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what are the elements of interactive media | interactive media often provides audio and visual components as well as animated images and graphics but it doesn t have to be that fancy you re engaging in this type of media whenever you simply enter text into an app or tap a key on your laptop tablet or smartphone interactive media is basically anything that gives you some measure of control over what you re watching or contributing the bottom lineinteractive media allows people to connect with friends acquaintances or even businesses and organizations in a way that allows them to maintain some control over the encounter as a consumer you most likely engage in it every day as a business owner it provides you with a great tool to gauge customer satisfaction and to make changes to keep your business up and running in response to complaints and concerns | |
what are interbank deposits | the term interbank deposit refers to an arrangement between two banks in which one bank holds funds in an account for the other the interbank deposit arrangement requires that the holding bank open a due to account for the other this is a general ledger account with funds payable to another party in the arrangement the correspondent bank is the one that waits for the deposit understanding interbank depositsinterbank deposits are part of the interbank market the interbank market is a system used by banks and other financial institutions to trade currencies this system excludes retail investors individuals who buy and sell securities for their personal account instead of for another company or organization and other smaller trading parties most interbank trading conducted on the market is proprietary meaning banks do so between and for each other there are instances though where this type of banking takes place for large institutional customers in the interbank market banks borrow from and lend money to each other in order to manage liquidity and meet the reserve requirements that regulators place on them a reserve requirement is the amount of money a bank must keep in its vaults deposits as well as loans are among the many types of transactions that take place between banks that help them meet these conditions these transactions also provide the market with a great deal of liquidity | |
when two banks make an arrangement for an interbank deposit the holding bank sets up a due to account for the corresponding bank the institution that makes the deposit the due to account is a holding account also known as a payable account | banks use a special interest rate on deposits and short term loans this rate is known as the interbank rate the interbank rate depends on maturity market conditions and the credit ratings of the institutions involved these rates are the lowest that can be found at any particular time and are reserved for big banking institutions | |
what is the interbank market | the interbank market is a global network used by financial institutions to trade currencies and other currency derivatives directly between themselves some interbank trading is done by banks on behalf of large customers but most interbank trading is proprietary it takes place on behalf of the banks own accounts banks around the world use the interbank market to manage their own exchange rate and interest rate risk as well as to take speculative positions based on research the interbank market is a subset of the interdealer market an over the counter otc venue where financial institutions can trade a variety of asset classes among one another and on behalf of their clients this is often facilitated by interdealer brokers idbs understanding the interbank marketthe interbank market for foreign exchange forex serves commercial turnover of currency investments as well as a large amount of speculative short term currency trading the typical maturity term for transactions in the interbank market is overnight or six months 1the forex interdealer market is characterized by large transaction sizes and tight bid ask spreads currency transactions in the interbank market can be either speculative initiated with the sole intention of profiting from a currency move or for the purposes of hedging currency exposure it may also be proprietary but it s customer driven to a lesser extent by an institution s corporate clients these might include exporters and importers history of the interbank forex marketthe interbank forex market developed after the collapse of the bretton woods agreement and following the decision by former u s president richard nixon to take the country off the gold standard in 1971 2currency rates of most of the large industrialized nations were allowed to float freely at that point with only occasional government intervention there s no centralized location for the market because trading takes place simultaneously around the world it stops only for weekends and holidays the advent of the floating rate system coincided with the emergence of low cost computer systems that allowed increasingly rapid trading on a global basis voice brokers over telephone systems matched buyers and sellers in the early days of interbank forex trading but they were gradually replaced by computerized systems that could scan large numbers of traders for the best prices trading systems from reuters and bloomberg allow banks to trade billions of dollars at once with daily trading volume topping 6 trillion on the market s busiest days 3participants in the interbank marketa bank must be willing to make prices to other participants as well as ask for prices to be considered an interbank market maker interbank deals can top 1 billion in a single deal 1citicorp and jp morgan chase are among the largest players in the united states deutsche bank in germany and hsbc in asia are also among the largest there are several other participants in the interbank market including trading firms and hedge funds they contribute to the setting of exchange rates through their purchase and sale operations but other participants don t have as much of an effect on currency exchange rates as large banks do credit and settlement within the interbank marketmost spot transactions settle two business days after execution t 2 the major exception to this rule is the u s dollar versus the canadian dollar which settles the next day banks must have credit lines with their counterparts to trade even on a spot basis most banks have netting agreements that require the offset of transactions in the same currency pair that settle on the same date with the same counterpart this reduces settlement risk it substantially reduces the amount of money that changes hands and thus the risk involved | |
what is a bid ask spread | the bid ask spread is the difference between the bid price and the ask price the bid price is lower most of the time 4 | |
what is a market maker | market makers make stock transactions at any given time and they do so on a more or less continuous basis they provide bid ask spreads and their participation keeps the market liquid and flowing along 5 | |
what is a spot transaction | a spot transaction dictates the sale or purchase of a commodity or a currency for immediate delivery on a specific date usually within two business days the deadline can shift a little however depending on the nature of the market involved 6the bottom linethe interbank market is decentralized it isn t regulated but most central banks will collect data from market participants to assess whether there are any economic implications this market has to be monitored because any problems can have a direct impact on overall economic stability brokers who put banks in touch with each other for trading purposes have also become an important part of the interbank market ecosystem over the years | |
what was interbank network for electronic transfer inet | interbank network for electronic transfer inet processed credit and debit card transactions between financial institutions fis it handled the transferring of funds from cards bearing the mastercard inc ma logo prior to the introduction of banknet understanding interbank network for electronic transfer inet interbank network for electronic transfer inet dealt with the transfer of funds while mastercard s interbank national authorization system inas processed card authorizations interbank national authorization system inas was the first component of mastercard s global telecommunications network providing electronic authorization to replace earlier phone authorization technology interbank network for electronic transfer inet followed later offering electronic settlement services to replace the previous system in which banks sent each other paperwork eventually interbank network for electronic transfer inet and interbank national authorization system inas were combined into a single entity named banknet a global telecommunications network linking all mastercard card issuers acquirers and data processing centers into one financial network banknet facilitates payments across the world it has been in operation since 1997 and can handle millions of secure transactions each hour via its thousand plus data centers littered all over the globe before banknet a payment through mastercard took approximately 650 milliseconds to process banknet has cut down that time to 210 milliseconds banknet s architecture is based on a peer to peer protocol that routes transactions to various endpoints data centers are equipped with technology that provides redundancy and automatic activations of backup services in the event that a shutdown occurs banknet s architecture allows the regulation of bandwidth in accordance with demand this function is crucial to regulate the capacity of the system at peak times such as during the holiday shopping season for this technology and others banknet primarily partners with at t inc banknet also provides a transaction research service for chargeback requests this makes it possible for cardholders to get approved chargebacks in just a few hours the banknet hub and data warehouse is one of the largest in the world and can be used by issuers and analysts to research payments and retail transactions mastercard vs visamastercard inc ma runs one of the largest credit and debit card networks according to creditcard com there were 249 million mastercard credit cards in the u s and 725 million cards in the rest of the world at the end of march 2021 1mastercard s banknet technology gives it a big advantage over its rival visa inc v instead of using a peer to peer network visa handles transactions through a centralized or star based system this type of network connects its many endpoints to only a few main data centers in other words that means that if one of mastercard s data centers fails there should be many others online whereas if one of visa malfunctions a larger portion of transactions are likely to be affected still in terms of global dominance mastercard continues to play catch up to visa creditcard com data shows that visa is the largest of the four major u s credit card networks there were 343 million visa credit cards in circulation in the u s and 798 million visa credit cards in circulation outside of the u s at the end of september 2020 1 | |
what is the interbank rate | the interbank rate is the rate of interest charged on short term loans made between u s banks banks may borrow money from other banks to ensure that they have enough liquidity for their immediate needs or lend money when they have excess cash on hand the interbank lending system is short term typically overnight and rarely more than a week the term interbank rate also refers to the interest rate charged when banks conduct wholesale transactions in foreign currencies with banks in other nations | |
how the interbank rate works | banks are required by federal regulators to hold enough cash in reserve to accommodate day to day withdrawals from their customers these liquidity needs are generally managed by borrowing to cover any shortfall and lending to earn a modest interest on any excess 1the rate of interest earned on the banks money is based on the current federal funds rate this rate also known as the interbank rate or the overnight rate is actually set by the banks themselves 2 it is not set by the fed per se but is affected by the the one rate the federal reserve actually does set which is the discount rate 3 the fed has a target range it tries to keep the fed funds within but they don t actually set it that is up to the banks involved in that transaction the federal funds rate is a tool that the federal reserve uses to increase or decrease the amount of cash in the system overall a low rate encourages banks to borrow freely while a higher rate discourages such activity 2in the economic crisis of 2008 that kicked off the great recession the board cut the target range of the rate to between 0 and 0 25 and kept it there for seven years to encourage investment and borrowing a series of modest increases pushed the target up to a range of 2 25 to 2 5 in december 2018 then in response to the economic fallout of the 2020 crisis the fed again cut rates to close to 0 4this does not mean that a consumer will be able to directly take advantage of near zero rates the interbank rate is available only to the largest and most creditworthy financial institutions however all interest rates for borrowing or saving money are based on that key federal fund s rate so a rate for a mortgage or a credit card will be based on the federal funds rate plus a premium a consumer will never get the interbank rate on a loan the lowest rate is available only to the largest and most creditworthy financial institutions 5the interbank rate in foreign exchangethe alternate definition of interbank rate is relevant to the interbank market the global market used by financial institutions to buy and sell foreign currencies 5 in this case the interbank rate or interbank exchange rate is the current value of any currency as compared to any other currency the rates fluctuate constantly by fractions when the market is open most of this trading is done by the banks to manage their own exchange rate and interest rate risk though they also trade on behalf of some large institutional clients the interbank rate is what you see when you compare any two currencies in an online currency calculator as with the interbank interest rate consumers are not going to get the interbank foreign exchange rate when they exchange money they will get the interbank rate plus a premium that represents the profit of the company that exchanges the money 5 | |
what is the intercontinental exchange ice | the intercontinental exchange ice is an american company that owns and operates financial and commodity marketplaces and exchanges it was founded in may 2000 in atlanta georgia ice operations include futures exchanges cash exchanges central clearing houses and market services for off exchange trading 1ice operates futures exchanges in the u s u k eu canada singapore and abu dhabi its cash exchanges include the new york stock exchange nyse nyse arca nyse national nyse amex options nyse arca options and nyse chicago ice also operates six central clearing houses ice clear europe ice clear u s ice clear credit ice clear netherlands ice clear singapore and ice ngx 2ice became a publicly traded company on november 16 2005 and was added to the russell 1000 index on june 30 2006 34understanding the intercontinental exchange ice in may 2000 ice was founded by jeffrey c sprecher a power plant developer who wanted to create a more transparent and efficient platform for over the counter otc energy commodity trading 5 compared with manual trading the new platform provided greater price transparency efficiency liquidity and had lower costs | |
when it was founded the company s primary focus was on energy products specifically crude and refined oil natural gas power and emissions 5 through various acquisitions the company s activities broadened to include other commodities such as sugar cotton and coffee in addition to foreign cash exchanges and equity index futures 6 | in response to the 2007 08 financial crisis sprecher formed ice clear credit which would serve as a clearing house for credit default swaps over the counter otc derivatives and provide crucial risk management services for the market in march 2009 ice clear credit was created and approved by the federal reserve as a bank and two years later was designated as a clearing house and regulated by the cftc and sec 7 ice was the first to offer clearing services in the otc energy and credit derivatives markets 8 according to ice s q1 2022 report ice had cleared more than 16 4 trillion in credit default swaps up yoy by 9 7 9since its founding in 2000 ice s company growth has primarily been achieved through the acquisition of other exchanges it s first acquisition was the international petroleum exchange ipe now ice futures europe in 2001 5 in the following decade the company expanded by acquiring the new york board of trade nybot in 2005 winnipeg commodity exchange which is now ice futures canada in 2007 creditex group in 2008 and climate exchange in 2010 10 several more acquisitions occurred the next ten years nyse euronext in 2013 interactive data corporation idc in 2015 standard poor s securities evaluations inc in 2016 virtu bondpoint in 2017 chicago stock exchange chx in 2018 and simplifile lc in 2019 1112 ice s most recent expansion has continued with the acquisitions of ellie mae in 2020 and black knight in 2022 1314in june 2016 ice launched a new suite of data services and software called ice data services the proprietary real time data valuations analytics reference data evaluated pricing and connectivity solutions employed by ice data services are used by nyse superderivatives interactive data idc and other ice customers including financial institutions asset managers and individual investors ice data services also provides its customers with unique data from global exchanges and fixed income markets 15according the 2021 fia report ice is the fourth largest exchange group in the world behind cme group brazil s b3 and the national stock exchange of india ranked at the top spot 16 as of july 2022 the company has a market capitalization of 53 88 billion 17 | |
what is interest | interest is the monetary charge for the privilege of borrowing money interest expense or revenue is often expressed as a dollar amount while the interest rate used to calculate interest is typically expressed as an annual percentage rate apr interest is the amount of money a lender or financial institution receives for lending out money interest can also refer to the amount of ownership a stockholder has in a company usually expressed as a percentage investopedia nono floresunderstanding interestinterest is the concept of compensating one party for incurring risk and sacrificing the opportunity to use funds while penalizing another party for the use of someone else s funds the person temporarily parting ways with their money is entitled to compensation and the person temporarily using those funds is often required to pay this compensation | |
when you leave money in your savings account your account is credited interest this is because the bank uses your money and loans it out to other clients resulting in you earning interest revenue | the amount of interest a person must pay is often tied to their creditworthiness the length of the loan or the nature of the loan all else being equal interest and interest rates are higher when there is greater risk as the lender faces a greater risk in the borrower not being able to make their payments the lender may charge more interest to incentivize them to make the loan apr includes the loan s interest rate as well as other charges such as origination fees closing costs or discount points history of interest ratesthis cost of borrowing money is considered commonplace today however the wide acceptability of interest became common only during the renaissance interest is an ancient practice however social norms from ancient middle eastern civilizations to medieval times regarded charging interest on loans as a kind of sin this was due in part because loans were made to people in need and there was no product other than money being made in the act of loaning assets with interest the moral dubiousness of charging interest on loans fell away during the renaissance people began borrowing money to grow businesses in an attempt to improve their own station growing markets and relative economic mobility made loans more common and made charging interest more acceptable it was during this time that money began to be considered a commodity and the opportunity cost of lending it was seen as worth charging for political philosophers in the 1700s and 1800s elucidated the economic theory behind charging interest rates for lent money authors included adam smith fr d ric bastiat and carl menger iran sudan and pakistan use interest free banking systems iran is completely interest free while sudan and pakistan have partial measures 1 with this lenders partner in profit and loss sharing instead of charging interest on the money they lend this trend in islamic banking refusing to take interest on loans became more common toward the end of the 20th century regardless of profit margins today interest rates can be applied to various financial products including mortgages credit cards car loans and personal loans interest rates started to fall in 2019 and were brought to near zero in 2020 formula and calculation for interestin its most basic form interest is calculated by multiplying the outstanding principal by the interest rate interest interest rate principal or balancethe more complex aspect of calculating interest is often determining the correct interest rate the interest rate is often expressed as a percentage and is usually designated as the apr however calculating the apr often does not reflect any effects of compounding instead the effective annual rate is used to express the actual rate of interest to be paid often an annual rate must be converted to calculate the applicable interest earned in a given period for example if a savings account is to pay 3 interest on the average balance the account may award 0 25 3 12 months each month the applicable interest rate is then multiplied against the outstanding amount of money related to the interest assessment for loans this is the outstanding principal balance for savings this is often the average balance of savings for a given period in either case the amount of interest assessed each period will likely change for loans borrowers will have likely made payments that reduce the principal balance resulting in lower interest for savers general activity including the addition of last month s interest often changes the applicable balance your credit score has the most impact on the interest rate you are offered when it comes to various loans and lines of credit simple interest vs compound interesttwo main types of interest can be applied to loans simple and compound simple interest is a set rate on the principal originally lent to the borrower that the borrower has to pay for the ability to use the money compound interest is interest on both the principal and the compounding interest paid on that loan the latter of the two types of interest is the most common for obvious reasons individuals attempting to earn interest prefer compound interest agreements this agreement results in interest being earned on interest and results in more total earnings savings accounts with banks often earn compound interest any prior interest earned on your savings is deposited into your account and this new balance is what earns interest in future periods on the other hand compound interest is extremely concerning for borrowers especially if their accrued compound interest is capitalized into their outstanding principal this means the borrower s monthly payment will actually increase due to now having a greater loan than what they started with common applications of interestthere s countless ways a person can charge or be charged interest below are some common examples of where interest may be earned by one party and paid by another a quick way to get a rough understanding of how long it will take for an interest bearing account to double is to use the so called rule of 72 simply divide the number 72 by the applicable interest rate at 4 interest for instance and you ll double your investment in around 18 years i e 72 4 advantages and disadvantages of paying interestimagine a situation where you absolutely need reliable transportation to get to work there is no public transit system you do not own a car work is far away and you can t afford to buy an entire car outright the largest advantage of paying interest is it is a relatively low expense compared to alternatives paying interest also means a payer is holding debt building their credit history and potentially effectively using leverage for example real estate developers often borrow money to construct and rent buildings if the rate of return on the building is greater than the interest rate they are charged the company is successfully using someone else s money to make money for themselves on the downside interest is a recurring cash expense payers are often contractually obligated to pay interest and monthly payments are typically applied to interest assessments before paying down the principal consumers may find interest assessments overwhelming in addition having too many loans and too high of monthly payments may restrict a borrower from being able to take out more credit may be the result of much needed capital relatively speaking it may be worth the small expense during emergencies | |
