and that you didn t designate beneficiaries for the account had no will and no relatives that these assets could pass to according to the laws in your state if you died and no one else claimed the account ownership would be passed to the government the bottom lineescheatment is the right of a government to take ownership of an account or other property when there is no apparent beneficiary heir or other entity that has a claim to it the account or other property can be reclaimed if someone emerges with a legal claim but reclamation is generally subject to a statute of limitations | |
what is escrow | escrow is a legal concept describing a financial agreement whereby an asset or money is held by a third party on behalf of two other parties that are in the process of completing a transaction escrow accounts are managed by the escrow agent the agent releases the assets or funds only upon the fulfillment of predetermined contractual obligations or upon receiving appropriate instructions money securities funds and other assets can all be held in escrow understanding escrowescrow is a financial process used when two parties take part in a transaction and there is uncertainty about the fulfillment of their obligations situations that may use escrow can involve internet transactions banking intellectual property real estate mergers and acquisitions law and more consider a company that is selling goods internationally that company requires assurance that it will receive payment when the goods reach their destination the buyer for their part is prepared to pay for the goods only if they arrive in good condition the buyer can place the funds in escrow with an agent with instructions to disburse them to the seller once the goods arrive in a suitable state this way both parties are protected and the transaction can proceed for real estate there are two escrow accounts the first is used when you re buying a home the second is used during the life of the mortgage types of escrowescrow accounts can apply to real estate transactions placing the funds in escrow with a third party allows the buyer to make a good faith deposit or perform due diligence on a potential property acquisition escrow accounts also assure the seller that the buyer is serious about the purchase for example an escrow account can be used for the sale of a house if there are conditions attached to the sale such as the passing of an inspection the buyer and seller may agree to use escrow in this case the buyer of the property deposits the payment for the house in an escrow account held by a third party the seller can proceed with e g house inspections confident that the funds are on deposit and the buyer is capable of making payment the amount in escrow is then transferred to the seller once all the conditions for the sale are satisfied escrow can also refer to an escrow account that is set up at the time of mortgage closing in this instance the escrow account contains future homeowners insurance and property tax payments a portion of the monthly mortgage payment is deposited into the escrow account to cover these payments thus borrowers that set up an escrow account if required by the lender or at their own discretion will have higher payments than those who do not however they will not have to worry about paying the yearly premiums or property tax bills as they re already paying portions of them monthly into their escrow account stocks are often issued in escrow in this case while the shareholder is the real owner of the stock the shareholder has limited rights when it comes to the disposal of the stock for example executives who receive stock as a bonus to their compensation often must wait for an escrow period to pass before they can sell the stock stock bonuses are often used to attract or retain top executives online escrow like real estate and stock market escrow protects the buyer and seller from fraud or nonpayment an online escrow service acts as the third party for online product sales buyers send their payments to the escrow service which holds the money until the product is received once the product is delivered and verified the online escrow service releases the funds to the seller escrow services are best suited for high value items such as jewelry or art the online escrow company charges a fee for the service you can request an escrow account yourself for the tax and insurance payments on your house even if your lender doesn t require it escrow can help a home owner be sure that money needed for property taxes and insurance will be available when payment is due in other words instead of having to come up with a large lump sum the homeowner can make smaller monthly deposits in an escrow account which will be disbursed by the agent at the appropriate times advantages and disadvantages of escrowfor a fee escrow can provide parties to transactions that involve large amounts of money an assurance of security escrow accounts for mortgages can help protect the borrower and lender from potentially late payments for property taxes and homeowners insurance these monthly amounts are usually estimated you can overpay or underpay into your escrow account which may require an adjustment when it comes time for the servicer to make the payments the convenience of monthly escrow payments requires a higher monthly payment compared to paying just principal and interest provides protection during transactions notably for real estate involving sizable amounts of moneyallows for monthly payments toward insurance and taxes instead of a large lump sum beneficial for both the buyer and seller when big ticket items are involvedhigher mortgage payments if escrow is used for taxes and insurance estimates might be incorrect for tax dueonline escrow service fees might be higher than those on other platforms such as paypalexample of escrowhomebuyers often use escrow twice first as earnest money and then at closing say that john wants to buy a home he finds a house and decides to make an offer the offer is accepted and he must put earnest money of 5 000 into escrow the money put in escrow shows the seller that john is seriously interested in buying the property in return the seller takes the property off the market and finalizes repairs etc all goes well and at the time of the purchase the escrow money is transferred to the seller and the purchase price is reduced by 5 000 at the closing john agrees to set up an escrow account with the lender to pay property taxes and homeowners insurance john s monthly payments look like this then when the yearly taxes and insurance payments are due the lender makes them using money in the escrow account some lenders require an escrow account to ensure that both of these are paid on time if taxes go unpaid the tax authority could place a lien on the property which is not in the best interest of the lender | |
what is the escrow of a house | escrow relating to buying a house is an account called the escrow account in which money from the potential homebuyer is deposited required escrow is generally 1 to 3 of the asking price for a home the money is required to ensure the buyer is seriously considering the home and has the funds to make the purchase in return the seller will usually take the property off the market and allow the potential buyer access to the home for inspections | |
how does escrow work | escrow required by mortgage lenders involves making monthly payments for property taxes and homeowners insurance into an escrow account held by a third party if escrow is required by the lender or requested by the borrower the monthly payment will include principal and interest for the loan as well as amounts for property taxes and homeowners insurance the lender will keep the amounts for taxes and insurance in the escrow account then when the bills come due they will make the appropriate payments | |
