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108-465: Private wealth management is sought by high-net-worth investors. Generally, this includes advice on the use of various estate planning vehicles, business-succession or stock-option planning, and the occasional use of hedging derivatives for large blocks of stock. Traditionally, the wealthiest retail clients of investment firms demanded a greater level of service, product offering and sales personnel than that received by average clients. With an increase in

216-425: A long position , and the party agreeing to sell the asset in the future assumes a short position . The price agreed upon is called the delivery price , which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time and date of trade

324-438: A "signalling effect" that has attracted new investment and ultimately staved off existential questions that have been asked of the social finance industry. Proponents of social finance Kent Baker and John Nofsinger claim that these trends of institutionalisation will lead to the legitimisation of the social finance industry, give way to the widespread institutional uptake of social finance, and ultimately embed social finance as

432-452: A CDO might issue the following tranches in order of safeness: Senior AAA (sometimes known as "super senior"); Junior AAA; AA; A; BBB; Residual. Separate special-purpose entities —rather than the parent investment bank —issue the CDOs and pay interest to investors. As CDOs developed, some sponsors repackaged tranches into yet another iteration called " CDO-Squared " or the "CDOs of CDOs". In

540-548: A Non-Agency MBS; in the United States they may be issued by structures set up by government-sponsored enterprises like Fannie Mae or Freddie Mac , or they can be "private-label", issued by structures set up by investment banks. The structure of the MBS may be known as "pass-through", where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of

648-483: A certain price is a " put option ". Both are commonly traded, but for clarity, the call option is more frequently discussed. Options valuation is a topic of ongoing research in academic and practical finance. In basic terms, the value of an option is commonly decomposed into two parts: Although options valuation has been studied since the 19th century, the contemporary approach is based on the Black–Scholes model , which

756-429: A corporation borrows a large sum of money at a specific interest rate. The interest rate on the loan reprices every six months. The corporation is concerned that the rate of interest may be much higher in six months. The corporation could buy a forward rate agreement (FRA), which is a contract to pay a fixed rate of interest six months after purchases on a notional amount of money. If the interest rate after six months

864-431: A defining characteristic of social finance and distinguish it from related practices, such as not-for-profit investing, charity, and philanthropy. Leading scholars in the field of social innovation, such as Stephen Sinclair, Neil McHugh, and Michael Roy, question the need for social finance given the extensive existing frameworks that govern corporate social responsibility in capital markets. Their critical analysis of

972-430: A derivative contract to speculate on the value of the underlying asset. Speculators look to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is less. Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson ,

1080-426: A formal definition of social finance due to a lack of clarity around its scope and intent; however, it is said to include elements of impact investing , socially responsible investing , and social enterprise lending . Investors include charitable foundations , retail investors , and institutional investors . Notable examples of social finance instruments are social impact bonds and social impact funds. Since

1188-404: A forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange. Unlike an option , both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from

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1296-484: A longer-term repayment schedule). The Social Innovation Fund is a well-known example of a SIF. Through a competitive process, it awards grants of up to $ 10 million per year to organisations with strong track records of effective social service. Efforts to create mechanisms to allocate capital for combined social and economic value creation are not new. Social finance is conceptually a very different approach to social welfare enhancement, however, in that, by combining

1404-500: A mainstream asset class of financial investments among the likes of stocks and bonds. However, several unfavourable trends have also become apparent, including uneven uptake. Key challenges remain, including the struggle to produce desirable returns for investors, high start-up and regulatory costs, and lack of access to retail investors. Baker and Nofsinger argue that until these gaps are addressed, mass participation in social finance will be prevented. Of all forms of social finance,

1512-515: A means for greater direct investment in addressing social challenges, whereas existing corporate governance frameworks work at the fringe. Othmar Lehner, Associate Professor of Social Enterprise at the University of Oxford Saïd Business School, states that while traditional financial institutions typically prioritise profitability and regard their societal impact only so much as regulation requires, social finance enterprises set social objectives as