is a result of building a strong credit history | may be used to leverage returns and generate higher profits | |
is usually paid before any principal balance can be paid down | may compound and become overwhelming for a borrower to overcome | |
are contractually obligated to be paid | advantages and disadvantages of collecting interesta strategy for many investors is to collect interest often a fixed amount or at least consistent interest often provides positive cash flow that is a reliable source of income depending on the creditworthiness of the person borrowing the money instead of having capital sitting around and not being used lending money to others is a more efficient way of deploying capital especially in the short term when the lender may need that money for a specific reason in the longer term interest is also touted as one of the simplest forms of passive income loans may require little to no administration or maintenance after the agreement is signed lenders may simply collect interest and principal payments there are some downsides to collecting interest first interest revenue is taxable even a small amount may push a taxpayer into a higher tax bracket next because you are collecting interest this means you are allowing someone else to use your capital though you may be satisfied collecting interest there will often be greater earning potential had you utilized the capital yourself also collecting interest may have philosophical opponents consider student loan debt assessments while some say interest rates near 10 are reasonable for the amount of risk these lenders are incurring others claim these rates are predatory to young adults and should not be assessed may provide source of cash flow if interest payments are collected monthly frequentlymay be a passive source of incomemay provide a consistent stream of income if the borrower is reliable in their payments | |
is a more efficient use of capital instead of not loaning it out | will increase a taxpayers tax liabilitymay be lower than what could have been earned had the lender deployed capital for their own investment purposemay attract negative attention in some situations depending on the borrower rate of interest and circumstanceinterest and macroeconomicsa low interest rate environment is intended to stimulate economic growth so that it is cheaper to borrow money this is beneficial for those who are shopping for new homes simply because it lowers their monthly payment and means cheaper costs when the federal reserve lowers rates it means more money in consumers pockets to spend in other areas and more large purchases of items such as houses banks also benefit from this environment because they can lend more money however low interest rates aren t always ideal a high interest rate typically tells us that the economy is strong and doing well in a low interest rate environment there are lower returns on investments and in savings accounts and of course an increase in debt which could mean more of a chance of default when rates go back up in response to covid 19 the federal reserve began enacting monetary policy as early as march 2020 3 then as the pandemic eased the federal reserve began raising the federal funds rate 4 as this federal funds rate influences the interest rate on many other types of loans borrowers soon found it to be more expensive to incur debt | |
what is accrued interest | accrued interest is interest that has been incurred but not paid for a borrower this is interest that is due for payment but cash has not been remit to the lender for a lender this is interest that has been earned that they have not yet been paid for interest is often accrued as part of a company s financial statements | |
what is the best way to earn interest | there are now many ways investors can deposit funds into alternative investments that generate interest this also means investors must take care in selecting borrowers the best way to earn interest is to property research the risk profile of your borrower should they default on the loan you may not have recourse to recover your lost principal | |
how much interest do bank accounts pay | the amount of interest paid by bank accounts will widely vary based on prevailing government rates and macroeconomic conditions for example during the covid 19 pandemic while the federal funds rate was low interest rates on bank accounts was near 0 then as the pandemic eased bank accounts began paying interest greater than 2 on bank deposits the bottom lineinterest is a critical part of our high functioning society by allowing individuals to borrower and lend money society has greater economic prosperity by encouraging spending as a result capital likely does not sit around idly it is borrowed by some and lent by others through the payment of interest individuals are encouraged to always be putting money to use | |
what is the interest coverage ratio | the interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt the interest coverage ratio is calculated by dividing a company s earnings before interest and taxes ebit by its interest expense during a given period the interest coverage ratio is sometimes called the times interest earned tie ratio lenders investors and creditors often use this formula to determine a company s riskiness relative to its current debt or for future borrowing investopedia laura porterformula and calculation of the interest coverage ratiothe coverage in the interest coverage ratio stands for the length of time typically the number of quarters or fiscal years for which interest payments can be made with the company s currently available earnings in simpler terms it represents how many times the company can pay its obligations using its earnings the formula used is interest coverage ratio ebit interest expense where ebit earnings before interest and taxes begin aligned text interest coverage ratio frac text ebit text interest expense textbf where text ebit text earnings before interest and taxes end aligned interest coverage ratio interest expenseebit where ebit earnings before interest and taxes the lower the ratio the more the company is burdened by debt expenses and the less capital it has to use in other ways when a company s interest coverage ratio is only 1 5 or lower its ability to meet interest expenses may be questionable companies need to have more than enough earnings to cover interest payments in order to survive future and perhaps unforeseeable financial hardships that may arise a company s ability to meet its interest obligations is an aspect of its solvency and is thus an important factor in the return for shareholders interest coverage ratio interpretationstaying above water with interest payments is a critical and ongoing concern for any company as soon as a company struggles with its obligations it may have to borrow further or dip into its cash reserve which is much better used to invest in capital assets or for emergencies while looking at a single interest coverage ratio may reveal a good deal about a company s current financial position analyzing interest coverage ratios over time will often give a much clearer picture of a company s position and trajectory looking at a company s interest coverage ratios on a quarterly basis for say the past five years lets investors know whether the ratio is improving declining or has remained stable and provides a great assessment of a company s short term financial health moreover the desirability of any particular level of this ratio is in the eye of the beholder to an extent some banks or potential bond buyers may be comfortable with a less desirable ratio in exchange for charging the company a higher interest rate on their debt example of the interest coverage ratiosuppose that a company s earnings during a given quarter are 625 000 and that it has debts upon which it is liable for payments of 30 000 every month to calculate the interest coverage ratio here one would need to convert the monthly interest payments into quarterly payments by multiplying them by three the remaining quarters in the calendar year the interest coverage ratio for the company is 625 000 90 000 30 000 x 3 6 94 this indicates the company has no current problems with liquidity on the other hand an interest coverage ratio of 1 5 is generally considered a minimum acceptable ratio for a company and the tipping point below which lenders will likely refuse to lend the company more money as the company s risk for default may be perceived as too high if a company s ratio is below one it will likely need to spend some of its cash reserves to meet the difference or borrow more which will be difficult for the reasons stated above otherwise even if earnings are low for a single month the company risks falling into bankruptcy types of interest coverage ratiostwo somewhat common variations of the interest coverage ratio are important to consider before studying the ratios of companies these variations come from alterations to ebit one such variation uses earnings before interest taxes depreciation and amortization ebitda instead of ebit in calculating the interest coverage ratio because this variation excludes depreciation and amortization the numerator in calculations using ebitda will often be higher than those using ebit since the interest expense will be the same in both cases calculations using ebitda will produce a higher interest coverage ratio than calculations using ebit another variation uses earnings before interest after taxes ebiat instead of ebit in interest coverage ratio calculations this has the effect of deducting tax expenses from the numerator in an attempt to render a more accurate picture of a company s ability to pay its interest expenses because taxes are an important financial element to consider for a clearer picture of a company s ability to cover its interest expenses ebiat can be used to calculate interest coverage ratios instead of ebit limitations of the interest coverage ratiolike any metric attempting to gauge the efficiency of a business the interest coverage ratio comes with a set of limitations that are important for any investor to consider before using it for one it is important to note that interest coverage is highly variable when measuring companies in different industries and even when measuring companies within the same industry for established companies in certain industries such as a utility company an interest coverage ratio of two is often an acceptable standard a well established utility will likely have consistent production and revenue particularly due to government regulations so even with a relatively low interest coverage ratio it may be able to reliably cover its interest payments other industries such as manufacturing are much more volatile and may often have a higher minimum acceptable interest coverage ratio of three or higher these kinds of companies generally see greater fluctuation in business for example during the recession of 2008 car sales dropped substantially hurting the auto manufacturing industry 1 a workers strike is another example of an unexpected event that may hurt interest coverage ratios because these industries are more prone to these fluctuations they must rely on a greater ability to cover their interest to account for periods of low earnings because of such wide variations across industries a company s ratio should be evaluated to others in the same industry and ideally those who have similar business models and revenue numbers furthermore while all debt is important to take into account when calculating the interest coverage ratio companies may choose to isolate or exclude certain types of debt in their interest coverage ratio calculations as such when considering a company s self published interest coverage ratio it s important to determine if all debts were included | |
what does the interest coverage ratio tell you | the interest coverage ratio measures a company s ability to handle its outstanding debt it is one of a number of debt ratios that can be used to evaluate a company s financial condition the term coverage refers to the length of time ordinarily the number of fiscal years for which interest payments can be made with the company s currently available earnings in simpler terms it represents how many times the company can pay its obligations using its earnings | |
how is the interest coverage ratio calculated | the ratio is calculated by dividing ebit or some variation thereof by interest on debt expenses the cost of borrowed funding during a given period usually annually | |
what is a good interest coverage ratio | a ratio above one indicates that a company can service the interest on its debts using its earnings or has shown the ability to maintain revenues at a fairly consistent level while an interest coverage ratio of 1 5 may be the minimum acceptable level two or better is preferred for analysts and investors for companies with historically more volatile revenues the interest coverage ratio may not be considered good unless it is well above three | |
what does a bad interest coverage ratio indicate | a bad interest coverage ratio is any number below one as this means that the company s current earnings are insufficient to service its outstanding debt the chances of a company being able to continue to meet its interest expenses on an ongoing basis are still doubtful even with an interest coverage ratio below 1 5 especially if the company is vulnerable to seasonal or cyclical dips in revenues the bottom linethe interest coverage ratio or times interest earned tie ratio is used to determine how well a company can pay the interest on its debts and is calculated by dividing ebit ebitda or ebiat by a period s interest expense generally a ratio below 1 5 indicates that a company may not have enough capital to pay interest on its debts however interest coverage ratios vary greatly across industries therefore it is best to compare ratios of companies within the same industry and with a similar business structure | |
what is an interest expense | an interest expense is the cost incurred by an entity for borrowed funds interest expense is a non operating expense shown on the income statement it represents interest payable on any borrowings bonds loans convertible debt or lines of credit it is essentially calculated as the interest rate times the outstanding principal amount of the debt interest expense on the income statement represents interest accrued during the period covered by the financial statements and not the amount of interest paid over that period while interest expense is tax deductible for companies in an individual s case it depends on their jurisdiction and also on the loan s purpose for most people mortgage interest is the single biggest category of interest expense over their lifetimes as interest can total tens of thousands of dollars over the life of a mortgage as illustrated by online calculators investopedia ellen lindner | |
how interest expenses work | interest expense often appears as a line item on a company s balance sheet since there are usually differences in timing between interest accrued and interest paid if interest has been accrued but has not yet been paid it would appear in the current liabilities section of the balance sheet conversely if interest has been paid in advance it would appear in the current assets section as a prepaid item while mortgage interest is tax deductible in the united states 1 it is not tax deductible in canada the loan s purpose is also critical in determining the tax deductibility of interest expense for example if a loan is used for bona fide investment purposes most jurisdictions would allow the interest expense for this loan to be deducted from taxes however there are restrictions even on such tax deductibility in canada for instance if the loan is taken out for an investment that is held in a registered account such as a registered retirement savings plan rrsp registered education savings plan resp or tax free savings account interest expense is not permitted to be tax deductible 2the amount of interest expense for companies that have debt depends on the broad level of interest rates in the economy interest expense will be on the higher side during periods of rampant inflation since most companies will have incurred debt that carries a higher interest rate on the other hand during periods of muted inflation interest expense will be on the lower side the amount of interest expense has a direct bearing on profitability especially for companies with a huge debt load heavily indebted companies may have a hard time serving their debt loads during economic downturns at such times investors and analysts pay particularly close attention to solvency ratios such as debt to equity and interest coverage interest coverage ratiothe interest coverage ratio is defined as the ratio of a company s operating income or ebit earnings before interest or taxes to its interest expense the ratio measures a company s ability to meet the interest expense on its debt with its operating income a higher ratio indicates that a company has a better capacity to cover its interest expense for example a company with 100 million in debt at 8 interest has 8 million in annual interest expense if annual ebit is 80 million then its interest coverage ratio is 10 which shows that the company can comfortably meet its obligations to pay interest conversely if ebit falls below 24 million the interest coverage ratio of less than 3 signals that the company may have a hard time staying solvent as an interest coverage of less than 3 times is often seen as a red flag | |
what is an interest only mortgage | an interest only mortgage is a type of mortgage in which the mortgagor the borrower is required to pay only the interest on the loan for a certain period the principal is repaid either in a lump sum at a specified date or in subsequent payments understanding an interest only mortgageinterest only mortgages can be structured in various ways interest only payments may be made for a specified time period may be given as an option or may last throughout the duration of the loan with some lenders paying the interest exclusively may be a provision that is only available for certain borrowers most interest only mortgages require only the interest payments for a specified time period typically five seven or 10 years after that the loan converts to a standard schedule a fully amortized basis in lender lingo and the borrower s payments will increase to include both interest and a portion of the principal 1usually interest only loans are structured as a particular type of adjustable rate mortgage arm known as an interest only arm you pay just the interest at a fixed rate for a certain number of years known as the introductory period after the introductory period ends the borrower starts repaying both principal and interest and the interest rate will start to vary 2 for example if you take out a 7 1 arm it means your introductory period of interest only payments lasts seven years and then your interest rate will adjust once a year 1fixed rate interest only mortgages are not very common they usually exist on longer 30 year mortgages paying off the interest only mortgageat the end of the interest only mortgage term the borrower has a few options some borrowers may choose to refinance their loan after the interest only term has expired which can provide for new terms and potentially lower interest payments with the principal other borrowers may choose to sell the home they mortgaged to pay off the loan still other borrowers may opt to make a one time lump sum payment when the loan is due having saved up by not paying the principal all those years 3special considerations for interest only mortgagessome interest only mortgages may include special provisions that allow for just paying interest under certain circumstances for example a borrower may be able to pay only the interest portion on their loan if damage occurs to the home and they are required to make a high maintenance payment in some cases the borrower may have to pay only interest for the entire term of the loan which requires them to manage accordingly for a one time lump sum payment interest only mortgage advantages and disadvantagesinterest only mortgages reduce the required monthly payment for a mortgage borrower by excluding the principal portion from a payment homebuyers have the advantage of increased cash flow and greater support for managing monthly expenses for first time home buyers an interest only mortgage also allows them to defer large payments into future years when they expect their income to be higher however just paying interest also means that the homeowner is not building up any equity in the property only the repayment of principal debt does that also when payments start to include principal they get significantly higher this could be a problem if it coincides with a downturn in one s finances loss of a job an unexpected medical emergency etc borrowers should cautiously estimate their expected future cash flow to ensure that they can meet the bigger monthly obligations and pay off the loan when required while interest only mortgage loans can be convenient for several reasons they may also add to default risk | |