what does escrow mean in mortgage | escrow relating to mortgages involves property tax and insurance payments this escrow account can last for the length of a mortgage loan lenders don t always require escrow however if you are required to set up an escrow account many lenders will consider a written request to end escrow after you ve made typically a year of on time mortgage payments and your loan to value is at most 90 some lenders may require 80 or lower | |
is escrow good or bad | escrow is generally considered good as it protects the buyer and seller in a transaction in addition escrow as part of mortgage payments is generally good for the lender and helps the buyer by ensuring property taxes and homeowners insurance are paid on time | |
what is an escrow disbursement | an escrow disbursement is a payment made from an escrow account with real estate it s made by the lender on behalf of a borrower to cover property taxes and homeowners insurance the bottom lineescrow can be used for various transactions including real estate stock issuances and online sales money from the buyer is held in an escrow account until the transaction is complete or the buyer is able to receive or verify the condition of the product once the buyer approves the transaction the money is released to the seller from the escrow account the company managing the escrow account generally takes a fee for performing the third party service | |
what is an escrow agent | an escrow agent is a person or entity that holds property in trust for third parties while a transaction is finalized or a disagreement is resolved the role of escrow agent is often played by an attorney or notary in civil law jurisdictions the escrow agent has a fiduciary responsibility to both parties of the escrow agreement escrow agent explainedan escrow agent essentially serves as a neutral middleman in the context of an escrow agreement an escrow agreement is a contract between two parties whereby each agrees that a third party should hold an asset on their behalf until their transaction is completed the funds or assets are held by the escrow agent until it receives the appropriate instructions or until predetermined contractual obligations have been fulfilled money securities funds and titles to real estate can all be held in escrow escrow agent vs trusteethere are similarities between the role of a trustee and the role of an escrow agent but there are significant differences as well the two roles are similar in that in each case a third party holds property in trust for someone else and has a fiduciary duty however a trustee has a duty toward the beneficiary or beneficiaries of the trust and must act in their best interest in contrast an escrow agent s duty is toward both parties of a transaction and they are tightly bound by the terms of the escrow agreement escrow agent in real estate transactionsescrow agents are typically associated with selling or buying a home or other real estate in some jurisdictions including the united states they may be referred to as title agents in these cases the escrow agent secures the property and examines documents to make sure the terms of the sale are met on each end thus serving both the buyer and seller in the transaction | |
when it comes to buying and selling a home an escrow agent may be a title company in such cases the title company holds the deed to the property in escrow until all of the terms of both the buyer and seller are met the buyer may deposit the money for the purchase or at least the down payment with the escrow agent which serves to validate the transaction and reassure the seller until last minute closing terms are met the amount in escrow is then transferred to the seller and the property deed to the buyer once all the conditions for the sale are satisfied | in summary whether the escrow agent is a business or an individual the purpose they serve is that of a neutral trusted third party to transactions that may involve persons who never end up meeting each other | |
what is an escrow agreement | an escrow agreement is a contract that outlines the terms and conditions between parties involved and the responsibility of each escrow agreements generally involve an independent third party called an escrow agent who holds an asset of value until the specified conditions of the contract are met however they should fully outline the conditions for all parties involved | |
how escrow agreements work | in an escrow agreement one party usually a depositor deposits funds or an asset with the escrow agent until the time that the contract is fulfilled once the contractual conditions are met the escrow agent will deliver the funds or other assets to the beneficiary escrow agreements are commonly used in different financial transactions especially those that involve significant dollar amounts such as real estate or online sales escrow agreements must fully outline the conditions between all parties involved having one in place ensures all the obligations of the parties involved are met and that the transaction is conducted in a safe and reliable manner an escrow agreement normally includes information such as most escrow agreements are put into place when one party wants to make sure the other party meets certain conditions or obligations before it moves forward with a deal for instance a seller may set up an escrow agreement to ensure a potential homebuyer can secure financing before the sale goes through if the buyer cannot secure financing the deal can be called off and the escrow agreement canceled for certain transactions such as real estate the escrow agent may open up an escrow account into which funds are deposited cash has traditionally been the go to asset that people entrust to an escrow agent but nowadays any asset that holds a value can be put into escrow including stocks bonds deeds mortgages patents or a check escrow agreements provide security by delegating an asset to an escrow agent for safekeeping until each party meets his or her contractual obligations special considerationsthere may come a time during a business transaction when it is in the best interest of one party to move forward only if it knows with absolute certainty that the other party can fulfill its obligations this is where the use of an escrow agreement comes into play for example a company purchasing goods internationally wants to be certain its counterpart can deliver the goods conversely the seller wants to ensure it gets paid if it sends the goods to the buyer both parties can put an escrow agreement in place to ensure delivery and payment they can agree the buyer will deposit the funds in escrow with an agent and give irrevocable instructions to disburse the funds to the seller once the goods arrive the escrow agent likely an attorney is bound by the terms of the agreement types of escrow agreementsescrow agreements are frequently used in real estate transactions title agents in the united states notaries in civil law countries and attorneys in other parts of the world routinely act as escrow agents by holding the seller s deed to a property payment is typically made to the escrow agent the buyer can perform due diligence on his potential acquisition like doing a home inspection or securing financing while assuring the seller of his capacity to close on the purchase if the purchase goes through the escrow agent will apply the money to the purchase price if the conditions set forth by the agreement are not met or the deal falls through the escrow agent can refund the money to the buyer stocks are often the subject of an escrow agreement in the context of an initial public offering ipo or when they are granted to employees under stock option plans these stocks are usually in escrow because there is a minimum time limit that needs to pass before they can be freely traded by their owners | |
