Processing Knowledge

I always was in a dilemma on whether to save or invest. I highlighted this dilemma in my previous post title “Save or Invest“. This dilemma was partially solved when I read the post titled “Save and Invest“. Financial researchers have always advised their clients to have a blend of savings and investments.  This is because savings is considered to be a protection from the volatilities that our investments in securities are exposed to.

History and the Religious Flavor to Saving:

Our forefathers have been for years highlighting the importance of saving in gold. This was taken a step further, when festivals were celebrated by the buying of gold. This form of regular savings accumulated over the years and acted as a suitable protection against financial storms.

Importance of having a blend of Savings and Investments:

Barack Obama has been recently quoted to have said, “At the end of the day, the best way to bring our deficit down in the long run is not with a budget that continues the very same policies that have led to a narrow prosperity and massive debt. …. It’s with a budget that leads to broad economic growth by moving from an era of borrow and spend to one where we save and to one where we save and invest”. This is a classical quote from a great visionary that he is.  The quest for optimum growth is the primary source of  the invention of the various financial instruments we  come across in our day to day lives. These include insurance, mutual funds, and even the stock market.  Financial valuation has its source in mathematics and over the years it has become one of the primary contributors for the research in mathematics.  These models have only one goal, i.e.,  optimization of these instruments to maximize their returns.

The definition of hedge which is most suitable for the financial sector is “Hedge: To shelter one’s self from danger, risk, etc.” One of the oldest forms of hedging in insurance, where the insurer insures the life and or assests owned by the person. Similarly, hedge funds are financial instruments that are used to hedge the investment in securities from the volatile behavior of the markets. Lately Financial researchers and KPOs have started sharing their research on the various financial instruments with hedge fund managers.

Short Selling

Short Selling: An Example

The practise of short selling was first observed in 1609 and has been banned by many markets before the 19th century.  An example of short selling is as follows. Alice borrows the 10 shares worth $5 each of company X from Bob for a day. Bob has decided not to sell the 10 shares for another 6 months as he speculates that the share price will go up. Alice should ensure that she returns 10 shares of company X to Bob by the end of the day. Alice sell the 10 shares for  $50 ($5 each) at the begining of the day as she knows that some bad news shall bring the price down to $3. As she predicted, the price falls to $3.50, and she buys the share for $35. She gives $5 to Bob and keeps $10 to herself.

Hedge Funds and Short Selling:

Short selling is on of the techniques used by hedge fund manager to hedge the risks involved in their long term investments. The wikipedia article on hedge funds gives a nice example of hedge funds and how short selling is used. The importance of investment data becomes really critcial while predicting the price ranges of securities, hence KPOs have entered into the business of sourcing financial data