what is an interest rate | the interest rate is the amount a lender charges a borrower and is a percentage of the principal the amount loaned the interest rate on a loan is typically noted on an annual basis and expressed as an annual percentage rate apr 1an interest rate can also apply to a savings account or certificate of deposit cd in this case a bank or credit union pays a percentage of the funds deposited to the account holder annual percentage yield apy refers to the interest earned on these deposit accounts 2investopedia julie bangunderstanding interest ratesinterest is essentially a charge to the borrower for the use of an asset assets borrowed can include cash consumer goods vehicles and property because of this an interest rate can be thought of as the cost of money higher interest rates make borrowing the same amount of money more expensive interest rates apply to most lending or borrowing transactions individuals borrow money to purchase homes fund projects launch or fund businesses or pay for college tuition businesses take out loans to fund capital projects and expand their operations by purchasing fixed and long term assets such as land buildings and machinery borrowed money is repaid either in a lump sum by a pre determined date or in periodic installments for loans the interest rate is applied to the principal which is the amount of the loan the interest rate is the cost of debt for the borrower and the rate of return for the lender the money to be repaid is usually more than the borrowed amount since lenders require compensation for the loss of use of the money during the loan period the lender could have invested the funds during that period instead of providing a loan which would have generated income from the asset the difference between the total repayment sum and the original loan is the interest charged | |
when the borrower is considered to be low risk by the lender the borrower will usually be charged a lower interest rate if the borrower is considered high risk the interest rate that they are charged will be higher which results in a higher cost loan | risk is typically assessed when a lender looks at a potential borrower s credit score which is why it s important to have an excellent one if you want to qualify for the best loans simple interest rateif you take out a 300 000 loan from the bank and the loan agreement stipulates that the interest rate on the loan is 4 simple interest this means that you will have to pay the bank the original loan amount of 300 000 4 x 300 000 300 000 12 000 312 000 the example above was calculated based on the annual simple interest formula which is the individual who took out the loan will have to pay 12 000 in interest at the end of the year assuming it was only a one year lending agreement if the loan was a 30 year mortgage the interest payment will be simple interest 300 000 x 4 x 30 360 000a simple interest rate of 4 annually translates into an annual interest payment of 12 000 after 30 years the borrower would have made 12 000 x 30 years 360 000 in interest payments which explains how banks make money through loans mortgages and other types of lending compound interest ratesome lenders prefer the compound interest method which means that the borrower pays even more in interest compound interest also called interest on interest is applied both to the principal and also to the accumulated interest made during previous periods the bank assumes that at the end of the first year the borrower owes the principal plus interest for that year the bank also assumes that at the end of the second year the borrower owes the principal plus the interest for the first year plus the interest on interest for the first year the interest owed when compounding is higher than the interest owed using the simple interest method the interest is charged monthly on the principal including accrued interest from the previous months for shorter time frames the calculation of interest will be similar for both methods as the lending time increases however the disparity between the two types of interest calculations grows using the example above at the end of 30 years the total owed in interest is almost 673 019 on a 300 000 loan with a 4 interest rate the following formula can be used to calculate compound interest let s look at another example ben takes out a three year loan of 10 000 at an interest rate of 5 which compounds annually in the end as worked out in the calculation below he pays 1 576 25 in interest on the loan compound interest and savings accounts | |
when you save money using a savings account compound interest is favorable the interest earned on these accounts is compounded and is compensation to the account holder for allowing the bank to use the deposited funds | if for example you deposit 500 000 into a high yield savings account the bank can take 300 000 of these funds to use as a mortgage loan to compensate you the bank pays 5 interest into the account annually so while the bank is taking 8 from the borrower it is giving 5 to the account holder netting it 3 in interest in effect savers lend the bank money which in turn provides funds to borrowers in return for interest borrower s cost of debtwhile interest rates represent interest income to the lender they constitute a cost of debt to the borrower companies weigh the cost of borrowing against the cost of equity such as dividend payments to determine which source of funding will be the least expensive since most companies fund their capital by either taking on debt and or issuing equity the cost of the capital is evaluated to achieve an optimal capital structure apr vs apyinterest rates on consumer loans are typically quoted as the annual percentage rate apr this is the rate of return that lenders demand for the ability to borrow their money 3 for example the interest rate on credit cards is quoted as an apr in our example above 4 is the apr for the mortgage or borrower the apr does not consider compounded interest for the year the annual percentage yield apy is the interest rate that is earned at a bank or credit union from a savings account or cd this interest rate takes compounding into account | |
how are interest rates determined | the interest rate charged by banks is determined by a number of factors such as the state of the economy a country s central bank e g the federal reserve in the u s sets the interest rate which each bank uses to determine the apr range they offer 4 when the central bank sets interest rates at a high level the cost of debt rises when the cost of debt is high it discourages people from borrowing and slows consumer demand interest rates tend to rise with inflation to combat inflation banks may set higher reserve requirements tight money supply ensues or there is greater demand for credit in a high interest rate economy people resort to saving their money since they receive more from the savings rate the stock market suffers since investors would rather take advantage of the higher rate from savings than invest in the stock market with lower returns businesses also have limited access to capital funding through debt which leads to economic contraction economies are often stimulated during periods of low interest rates because borrowers have access to loans at inexpensive rates since interest rates on savings are low businesses and individuals are more likely to spend and purchase riskier investment vehicles such as stocks this spending fuels the economy and provides an injection to capital markets leading to economic expansion while governments prefer lower interest rates they eventually lead to market disequilibrium where demand exceeds supply causing inflation when inflation occurs interest rates increase which may relate to walras law the average interest rate on a 30 year fixed rate mortgage in february 2024 this is up from 6 50 a year earlier and 3 89 two years earlier 5interest rates and discriminationdespite laws such as the equal credit opportunity act ecoa that prohibit discriminatory lending practices systemic racism prevails in the u s there is evidence proving that white people get approved more often for mortgages data reported under the home mortgage disclosure act the most comprehensive publicly available information on mortgage market activity showed that black hispanic white and asian applicants were denied conventional mortgage loans in 2022 16 4 11 1 and 9 2 of the time respectively denial rates for white applicants on the other hand were much lower at 5 8 6there is also data suggesting that race impacts interest rates realtor com drawing on mortgage data from 2018 and 2019 discovered that homebuyers in predominantly black communities are offered mortgages with interest rates that are 13 basis points higher than homebuyers in white communities 7evidence of interest rate discrimination with mortgages has been confirmed by other sources including harvard university and think tank the urban institute which claimed in 2022 that the average black homeowner gets charged an interest rate 33 basis points higher than the average white homeowner and pays about 250 more per year in interest 89not everybody agrees with these findings a study by economists at the federal reserve board concluded that no race gets preferential treatment leading its authors to speculate that reporting of disparities elsewhere may be down to black and hispanic borrowers tending to choose slightly higher interest rates in return for lower up front costs 10the federal reserve board believes discrimination is improving and credits this in part to a rise in automated underwriting and stricter enforcement of the fair housing act and the ecoa 11 | |
why are interest rates on 30 year loans higher than 15 year loans | interest rates are a function of risk of default and opportunity cost longer dated loans and debts are inherently more risky as there is more time during which the borrower can default at the same time the opportunity cost is larger over longer time periods during which time that principal is tied up and cannot be used for any other purpose | |
how does the fed use interest rates in the economy | the federal reserve along with other central banks around the world uses interest rates as a monetary policy tool by increasing the cost of borrowing among commercial banks the central bank can influence many other interest rates such as those on personal loans business loans and mortgages this makes borrowing more expensive in general lowering the demand for money and cooling off a hot economy lowering interest rates on the other hand makes money easier to borrow stimulating spending and investment | |
why do bond prices react inversely to interest rate changes | a bond is a debt instrument that typically pays a fixed rate of interest over its lifetime 12 say that prevailing interest rates are 5 if a bond is priced at par 1 000 and has an interest rate coupon of 5 it will pay 50 a year to bondholders if interest rates rise to 10 new bonds issued will pay double i e 100 per 1 000 in face value an existing bond that only pays 50 will have to sell at a steep discount in order for somebody to want to buy it likewise if interest rates drop to 1 new bonds will only pay 10 per 1 000 in face value hence a bond that pays 50 will be in high demand and its price will be bid up quite high the bottom linean interest rate is the cost of debt for the borrower and the rate of return for the lender when you take out a loan you are expected to pay the entity lending you money something extra as compensation likewise if you deposit money in a savings account the financial institution may reward you because it can use part of this money to make more loans to its customers these charges or payments are called interest and are applied at a specified rate | |
what is an interest rate call option | an interest rate call option is a derivative in which the holder has the right to receive an interest payment based on a variable interest rate and then subsequently pays an interest payment based on a fixed interest rate if the option is exercised the investor who sells the interest rate call option will make a net payment to the option holder understanding interest rate call optionsto understand interest rate call options let s first remind ourselves of how prices in the debt market work there is an inverse relationship between interest rates and bond prices when prevailing interest rates in the market increase fixed income prices fall similarly when interest rates decline prices increase investors looking to hedge against an adverse movement in interest rates or speculators seeking to profit from an expected movement in rates can do so through interest rate options an interest rate option is a contract that has its underlying asset as an interest rate such as the yield of a three month treasury bill t bill or 3 month london interbank offered rate libor an investor who expects the price of treasury securities to fall or yield to increase will buy an interest rate put if she expects the price of the debt instruments to increase or yield to decrease an interest rate call option will be purchased an interest rate call option gives the buyer the right but not the obligation to pay a fixed rate and receive a variable rate if the underlying interest rate at expiration is higher than the strike rate the option will be in the money and the buyer will exercise it if the market rate drops below the strike rate the option will be out of the money and the investor will allow the contract to expire the amount of the payment when the option is exercised is the present value of the difference between the market rate on the settlement date and the strike rate multiplied by the notional principal amount specified in the option contract the difference between the settlement rate and strike rate must be adjusted for the period of the rate example of an interest rate call optionas a hypothetical example suppose an investor holds a long position in an interest rate call option which has the 180 day t bill as its underlying interest rate the notional principal amount stated in the contract is 1 million and the strike rate is 1 98 if the market rate increases past the strike rate to say 2 2 the buyer will exercise the interest rate call exercising the call gives the holder the right to receive 2 2 and pay 1 98 the payoff to the holder is payoff 2 2 1 9 8 1 8 0 3 6 0 1 million 2 2 5 1 million 1 1 0 0 begin aligned text payoff 2 2 1 98 times left frac 180 360 right times 1 text million 22 times 5 times 1 text million 1 100 end aligned payoff 2 2 1 98 360180 1 million 22 5 1 million 1 100 the interest rate options take the days to maturity attached to the agreement into account also the payoff from the option is not made until the end of the number of days attached to the rate for example if the interest rate option in our example expires in 60 days the holder will not be paid for 180 days since the underlying t bill matures in 180 days the payoff should therefore be discounted to the present time by finding the present value of 1 100 at 6 benefits of interest rate call optionslending institutions that wish to lock in a floor on future lending rates are the main buyers of interest rate call options clients are mostly corporations who need to borrow at some point in the future so the lenders would want to insure or hedge against adverse changes in interest rates during the interim a balloon payment is a large payment due at the end of a balloon loan interest rate call options can be used by an investor wishing to hedge a position in a loan in which interest is paid based on a floating interest rate by purchasing the interest rate call option an investor can limit the highest rate of interest for which payments would have to be made while enjoying lower rates of interest and she can forecast the cash flow that will be paid when the interest payment is due interest rate call options can be used in either a periodic or balloon payment situation also interest rate options can be traded on an exchange or over the counter otc | |
what is an interest rate collar | an interest rate collar is a relatively low cost interest rate risk management strategy that uses derivatives to hedge an investor s exposure to interest rate fluctuations understanding interest rate collara collar is a broad group of options strategies that involve holding the underlying security and buying a protective put while simultaneously selling a covered call against the holding the premium received from writing the call pays for the purchase of the put option in addition the call caps the upside potential for appreciation of the underlying security s price but protects the hedger from any adverse movement in the value of the security a type of collar is the interest rate collar essentially an interest rate collar involves the simultaneous purchase of an interest rate cap and sale of an interest rate floor on the same index for the same maturity and notional principal amount an interest rate collar uses interest rate options contracts to protect a borrower against rising interest rates while also setting a floor on declining interest rates an interest rate collar can be an effective way of hedging interest rate risk associated with holding bonds with an interest rate collar the investor purchases an interest rate ceiling which is funded by the premium received from selling an interest rate floor remember that there is an inverse relationship between bond prices and interest rates interest rates fall as bond prices rise and vice versa the objective of the buyer of an interest rate collar is to protect against rising interest rates purchasing an interest rate cap i e a bond put option or rates call option can guarantee a maximum decline in the bond s value although an interest rate floor bond call option or rates put option limits the potential appreciation of a bond given a decrease in rates it provides upfront cash and generates premium income that pays for the cost of the ceiling let s say an investor enters a collar by purchasing a ceiling with a strike rate of 10 and sells a floor at 8 whenever the interest rate is above 10 the investor will receive a payment from the seller of the ceiling if the interest rate drops below 8 which is below the floor the investor who is short the call must now make a payment to the party that purchased the floor clearly the interest rate collar strategy protects the investor by capping the maximum interest rate paid at the collar s ceiling but sacrifices the profitability of interest rate drops interest rate caps and floorsan interest rate cap establishes a ceiling on interest payments it is simply a series of call options on a floating interest rate index usually 3 or 6 month london inter bank offered rate libor which coincides with the rollover dates on the borrower s floating liabilities the strike price or strike rate of these options represent the maximum interest rate payable by the purchaser of the cap an interest rate floor is the minimum interest rate that is created using put options it reduces the risk to the party receiving the interest payments since the coupon payment each period will be no less than a certain floor rate or strike rate reverse interest rate collara reverse interest rate collar protects a lender e g a bank against declining interest rates which would cause a variable rate lender to receive less interest income if rates decline it involves the simultaneous purchase or long of an interest rate floor and sale or short of an interest rate cap the premium received from the short cap partly offsets the premium paid for the long floor the long floor receives a payment when the interest rate falls below the floor exercise rate the short cap makes payments when the interest rate exceeds the cap exercise rate | |
what is an interest rate derivative | an interest rate derivative is a financial instrument with a value that is linked to the movements of an interest rate or rates these may include futures options or swaps contracts interest rate derivatives are often used as hedges by institutional investors banks companies and individuals to protect themselves against changes in market interest rates but they can also be used to increase or refine the holder s risk profile or to speculate on rate moves understanding interest rate derivativesinterest rate derivatives are most often used to hedge against interest rate risk or else to speculate on the direction of future interest rate moves interest rate risk exists in an interest bearing asset such as a loan or a bond due to the possibility of a change in the asset s value resulting from the variability of interest rates interest rate risk management has become very important and assorted instruments have been developed to deal with interest rate risk interest rate derivatives can range from simple to highly complex they can be used to reduce or increase interest rate exposure among the most common types of interest rate derivatives are interest rate swaps caps floors and interest rate collars which create both a cap and a floor also popular are interest rate futures here the futures contract exists between a buyer and seller agreeing to the future delivery of any interest bearing asset such as a bond the interest rate future allows the buyer and seller to lock in the price of the interest bearing asset for a future date forwards on interest rate operate similarly to futures but are not exchange traded and may be customized between counterparties interest rate swapsa plain vanilla interest rate swap is the most basic and common type of interest rate derivative there are two parties to a swap party one receives a stream of interest payments based on a floating interest rate and pays a stream of interest payments based on a fixed rate party two receives a stream of fixed interest rate payments and pays a stream of floating rate payments both payment streams are based on the same notional principal and the interest payments are netted through this exchange of cash flows the two parties aim to reduce uncertainty and the threat of loss from changes in market interest rates a swap can also be used to increase an individual or institution s risk profile if they choose to receive the fixed rate and pay floating this strategy is most common with companies that have a credit rating that allows them to issue bonds at a low fixed rate but prefer to swap to a floating rate to take advantage of market movements caps and floorsa company with a floating rate loan that does not want to swap to a fixed rate but does want some protection can buy an interest rate cap the cap is set at the top rate that the borrower wishes to pay if the market moves above that level the owner of the cap receives periodic payments based on the difference between the cap and the market rate the premium which is the cost of the cap is based on how high the protection level is above the then current market the interest rate futures curve and the maturity of the cap longer periods cost more as there is a higher chance that it will be in the money a company receiving a stream of floating rate payments can buy a floor to protect against declining rates like a cap the price depends on the protection level and maturity selling rather than buying the cap or floor increases rate risk other interest rates instrumentsless common interest rate derivatives include eurostrips which are a strip of futures on the eurocurrency deposit market swaptions which give the holder the right but not the obligation to enter into a swap if a given rate level is reached and interest rate call options which give the holder the right to receive a stream of payments based on a floating rate and then make payments based on a fixed rate a forward rate agreement fra is an over the counter contract that fixes the rate of interest to be paid on an agreed upon date in the future to exchange an interest rate commitment on a notional amount the notional amount is not exchanged but rather a cash amount based on the rate differentials and the notional value of the contract | |