what are escrowed shares | escrowed shares are shares held in an escrow account secured by a third party pending the completion of a corporate action or an elapse of time leading up to an event shares are escrowed in three common cases understanding escrowed sharesescrow is a process whereby money or a financial asset is held by a third party on behalf of two other parties the assets or funds that are held in escrow remain there and are not released until all of the obligations outlined in the agreement are fulfilled escrow reduces the risk in a transaction by having a third party hold assets which prevents one party from having to pursue the other party for the funds or assets the release of escrowed shares can depress investors shares and significantly affect share price 1in stock transactions the equity shares are held in escrow essentially a holding account until a transaction or other specific requirements have been satisfied many times a stock issued in escrow will be owned by the shareholder however the shareholder may be prevented from selling the stock immediately or may have limited access to selling the shares | |
when shares are escrowed | oftentimes companies issue shares of stock as a bonus or as part of the company s compensation program for executive employees in these scenarios the employees are typically required to wait a specified period of time before selling their shares these shares are called restricted shares as the employee must wait until the vesting period has elapsed to own the shares between the grant date and vesting date the shares are held in escrow upon the vesting date the shares are released to the employee the reason companies hold their stock in escrow is that it provides an extra incentive for the employees to remain with the company for the long term shares of stock can be held in escrow for anywhere between one to three years before an employee or executive can cash them out for example funds for an acquisition can be held in escrow until government regulatory authorities approve the transaction other times the purchase price might need to be adjusted at some point during the process and as a result funds are placed in escrow to cover for the variance a targeted company may also request that a holdback in the form of acquirer shares be held in escrow to protect against non performance by the acquirer in a business combination however the holdback can be in the form of escrow shares cash or a combination of both the practice of placing shares in escrow for a specified period is common for non public companies as well as public ones a company s shares may be suspended from trading during a bankruptcy filing or a company reorganization pending the resolution of the corporate action in this case a shareholder s holding will be converted to escrow shares and then converted back to their original form if any equity remains in the company after the completion of the bankruptcy or reorganization process a merger or acquisition can result in the buyer acquirer requesting a portion of the deal in consideration typically 10 to 15 to be held in escrow typically shares of the seller or target company would be held the escrowed shares protect the buyer from potential breaches in seller representation and warranties covenants contingencies and working capital adjustments among other material adverse items that may affect the valuation of deal or the closing itself benefits of escrowed sharesescrowed shares are designed to protect both parties to a transaction the escrow agent ensures that shares are protected while the agreement is being executed and that all parties fulfill their contractual obligations holding shares in escrow can also prevent losses from market fluctuations in mergers and acquisitions m a if the seller breaches the agreement the buyer may recover the escrowed shares to mitigate losses 2 if the buyer breaches the agreement the seller may retain the escrowed shares also if the buyer needs more money to fulfill the agreement the escrowed shares are available to facilitate the transaction this access prevents the buyer from disturbing operations and adversely affecting shareholders real world examplesin 2009 adventrix pharmaceuticals seeking to gain fda approval for its chemotherapy agent sold 5 of its series b convertible preferred stock to an institutional investor 3 twenty five percent of the gross proceeds or approximately 340 000 was put into an escrow account to be released over time under certain circumstances in the same year dax partners lp entered into a share purchase agreement with selectica inc as part of its acquisition of the company 4 dax partners agreed to buy 3 22 million in shares of which 1 million worth was held in escrow the escrow funds were released to the seller upon the full execution of the agreement | |
what is esoteric debt | esoteric debt refers to debt instruments as well as other investments called esoteric assets that are structured in a way that few people fully understand esoteric debt is complex and can be a product of securitization or simply arise through a complex financing arrangement as such the pricing of these securities can be contested or seem to be known to relatively few market participants moreover the structure of these instruments may lead to deceptively attractive risk return profiles over other investments when the instruments function properly but can also lead to illiquidity and pricing problems when markets are disrupted understanding esoteric debtesoteric debt can refer to a range of debt investments some are based off collateral that isn t a traditional base from which to offer bonds or other debt securities including things like patents fees licensing agreements and so on others offer complex payment terms to the issuing company pay in kind toggle notes for example are debt securities that allow a company to toggle between two options one is to make the interest payment the other is to take on extra debt owing to the security holder these investments come with higher risks and therefore offer higher yields than regular bonds or even junk bonds they also come with the extra issues of liquidity as the market for complex instruments is thin at the best of times and can completely vanish during periods of uncertainty a common type of esoteric debt are pass through securities pools of individual fixed income securities that are in turn backed by a package of assets a servicing intermediary collects the monthly payments from issuers and after deducting a fee remits or passes them through to the holders of the pass through security mortgage backed securities mbs are a common example of pass through securities they derive their value from unpaid mortgages in which the owner of the security receives payments based on a partial claim to the payments being made by the various debtors multiple mortgages are packaged together forming a pool which thus spreads the risk across multiple loans however some mortgage owners are likely to refinance their home or sell meaning that their loans will be paid off early others may default on their loan these unknowns lead to esoteric pricing models that can vary among and between counterparties in this market auction rate securities are another example of an esoteric debt vehicle that has been effectively shut down since the 2008 financial crisis esoteric debt and the financial crisisthe financial crisis of 2008 2009 introduced the global economy to some of the risks inherent in having too much esoteric debt and too many esoteric investments in general during this time credit was flowing so freely that many companies and third party issuers were creating innovative and imaginative debt vehicles tailored to whatever a particular investor wanted the primary driver of course was to make a lot of money in fees and meet the financing needs of some desperate companies rather than as a favor to investors | |
