Common Cost
Definition: A common cost is an expense associated with operating a facility, product, or segment that is shared between two or more departments or users. In other words, it’s a shared expense of creating a product or providing a service that can’t be attributed to a single department or user.
Common costs must be allocated equitably to all of the users that share the expense based on the cost object. This treatment is far better for each department involved because their shared costs are much lower than the total expense associated with the activity if they were required to pay for it individually.
Let’s look at an example.
Example
Bill is the CEO of a small product company in Seattle that has to visit two different suppliers for two different products Bill’s company produces. One is in Germany and the other is in Canada. The plane ticket to Germany is $2,000 and the ticket to Canada is $500. If Bill buys one ticket with a stop in Canada, he can reduce his costs to $2,000 thus saving his company $500 on the total trip.
Common costs are typically assigned or allocated to joint products, processes, and activities, so the company can accurately determine the cost of each activity and adjust prices accordingly. In this case the joint activities are trips to different suppliers related to different departments. Now what product should these travel costs be associated with?
The answer is both. They are shared costs because the trip benefited both product departments and cost objects. By booking the flights together, Bill was able to lower the overall expenses of the trip and lower the expenses that each department will have to pay. Bill can use either the stand-alone cost allocation method or the incremental cost allocation method to assign these travel costs to each department.
Treasury Strips:
Definition: STRIPS is the acronym used for Separate Trading of Registered Interest and Principal of Securities. It is the security which separates the coupons from the principal. These are sold at a discount and are matured at par. In literal terms, it strips a bond into a number of several bonds with an individual par value.
Simply put, Treasury STRIPS are the stripped cash flows of one bond which has been separated into separate zero-coupon bonds. These stripped cash flows include the coupon payments as the coupon strips and the face value of the bond as a principal strip.
For example.
To better understand this concept, let’s assume that a 5-year bond with a face value of $10,000 with 5% annual coupon payments would have a total of 6 zero-coupon bonds. It includes the 5 interest payments and 1 principal payment, all stripped separately and converted into individual bonds with their face value equal to their coupon value of $500 and their maturity date same as their coupon payment date. Each of the interest payment dates would then become the new stripped bond’s date of maturity. As this new bond does not have any coupon payment, thus it becomes a zero-coupon bond. Similarly, another 5-year $10,000 bond with 5% “semi-annual” coupon payments will be stripped into a total of 11 zero-coupon bonds with 10 coupon strips and 1 principal strip.
This type of bond is categorized as fixed income securities and is considered a zero-coupon bond as it has no interest payment. It is used for bringing liquidity in the marketplace by giving the investor more options for the maturity of the bonds. Each of the individual stripped bonds could be effectively traded as zero-coupon bonds as it has its maturity date.
Trading Account
Definition: A trading account is an investment account which holds cash, securities or any other holdings. It refers to the securities or funds which have been deposited with a broker or financial institution. It enables the account holder to buy and sell securities or holdings.
The trading account can hold any investment vehicle like any brokerage account; however, it differs from it on the level, risk, and purpose of the activity involved in it. This account is usually used for the purpose of speculation and acts as a day trader’s primary account for trading. The trading account holders usually use it to buy or sell securities frequently and mostly in the same trading session. The activity of this account therefore usually constitutes to day trading. These accounts are hence subject to specialized regulations as well. The trading accounts asset differs from the other long-term assets as well.
For example.
Trading accounts are usually held by financial institutions and managed by investment dealers who run a trading strategy for the account holder. The account holders are the investors who are going to speculate on the tradable asset’s movements in expectation of the benefits that they can make from these transactions. The investor who is in charge of the account would decide on which assets to trade, how large the position should be and on whether to be long or short. Many of the trading accountholders use technical analysis to help them make their decisions to make it more objective.
If a person wants to open a trading account, he/she should know that he/she would need to fund this account from his/her own bank account. The selection of the type of trading account would depend on facts like; whether the person’s account is tax-deferred or taxable, whether it belongs to one person or is a joint account. The next thing is to decide on whether to have a margin or cash trading account. The cash trading account is limited to the amount of the person’s own cash in the account while the margin account extends a line of credit from the institution for trading if the person desires so.