what is an interest rate differential ird | an interest rate differential ird weighs the contrast in interest rates between two similar interest bearing assets most often it is the difference between two interest rates traders in the foreign exchange market use irds when pricing forward exchange rates based on the interest rate parity a trader can create an expectation of the future exchange rate between two currencies and set the premium or discount on the current market exchange rate futures contracts understanding interest rate differential ird irds simply measure the difference in interest rates between two securities 1 if one bond yields 5 and another 3 the ird would be 2 percentage points or 200 basis points bps ird calculations are most often used in fixed income trading forex trading and lending calculations the ird is used in the housing market to describe the difference between the interest rate and a bank s posted rate on the prepayment date for mortgages 1the ird is also a key component of the carry trade a trading strategy that involves borrowing at a low interest rate and investing the proceeds in an asset that provides a higher rate of return carry trades often consist of borrowing in a low interest rate currency and then converting the borrowed amount into another currency with a higher yield 2interest rate differential a bond trade examplethe ird is the amount the investor can expect to profit using a carry trade 3 say an investor borrows 1 000 and converts the funds into british pounds allowing for the purchase of a british bond if the purchased bond yields 7 while the equivalent u s bond yields 3 then the ird equals 4 or 7 3 this profit is ensured only if the exchange rate between dollars and pounds remains constant one of the primary risks involved with this strategy is the uncertainty of currency fluctuations 3 in this example if the british pound were to fall in relation to the u s dollar the trader may experience losses additionally traders may use leverage such as a factor of 10 to 1 to improve their profit potential if the investor leveraged the borrowing by a factor of 10 to 1 they could make a profit of 40 however leverage could also cause larger losses if there are strong movements in exchange rates interest rate differential a mortgage example | |
when homebuyers borrow money to purchase houses there may be an ird | for example say a homebuyer purchased a home and took out a mortgage at a rate of 5 50 for 30 years assume 25 years have passed and the borrower only has five years left in the mortgage term the lender could use the current market interest rate it is offering for a five year mortgage to determine the ird if the current market interest rate on a five year mortgage is 3 85 the ird is 1 65 or 0 1375 per month 4interest rate differential ird vs net interest rate differential nird the net interest rate differential nird is a specific type of ird used in forex markets in international currency markets the nird is the difference between the interest rates of two distinct economic regions for instance if a trader is long the nzd usd pair they would own the new zealand currency and borrow the us currency these new zealand dollars can be placed into a new zealand bank while simultaneously taking out a loan for the same amount from the u s bank the nird is the difference in any interest earned and any interest paid while holding the currency pair position | |
what are interest rate differential calculations used for | ird calculations are used to demonstrate the difference in interest rates between two financial securities usually in fixed income trading forex trading and lending calculations | |
how is the interest rate differential used in the housing market | it s used in the housing market to illustrate the difference in rating between the stated interest rate and a bank s posted rate when it comes to prepayment dates for mortgages | |
how is the interest rate differential used in the carry trade | in carry trade investing an investor would borrow money in a low interest rate currency and then convert the amount that was borrowed into a higher yielding currency the ird is the difference between the two interest rates | |
what is an interest rate floor | an interest rate floor is an agreed upon rate in the lower range of rates associated with a floating rate loan product interest rate floors are utilized in derivative contracts and loan agreements this is in contrast to an interest rate ceiling or cap interest rate floors are often used in the adjustable rate mortgage arm market often this minimum is designed to cover any costs associated with processing and servicing the loan an interest rate floor is often present through the issuing of an arm as it prevents interest rates from adjusting below a preset level understanding interest rate floorsinterest rate floors and interest rate caps are levels used by varying market participants to hedge risks associated with floating rate loan products in both products the buyer of the contract seeks to obtain a payout based on a negotiated rate in the case of an interest rate floor the buyer of an interest rate floor contract seeks compensation when the floating rate falls below the contract s floor this buyer is buying protection from lost interest income paid by the borrower when the floating rate falls interest rate floor contracts are one of three common interest rate derivative contracts the other two being interest rate caps and interest rate swaps interest rate floor contracts and interest rate cap contracts are derivative products typically bought on market exchanges similar to put and call options interest rate swaps require two separate entities to agree on the swapping of an asset typically involving the exchanging of fixed rate debt for floating rate debt interest rate floor and interest rate cap contracts can provide a different alternative to the exchanging of balance sheet assets in an interest rate swap real world example of an interest rate flooras a hypothetical example assume that a lender is securing a floating rate loan and is looking for protection against lost income that would arise if interest rates were to decline suppose the lender buys an interest rate floor contract with an interest rate floor of 8 the floating rate on the 1 million negotiated loan then falls to 7 the interest rate floor derivative contract purchased by the lender results in a payout of 10 000 1 million 08 1 million 07 the payout to the holder of the contract is also adjusted based on days to maturity or days to reset which is determined by the details of the contract an interest rate floor is carefully calculated based on future market expectations the lender imposing the floor doesn t want to include this unfavorable loan term to the borrower only for the floor to never be met the use of floors in adjustable rate loan contractsan interest rate floor can also be an agreed upon rate in an adjustable rate loan contract such as an adjustable mortgage the lender s lending terms structure the contract with an interest rate floor provision which means that the rate is adjustable based on the agreed upon market rate until it reaches the interest rate floor a loan with an interest rate floor provision has a minimum rate that must be paid by the borrower to protect the income for the lender | |
how does an interest rate floor apply to my loan | an interest rate floor impacts your loan by creating a minimum interest rate even if prevalent market rates drop to 0 you will still be subject to a rate equal to at least the floor if your loan has an interest rate floor you will always be assessed interest on the outstanding principal | |
what does interest rate floor mean | an interest rate floor is a financing mechanism to ensure the lender is able to assess interest regardless of how external variable interest rates are performing an interest rate floor is a fixed interest rate that is triggered should interest rates drop below the floor | |
what does floor mean in finance | in general a floor in finance refers to a minimum that a certain set of criteria can not drop below an interest rate floor means regardless of other contingent interest rates a loan may be subject to a price floor means regardless of other market conditions the price of an item can not contractually fall below a specific limit a floor in finance is often set in protection of one party for example a lender will implement an interest rate floor to ensure their risk exposure to low rates is minimized even in the most unfavorable conditions the lender can still expect minimum contract conditions | |
what is floor or ceiling rate | a floor rate is the minimum rate a borrower will be charged alternatively a ceiling rate protects the borrow and caps the upper limit at which a borrower can be charged a floor rate protects the lender as the lender can always expect to collect a minimum amount of interest alternatively a ceiling rate protects the borrower as the borrower can always expect to never be forced to pay higher than a specific amount of interest | |
what is a floor on a libor rate | a floor rate is often established in conjunction with a variable rate like libor or sofr for example imagine a loan assessed at a rate of 1 month libor 1 50 with an interest rate ceiling of 4 and floor of 2 if 1 month libor falls to 0 25 the calculated rate would be 1 75 however this rate falls below the floor this loan would not be assessed at 1 75 instead the floor would be triggered and the rate used is 2 if 1 month libor rises to 3 the calculated rate would be 4 50 however this rate falls above the ceiling this loan would not be assessed at 4 50 instead the ceiling would be triggered and the rate used is 4 last if 1 month libor stabilizes at 1 the calculated rate would be 2 5 because 2 5 falls between the ceiling and the floor neither boundary is triggered the interest rate used for this period is 2 5 | |
when volatility strikes the bond markets traders turn to interest rate futures to hedge risks or speculate on where interest rates will head | an interest rate future is a contract with an underlying instrument that pays interest the contract is an agreement between the buyer and seller for future delivery of any interest bearing asset the interest rate futures contract lets traders lock in the price of the interest bearing asset for a future date as of january 2024 they were the second most popular type of futures contract after equities 1understanding interest rate futuresinterest rate futures have underlying instruments like treasury bills t bills with futures traded on the chicago mercantile exchange cme or treasury bonds t bond with t bond futures traded on the chicago board of trade cbot a division of the cme other products such as certificates of deposit cds treasury notes and ginnie mae securities are also available to trade as underlying assets of an interest rate future the most popular interest rate futures are the 30 year 10 year five year and two year treasurys as well as the eurodollar 23participants in the futures market range from large institutional hedgers seeking to mitigate risk on interest rate exposures to speculators aiming to profit from correctly betting on the direction in which rates move these futures contracts change hands daily on regulated commodity exchanges settling prices based on supply and demand | |
how do interest rate futures work | interest rate futures are contracts that allow buyers and sellers to lock in rates on an interest bearing asset like a government bond or interbank lending rate although actual delivery of these assets doesn t occur their value is tied to the underlying asset s price if interest rates go up the value of existing bonds goes down because their fixed rates look less attractive another popular interest rate future is treasury bond futures the underlying asset is a 100 000 face value u s treasury bond with a remaining term of at least 15 years until maturity 4 suppose a fund manager holds a large quantity of long term u s treasury bonds and worries that t bond prices will decline if interest rates rise in the coming months to hedge the risk the manager could sell treasury bond futures contracts locking in prices to sell at a future date if interest rates do rise as expected the prices of the manager s treasury portfolio would fall but gains in their short futures position would offset that loss this allows investors to mitigate their exposure to fluctuations in interest rates without having to sell their bond holdings speculators could take the opposing view and buy futures contracts to bet that interest rates will fall if rates decline then treasury bond prices rise as do the prices of their long futures contracts at expiration the contracts settle in cash based on the current market price without any bonds changing hands 5every day gains and losses on interest rate futures are cashed out in a marking to market process money is debited or credited to traders accounts depending on how the rates they locked in compare with the latest market prices 6by providing direct rate exposure in a standardized and efficiently traded vehicle interest rate futures afford participants a useful tool to manage risks or capitalize on rate swings across the yield curve their unique settlement procedures make investing based on your expectations for future interest rates and can often be more convenient than transacting in the cash bond markets pros and cons of interest rate futureshigh liquidity ensuring easy tradingeffective tool for hedging against riskreal time price transparency enhances trading decisions no control over unpredictable future eventsoverleveraging can lead to significant losses expiry dates present additional trading challenges components of interest rate futuresinterest rate futures are complex financial instruments with several key components the most relevant components include the underlying asset expiration date contract size and margin requirement 789contract size the contract size of an interest rate future refers to the face value of the underlying asset for instance with treasury bond futures the contract size is usually 100 000 or 200 000 worth of bonds expiration date the expiration date is the specified future date upon which the contract is set to be fulfilled the seller must deliver the interest bearing asset to the buyer on this date far more often there is a cash settlement margin requirement this is the amount of money that both parties must deposit as collateral this ensures that both the buyer and seller have sufficient means to cover potential losses and fulfill their obligations under the contract underlying asset this is typically a government bond or other debt instrument this asset will bear a fixed interest rate that is agreed upon when the contract is made interest rate futures exampletreasury based interest rate futures and eurodollar based interest rate futures trade differently the face value of most treasurys is 100 000 thus the contract size for a treasury based interest rate future is usually 100 000 each contract trades in handles of 1 000 which are split into thirty seconds or increments of 31 25 1 000 32 5 if a quote on a contract is listed as 101 25 or often listed as 101 25 this would mean the total price of the contract is the face value plus one handle plus 25 32 of another handle 101 25 price 100 000 1 000 1 000 2532 101 781 25 begin aligned 101 prime25 text price 100 000 1 000 left 1 000 times frac 25 32 right 101 781 25 end aligned 101 25 price 100 000 1 000 1 000 3225 101 781 25 eurodollar based contracts have a handle size of 2 500 and trade in increments of 25 unlike treasury based agreements these contracts can trade at half tick and quarter tick values this means that the minimum price movement of a 1 million contract is only 6 25 which equals 25 25 10the price of an interest rate future moves inversely to the change in interest rates if interest rates go down the price of the interest rate in the future will go up and vice versa for instance suppose a trader speculates that interest rates will fall over the next month and bond prices will rise the trader purchases a 30 year treasury bond futures contract for 102 28 one month later the trader s prediction is proven correct interest rates are lower and the interest rate future is now priced at 104 05 the trader sells here s the profit | |
what is an interest rate option | an interest rate option is a financial derivative that allows the holder to benefit from changes in interest rates investors can speculate on the direction of interest rates with interest rate options it is similar to an equity option and can be either a put or a call interest rate options are option contracts on the rate of bonds like u s treasury securities | |
what do interest rate options tell you | as with equity options an interest rate option has a premium attached to it or a cost to enter into the contract a call option gives the holder the right but not the obligation to benefit from rising interest rates the investor holding the call option earns a profit if at the expiry of the option interest rates have risen and are trading at a rate that s higher than the strike price and high enough to cover the premium paid to enter the contract conversely an interest rate put gives the holder the right but not the obligation to benefit from falling interest rates if interest rates fall lower than the strike price and low enough to cover the premium paid the option is profitable or in the money the option values are 10x the underlying treasury yield for that contract a treasury that has a 6 yield would have an underlying option value of 60 in the options market when treasury rates move or change so do the underlying values of their options if the 6 yield for a treasury rose to 6 5 the underlying option would increase from 60 to 65 12aside from outright speculation on the direction of interest rates interest rate options are also used by portfolio managers and institutions to hedge interest rate risk interest rate options can be entered into using short term and long term yields or what s commonly referred to as the yield curve which refers to the slope of the yields for treasuries over time if short term treasuries like the two year treasury have lower yields than long term treasuries like the 30 year yield the yield curve is upward sloping if long term yields are lower than short term yields the curve is said to be downward sloping interest rate options trade formally through the cme group one of the largest futures and options exchanges in the world regulation of these options is managed by the securities and exchange commission sec an investor may use options on treasury bonds and notes and eurodollar futures 3interest rate options have european style exercise provisions which means the holder can only exercise their options at expiration the limitation of option exercise simplifies their usage as it eliminates the risk of early buying or selling of the option contract the rate option strike values are yields not units of price also no delivery of securities is involved instead interest rate options are cash settled which is the difference between the exercise strike price of the option and the exercise settlement value determined by the prevailing spot yield 42example of an interest rate optionif an investor wants to speculate on rising interest rates they could buy a call option on the 30 year treasury with a strike price 60 and an expiration date of august 31 the premium for the call option is 1 50 per contract in the options market the 1 50 is multiplied by 100 so that the cost for one contract would be 150 and two call option contracts would cost 300 the premium is important because the investor must make enough money to cover the premium if yields rise by august 31 and the option is worth 68 at expiry the investor would earn the difference of 8 or 800 based on the multiplier of 100 if the investor had originally bought one contract the net profit would be 650 or 800 minus the 150 premium paid to enter into the call option 5conversely if yields were lower on august 31 and the call option was now worth 55 the option would expire worthless and the investor would lose the 150 premium paid for the one contract for an option that expires worthless it s said to be out of the money in other words its value would be zero and the buyer of the option loses the entire premium paid as with other options the holder does not have to wait until expiration to close the position all the holder needs to do is sell the option back in the open market for an options seller closing the position before expiration requires the purchase of an equivalent option with the same strike and expiration however there can be a gain or loss on unwinding the transaction which is the difference between the premium originally paid for the option and the premium received from the unwinding contract the difference between interest rate options and binary optionsa binary option is a derivative financial product with a fixed or maximum payout if the option expires in the money or the trader loses the amount they invested in the option if the option expires out of the money the success of a binary option is thus based on a yes or no proposition hence binary binary options have an expiry date or time at the time of expiry the price of the underlying asset must be on the correct side of the strike price based on the trade taken in order for the trader to make a profit 6an interest rate option is often called a bond option and can be confused with binary options however interest rate options have different characteristics and payout structures than binary options limitations of interest rate optionssince interest rate options are european based options they can t be exercised early like american style options however the contract can be unwound by entering into an offsetting contract but that s not the same as exercising the option investors must have a sound grasp of the bond market when investing in interest rate options treasury and bond yields have a fixed rate attached to them and treasury yields move inversely to bond prices as yields rise bond prices fall because existing bondholders sell their previously purchased bonds since their bonds have a lower paying yield than the current market in other words in a rising rate market existing bondholders don t want to hold their lower yielding bonds to maturity instead they sell their bonds and wait to buy higher yielding bonds in the future as a result when rates rise bond prices fall because of a sell off in the bond market 7 | |