when the credit market seized up as companies struggled to accurately value their holdings of mortgage backed securities and credit default swaps the oddball esoteric debt was considered too complex to even bother with so while there was a slow and painful process that eventually led to the troubled mbs being priced and then moved the market for esoteric debt froze entirely without accurate pricing information there were few buyers to help investors move esoteric debt off their balance sheets this took down the auction rate securities market which was once perceived as being slightly more risky than the money market the sec stepped in on that particular file to force settlements over improper disclosure of risk but not all forms of esoteric debt received the same treatment | interestingly enough esoteric debt began reappearing shortly after the financial crisis transitioned to the great recession starved for yield investors were once again willing to take on complexity and liquidity risk for a better return while these complicated instruments may be more attractive than plain vanilla debt in good times they can present immense problems when the credit markets tighten | |
what is an estate | an estate is everything comprising the net worth of an individual including all land and real estate possessions financial securities cash and other assets that the individual owns or has a controlling interest in understanding estatesthe word estate is colloquially used to refer to all of the land and improvements on a vast property often some farm or homestead or the historic home of a prominent family however in the financial and legal sense of the term an estate refers to everything of value that an individual owns real estate art collections antique items investments insurance and any other assets and entitlements and is also used as an overarching way to refer to a person s net worth legally a person s estate refers to an individual s total assets minus any liabilities the value of a personal estate is of particular relevance in two cases if the individual declares bankruptcy and if the individual dies when an individual debtor declares bankruptcy their estate is assessed to determine which of their debts they can be reasonably expected to pay bankruptcy proceedings involve the same rigorous legal assessment of an estate that also occurs upon an individual s death estates are most relevant upon the death of an individual estate planning is the act of managing the division and inheritance of your personal estate and arguably represents the most important financial planning of an individual s life it s important to keep in mind that every country has specific rules about passing on wealth the allowed amounts and the approved estate planning trusts generally an individual draws up a will that explains the testator s intentions for the distribution of their estate upon their death a person who receives assets through inheritance is called a beneficiary | |
how estates are managed | in almost all cases estates are divided among members of the deceased s family this passage of wealth from one generation of a family to the next has a tendency to entrench income in certain social classes or families inheritance accounts for a massive proportion of total wealth in the united states and around the world and is in part responsible for persistent income inequality though there are of course many other factors partially as a response to the stagnation of wealth movement as a result of inheritance most governments require those in line for an inheritance to pay an inheritance tax estate tax on the estate this tax can be very large sometimes requiring the beneficiary to sell some of the inherited assets to pay the tax bill in the u s assets of an estate left to a spouse or a charity are generally not taxed 1it is generally advisable for both the individual drafting the will and the beneficiaries of an estate to employ the services of estate attorneys inheritance taxes are notorious for their complexity and exorbitance and the use of an attorney helps ensure that your inheritance taxes are paid correctly on the drafting end several measures can be taken to minimize the amount of tax one s beneficiaries will have to pay for example setting up trusts writing a willa will is a legal document created to provide instructions on how an individual s property and custody of minor children if any should be handled after death the individual expresses their wishes through the document and names a trustee or executor that they trust to fulfill the stated intentions the will also indicates whether a trust should be created after death depending on the estate owner s intentions a trust can go into effect during their lifetime living trust or after the death of the individual testamentary trust 2the authenticity of a will is determined through a legal process known as probate probate is the first step taken in administering the estate of a deceased person and distributing assets to the beneficiaries when an individual dies the custodian of the will must take the will to the probate court or to the executor named in the will typically within 30 days of the death of the testator however it varies by state for example florida requires a will be filed within 10 days of being notified of the death 3the probate process is a court supervised procedure in which the authenticity of the will left behind is proven to be valid and accepted as the true last testament of the deceased the court officially appoints the executor named in the will which in turn gives the executor the legal power to act on behalf of the deceased 4 | |
what is estate planning | estate planning refers to the preparation of tasks that manage an individual s financial situation in the event of their incapacitation or death this planning includes the bequest of assets to heirs and the settlement of estate taxes and debts along with other considerations like the guardianship of minor children and pets most estate plans are set up with the help of an attorney experienced in estate law some of the steps include listing assets and debts reviewing accounts and writing a will the estate planning processestate planning involves determining how an individual s assets will be preserved managed and distributed after death it also takes into account the management of an individual s properties and financial obligations in the event that they become incapacitated assets that could make up an estate include houses vehicles stocks art collectibles life insurance pensions debt and more contrary to what you might think this isn t a tool meant just for the ultra wealthy anyone can and should consider estate planning there are various reasons why you might begin estate planning such as preserving family wealth providing for a surviving spouse and children funding children s or grandchildren s education and leaving your legacy for a charitable cause writing a will is one of the most important steps but there s so much more to do other major estate planning tasks include the following the following table serves as a checklist when it comes to planning your estate writing a willa will is a legal document that provides instructions about how an individual s property and custody of minor children if any should be handled after death the individual expresses their wishes and names a trustee or executor that they trust to fulfill their stated intentions the will also indicates whether a trust should be created after death depending on the estate owner s intentions a trust can go into effect during their lifetime through a living trust or with a testamentary trust after their death 1the authenticity of a will is determined through a legal process known as probate probate is the first step taken in administering the estate of a deceased person and distributing assets to the beneficiaries when an individual dies the custodian of the will must take the will to the probate court or to the executor named in the will typically within 10 to 30 days of the death of the individual who is also called a testator 2the probate process is a court supervised procedure in which the authenticity of the will left behind is proved to be valid and accepted as the true last testament of the deceased 3 the court officially appoints the executor named in the will which in turn gives the executor the legal power to act on behalf of the deceased 45estate planning is an action plan you can use to determine what happens to your assets and obligations while you re alive and after you die a will on the other hand is a legal document that outlines how assets are distributed who