1620-399: A model which asks clients about life goals, working environments, and spending patterns as a way to increase communication. The industry-recognized wealth management was more than an investment advisory discipline. In 2015, United Capital rebranded their wealth management services using the term "financial life management", which, according to the company, was intended to more clearly define

1728-452: A particular type of that security—one backed by consumer loans (example: "As a rule of thumb, securitization issues backed by mortgages are called MBS, and securitization issues backed by debt obligations are called CDO, [and] Securitization issues backed by consumer-backed products—car loans, consumer loans and credit cards, among others—are called ABS.) Originally developed for the corporate debt markets, over time CDOs evolved to encompass

1836-488: A pool of other MBSs. Other types of MBS include collateralized mortgage obligations (CMOs, often structured as real estate mortgage investment conduits) and collateralized debt obligations (CDOs). The shares of subprime MBSs issued by various structures, such as CMOs, are not identical but rather issued as tranches (French for "slices"), each with a different level of priority in the debt repayment stream, giving them different levels of risk and reward. Tranches—especially

1944-487: A profit in the exchange. However, Aristotle did not define this arrangement as a derivative but as a monopoly (Aristotle's Politics, Book I, Chapter XI). Bucket shops , outlawed in 1936 in the US, are a more recent historical example. Derivatives are contracts between two parties that specify conditions (especially the dates, resulting values and definitions of the underlying variables, the parties' contractual obligations, and

2052-630: A result, Maurer suggests, mainstream corporations looking to rebuild their reputations are now entering the market, bringing with them significant inflows of capital and investment. One study, which provides a statistical analysis of participation, satisfaction, and retention rates in the European social finance market, suggests that the 2007–2008 financial crisis occurred at a time when social finance organizations were beginning to develop track records that demonstrated their market feasibility. Geobey and Harji, in their anecdotal study of social finance in

2160-401: A single buyer and seller, one or both of which may be a dealer or market-maker. Options are part of a larger class of financial instruments known as derivative products or simply derivatives. A swap is a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on

2268-426: A specified strike price on or before a specified date . The seller has the corresponding obligation to fulfill the transaction—that is to sell or buy—if the buyer (owner) "exercises" the option. The buyer pays a premium to the seller for this right. An option that conveys to the owner the right to buy something at a certain price is a " call option "; an option that conveys the right of the owner to sell something at

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2376-404: A specified amount of cash for a specified amount of wheat in the future. Both parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and for the miller, the availability of wheat. However, there is still the risk that no wheat will be available because of events unspecified by the contract, such as the weather, or that one party will renege on the contract. Although

2484-451: A specified future time at an amount agreed upon today, making it a type of derivative instrument. This is in contrast to a spot contract , which is an agreement to buy or sell an asset on its spot date, which may vary depending on the instrument, for example most of the FX contracts have Spot Date two business days from today. The party agreeing to buy the underlying asset in the future assumes

2592-488: A standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price ) with delivery and payment occurring at a specified future date, the delivery date , making it a derivative product (i.e. a financial product that is derived from an underlying asset). The contracts are negotiated at a futures exchange , which acts as an intermediary between buyer and seller. The party agreeing to buy

2700-424: A third party, called a clearing house , insures a futures contract, not all derivatives are insured against counter-party risk. From another perspective, the farmer and the miller both reduce a risk and acquire a risk when they sign the futures contract: the farmer reduces the risk that the price of wheat will fall below the price specified in the contract and acquires the risk that the price of wheat will rise above

2808-458: A trader at Barings Bank , made poor and unauthorized investments in futures contracts. Through a combination of poor judgment, lack of oversight by the bank's management and regulators, and unfortunate events like the Kobe earthquake , Leeson incurred a $ 1.3 billion loss that bankrupted the centuries-old institution. Individuals and institutions may also look for arbitrage opportunities, as when