what is interest rate parity irp | interest rate parity irp is a theory that the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate investopedia jessica olahunderstanding interest rate parity irp interest rate parity irp plays an essential role in foreign exchange markets by connecting interest rates spot exchange rates and foreign exchange rates 1it s the fundamental equation that governs the relationship between interest rates and currency exchange rates the basic premise of irp is that hedged returns from investing in different currencies should be the same regardless of their interest rates irp is the concept of no arbitrage in the foreign exchange markets the simultaneous purchase and sale of an asset to profit from a difference in the price investors can t lock in the current exchange rate in one currency for a lower price and then purchase another currency from a country offering a higher interest rate the formula for irp is f0 s0 1 ic1 ib where f0 forward rates0 spot rateic interest rate in country cib interest rate in country b begin aligned f 0 s 0 times left frac 1 i c 1 i b right textbf where f 0 text forward rate s 0 text spot rate i c text interest rate in country c i b text interest rate in country b end aligned f0 s0 1 ib 1 ic where f0 forward rates0 spot rateic interest rate in country cib interest rate in country b forward exchange ratean understanding of forward rates is fundamental to irp especially as it pertains to arbitrage forward exchange rates for currencies are exchange rates at a future point in time unlike spot exchange rates which are current rates 2forward rates are available from banks and currency dealers for periods ranging from less than a week to five years and more forwards are quoted with a bid ask spread as are spot currency quotations the difference between the forward rate and the spot rate is known as swap points it s known as a forward premium if the forward rate minus the spot rate is positive a negative difference is a forward discount a currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate the u s dollar typically trades at a forward premium against the canadian dollar conversely the canadian dollar trades at a forward discount versus the u s dollar covered vs uncovered interest rate paritythe irp is said to be covered when the no arbitrage condition can be satisfied through the use of forward contracts in an attempt to hedge against foreign exchange risk 3the irp is uncovered when the no arbitrage condition could be satisfied without the use of forward contracts to hedge against foreign exchange risk 4the relationship is reflected in the two methods an investor can adopt to convert foreign currency into u s dollars the first option an investor can choose is to invest the foreign currency locally at the foreign risk free rate for a specific period the investor would then simultaneously enter into a forward rate agreement to convert the proceeds from the investment into u s dollars using a forward exchange rate at the end of the investing period the second option would be to convert the foreign currency to u s dollars at the spot exchange rate and then invest the dollars for the same amount of time as in option a at the local u s risk free rate the cash flows from both options are equal when no arbitrage opportunities exist arbitrage is defined as the simultaneous purchase and sale of the same asset in different markets to profit from tiny differences in the asset s listed price arbitrage trading in the foreign exchange world involves the buying and selling of different currency pairs to exploit any pricing inefficiencies | |
what is interest rate risk | interest rate risk is the potential for investment losses that can be triggered by a move upward in the prevailing rates for new debt instruments if interest rates rise for instance the value of a bond or other fixed income investment in the secondary market will decline the change in a bond s price given a change in interest rates is known as its duration interest rate risk can be reduced by buying bonds with different durations or by hedging fixed income investments with interest rate swaps options or other interest rate derivatives investopedia crea taylorunderstanding interest rate riskinterest rate changes can affect many investments but it impacts the value of bonds and other fixed income securities most directly bondholders therefore carefully monitor interest rates and make decisions based on how interest rates are perceived to change over time for fixed income securities as interest rates rise security prices fall and vice versa this is because when interest rates increase the opportunity cost of holding those bonds increases that is the cost of missing out on an even better investment is greater the rates earned on bonds therefore have less appeal as rates rise so if a bond paying a fixed rate of 5 is trading at its par value of 1 000 when prevailing interest rates are also at 5 it becomes far less attractive to earn that same 5 when rates elsewhere start to rise to say 6 or 7 in order to compensate for this economic disadvantage in the market the value of these bonds must fall because who will want to own a 5 interest rate when they can get 7 with some different bond therefore for bonds that have a fixed rate when interest rates rise to a point above that fixed level investors switch to investments that reflect the higher interest rate securities that were issued before the interest rate change can compete with new issues only by dropping their prices interest rate risk can be managed through hedging or diversification strategies that reduce a portfolio s effective duration or negate the effect of rate changes for more on this seemanaging interest rate risk example of interest rate riskfor example say an investor buys a five year 500 bond with a 3 coupon then interest rates rise to 4 the investor will have trouble selling the bond when newer bond offerings with more attractive rates enter the market the lower demand also triggers lower prices on the secondary market the market value of the bond may drop below its original purchase price the reverse is also true a bond yielding a 5 return holds more value if interest rates decrease below this level since the bondholder receives a favorable fixed rate of return relative to the market bond price sensitivitythe value of existing fixed income securities with different maturity dates declines by varying degrees when market interest rates rise this phenomenon is referred to as price sensitivity and is measured by the bond s duration for instance suppose there are two fixed income securities one that matures in one year and another that matures in 10 years when market interest rates rise the owner of the one year security can reinvest in a higher rate security after hanging onto the bond with a lower return for only one year at most but the owner of the 10 year security is stuck with a lower rate for nine more years that justifies a lower price value for the longer term security the longer a security s time to maturity the more its price declines relative to a given increase in interest rates note that this price sensitivity occurs at a decreasing rate a 10 year bond is significantly more sensitive than a one year bond but a 20 year bond is only slightly less sensitive than a 30 year one the maturity risk premiuma long term bond generally offers a maturity risk premium in the form of a higher built in rate of return to compensate for the added risk of interest rate changes over time the larger duration of longer term securities means higher interest rate risk for those securities to compensate investors for taking on more risk the expected rates of return on longer term securities are typically higher than rates on shorter term securities this is known as the maturity risk premium other risk premiums such as default risk premiums and liquidity risk premiums may determine rates offered on bonds | |
what is interest rate sensitivity | interest rate sensitivity is a measure of how much the price of a fixed income asset will fluctuate as a result of changes in the interest rate environment securities that are more sensitive have greater price fluctuations than those with less sensitivity this type of sensitivity must be taken into account when selecting a bond or other fixed income instrument the investor may sell in the secondary market interest rate sensitivity affects buying as well as selling | |
how interest rate sensitivity works | fixed income securities and interest rates are inversely correlated therefore as interest rates rise prices of fixed income securities tend to fall when applied to calculate fixed income securities interest rate sensitivity is known as the asset s duration this is one way to determine how interest rates affect a fixed income security portfolio the higher a bond or bond fund s duration the more sensitive the bond or bond fund to changes in interest rates 1the duration of fixed income securities gives investors an idea of the sensitivity to potential interest rate changes duration is a good measure of interest rate sensitivity because the calculation includes multiple bond characteristics such as coupon payments and maturity generally the longer the maturity of the asset the more sensitive the asset to changes in interest rates changes in interest rates are watched closely by bond and fixed income traders as the resulting price fluctuations affect the overall yield of the securities investors who understand the concept of duration can immunize their fixed income portfolios to changes in short term interest rates types of interest rate sensitivitythere are four widely used duration measurements to determine a fixed income security s interest rate sensitivity the macaulay duration modified duration effective duration and key rate duration to calculate the macaulay duration certain metrics must be known including the time to maturity remaining cash flows required yield cash flow payment par value and bond price the modified duration is a modified calculation of the macaulay duration that incorporates yield to maturity ytm it determines how much the duration would change for each percentage point change in the yield the effective duration is used to calculate the duration of bonds with embedded options it determines the approximate price decline for a bond if interest rates rise instantaneously by 1 the key rate duration determines a fixed income security s or fixed income portfolio s duration at a specific maturity on the yield curve 23example of interest rate sensitivityone widely used measure to determine the interest rate sensitivity is the effective duration for example assume a bond mutual fund holds 100 bonds with an average duration of nine years and an average effective duration of 11 years if interest rates rise instantaneously by 1 0 the bond fund is thus expected to lose 11 of its value based on its effective duration likewise a trader can look at a particular corporate bond with a maturity of six months and a duration of 2 5 if interest rates fall 0 5 the trader can expect that the bond s price to rise by 1 25 | |
what is an interest rate swap | an interest rate swap is a forward contract in which one stream of future interest payments is exchanged for another based on a specified principal amount 1interest rate swaps usually involve the exchange of a fixed interest rate payment for a floating rate payment or vice versa to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap a swap can also involve the exchange of one type of floating rate for another which is called a basis swap joules garcia investopediaunderstanding interest rate swapsinterest rate swaps are the exchange of one set of cash flows for another because they trade over the counter otc the contracts are between two or more parties are structured according to their desired specifications and can be customized in many different ways 2swaps are often utilized if a company can borrow money easily at one type of interest rate but prefers a different type types of interest rate swapsthere are three different types of interest rate swaps fixed to floating floating to fixed and float to float consider a company named tsi that can issue a bond at a very attractive fixed interest rate to investors the company s management feels that it can get a better cash flow from a floating rate in this case tsi can enter into a swap with a counterparty bank in which the company receives a fixed rate and pays a floating rate 3the swap is structured to match the maturity and cash flow of the fixed rate bond and the two payment streams are netted tsi and the bank choose the preferred floating rate index which is usually the secured overnight financing rate sofr tsi then receives the sofr plus or minus a spread that reflects both interest rate conditions in the market and its credit rating the ice benchmark administration limited the authority responsible for libor stopped publishing rates as of june 30 2023 however it still publishes what it calls synthetic 1 month 3 month and 6 month usd libor rates under order by the uk financial conduct authority this will end on sept 30 2024 4a company that does not have access to a fixed rate loan may borrow at a floating rate and enter into a swap to acquire a fixed rate the floating rate tenor reset and payment dates on the loan are mirrored on the swap and netted the fixed rate leg of the swap becomes the company s borrowing rate companies sometimes enter into a swap to change the type or tenor of the floating rate index that they pay this is known as a basis swap 3 a company can swap from the three month sofr to six month sofr for example because the rate either is more attractive or matches other payment flows a company can also switch to a different index such as the federal funds rate commercial paper or the treasury bill rate real world example of an interest rate swapsuppose that pepsico needs to raise 75 million to acquire a competitor in the united states they may be able to borrow the money with a 3 5 interest rate but outside of the u s they may be able to borrow at just 3 2 the catch is that they would need to issue the bond in a foreign currency which is subject to fluctuation based on the home country s interest rates pepsico could enter into an interest rate swap for the duration of the bond under the terms of the agreement pepsico would pay the counterparty a 3 2 interest rate over the life of the bond the company would then swap 75 million at the agreed upon exchange rate when the bond matures and avoid any exposure to exchange rate fluctuations | |
why is it called interest rate swap | the name is derived from two parties exchanging swapping future interest payments based on a specified principal amount interest rate swaps are traded in over the counter otc markets and are designed to suit the needs of each party the most common swap is a fixed exchange rate for a floating rate this is also known as a vanilla swap 2 | |
why do companies engage in interest rate swaps | the primary reasons why financial institutions use interest rate swaps are to hedge against losses manage credit risk or speculate | |
what s an example of an interest rate swap | say that company a issued 10 million in two year bonds that have a variable interest rate of sofr plus 1 sofr is 2 but the company is worried that interest rates may rise it locates company b which agrees to pay company a the sofr annual rate plus 1 for two years on the notional principal amount of 10 million in exchange company a pays company b a fixed rate of 4 on a notional value of 10 million for two years if interest rates rise significantly company a will benefit conversely company b will stand to benefit if interest rates stay flat or fall the bottom linean interest rate swap is an agreement between different parties to exchange one stream of interest payments for another over a specified time period they are derivative contracts that trade over the counter otc and can be customized by the participating parties to match their financial needs usually interest rate swaps exchange fixed rate payments for floating rate payments or the other way around they are used to manage exposure to fluctuating interest rates or to get a lower borrowing rate | |
what is an interim dividend | an interim dividend is a dividend payment made before a company s annual general meeting agm and the release of final financial statements this declared dividend usually accompanies the company s interim financial statements the interim dividend is issued more frequently in the united kingdom where dividends are often paid semi annually the interim dividend is typically the smaller of the two payments made to shareholders understanding an interim dividendindividuals invest in companies through bonds or stocks bonds pay a set rate of interest and investors have seniority over shareholders in the case of bankruptcy but investors do not benefit from share price appreciation stocks do not pay interest but some do pay dividends dividend payments allow shareholders to benefit from earnings growth through both interim and final dividends as well as share price appreciation directors declare an interim dividend but it is subject to shareholder approval by contrast a normal dividend also called a final dividend is voted on and approved at the annual general meeting once earnings are known both interim and final dividends can be paid out in cash and stock the issuing of an interim dividend is a more common practice in the united kingdom where dividends are often paid to shareholders on a semi annual basis final versus interim dividendsdividends are paid out per share owned for example if you own 100 shares of company a and company a pays out 1 in dividends every year you will receive 100 in dividend income every year if company a doubles its dividend the company will pay out 2 per share and investors will receive 200 annually final dividends are announced and paid out on an annual basis along with earnings final dividends are announced after earnings are determined but companies pay out interim dividends from retained earnings not current earnings retained earnings can also be thought of as undistributed profits companies typically pay these dividends on a quarterly or six month basis before the end of the year interim dividends are paid every six months in the united kingdom and every three months in the united states companies declare and distribute an interim dividend during an exceptional earnings season or when legislation makes it more advantageous to do so a final or regular dividend can be a set amount that is paid every quarter six months or year it can be a percentage of net income or earnings it can also be paid out of the earnings left over after the company pays for capital expenditures capex and working capital the dividend policy or strategy used is dependent on management s goals and intentions for shareholders interim dividends can follow the same strategy as final dividends but since interim dividends are paid out before the end of the fiscal year the financial statements that accompany interim dividends are unaudited if both an interim and final dividend is handed out in the same fiscal year the interim dividend is typically the smaller of the two interim dividend exampleon feb 13 2019 plato income maximiser ltd asx pl8 announced an interim dividend shareholders of record on thursday feb 28th would be given a dividend of 0 005 per share on that day the firm s director notes that the firm understands retirees need to supplement government pensions this need is why the firm s investment strategy prioritizes regular and sustainable dividend payments | |
what is an interim statement | an interim statement is a financial report covering a period of less than one year interim statements are used to convey the performance of a company before the end of normal full year financial reporting cycles unlike annual statements interim statements do not have to be audited interim statements increase communication between companies and the public and provide investors with up to date information between annual reporting periods these may also be referred to as interim reports understanding interim statementsa quarterly report is an example of an interim statement because it is issued before year end the international accounting standards board iasb suggests certain standards be included while preparing interim statements these include a series of condensed statements covering the company s financial position income cash flows and changes in equity along with notes of explanation the iasb also suggests that companies should follow the same guidelines in their interim statements as they use in preparing their annual reports which are audited including the use of similar accounting methods interim statements offer a more timely look into a business s operations rather than waiting until year end statements which do not officially become available for months after year end close anyway investors find the periodic snapshots helpful when allocating investment capital all of which leads to greater market liquidity a prime goal of capital markets these reports can also alert investors and analysts to recent changes that meaningfully affect the corporation a form 8 k for instance is used to report unscheduled material events or corporate changes at a company that could be of importance to the shareholders or the securities and exchange commission sec the report notifies the public of events reported including acquisition bankruptcy resignation of directors or a change in the fiscal year form 8 k reports may be issued based on other events up to the company s discretion that the registrant considers to be of importance to shareholders example quarterly reportsthe most common interim statement may be the quarterly report a quarterly report is a summary or collection of un audited financial statements such as balance sheets income statements and cash flow statements issued by companies every quarter three months in addition to reporting quarterly figures these statements may also provide year to date and comparative e g last year s quarter to this year s quarter results publicly traded companies must file their reports with the securities exchange commission this form known as a 10 q does not include all the detailed information such as background and operations detail that the annual report known as a 10 k would the sec also mandates that investment companies file quarterly reports if they manage more than 100 million using a form 13f most companies have an accounting period that ends with the calendar year dec 31 and quarters that end on march 31 june 30 september 30 and december 31 quarterly reports are typically filed within a few weeks of a quarter s end | |