takes care of children and pets and any other wishes after you die appointing the right executorthe legal personal representative or executor approved by the court is responsible for resolving the financial affairs of the deceased 4 including locating and overseeing all assets the executor has to estimate the value of the estate by using either the date of death value or the alternative valuation date as provided in the internal revenue code irc 67assets that need to be assessed during probate include most assets that are subject to probate administration come under the supervision of the probate court in the place where the decedent lived at death the exception is real estate which may need to be probated in the county in which it is located 8the executor also has to pay off any taxes and debt owed by the deceased from the estate creditors usually have a limited amount of time from the date they were notified of the testator s death to make claims against the estate for money owed to them 9 claims that are rejected by the executor can be taken to court where a probate judge will have the final say as to whether or not the claim is valid the executor is also responsible for filing the final personal income tax returns on behalf of the deceased 10 after the inventory of the estate has been taken the value of assets calculated and taxes and debt paid off the executor will then seek authorization from the court to distribute whatever is left of the estate to the beneficiaries 3any estate taxes that are pending will come due within nine months of the date of death 10planning for estate taxesfederal and state taxes applied to an estate can reduce its value considerably before assets are distributed to beneficiaries death can result in large liabilities for the family necessitating generational transfer strategies that can reduce eliminate or postpone tax payments there are significant steps in the estate planning process that individuals and married couples can take to reduce the impact of these taxes married couples for example can set up an a b trust that divides into two after the death of the first spouse trust a is the survivor s trust while trust b becomes the decedent s trust typically for the beneficiaries such as the couple s children each individual places their assets in the trust and names someone other than their spouse as the beneficiary 11 however a b trusts have become less popular as the estate tax exemption works well for most estates grandparents may transfer assets to an entity such as a 529 plan to support grandchildrens education 1213that may be a more tax efficient move than having those assets transferred after death to fund college or other schooling when the beneficiaries are of age the latter may trigger multiple tax events that can limit the amount of funding available to grandchildren another strategy an estate planner can take to minimize the estate s tax liability after death is giving to charitable organizations while alive the gifts reduce the financial size of the estate since they are excluded from the taxable estate thus lowering the estate tax bill 14as a result the individual has a lower effective cost of giving which provides additional incentive to make those gifts estate planners can work with the donor in order to reduce taxable income as a result of those contributions or formulate strategies that maximize the effect of those donations 1514this is another strategy that can be used to limit death taxes it involves an individual locking in the current value and thus tax liability of their property while attributing the value of future growth of that capital to another person any increase that occurs in the value of the assets in the future is transferred to the benefit of another person such as a spouse child or grandchild 16this method involves freezing the value of an asset at its value on the date of transfer accordingly the amount of potential capital gain at death is also frozen allowing the estate planner to estimate their potential tax liability upon death and better plan for the payment of income taxes 1718using life insurance in estate planninglife insurance serves as a source to pay death taxes and expenses fund business buy sell agreements and fund retirement plans if sufficient insurance proceeds are available and the policies are properly structured any income tax on the deemed dispositions of assets following the death of an individual can be paid without resorting to the sale of assets proceeds from life insurance that are received by the beneficiaries upon the death of the insured are generally income tax free 19 | |
what is estate planning | estate planning is a broad term that is used to describe the process that individuals go through to plan the administration of their assets and liabilities before and after they die this process also includes writing a will reviewing accounts and assets creating joint accounts preparing other legal documents and appointing an executor among other things | |
how expensive is estate planning | estate planning costs vary based on the steps you take and how you undergo the process for instance using an estate planner or lawyer may require you to pay an hourly fee for their services keep in mind that you may be able to secure a flat fee for services rendered other fees associated with estate planning include the preparation of a will which can be as low as a few hundred dollars if you use one of the best online will makers | |
what documents do i need as part of my estate planning | there are certain documents you ll need as part of the estate planning process some of the most common ones include wills powers of attorney poas guardianship designations and living wills other paperwork you ll need and will find useful include bank account statements full lists of your holdings assets and liabilities and beneficiary designations | |
is estate planning only for the wealthy | there is a myth that estate planning is only for high net worth individuals but that s not true in fact estate planning is a tool that everyone can use estate planning makes it easier for individuals to determine their wishes before and after they die contrary to what most people believe it extends beyond what to do with assets and liabilities in fact estate planning can also answer questions about the guardianship of minor children and pets what to do when it comes time for your funeral and what charities you want to support after you die the bottom lineyou should start planning for your estate as soon as you have any measurable asset base it s an ongoing process as life progresses your estate plan should shift to match your circumstances in line with your new goals and keep at it not doing your estate planning can cause undue financial burdens to loved ones estate taxes can run as high as 40 so at the very least set up a will even if the taxable estate is not large 20estate planning is often thought of as a tool for the wealthy but that isn t the case it can be a useful way for you to deal with your assets and liabilities before and after you die estate planning is also a great way for you to lay out plans for the care of your minor children and pets and to outline your wishes for your funeral and favorite charities but don t confuse writing a will with estate planning the former is just one of the steps you ll need to take in the estate planning process while you re at it make sure you appoint a responsible executor and review your accounts on a regular basis to ensure you re getting the most bang for your buck | |
what is an estate tax | the estate tax is a federal tax levied on the transfer of the estate of a person who dies an estate tax applies when the value exceeds an exclusion limit set by law only the amount that exceeds that minimum threshold is subject to tax 1assessed by the federal government and several state governments these levies are calculated based on the estate s fair market value fmv rather than what the deceased originally paid for its assets the tax is levied by the federal government and also the state where the deceased was living when they died if that state has an estate tax | |