2916-504: A variety of reasons. In broad terms, there are two groups of derivative contracts, which are distinguished by the way they are traded in the market: Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps , forward rate agreements , exotic options – and other exotic derivatives – are almost always traded in this way. The OTC derivative market

3024-466: Is above the contract rate, the seller will pay the difference to the corporation, or FRA buyer. If the rate is lower, the corporation will pay the difference to the seller. The purchase of the FRA serves to reduce the uncertainty concerning the rate increase and stabilize earnings. Derivatives can be used to acquire risk, rather than to hedge against risk. Thus, some individuals and institutions will enter into

3132-443: Is characterized by socially responsible investment. The social finance ecosystem is composed of four key groups: Research reveals that the term social finance is familiar mainly to people working in the niche sector of financial services. Since the 2007–2008 financial crisis , however, the social finance industry has experienced a period of accelerated growth and institutional uptake. For example, in 2011 Deutsche Bank became

3240-422: Is no central counter-party. Therefore, they are subject to counterparty risk , like an ordinary contract , since each counter-party relies on the other to perform. Exchange-traded derivatives (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by

3348-435: Is no required reporting of transactions to a government agency. During the 2007–2008 financial crisis , the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk . In March 2010, the [DTCC] Trade Information Warehouse announced it would give regulators greater access to its credit default swaps database. CDS data can be used by financial professionals , regulators, and

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3456-460: Is not paid back as a single payment to the bond holder at maturity but rather is paid along with the interest in each periodic payment (monthly, quarterly, etc.). This decrease in face value is measured by the MBS's "factor", the percentage of the original "face" that remains to be repaid. In finance , an option is a contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset or instrument at

3564-403: Is not the same as the value date where the securities themselves are exchanged. The forward price of such a contract is commonly contrasted with the spot price , which is the price at which the asset changes hands on the spot date . The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit , or loss, by

3672-401: Is secured by a mortgage , or more commonly a collection ("pool") of sometimes hundreds of mortgages . The mortgages are sold to a group of individuals (a government agency or investment bank) that " securitizes ", or packages, the loans together into a security that can be sold to investors. The mortgages of an MBS may be residential or commercial , depending on whether it is an Agency MBS or

3780-441: Is the insurer (risk taker) for one type of risk, and the counter-party is the insurer (risk taker) for another type of risk. Hedging also occurs when an individual or institution buys an asset (such as a commodity, a bond that has coupon payments , a stock that pays dividends, and so on) and sells it using a futures contract. The individual or institution has access to the asset for a specified amount of time, and can then sell it in

3888-571: Is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as hedge funds . Reporting of OTC amounts is difficult because trades can occur in private, without activity being visible on any exchanges According to the Bank for International Settlements , who first surveyed OTC derivatives in 1995, reported that

3996-437: The 2007–2008 financial crisis , the social finance industry has been experiencing a period of accelerated growth as shifts in investor sentiment have increased demand for ethically responsible investment alternatives by retail investors. Mainstream sources of capital have entered the market as a result, including Deutsche Bank, which in 2011 became the first commercial bank to raise a social investment fund. New research in

4104-474: The 2007–2008 financial crisis , there has been increased pressure to move derivatives to trade on exchanges. Derivatives are one of the three main categories of financial instruments, the other two being equity (i.e., stocks or shares) and debt (i.e., bonds and mortgages ). The oldest example of a derivative in history, attested to by Aristotle , is thought to be a contract transaction of olives , entered into by ancient Greek philosopher Thales , who made

4212-1021: The Institute for Private Investors in 1991, and CCC Alliance in 1995. These companies aimed to offer an online community as well as a network of peers for ultra high-net-worth individuals and their families. These entities have grown since the 1990s, with total IT spending (for example) by the global wealth management industry predicted to reach $ 35bn by 2016, including heavy investment in digital channels. Wealth management can be provided by large corporate entities, independent financial advisers or multi-licensed portfolio managers who design services to focus on high-net-worth clients. Large banks and large brokerage houses create segmentation marketing-strategies to sell both proprietary and non-proprietary products and services to investors designated as potential high-net-worth clients. Independent wealth-managers use their experience in estate planning, risk management, and their affiliations with tax and legal specialists, to manage