what is an intermediate good | an intermediate good is a product used to produce a final good or finished product also referred to as a consumer good intermediate goods like salt can also be finished products since it is consumed directly by consumers and used by producers to manufacture other food products intermediate goods are sold between industries for resale or the production of other goods these goods are also called semi finished products because they are used as inputs to become part of the finished product investopedia zoe hansen | |
how intermediate goods work | intermediate goods are vital to the production process which is why they are also called producer goods industries sell these goods to each other for resale or to produce other goods when they are used in the production process they are transformed into another state there are typically three options for the use of intermediate goods inevitably all intermediate goods are either a component of the final product or completely reconfigured during the production process intermediate goods exampleconsider a farmer who grows wheat the farmer sells his crop to a miller for 100 giving the farmer 100 in value the miller breaks down the wheat to make flour a secondary intermediate good the miller sells the flour to a baker for 200 and creates 100 in value 200 sale 100 purchase 100 the final good which is sold directly to the consumer is the bread the baker sells all of it for 300 adding another 100 of value 300 200 100 the final price at which the bread is sold is equal to the value that is added at each stage in the production process 100 100 100 services can also be intermediate as in the case of a photographer the photography is the intermediate service while the photographs are the final product intermediate goods vs consumer and capital goodsintermediate goods can be used in production but they can also be consumer goods how it is classified depends on who buys it if a consumer buys a bag of sugar to use at home it is a consumer good but if a manufacturer purchases sugar to use during the production of another product it becomes an intermediate good capital goods on the other hand are assets that are used in the production of consumer goods that means they are purchased to help in the production process so the baker who bakes the bread in the example above will buy an oven to use in the production process that oven is considered a capital good which doesn t transform or change shape unlike the wheat intermediate goods and gross domestic product gdp economists do not factor intermediate goods when they calculate gross domestic product gdp gdp is a measurement of the market value of all final goods and services produced in the economy the reason why these goods are not part of the calculation is that they would be counted twice so if a confectioner buys sugar to add it to her candy it can only be counted once when the candy is sold rather than when she buys the sugar for production this is called a value added approach because it values every stage of production involved in producing a final good special considerationsthere are many intermediate goods that can be used for multiple purposes steel is an example of an intermediate good it can be used in the construction of homes cars bridges planes and countless other products wood is used to make flooring and furniture glass is used in the production of windows and eyeglasses and precious metals like gold and silver are used to make decorations housing fixtures and jewelry | |
what are other names for intermediate goods | intermediate goods are also called semi finished products because they are used as inputs to become part of a finished product or producer goods because they are vital to the production process | |
what are some examples of intermediate goods | examples of intermediate goods include flour precious metals salt steel sugar wheat and wood | |
what intermediate goods does the united states export | examples of intermediate goods exported by the united states include corn non monetary gold soybeans and wheat 1the bottom lineintermediate goods are products used in production to make other goods which are ultimately sold to consumers intermediate goods are sold industry to industry for resale or to produce other products | |
what is an internal audit | internal audits evaluate a company s internal controls including its corporate governance and accounting processes these types of audits ensure compliance with laws and regulations and help to maintain accurate and timely financial reporting and data collection internal auditors are hired by companies who work on behalf of their management teams these audits also provide management with the tools necessary to attain operational efficiency by identifying problems and correcting lapses before they are discovered in an external audit understanding internal auditsinternal audits play a critical role in a company s operations and corporate governance especially now that the sarbanes oxley act of 2002 holds managers legally responsible for the accuracy of their company s financial statements sox also required that a company s internal controls be documented and reviewed as part of its external audit in addition to ensuring that a company complies with laws and regulations internal audits also provide a degree of risk management and safeguard against potential fraud waste or abuse the results of internal audits provide management with suggestions for improvements to current processes not functioning as intended which may include information technology systems as well as supply chain management internal audits may take place on a daily weekly monthly or annual basis some departments may be audited more frequently than others for example a manufacturing process may be audited on a daily basis for quality control while the human resources department might only be audited once a year audits may be scheduled to give managers time to gather and prepare the required documents and information or they may be a surprise especially if unethical or illegal activity is suspected types of internal auditsa company may be required to adhere to local laws compliance needs government regulations external policies or other restrictions to demonstrate compliance with these rules a company may task an internal audit committee to review compile appropriate information and provide an overall opinion on the status of the compliance requirement public companies are required to perform certain levels of external financial auditing where a completely independent third party provides an opinion on the company s financial records companies may want to dive further into audit findings or perform an internal financial audit in preparation for an external audit many of the tests between an internal or external auditor may be similar the nature of independence separates the two types of audits for financial audits as companies become continually more environmentally conscious some take the steps of reviewing the business impact on the planet this results in an internal audit covering how a company safely sources raw materials minimizes greenhouse gases during production utilizes eco friendly distribution methods and reduces energy consumption companies leveraging triple bottom line reporting may perform internal environmental audits as part of annual reporting an it audit may have different objectives the internal audit may be the result of an external lawsuit a company complaint or a target to become more efficient an internal audit focused on technology reviews the controls hardware software security documentation and backup recovery of systems the goal is likely to assess general it accuracy and processing capabilities an internal audit focused on performance pays less attention to the processes and more on the final result the company will have likely have set performance objectives or metrics that may be tied to performance bonuses or other incentives as a result an internal auditor assesses the outcome of an objective that may not be easily quantifiable for example a company may wish to have expanded its use of diverse suppliers the internal auditor independent of any purchasing process will be tasked with analyzing how the company s spending patterns have changed since this goal was set an operational audit is most likely to occur when key personnel leaves or when new management takes over an entity the company may want to assess how things are done and whether resources are being used more efficiently during an operational internal audit the auditor will review whether current staff and processes fulfil the mission statement value and objectives of a company development operating real estate or construction companies may perform construction audits to ensure not only appropriate physical development of a building but appropriate project billing along the life of the project this mostly includes adherence to contract terms with the general contractor sub contractors or standalone vendors as necessary this may also include ensuring the company has remit the appropriate payments collected the appropriate payments and internal project reports regarding project completion are correct many of the audits above may be recurring and performed each year in some cases it might make sense for an internal audit committee to evaluate a special circumstance that will occur only once this may entail gathering a report on the efficiency on a recent merger the hiring of a key employee or a complaint from staff when selecting the individuals for the special investigation audit a company must be especially mindful to select members with appropriate expertise and independence depending on the structure of the organization the internal audit may be prepared by the board of directors of by upper management internal audit vs external auditinternal and external audits have the same objective both types of audits analyze an aspect of a company to determine a specific opinion however there are many differences between the two types of audits in an internal audit the company is often able to select its own audit team as such the team represents the interests of the company s management team this may be advantageous to specifically place certain employees with very niche experience on the team in an external audit the company can often select the external audit firm however the company often does not have a say in the specific employees put on their external audit there may be some requirements regarding the external audit staff depending on the audit for example in an external financial audit a certified public accountant cpa must certify the financial statements in an internal audit there is no requirement that any member of the audit team must be a cpa the end goal of either audit is an audit report however audit reports are used for very different reasons an internal audit report is usually used by internal management to improve the operations processes or policies of the company an external audit report is often required for an outside reason and is more often used by members outside of the company finally the nature of the engagement will be very different during an internal audit the employees of a company may often freely give advice discuss unrelated matters with the company or may have a very fluid consulting agreement during an external audit a very defined scope is often set and the external auditor will often take great care to ensure they do not exceed their audit boundaries a company is usually able to select its own internal audit lead and team membersmembers of the audit team often do not need to have specific titles or licensesaudit reports are primarily used by internal management to improve company operationsinternal audits may be less formal with blurred structure as the auditor provides casual guidancea company or board can usually pick the audit firm but not audit team membersmembers of the audit team may be required to hold specific titles or license as part of the audit agreementaudit reports are primarily used by external parties to satisfy a reporting requirementexternal audits are often more formal with defined boundaries and disallowed servicesinternal audit processinternal auditors generally identify a department gather an understanding of the current internal control process conduct fieldwork testing follow up with department staff about identified issues prepare an official audit report review the audit report with management and follow up with management and the board of directors as needed to ensure recommendations have been implemented before any audit procedures are performed the internal auditors often start by developing the audit plan this sets the audit requirements objectives timeline schedule and responsibilities across audit team members the audits may review prior audits to understand management expectations for presentation and data collection the audit plan often has a checklist to ensure members of the team adhere to broad expectations the internal audit team may also preemptively plan to meet with management throughout the audit to communicate the status and any struggles of the audit the planning stage often ends with a kick off meeting that launches the audit and communicates the initial information needed many of the auditing procedures used by internal audits are the same as external auditors some companies might use continuous audits to ensure ongoing oversight of company practices assessment techniques ensure an internal auditor gathers a full understanding of the internal control procedures and whether employees are complying with internal control directives to avoid disrupting the daily workflow auditors begin with indirect assessment techniques such as reviewing flowcharts manuals departmental control policies or other existing documentation auditing fieldwork procedures can include transaction matching physical inventory count audit trail calculations and account reconciliation as is required by law analysis techniques may test random data or target specific data if an auditor believes an internal control process needs to be improved the internal audit may have started with a defined scope but as the internal audit team gathers and analyzes information it may become necessary to redefine the purpose and extent of the audit this includes re evaluating the original timeline or resources allocated to the audit internal audit reporting includes a formal report and may include a preliminary or memo style interim report an interim report typically includes sensitive or significant results the auditor thinks the board of directors needs to know right away similar to an interim financial statement an interim audit communicates a partial set of information useful for laying the road for the remaining portion often a company may deliver a draft copy of the final audit report and host a pre close internal audit meeting with management this may allow management to provide rebuttals additional information that may change findings or provide commentary on their feedback regarding the audit findings the final report includes a summary of the procedures and techniques used for completing the audit a description of audit findings and suggestions for improvements to internal controls and control procedures the final report may also communicate next steps in terms of changes to be implemented future monitoring processes and what future reviews will entail after a designated amount of time an internal audit may call for follow up steps to make sure the appropriate post close audit changes were implemented the details and process for these monitoring and review steps is often agreed to at the delivery of the final audit for example an internal financial audit may find severe internal control deficiencies that an internal auditor believes will not pass an external financial audit management agreed to implement changes within the next six weeks after six weeks the internal auditor may be tasked with implementing a small scope or limited review of the deficiency to see if the issue still persists the monitoring step of an internal audit is technically not required management or the board may decide to disregard internal audit findings and not implement the changes the audit report suggests internal audit reports the 5 c sinternal audit reports are often known for adhering to the 5 c s reporting requirement a complete sufficient internal audit often ends with a summary report that communicates answers to the following questions importance of internal auditssome may think internal audits are not as valuable as external audits after all a company may hand pick its own internal audits who do not have full independence from the company however there are many ways internal audits provide value to the company and external parties | |
what are the types of internal audits | a company can choose to perform an internal audit for almost any reason this may lead to an internal financial audit operational audit compliance audit environmental audit it audit or a special one time circumstance | |
what is the role of internal audit | the role of an internal audit is to identify a deficiency or substantiate a proficiency for example a company may issue an internal financial audit to make sure its internal controls over accounts payable adhere to company policy alternatively the company may launch an internal environmental audit to explore how environmental impact its eco friendly changes had on the planet last year | |
what is the internal audit process | the internal audit process entails planning the audit performing the audit procedures compiling the audit report and monitoring post audit changes management may choose to expand the scope of an audit at any point of the audit if findings during the audit cause the scope to shift a different direction | |
what are the 5 c s of internal audit | internal audit reports often outline the criteria condition cause consequence and corrective action these five areas report why the audit was performed what caused the reason for the audit how the audit will be performed what the auditor aims to achieve and what steps will be taken after the audit findings are presented the bottom linean internal audit is a process that allows a company to self select an audit team to carry out the review of its operations the company can often define the scope of the internal audit in addition the company can often choose almost any reason to conduct an internal audit though internal audits are less useful for meeting external reporting requirements they hold tremendous value for improving internal operations as well as informing management ways the company can get better | |
what is an internal auditor ia | an internal auditor ia is a trained professional employed by companies to provide independent and objective evaluations of financial and operational business activities including corporate governance they are tasked with ensuring that companies comply with laws and regulations follow proper procedures and function as efficiently as possible understanding an internal auditor ia the main job of an internal auditor ia is to identify problems and correct them before they are discovered during an external audit by an outside firm or regulatory agencies such as the securities and exchange commission sec one of the roles of the sec is to regulate how companies report their financial statements to help ensure that investors have access to all of the necessary information before investing an internal audit generally performs the three tasks outlined below internal auditing processto achieve this goal internal auditors will typically perform a multitude of tasks including examining financial statements expense reports inventory financial data budgeting and accounting practices as well as creating risk assessments for each department detailed notes are taken interviews with employees are conducted work schedules are supervised physical assets are verified and financial statements are scrutinized to eliminate potentially damaging errors or falsehoods and find ways to boost productivity once an internal auditor has completed the examination the findings are presented in a formal report the audit report describes how the audit was done what it discovered and if necessary suggestions for what improvements could be made it is usually presented to senior executives at the company if changes are recommended it s common for an internal auditor to be asked to complete a follow up audit to determine how well the advised changes have been executed properly managed publicly traded companies also carry out internal audits to ensure that the company is complying with federal and state regulations including those mandated by the sec however companies must also ensure that their accounting practices follow the accounting guidelines as laid out by the generally accepted accounting principles gaap requirements for internal auditorsthe institute of internal auditors iia established in 1941 and headquartered in florida is the international professional organization that sets standards guidance best practices and code of ethics for practitioners 1 on its website the iia defines internal auditing as an independent objective assurance and consulting activity designed to add value and improve an organization s operations it helps an organization accomplish its objectives by bringing a systematic disciplined approach to evaluate and improve the effectiveness of risk management control and governance processes internal auditor vs external auditorsometimes the role of internal and external auditors can be confused the main difference between the two is that internal auditors ia work on behalf of company management internal auditors are hired by the company while external auditors are appointed by a shareholder vote internal auditors are employed to educate management and staff about how the business can function better external auditors on the other hand have no such obligations they are responsible for reviewing financial statements to ensure that they are accurate and conform to gaap their findings are then reported back to shareholders rather than management according to the association of certified fraud examiners the role of the external auditor is to inspect clients accounting records and express an opinion as to whether financial statements are presented fairly in accordance with the applicable accounting standards of the entity such as generally accepted accounting principles gaap or international financial reporting standards ifrs they must assert whether financial statements are free of material misstatement whether due to error or fraud 2 it is a legal requirement for all financial statements from public companies to be audited by a third party accountant in accordance with the securities act of 1933 and the securities exchange act of 1934 3 4 5 benefits of an internal auditor ia many companies choose to employ an internal auditor despite not being legally obligated to do so robust internal audits are viewed as a key way to correct issues quickly maintain a good reputation and prevent money from being wasted reports filed by internal auditors ia can help companies to prosper and operate at maximum efficiency for this reason many executives view them as a necessary expense many companies choose to employ an internal auditor despite not being legally obligated to do so robust internal audits are viewed as a key way to correct issues quickly maintain a good reputation and prevent money from being wasted reports filed by internal auditors ia can help companies to prosper and operate at maximum efficiency internal auditors also set the company up for success when it s annual external audit comes around the job of an internal auditor is essentially to help catch and fix issues before an external auditor has the chance to so do for this reason many executives view them as a necessary expense | |