how federal estate taxes work | the internal revenue service irs requires estates with combined gross assets and prior taxable gifts exceeding 12 92 million for 2023 and 13 61 million for 2024 to file a federal estate tax return and pay estate tax for an estate worth 13 7 million with a 2024 exclusion limit of 13 61 million estate taxes would be levied on 90 000 of the estate 2the unlimited marital deduction eliminates the estate tax on assets transferred to a surviving spouse however when the surviving spouse who inherited an estate dies the beneficiaries may owe estate taxes if the estate exceeds the exclusion limit 3 | |
how state estate taxes work | an estate that escapes federal tax may still be subject to taxation by the state in which the decedent was living at the time of their death however estates valued at less than 1 000 000 are not taxed in any jurisdiction 4connecticut has enacted legislation for its exemption to match the federal exemption beginning in 2023 5 as of 2024 these jurisdictions have estate taxes with the following threshold minimums estate tax and gift taxsince estate taxes are levied on an individual s assets and estate after death they can be avoided if you gift assets before you die however the federal gift tax applies to assets that are given away within certain limits while the taxpayer is living according to the irs the gift tax applies whether the donor meant the transfer as a gift or not 7the irs offers generous gift exclusions for 2024 the annual exclusion is 18 000 meaning tax filers can gift up to 18 000 to each person they wish without paying tax on any of those gifts for the 2023 tax year the annual exclusion was 17 000 8these provisions make gifting an effective way to avoid tax on assets transferred to people besides your spouse who might be subject to the estate tax if the assets were transferred as part of an estate if your gifts exceed the gift exclusion limit they aren t subject to tax immediately and may never be taxed unless your estate is substantial the amount above the gift limit is noted and added to the taxable value of your estate when calculating estate tax after you die 9if making a gift of 79 000 in 2024 with an exclusion of 18 000 the remaining 61 000 will need to be reported on a 709 gift tax return that 61 000 will reduce your lifetime exclusion to 13 million and also your estate tax exclusion to 13 million 819the estate tax is sometimes referred to pejoratively as a death tax since it is levied on the assets of a deceased individual estate tax and inheritance taxan estate tax is applied to an estate before the assets are given to beneficiaries in contrast an inheritance tax applies to assets after they have been inherited and are paid by the inheritor 10there is no federal inheritance tax however select states including iowa kentucky maryland nebraska new jersey and pennsylvania levy inheritance taxes maryland has both an estate and an inheritance tax 11the inheritance tax is assessed by the state in which the beneficiary is living whether your inheritance will be taxed and at what rate depends on its value your relationship to the decedent and the prevailing rules and rates where you live 12as with estate tax an inheritance tax if due is applied only to the sum that exceeds the exemption above those thresholds the tax is usually assessed on a sliding basis rates typically begin in the single digits and rise to between 15 and 20 as of 2024 the exemption you receive and the rate you re charged may vary by your relationship with the deceased life insurance payable to a named beneficiary is not typically subject to an inheritance tax although life insurance payable to the deceased person or their estate is usually subject to an estate tax 1314as a rule the closer your relationship to the decedent the lower the rate you ll pay surviving spouses are exempt from inheritance tax in all six states domestic partners too are exempt in new jersey 1115 nebraska and pennsylvania exempt descendants aged 21 and younger 1617here are the jurisdictions that have inheritance taxes and their threshold minimums for 2024 iowa will abolish its inheritance taxation in 2025 18because the rates for estate tax can be quite high careful estate planning is advisable for individuals who have estates worth millions of dollars that they want to leave to heirs or other beneficiaries | |
what is estimated ultimate recovery | estimated ultimate recovery eur is a production term commonly used in the oil and gas industry estimated ultimate recovery is an approximation of the quantity of oil or gas that is potentially recoverable or has already been recovered from a reserve or well eur is similar in concept to recoverable reserves understanding estimated ultimate recoveryestimated ultimate recovery can be calculated using many differing methods and units depending on the project or study being conducted in the oil and gas industry it is of the utmost importance that drilling projects meet an acceptable eur threshold for a project to be considered viable and profitable a more precise definition of eur is discovered oil reserves and there are three categories each based on the degree of likelihood that the oil can be recovered using current technology keep in mind that part of an oil field s probable and possible reserves are converted into proven reserves over time these reserves can be re categorized for a number of reasons ranging from improvements in oil recovery methods and techniques to changing oil prices for example as oil prices rise the quantity of proven reserves also rises because the breakeven price of recovery can be met reserves that were too expensive to produce at lower oil prices become viable as oil prices rise this makes it possible to reclassify these more costly reserves as proven the opposite happens as oil prices fall if oil reserves become too expensive to recover at current market prices the probability of them being produced also falls this results in reserves being reclassified from proven back to probable or even possible eur s use to value oil reserveswithout an estimated ultimate recovery oil companies would not be able to make rational investment decisions like all projects management needs to be able to estimate accurately the net present value npv of an oil drilling project this valuation exercise requires several inputs like the cost of bringing the first barrel to production the cost of capital the long term price of oil and the ultimate amount of oil that will be produced or eur without an eur it would not be possible to reach an accurate valuation of the potential oil reserves | |
what is estoppel | the term estoppel refers to a legal principle that prevents someone from arguing something or asserting a right that contradicts what they previously said or agreed to by law put simply estoppel prevents one person from contradicting an action or statement from the past it is part of common law and is meant to prevent people from being unjustly wronged by the inconsistencies of another person s words or actions some of the most common forms of estoppel include collateral estoppel and promissory estoppel investopedia michela buttignol | |