4320-408: The notional amount ) under which payments are to be made between the parties. The assets include commodities , stocks , bonds , interest rates and currencies , but they can also be other derivatives, which adds another layer of complexity to proper valuation. The components of a firm's capital structure , e.g., bonds and stock, can also be considered derivatives, more precisely options, with

4428-412: The spot value (i.e., the original value agreed upon, since any gain or loss has already been previously settled by marking to market). Upon marketing the strike price is often reached and creates much income for the "caller". A closely related contract is a forward contract . A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However,

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4536-700: The " gross market value , which represent the cost of replacing all open contracts at the prevailing market prices, ... increased by 74% since 2004, to $ 11 trillion at the end of June 2007 (BIS 2007:24)." Positions in the OTC derivatives market increased to $ 516 trillion at the end of June 2007, 135% higher than the level recorded in 2004. The total outstanding notional amount is US$ 708 trillion (as of June 2011). Of this total notional amount, 67% are interest rate contracts , 8% are credit default swaps (CDS) , 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there

4644-462: The "Private Wealth Management" retail division focuses on serving clients with greater than $ 20 million in investment assets while "Global Wealth Management" focuses on accounts smaller than $ 10 million. In the late 1980s, private banks and brokerage firms began to offer seminars and client events designed to showcase the expertise and capabilities of the sponsoring firm. Within a few years a new business model emerged – Family Office Exchange in 1990,

4752-855: The 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade and the 2008 acquisition of the New York Mercantile Exchange ). According to BIS, the combined turnover in the world's derivatives exchanges totaled US$ 344 trillion during Q4 2005. By December 2007 the Bank for International Settlements reported that "derivatives traded on exchanges surged 27% to a record $ 681 trillion." Inverse exchange-traded funds (IETFs) and leveraged exchange-traded funds (LETFs) are two special types of exchange traded funds (ETFs) that are available to common traders and investors on major exchanges like

4860-448: The 2007-9 subprime mortgage crisis . A credit default swap ( CDS ) is a financial swap agreement that the seller of the CDS will compensate the buyer (the creditor of the reference loan) in the event of a loan default (by the debtor) or other credit event . The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if

4968-472: The NYSE and Nasdaq. To maintain these products' net asset value , these funds' administrators must employ more sophisticated financial engineering methods than what's usually required for maintenance of traditional ETFs. These instruments must also be regularly rebalanced and re-indexed each day. Some of the common variants of derivative contracts are as follows: Some common examples of these derivatives are

5076-577: The United States in particular. While capital flows and trust between suppliers (investors) and demanders (social finance institutions) of capital are improving, regulatory developments have lagged behind. One study concedes that the rapid growth of social finance in the 21st century has exposed its self-regulatory capacity, the need to strengthen governance mechanisms, and the need to develop sophisticated intermediaries to link capital and opportunities. The source suggests that institutional uptake of social finance will be held back by these headwinds and, unless

5184-511: The United States, the Community Reinvestment Act provided the impetus for financial institutions to invest in underserved local regions and marginalized sectors of the economy, furthering state transfers of wealth to the private sector. This spawned a plethora of community development financial institutions , which deployed significant amounts of capital in affordable housing, renewable energy, and financial inclusion across

5292-507: The United States. Furthermore, many prominent foundations, including the Ford, Rockefeller, and MacArthur Foundations, have actively invested their endowments in a manner that aligns with this practice of mission-related investing . Some scholars contest that social finance has its origins in Islamic finance, which was practiced by the sharia-compliant Islamic economies of the 1960s and which