what is an internal auditor ia | an internal auditor ia is a trained professional employed by companies to provide independent and objective evaluations of financial and operational business activities including corporate governance they are tasked with ensuring that companies comply with laws and regulations follow proper procedures and function as efficiently as possible understanding an internal auditor ia the main job of an internal auditor ia is to identify problems and correct them before they are discovered during an external audit by an outside firm or regulatory agencies such as the securities and exchange commission sec one of the roles of the sec is to regulate how companies report their financial statements to help ensure that investors have access to all of the necessary information before investing an internal audit generally performs the three tasks outlined below internal auditing processto achieve this goal internal auditors will typically perform a multitude of tasks including examining financial statements expense reports inventory financial data budgeting and accounting practices as well as creating risk assessments for each department detailed notes are taken interviews with employees are conducted work schedules are supervised physical assets are verified and financial statements are scrutinized to eliminate potentially damaging errors or falsehoods and find ways to boost productivity once an internal auditor has completed the examination the findings are presented in a formal report the audit report describes how the audit was done what it discovered and if necessary suggestions for what improvements could be made it is usually presented to senior executives at the company if changes are recommended it s common for an internal auditor to be asked to complete a follow up audit to determine how well the advised changes have been executed properly managed publicly traded companies also carry out internal audits to ensure that the company is complying with federal and state regulations including those mandated by the sec however companies must also ensure that their accounting practices follow the accounting guidelines as laid out by the generally accepted accounting principles gaap requirements for internal auditorsthe institute of internal auditors iia established in 1941 and headquartered in florida is the international professional organization that sets standards guidance best practices and code of ethics for practitioners 1 on its website the iia defines internal auditing as an independent objective assurance and consulting activity designed to add value and improve an organization s operations it helps an organization accomplish its objectives by bringing a systematic disciplined approach to evaluate and improve the effectiveness of risk management control and governance processes internal auditor vs external auditorsometimes the role of internal and external auditors can be confused the main difference between the two is that internal auditors ia work on behalf of company management internal auditors are hired by the company while external auditors are appointed by a shareholder vote internal auditors are employed to educate management and staff about how the business can function better external auditors on the other hand have no such obligations they are responsible for reviewing financial statements to ensure that they are accurate and conform to gaap their findings are then reported back to shareholders rather than management according to the association of certified fraud examiners the role of the external auditor is to inspect clients accounting records and express an opinion as to whether financial statements are presented fairly in accordance with the applicable accounting standards of the entity such as generally accepted accounting principles gaap or international financial reporting standards ifrs they must assert whether financial statements are free of material misstatement whether due to error or fraud 2 it is a legal requirement for all financial statements from public companies to be audited by a third party accountant in accordance with the securities act of 1933 and the securities exchange act of 1934 3 4 5 benefits of an internal auditor ia many companies choose to employ an internal auditor despite not being legally obligated to do so robust internal audits are viewed as a key way to correct issues quickly maintain a good reputation and prevent money from being wasted reports filed by internal auditors ia can help companies to prosper and operate at maximum efficiency for this reason many executives view them as a necessary expense many companies choose to employ an internal auditor despite not being legally obligated to do so robust internal audits are viewed as a key way to correct issues quickly maintain a good reputation and prevent money from being wasted reports filed by internal auditors ia can help companies to prosper and operate at maximum efficiency internal auditors also set the company up for success when it s annual external audit comes around the job of an internal auditor is essentially to help catch and fix issues before an external auditor has the chance to so do for this reason many executives view them as a necessary expense | |
what is an internal growth rate igr | an internal growth rate igr is the highest level of growth achievable for a business without obtaining outside financing and a firm s maximum internal growth rate is the level of business operations that can continue to fund and grow the company formula and calculating igrto calculate the internal growth rate for a company you have to determine two variables first you need the company s return on assets roa which is net income total assets or average of total assets across periods begin aligned text net income div text total assets or average of total assets across periods end aligned net income total assets or average of total assets across periods then you need its retention ratio rr which is the percentage of how much net income is kept by the company finally you can calculate the igr so imagine company a had the following data in its financial statements using the formula for roa 30 843 000 114 938 000 you get 0 27 the retention ratio 1 358 000 30 834 000 results in 0 04 then you multiply the roa and rr to get your igr | |
what is irr | irr or internal rate of return is a metric used in financial analysis to estimate the profitability of potential investments irr is a discount rate that makes the net present value npv of all cash flows equal to zero in a discounted cash flow analysis irr calculations rely on the same formula as npv does keep in mind that irr is not the actual dollar value of the project it is the annual return that makes the npv equal to zero generally speaking the higher an internal rate of return the more desirable an investment is to undertake irr is uniform for investments of varying types and as such can be used to rank multiple prospective investments or projects on a relatively even basis in general when comparing investment options with other similar characteristics the investment with the highest irr probably would be considered the best investopedia julie bangsubscribe to term of the day and learn a new financial term every day stay informed and make smart financial decisions sign up now the formula for irrthe formula used to determine irr is as follows 0 npv t 1tct 1 irr t c0where ct net cash inflow during the period tc0 total initial investment costsirr the internal rate of returnt the number of time periods begin aligned text 0 text npv sum t 1 t frac c t left 1 irr right t c 0 textbf where c t text net cash inflow during the period t c 0 text total initial investment costs irr text the internal rate of return t text the number of time periods end aligned 0 npv t 1 t 1 irr tct c0 where ct net cash inflow during the period tc0 total initial investment costsirr the internal rate of returnt the number of time periods the manual calculation of the irr metric involves the following steps because of the nature of the formula irr cannot be easily calculated analytically and instead must be calculated iteratively through trial and error or by using software programmed to calculate irr e g using excel 1using the irr function in excel makes calculating the irr easy excel does all the necessary work for you arriving at the discount rate you are seeking to find here is a simple example of an irr analysis with cash flows that are known and annually periodic one year apart assume a company is assessing the profitability of project x project x requires 250 000 in funding and is expected to generate 100 000 in after tax cash flows in the first year and grow by 50 000 for each of the next four years image by sabrina jiang investopedia 2020in this case the irr is 56 72 which is quite high excel also offers two other functions that can be used in irr calculations the xirr and the mirr xirr is used when the cash flow model does not exactly have annual periodic cash flows the mirr is a rate of return measure that includes the integration of the cost of capital and the risk free rate 23understanding irrthe ultimate goal of irr is to identify the rate of discount which makes the present value of the sum of annual nominal cash inflows equal to the initial net cash outlay for the investment several methods can be used when seeking to identify an expected return but irr is often ideal for analyzing the potential return of a new project that a company is considering undertaking think of irr as the rate of growth that an investment is expected to generate annually thus it can be most similar to a compound annual growth rate cagr in reality an investment will usually not have the same rate of return each year usually the actual rate of return that a given investment ends up generating will differ from its estimated irr | |
what is irr used for | in capital planning one popular scenario for irr is comparing the profitability of establishing new operations with that of expanding existing operations for example an energy company may use irr in deciding whether to open a new power plant or to renovate and expand an existing power plant while both projects could add value to the company one will likely be the more logical decision as prescribed by irr note that because irr does not account for changing discount rates it s often not adequate for longer term projects with discount rates that are expected to vary irr is also useful for corporations in evaluating stock buyback programs clearly if a company allocates substantial funding to repurchasing its shares then the analysis must show that the company s own stock is a better investment that is has a higher irr than any other use of the funds such as creating new outlets or acquiring other companies individuals can also use irr when making financial decisions for instance when evaluating different insurance policies using their premiums and death benefits the consensus is that policies that have the same premiums and a high irr are much more desirable note that life insurance has a very high irr in the early years of the policy often more than 1 000 it then decreases over time this irr is very high during the early days of the policy because if you made only one monthly premium payment and then suddenly died your beneficiaries would still get a lump sum benefit another common use of irr is in analyzing investment returns in most cases the advertised return will assume that any interest payments or cash dividends are reinvested back into the investment what if you don t want to reinvest dividends but need them as income when paid and if dividends are not assumed to be reinvested are they paid out or are they left in cash what is the assumed return on the cash irr and other assumptions are particularly important on instruments like annuities where the cash flows can become complex finally irr is a calculation used for an investment s money weighted rate of return mwrr the mwrr helps determine the rate of return needed to start with the initial investment amount factoring in all of the changes to cash flows during the investment period including sales proceeds using irr with waccmost irr analyses will be done in conjunction with a view of a company s weighted average cost of capital wacc and npv calculations irr is typically a relatively high value which allows it to arrive at an npv of zero most companies will require an irr calculation to be above the wacc wacc is a measure of a firm s cost of capital in which each category of capital is proportionately weighted all sources of capital including common stock preferred stock bonds and any other long term debt are included in a wacc calculation in theory any project with an irr greater than its cost of capital should be profitable in planning investment projects firms will often establish a required rate of return rrr to determine the minimum acceptable return percentage that the investment in question must earn to be worthwhile the rrr will be higher than the wacc any project with an irr that exceeds the rrr will likely be deemed profitable although companies will not necessarily pursue a project on this basis alone rather they will likely pursue projects with the highest difference between irr and rrr as these will likely be the most profitable irr may also be compared against prevailing rates of return in the securities market if a firm can t find any projects with an irr greater than the returns that can be generated in the financial markets then it may simply choose to invest money in the market market returns can also be a factor in setting an rrr analyses will also typically involve npv calculations at different assumed discount rates irr vs compound annual growth ratethe cagr measures the annual return on an investment over a period of time the irr is also an annual rate of return however the cagr typically uses only a beginning and ending value to provide an estimated annual rate of return irr differs in that it involves multiple periodic cash flows reflecting that cash inflows and outflows often constantly occur when it comes to investments another distinction is that cagr is simple enough that it can be calculated easily irr vs return on investment roi companies and analysts may also look at the return on investment roi when making capital budgeting decisions roi tells an investor about the total growth start to finish of the investment it is not an annual rate of return irr tells the investor what the annual growth rate is the two numbers normally would be the same over the course of one year but won t be the same for longer periods roi is the percentage increase or decrease of an investment from beginning to end it is calculated by taking the difference between the current or expected future value and the original beginning value divided by the original value and multiplied by 100 roi figures can be calculated for nearly any activity into which an investment has been made and an outcome can be measured however roi is not necessarily the most helpful for lengthy time frames it also has limitations in capital budgeting where the focus is often on periodic cash flows and returns limitations of irrirr is generally ideal for use in analyzing capital budgeting projects it can be misconstrued or misinterpreted if used outside of appropriate scenarios in the case of positive cash flows followed by negative ones and then by positive ones the irr may have multiple values moreover if all cash flows have the same sign i e the project never turns a profit then no discount rate will produce a zero npv within its realm of uses irr is a very popular metric for estimating a project s annual return however it is not necessarily intended to be used alone irr is typically a relatively high value which allows it to arrive at an npv of zero the irr itself is only a single estimated figure that provides an annual return value based on estimates since estimates of irr and npv can differ drastically from actual results most analysts will choose to combine irr analysis with scenario analysis scenarios can show different possible npvs based on varying assumptions as mentioned most companies do not rely on irr and npv analyses alone these calculations are usually also studied in conjunction with a company s wacc and an rrr which provides for further consideration companies usually compare irr analysis to other tradeoffs if another project has a similar irr with less up front capital or simpler extraneous considerations then a simpler investment may be chosen despite irrs in some cases issues can also arise when using irr to compare projects of different lengths for example a project of a short duration may have a high irr making it appear to be an excellent investment conversely a longer project may have a low irr earning returns slowly and steadily the roi metric can provide some more clarity in these cases although some managers may not want to wait out the longer time frame investing based on irrthe internal rate of return rule is a guideline for evaluating whether to proceed with a project or investment the irr rule states that if the irr on a project or investment is greater than the minimum rrr typically the cost of capital then the project or investment can be pursued conversely if the irr on a project or investment is lower than the cost of capital then the best course of action may be to reject it overall while there are some limitations to irr it is an industry standard for analyzing capital budgeting projects irr exampleassume a company is reviewing two projects management must decide whether to move forward with one both or neither its cost of capital is 10 the cash flow patterns for each are as follows project aproject bthe company must calculate the irr for each project the initial outlay period 0 will be negative solving for irr is an iterative process using the following equation | |
where | or using the above examples the company can calculate irr for each project as irr project a 0 5 000 1 700 1 irr 1 1 900 1 irr 2 1 600 1 irr 3 1 500 1 irr 4 700 1 irr 5irr project a 16 61 irr project b 0 2 000 400 1 irr 1 700 1 irr 2 500 1 irr 3 400 1 irr 4 300 1 irr 5irr project b 5 23 given that the company s cost of capital is 10 management should proceed with project a and reject project b | |
what does internal rate of return mean | the internal rate of return irr is a financial metric used to assess the attractiveness of a particular investment opportunity when you calculate the irr for an investment you are effectively estimating the rate of return of that investment after accounting for all of its projected cash flows together with the time value of money when selecting among several alternative investments the investor would then select the investment with the highest irr provided it is above the investor s minimum threshold the main drawback of irr is that it is heavily reliant on projections of future cash flows which are notoriously difficult to predict | |
is irr the same as roi | although irr is sometimes referred to informally as a project s return on investment it is different from the way most people use that phrase often when people refer to roi they are simply referring to the percentage return generated from an investment in a given year or across a period however that type of roi does not capture the same nuances as irr and for that reason irr is generally preferred by investment professionals another advantage of irr is that its definition is mathematically precise whereas the term roi can mean different things depending on the context or the speaker | |
what is a good internal rate of return | whether an irr is good or bad will depend on the cost of capital and the opportunity cost of the investor for instance a real estate investor might pursue a project with a 25 irr if comparable alternative real estate investments offer a return of say 20 or lower however this comparison assumes that the riskiness and effort involved in making these difficult investments are roughly the same if the investor can obtain a slightly lower irr from a project that is considerably less risky or time consuming then they might happily accept that lower irr project in general though a higher irr is better than a lower one all else being equal the bottom linethe internal rate of return irr is a metric used to estimate the return on an investment the higher the irr the better the return of an investment as the same calculation applies to varying investments it can be used to rank all investments to help determine which is the best the one with the highest irr is generally the best investment choice irr is an important tool for companies in determining where to invest their capital companies have a variety of options to help grow their business these include building out new operations improving existing operations making acquisitions and so on irr can help determine which option to choose by showing which will have the best return | |