how estoppel works | common law is a form of law that is derived from judicial decisions and precedent this means that the laws aren t established or based on legislation or statutes most of the legal system in the united states was based on english common law that was until the country s legal system became developed enough to set precedent to shape its own form of common law almost all countries with a judicial system based on common law including the united kingdom canada and the united states have incorporated multiple forms of the doctrine of estoppel in their laws while the names of the principles differ from country to country the concept is essentially the same consistency in both words and actions matters as noted above estoppel legally prevents people from making contradictory claims or actions as opposed to something they may have said or done in the past in simpler terms estoppel ensures that a person stays true to their word and doesn t unfairly damage someone else so if person a must adhere to their word if they make a promise to person b and later rescind it estoppel can take many different forms the most common of which are listed below the action of preventing someone from going back on their word is referred to as estop the person being who goes back on their word is considered estopped types of estoppelthere are different types of estoppel the following are some of the most common ones found in the legal arena other lesser known forms of estoppel are estoppel by record estoppel by deed laches estoppel by silence and reliance based estoppel estoppel certificate componentsan estoppel certificate is common in the mortgage and commercial real estate industries it is a document that is often required by lenders and third parties if and when property owners either try to sell their properties that are tenanted or refinance a loan this document which is also called an estoppel letter is generally prepared by the landlord and is signed by the lessee or tenant in essence it verifies and asserts claims made to the third party either a lender or a buyer by the landlord some of the most common details included in the certificate or letter are example of estoppelpromissory estoppel was the heart of a case pitting two neighbors against one another in iowa a farmer leased property from his neighbor who he said promised to sell him his farm at some point in the future for 3 000 an acre 1the farmer then made substantial improvements to the property during the term of the lease with the expectation that he would become its eventual owner but the owner sold the property to a third party prompting his neighbor to file a lawsuit saying he had the right to purchase the farm 1at the trial the jury awarded the farmer 52 000 in damages to cover the improvements made to the property eventually the case found its way to the iowa court of appeals which ruled that the option for the farmer to purchase the farm did not need to be included in the written lease agreement to be valid the court stated that there was a clear and definite promise along with the neighbor s understanding that the farmer was relying on that promise as such the property owner was ordered to pay the farmer damages 1 | |
how do you define estoppel | estoppel is part of common law it is a legal principle that prevents someone from going back on their word to someone else and unfairly causing damage to someone else if legal action is taken the court can stop or estop an individual from rescinding a promise made to another party | |
what is an estoppel certificate | estoppel is common in the mortgage industry and commercial real estate also called an estoppel letter or certificate it entails the use of a document that is signed by a tenant this document confirms the rental agreement set forth by the landlord it can be presented to a third party if the landlord or property owner tries to do anything with the property including selling it or trying to refinance a loan | |
what are the different types of estoppel | estoppel comes in many different forms some are more common while others are lesser known they include equitable estoppel promissory estoppel collateral estoppel and estoppel by deed others include estoppel by record estoppel by deed laches estoppel by silence and reliance based estoppel the bottom linecommon law is a legal system that is based on judicial precedents rather than statutes one of the principles of common law is estoppel although it may seem complicated estoppel ensures that one party doesn t unfairly damage another by going back on their word that means that someone can t legally take back something that they ve promised to another party this is especially true if one person s actions do harm to another | |
what is ether eth | ether is a cryptocurrency used in ethereum s global virtual machine it has several uses it is used to pay network participants for their contributions to the blockchain investors use it as a store of value and traders use it to take advantage of price movements consumers can use it to pay for goods and services at businesses that accept it learn more about ether and how it acts as the fuel that powers the ethereum blockchain and network understanding ether eth the ethereum blockchain is a distributed ledger designed as a platform that makes it easier for people to create decentralized applications additionally it was created to remove third parties from global financial systems and transfer monetary control to the people instead of governments and businesses a distributed worldwide virtual computer hosts the platform and the blockchain it uses nodes the remote hosts a consensus layer an execution layer an application layer and participants who provide the equipment necessary for hosting the virtual machine the operational costs of maintaining a host and participating in the network and blockchain are minimal but the volunteer validators must stake valuable ether of their own to host nodes validators receive a chance to validate transactions and earn a reward for their work issued in ether eth ether also holds market value and is exchangeable for fiat currency on cryptocurrency exchanges ether is thus a native cryptocurrency investment asset and a means of exchange the developers and community metaphorically refer to ether as the gas that powers the network it is called gas because ether is exchanged for the work done to verify transactions and secure the blockchain much like money spent to buy the gas that powers a car | |
how is ether different from bitcoin | while ether and bitcoin are cryptocurrencies they have many distinguishing differences this discussion is strictly about the token differences not the blockchains a bitcoin can be broken down into smaller denominations called satoshis one bitcoin is equal to 0 00000001 satoshi so there are 100 million satoshi per bitcoin you might see denominations of bitcoin referred to as mbtc or milli btc in this case 1 mbtc is 0 001 bitcoins or 100 000 satoshi ether consists of several denominations some of which are much smaller incrementally than a satoshi one ether is equal to bitcoin and ether both have uses on the blockchain they are both used to pay and reward participants for work done however ether has an additional use it is used as validator collateral | |
when a user wants to become a validator and receive payments for blockchain work they must lock ether in a process called staking when ether is staked it cannot be spent if a user acts unethically their staked ether is forfeited | investors may soon be able to invest in eight different spot ether etfs as the securities and exchange commission sec in may 2024 approved a rule change to list and trade shares of these etfs on the ethereum blockchain participants with enough ether staked are randomly chosen as validators and receive ether as a reward bitcoin is given as a reward for opening a new block on the blockchain ethereum validators are awarded newly minted ether and tips from users new ether tokens are awarded at a rate of about 1 700 eth per day per 14 million eth staked bitcoin will only ever have 21 million coins circulating the last of which is expected to be rewarded in 2140 the blockchain is also programmed to split rewards in half every 210 00 blocks roughly four years ether is limited to a total supply of 120 million when transactions are paid for in ether the fees are burned sent to an address with no keys the network mints new ether and pays the validators maintaining a balance of about 1 700 new ether issued per day | |
how high are ethereum gas fees | on may 27 2024 the average gas fee which varies was 13 gwei or about 0 99 | |