Portfolio Diversification
Definition: Portfolio diversification is the strategy used for the management of a portfolio of assets through which the investor tends to reduce its risk by spreading its investment among a wide selection of assets with lower correlations with each other in the expectation that losses from one asset would be offset by the gains of another asset in the portfolio.
It is a kind of risk management strategy as well which is based on the rationale that a portfolio with lower correlations would yield higher returns and lower risk on average as compared to the individual investments within the portfolio. It strives to reduce the overall risk of the investment by combining a variety of assets.
The basic idea is that negative performance of one investment would be outweighed by the good performance of other investments. It can be explained by the example of a Software company ABC for which a person works and has $ 2 million to invest. If it is assumed that the person has the right to invest all of its $2 million in his employer company. Now, consider two scenarios.
Scenario A:
This person can invest 100% of his $2 million in ABC Company. If the stock of ABC Company moves from $6 to $4 per share, then the personal investment of $ 2 million would devalue to $ 1 million, losing 50% of its value.
Scenario B:
Or he invests 50% of its investment, i.e. $1 million in ABC Company and the remaining 50% ($ 1 million) in another stock XYZ which is a financial institution.
Assuming the same for the stock price of ABC while the share of XYZ Company goes from $6 to $7.50, the results would be different. The person would have a $ 500,000 value for its $ 1 million investment in stock ABC, which has devalued from $6 to $4 losing 50% of its value, but also its $ 1 million investment in stock XYZ would be revalued at $ 125,000 with a 25 % gain. The total investment would have a worth of $175,000 with a loss of $ 25,000 which is lower than that of the first scenario.
Open-End Fund
Definition: An open-end fund is funds which are operated by an investment firm who raises funds from the sale of its own shares and invests these funds in a group of assets which are all aligned with a group of the stated objectives of the fund. It sells its shares like any other public firm which can sell stock, but it then takes the money raised from it to purchase investment vehicles like bonds, securities, and stocks.
These funds purchase and sell a combination of units on a constant basis, allowing their fundholders to own or sell their shares as per their ease. The units are open for trading after the initial offering period as well as the NAV (net asset value) which has been stated by the fund.
The shareholders own the equity position equal to their invested amount in the fund and consequently in the underlying securities as well. The shareholders are free to sell these shares at any time. The number of outstanding units varies on a daily basis as selling and buying is being done all the time. With more purchasing of the units, the fund size reduces as its selling is lower than its purchases while its size expands when it sells more units than it repurchases. It can stop accepting subscriptions if the fund management thinks its size is getting beyond manageable. However, it has to keep on repurchasing units all times.
The benefit of the fund is that it offers a diversified portfolio and professional money management services. It often requires minimum investment and offers liquidity, choice, and convenience for a fee. Some examples of US mutual funds include the Vanguard Group’s S&P 500 fund, T. Rowe Price or the PIMCO Total Return funds.
2 for 1 Stock Split
Definition: All public companies have a constant number of outstanding shares at one point in time. The stock split refers to the board of directors’ decision to add to the existing number of outstanding shares with the issuance of more stocks to the current shareholders. The 2 for 1 stock split refers to the decision of splitting one stock in two by giving an additional one share for each of the shares held by the shareholder.
The 2 for 1 stock split increases the shares outstanding for a firm without changing the market value and the proportionate ownership of the shareholders of the company. Additional shares are issued to the existing shareholders of the company with the approval of the board of the directors of the company.
For better understanding, let’s take an example of a company who has 1 million shares outstanding. After the approval of 2 for 1 stock split, the company would have 2 million shares outstanding. Even though the market value and ownership of the company does not change from this stock split, the share price of the company is affected. For 2 for 1 stock split, after the splitting of each of the stocks, the price of the shares would be halved. This is the result which is aimed for by the management of the company. A company goes for stock split when it considers its share price to be too high relative to its sector. This helps in increasing liquidity of the stock by making stock affordable for the investors without changing the market value of the company. The stock split may often result in an increment in the stock price right after the split as smaller investors would consider it affordable as well increasing the demand of the stock.