what is the internal revenue code irc | the internal revenue code irc refers to title 26 of the u s code the official consolidation and codification of the general and permanent laws of the united states as the code s preface explains 1 commonly referred to as the irs code or irs tax code the laws in title 26 are enforced by the internal revenue service irs the united states code was first published in 1925 by the u s house of representatives 2 title 26 covers all relevant rules pertaining to income gift estate sales payroll and excise taxes 3understanding the internal revenue code irc the internal revenue code is broken down into the following topics or subcategories history of the internal revenue codein 1919 a committee of the u s house of representatives began a project to re codify the u s statutes 5 the completed version was published in 1925 2 title 26 the internal revenue code was originally compiled in 1939 3 congress has the authority to rewrite the tax code and add items to it every year 6 for example in 2017 congress passed the tax cut and jobs act which brought about major reforms of the tax code affecting both individuals and businesses 7the internal revenue service irs founded in 1862 governs the codes in title 26 8 based in washington d c the irs is also responsible for collecting taxes the irs is granted the right to issue fines and punishments for violations of the internal revenue code 9campaigns to abolish the codethe tax cuts and jobs act tcja of 2017 enacted significant changes to the previous laws however there have also been ongoing campaigns to abolish the entire system the two most recent bills in 2017 the house of representatives bill h r 29 the tax code termination act was filed to abolish the internal revenue code of 1986 by the end of 2021 the h r 29 bill would require congress to approve a new federal tax system by july 4 2021 prior to abolishing the current system 10bill s 18 the fair tax act of 2017 was introduced into congress on january 3 2017 the bill proposes imposing a national sales tax on the use or consumption of taxable property or services in the u s in place of personal and corporate income tax employment and self employment tax and estate and gift taxes the proposed sales tax rate would be 23 in 2019 with adjustments to the rate made in subsequent years the bill includes exemptions for the tax for used and intangible property property or services purchased for business export or investment purposes and for state government functions the internal revenue service would be disbanded entirely with no funding for operations authorized after 2021 11the fair tax act would allow u s residents to receive a monthly sales tax rebate based on household size and income and all states would be responsible for administering collecting and remitting sales tax to the federal government most significantly the bill would terminate the national sales tax if the sixteenth amendment which authorizes federal income tax is not repealed within seven years following the bill s enactment 11the fair tax act has made little progress since its introduction 12 the passage of the tcja which made significant changes in the current tax system but reaffirmed its basic structure makes the future of the fair tax act and the tax care termination act as well uncertain to unlikely john buhl former manager of media relations for the tax foundation says that the recent adoption of changes to the tax code may reduce the appetite for pursuing a larger overhaul of the tax system in addition he notes that the new tax reform plan evolved to alleviate concerns that the original plan was designed to benefit the wealthy and that trying to replace it with a sales tax would raise similar issues of whether this would benefit wealthier americans more distributionally replacing all federal taxes with a consumption tax would heighten those arguments buhl says | |
what is the irs | the internal revenue service irs is the division of the u s treasury department tasked with enforcing the internal revenue code irc administering federal tax laws and collecting federal taxes from u s individual and corporate taxpayers the irs collects gift excise estate and income taxes and routinely conducts audits to ensure that taxpayers comply with tax laws investopedia joules garciahistory of the internal revenue service irs president abraham lincoln created the office of commissioner of internal revenue in 1862 to collect taxes levied to fund the civil war in 1913 congress was given the power to enact income tax laws paving the way for the bureau of internal revenue the agency s name was changed to the internal revenue service in the 1950s 1collecting revenuethe irs collects estimated taxes from wage earners throughout the year via payroll deductions and quarterly estimated tax payments from businesses based on quarterly tax filings an annual filing usually due by april 15th for the previous tax year reconciles the amounts paid by each individual and business and the actual amounts owed if the taxpayer has overpaid the irs issues a tax refund if the taxpayer owes money the payment is due with the annual tax return the irs website explains how federal tax laws work u s taxpayers must comply with tax laws passed by congress and meet tax obligations 2the amount of tax revenue collected by the irs in the 2023 tax year this represents about 99 of the country s gross receipts 3tax returnstaxpayers may file their tax returns by mail or electronically using tax preparation software designed for consumer use a taxpayer may use the services of tax professionals such as tax preparers or accountants nearly all individual taxpayers use form 1040 u s individual tax return definition types and use or form 1040 sr tax return for seniors in 2023 the irs received 162 0 million individual returns and issued 105 7 million refunds totaling 334 9 billion 4many individuals complete and attach additional forms and documents to support the numbers they record on the main forms including the w 2 and 1099 supplied by the companies that paid money to the taxpayer schedule d is used to report capital gains received from the sale of stocks properties and other taxable income sources and schedule a records the details of tax deductions claimed by the taxpayer corporations use form 1120 u s corporation income tax return to report their income and tax liabilities there are variations of the form depending on the type of corporation including irs auditsthe irs audits a percentage of income tax returns annually as part of its enforcement mission the agency randomly selects taxpayers to audit or singles out those whose returns are related to others audited while there is no single factor that determines who gets an irs audit each year there are some red flags that may trigger a review the audit process begins with a review of the return by an auditor the auditor may either accept the return or request a further review by an examination group in the latter case the taxpayer is notified by mail the audit involves reviewing paperwork and may be conducted by mail or in person at an irs office or another location such as the taxpayer s home business or accountant s office 6the irs reported 708 309 audits as of the end of its 2022 fiscal year out of all of these audits the irs audited 0 49 of individual returns and 0 84 of corporate returns 7contacting the irsa list of mailing addresses for the irs is available on the irs website 8individuals can contact the irs by phone at 800 829 1040 monday through friday 7 a m to 7 p m local time there are other toll free numbers for businesses and other purposes 9for online assistance try the interactive tax assistant on the irs website 10in person appointments are also available at a local irs office 11 | |
how is the irs funded | the irs operates on a budget approved by congress this is divided into four accounts taxpayer services enforcement operations support and business systems modernization the money allotted to each cannot be reallocated to other sections irs commissioner danny werfel was appointed as the agency s 50th commissioner on march 13 2023 12 | |
what is the best way to file a tax return | it s best to file taxes electronically as 93 8 of taxpayers did in the irs s 2022 fiscal year 13 individuals can still file a paper return by mail but doing so will delay refunds 14 | |
what are the chances of being audited by the irs | the audit rate for individual tax returns was 0 49 in 2022 the irs has audited the returns of 8 5 of the people making 10 million or more between 2012 and 2020 15 individuals may be randomly selected and others triggered by departures from the norm such as a charitable deduction that exceeds the filer s reported income the bottom linethe irs emerged to collect money to fund the civil war the internal revenue service is part of the u s department of the treasury and enforces and administers federal tax laws and operates within a budget approved by congress | |
what is internalization | internalization occurs when a business decides to handle a transaction internally rather than route it out of house to another entity to handle all kinds of businesses including multination corporations practice internalization so do investment firms and brokerages some individuals even put internalization to use when they decide to for example fix an appliance rather than pay someone else to do so understanding internalizationinternalization can occur when an individual or business decides to handle an issue in house instead of outsourcing it to an unrelated third party companies may decide to internalize the production of a particular material have the work done in house by its own employees rather than have another manufacturer produce it | |
where delivery of products is concerned a company may feel that it s more efficient or effective to handle the distribution itself using its own channels rather than to hire an external shipping company | internalization can also apply to a multinational corporation it s seen when a corporation decides to shift assets between its own subsidiaries in different countries internalization can be beneficial to a company when it reduces what it spends overall on outsourcing it can be disadvantageous when it ends up costing the company more than expected to do a job itself for example companies may be required unexpectedly to purchase additional resources and or facilities to handle processes themselves they may have to assign more employees to the job than first planned or they may have to spend more to train more employees for a particular job than they originally projected a company probably should consider not internalizing jobs with which it s unfamiliar and for which its employees aren t trained if it lacks necessary expertise facilities equipment or machinery internalization may not be worth it internalized trading | |
when a client places an order with their broker to buy certain shares of stock the broker has to get those shares from somewhere to fill the order such an order completed for an investor using shares in the broker s inventory is referred to as internalization | this internalized trading is often less expensive than the alternatives mentioned above as it is not necessary to work with an outside firm to complete the transaction moreover brokerage firms that internalize securities orders can also make money off the spread the difference between what they purchased shares for and what they sell them to the investor for additionally because such share sales are not conducted on the open market the brokerage firm is less likely to influence prices if it sells a large portion of its own shares internal sourcinginternal sourcing refers to the internalization process of acquiring any needed asset service or material from within a business instead of from an external source this commonly refers to a business s decision to produce goods internally instead of retaining an outside supplier internal sourcing can also refer to the hiring practice where preference is given to current employees when recruiting for a vacancy it can also involve keeping certain business activities within the business structure such as marketing activities a business also may work to keep its financing source internalized for example it may focus on reinvesting certain assets in the business instead of seeking financing by borrowing or getting new investors | |
does a brokerage always internalize trading | no because it has various choices for filling trade orders and it has a duty to obtain the best execution reasonably available for its customers but if filling an order with securities in its inventory works best then it may choose to internalize to save money on an outside execution and to make money on the spread | |
what is a benefit of internalization | savings is one benefit if a company can spend less by producing a product or completing a project in house compared to what it would spend on an outside vendor then internalization would be a beneficial move | |
is internal sourcing different from internalization | it is simply a form of internalization whereby a business sources finds resources for a job or business need internally rather than externally broadly speaking this means it finds employees materials a department or a division of its own to complete a job instead of paying an out of house source to do so the bottom lineinternalization refers to the process of taking a job or project in house when making such a move makes financial sense oftentimes paying an outside vendor to complete a process makes sense especially when a business isn t equipped employee or production wise to handle it but if a company projects enough savings and better efficiency by handling it itself it may decide to internalize the job | |
what are international accounting standards ias | international accounting standards ias are a set of rules for financial statements that were replaced in 2001 by international financial reporting standards ifrs and have subsequently been adopted by most major financial markets around the world 1 both sets of standards were issued by the international accounting standards board iasb an independent body based in london the united states does not follow ifrs instead the u s securities exchange commission requires public companies in the u s to follow generally accepted accounting standards gaap china and japan also declined to adopt ifrs understanding international accounting standards ias international accounting standards ias were the first international accounting standards that were issued by the international accounting standards committee iasc formed in 1973 the goal then as it remains today was to make it easier to compare businesses around the world increase transparency and trust in financial reporting and foster global trade and investment 6globally comparable accounting standards promote transparency accountability and efficiency in financial markets around the world this enables investors and other market participants to make informed economic decisions about investment opportunities and risks and improves capital allocation universal standards also significantly reduce reporting and regulatory costs especially for companies with international operations and subsidiaries in multiple countries moving toward new global accounting standardsthere has been significant progress towards developing a single set of high quality global accounting standards since the iasc was replaced by the iasb ifrs have been adopted by the european union leaving the united states japan where voluntary adoption is allowed and china which says it is working towards ifrs as the only major capital markets without an ifrs mandate 234as of 2022 144 jurisdictions required the use of ifrs for all or most publicly listed companies and a further 12 jurisdictions permit its use 7globally comparable accounting standards promote transparency accountability and efficiency in financial markets around the world the united states is exploring adopting international accounting standards since 2002 america s accounting standards body the financial accounting standards board fasb and the iasb have collaborated on a project to improve and converge the u s generally accepted accounting principles gaap and ifrs 5 however while the fasb and iasb have issued norms together the convergence process is taking much longer than was expected in part because of the complexity of implementing the dodd frank wall street reform and consumer protection act 8the securities and exchange commission sec which regulates u s securities markets has long supported high quality global accounting standards in principle and continues to do so in the meantime because u s investors and companies routinely invest trillions of dollars abroad fully understanding the similarities and differences between u s gaap and ifrs is crucial one conceptual difference ifrs is thought to be a more principles based accounting system while gaap is more rules based | |
what is an international bank account number iban | an iban or international bank account number is a standard international numbering system developed to identify an overseas bank account the number starts with a two digit country code then two numbers followed by several more alphanumeric characters note that an iban does not replace a bank s own account numbering as it s only meant to provide additional information that helps in identifying overseas payments | |
how international bank account numbers ibans work | the iban consists of a two letter country code followed by two check digits and up to thirty five alphanumeric characters these alphanumeric characters are known as the basic bank account number bban it is up to the banking association of each country to determine which bban they will select as the standard for that country s bank accounts an iban will be used when sending interbank transfers or wiring money from one bank to another especially across international borders in the register of countries currently using the iban system several examples are as follows the u s and canada are two major countries that do not use the iban system however they recognize the system and process payments according to the system 67iban examplean iban is made up of a maximum of 34 alphanumeric characters it is made up of the following components the chart below shows an example of an iban for a hypothetical bank in finland the iban would be fi21 1234 5698 7654 3210 8iban vs swift codesthere are two internationally recognized standardized methods of identifying bank accounts when a transfer is being made from one country to another the international bank account number iban and the society for worldwide interbank financial telecommunication swift code the difference between the two methods lies in what they identify a swift code is used to identify a specific bank during an international transaction whereas iban is used to identify an individual account involved in the international transaction both play an essential role in the smooth running of the international financial market the swift system predates attempts to standardize international banking transactions through iban it remains the method by which the majority of international fund transfers are made one of the main reasons for this is that the swift messaging system allows banks to share a significant amount of financial data this data includes the status of the account debit and credit amounts and details related to the money transfer banks often use the bank identifier code bic instead of the swift code however the two are easily interchangeable both contain a mix of letters and numbers and are generally between eight and 11 characters in length requirements for international bank account numbersthe iban developed out of diverging national standards for bank account identification varying uses of alphanumeric forms to represent specific banks branches routing codes and account numbers often led to misinterpretations and or omissions of critical information from payments to smooth this process the international organization for standardization iso published iso 13616 1997 in 1997 9 shortly after the european committee for banking standards ecbs published a smaller version believing the original flexibility allowed in the iso version was unworkable in the ecbs s version they allowed only upper case letters and a fixed length iban for each country 10since 1997 a new version the iso 13616 2003 replaced the initial ecbs version 11 a subsequent version in 2007 stipulated that iban elements must facilitate the processing of data internationally in both financial environments and among other industries however it does not specify any internal procedures including but not limited to file organization techniques storage media or languages 12who uses an iban iban was first created to facilitate electronic payments between banks across europe 13 since then it has expanded worldwide although not all banks and not all regions have joined the standard and you may still need to rely on an alternative system such as swift north american australian and asian countries do not use the iban for domestic money transfers and will only do so when sending a payment to a country that has adopted the iban 14 | |
why was iban created | iban was developed to reduce errors and improve the verification of cross border payments by reducing rejected payments transfer delays and associated bank charges and fees | |
what does an iban number look like | an iban number contains up to 34 alphanumeric characters 15 it is prefaced by a two character country code two check digits and a basic bank account number bban that contains specific bank and account details the format of the bban portion varies from country to country which will typically include a bank code and branch code | |
how can i get an iban | you can request an iban if you are a customer of a bank in an iban region 16 note that an iban can only be used to receive payments and is not used when making withdrawals the bottom linean iban is only used during international financial transfers transactions the latest iban registry released in july 2023 states that there are 86 countries using iban 17 if your country doesn t use iban it may use another system such as swift transferring money internationally can be tricky these systems are designed to reduce issues with international transfers |
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