what is the gas fee in ethereum | gas fees are fees paid for transactions such as transferring ether to someone to pay for an item or creating smart contracts who earns ethereum gas fees ethereum gas fees consist of two portions a block base fee and a tip the block base fee is burned after the transaction and the tip is received by the randomly chosen validator the bottom lineat its base level ether functions as an on chain payment method for the ethereum blockchain and applications developed using it externally ether is a cryptocurrency generally accepted as a unit of account a medium of exchange and a store of value the comments opinions and analyses expressed on investopedia are for informational purposes only read our warranty and liability disclaimer for more info | |
what is ethereum classic etc | ethereum classic etc is an open source decentralized blockchain based distributed cryptocurrency platform that runs smart contracts ethereum classic was established in 2016 after the decentralized autonomous organization dao which used smart contracts operating on the ethereum blockchain was hacked the original blockchain was split in two with the majority of users choosing to reverse the hack and return the stolen funds ethereum classic and ethereum are rooted in the same code but have different technical and philosophical differences understanding ethereum classic etc ethereum classic is a blockchain platform it facilitates smart contracts which automate actions via the blockchain for example if one party agreed to sell an item for a specific price to another the smart contract would automate the payment and transfer of ownership removing the need to trust that either party would fulfill its obligation as noted above the blockchain was split into etc and ethereum after a hacking incident this split revealed philosophical divisions within the ethereum community based on the principle that code is law a small number of developers and miners believed that the dao s investors should suffer the consequences of investing in a flawed cryptocurrency project however the majority of the ethereum community decided to roll back the blockchain effectively creating a bailout for investors there have been many upgrades and improvements to the etc project since the split the goal of the project continues to be working toward becoming a global payment network using smart contracts that can function without centralized governance as with other cryptocurrencies ethereum classic will likely continue to strive to be a digital store of value meaning it can be saved and exchanged while retaining its value as of june 15 2024 the maximum supply of etc was 210 70 million coins with 147 5 million coins in circulation the crypto s market capitalization was 3 78 billion similar to bitcoin ethereum classic records transactions of value it can also be used as a distributed computer to run self executing smart contracts history of ethereum classicethereum was conceived by vitalik buterin and the ethereum foundation and launched in 2015 the ethereum blockchain was established as a network where transactions were facilitated using its native token ether eth the new network quickly became popular for initial coin offerings icos as different teams used the platform to launch their own tokens one of the most successful icos was the dao a decentralized venture fund where investors would vote on assets in which to invest this fund quickly accumulated more than 11 million eth from over 18 000 investors before unknown hackers discovered a smart contract bug allowing them to withdraw about one third of the dao s accumulated ether due to the scale of the hack many investors proposed reversing the ethereum blockchain to rescue the affected investors while others argued that doing so would set the precedent for future bailouts as many as 85 of the miners on the network switched to the hard fork as a result the ethereum blockchain split into two separate networks the newer network inherited the name ethereum and the native token ether the older one was renamed ethereum classic it also uses ether but it has a different symbol etc the network experienced a migration of miners after ethereum integrated proof of stake in 2022 developers have created several apps using its virtual machine concerns about ethereum classicalthough ethereum and ethereum classic offer smart contracts and are after the same market ethereum remains the more popular of the two networks ethereum s eth is second only to bitcoin as the most valuable cryptocurrency network in the world one of ethereum classic s chief concerns is its potential limitations regarding scalability the network can handle between 10 and 20 transactions per second but that number is far less than that of traditional payment networks although ethereum classic underwent many software upgrades the scalability of its payment systems remains one of its biggest challenges cryptocurrency market regulations continue to develop which may or may not change how ethereum classic and other networks operate future of ethereum classicthe future of etc looks less bright than that of ethereum since ethereum remains the more popular of the two networks the blockchain and cryptocurrency failed to gain much traction in the market losing market share to other cryptocurrencies notably bitcoin etc continues trading on exchanges and is mined by the crypto community the blockchain and cryptocurrency hang on to a seemingly solid base of traders and fans like ethereum etc has an improvement proposal process since its hard fork it has undergone several upgrades such as developing compatibility with ethereum s latest changes despite all this demand for etc continues to be strong and there is the possibility that the blockchain and cryptocurrency will remain competitors in the space investors will be able to start trading spot ether exchange traded funds etfs following approval from the securities and exchange commission sec in may 2024 these etfs will trade on the new york stock exchange nyse the nasdaq and the cboe bzx exchange ethereum classic vs ethereumone of the most significant differences from ethereum is that ethereum classic retained its proof of work mechanism and the competitive reward system ethereum used pre merge this means that ethereum classic s token can be mined whereas ethereum s cannot another difference is that ethereum does not have a limit on the number of tokens that can be issued ethereum classic has a limit of 210 7 million coins that will ever be introduced for every five million blocks the ethereum classic blockchain undergoes a fifthening this event is similar to bitcoin s halving where the block rewards are reduced by 20 every two years the last fifthening occurred in june 2024 and the reward dropped to 2 048 etc this reduction of rewards every two years is expected to continue as much as 95 of etc will mined by 2059 | |
does ethereum classic have a future | ethereum classic has weathered ups and downs since it forked from ethereum it continues to be developed and has a consistent base of traders investors and users whether it has a future depends on its ability to maintain its position as an attractive cryptocurrency and blockchain can ethereum classic reach 10 000 just like any other type of security it s difficult to predict what will happen to cryptocurrency prices etc could reach 10 000 but it s just as likely it will collapse and be worthless | |
is ethereum classic a good buy | it depends on your outlook preferences and risk tolerance it also depends entirely on how the market performs and when you decide to make an entry point your trading strategy also determines the viability of an investment in ethereum classic for instance you may choose to buy and hold the cryptocurrency as a long term investment or you may only keep it in your portfolio for a short time the bottom lineethereum classic is a blockchain that forked from ethereum in 2016 it maintains the blockchain that existed before the community voted to roll back the ethereum blockchain state after thieves stole millions from investors the comments opinions and analyses expressed on investopedia are for informational purposes online read our warranty and liability disclaimer for more info |
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