5400-712: The aftermath of the 2007–2008 financial crisis , it is notable for its public benefit focus. Mechanisms of creating shared social value are not new; however, social finance is conceptually unique as an approach to solving social problems while simultaneously creating economic value. Unlike philanthropy, which has a similar mission-motive, social finance secures its own sustainability by being profitable for investors. Capital providers lend to social enterprises , who in turn, by investing borrowed funds in socially beneficial initiatives, deliver investors measurable social returns in addition to traditional financial returns on their investment. Consensus has yet to be established on

5508-416: The aftermath of the 2007–2008 financial crisis . Social finance, through its innovative approach to solving social problems while creating economic value, has met the need of disaffected retail investors who seek ethical investment alternatives following revelations in the aftermath of the 2007–2008 financial crisis of widespread unethical business practices by mainstream corporations in pursuit of profit. As

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5616-468: The aim of reducing the need for these services in the first place. Proceeds from the savings are used to reward investors for facilitating the process. Unlike conventional bonds, however, SIBs operate on a pay-for-performance basis, in which bondholders are repaid only if the program’s outcome targets are achieved. Social investment funds (SIFs) pool funds from investors to provide not-for-profit organisations with “patient working capital” (funding with

5724-468: The breakup of ownership and participation in the market value of an asset. This also provides a considerable amount of freedom regarding the contract design. That contractual freedom allows derivative designers to modify the participation in the performance of the underlying asset almost arbitrarily. Thus, the participation in the market value of the underlying can be effectively weaker, stronger (leverage effect), or implemented as inverse. Hence, specifically

5832-422: The budget for total expenditure of the United States government during 2012 was $ 3.5 trillion, and the total current value of the U.S. stock market is an estimated $ 23 trillion. Meanwhile, the global annual Gross Domestic Product is about $ 65 trillion. At least for one type of derivative, credit default swaps (CDS), for which the inherent risk is considered high , the higher, nominal value remains relevant. It

5940-494: The cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer losses first. The last to lose payment from default are the safest, most senior tranches. Consequently, coupon payments (and interest rates) vary by tranche with the safest/most senior tranches paying the lowest and the lowest tranches paying the highest rates to compensate for higher default risk . As an example,

6048-458: The current buying price of an asset falls below the price specified in a futures contract to sell the asset. The true proportion of derivatives contracts used for hedging purposes is unknown, but it appears to be relatively small. Also, derivatives contracts account for only 3–6% of the median firms' total currency and interest rate exposure. Nonetheless, we know that many firms' derivatives activities have at least some speculative component for

6156-420: The decline. The social finance industry faces several headwinds, including the struggle to produce desirable returns for investors, high start-up and regulatory costs, neglect from mainstream banks, and lack of access to retail investors, an area that is believed to have perhaps the most demand. Furthermore, although the industry has matured, it has done so at an uneven pace across its ecosystem, as evidenced in

6264-733: The difference between wealth management companies and more affordable brokerage firms . The same year Merrill Lynch began a program, Merrill Lynch Clear, which asks investors to describe life goals, and includes an educational program for clients' children. For clients looking to leverage their wealth for the sake of achieving philanthropical and charitable goals, social finance investments may be included. According to Euromoney's annual Private banking and wealth management ranking 2023, which consider (DE FACTO) [[STANLEY, ANTWANNA DARYLN [ZION]], net income and net new assets, global private banking assets grew just 10.8%YoY (compared with 16.7% ten years ago). The largest private banks and wealth managers in

6372-493: The diverse holdings of high-net-worth clients. Banks and brokerage firms use advisory talent-pools to aggregate these same services. The Great Recession of the late 2000s caused investors to address concerns within their portfolios. For this reason wealth managers have been advised that clients have a greater need to understand, access, and communicate with advisers about their situation. As awareness of wealth management has become more common, some companies have shifted towards

6480-520: The early 2000s, CDOs were generally diversified, but by 2006–2007—when the CDO market grew to hundreds of billions of dollars—this changed. CDO collateral became dominated not by loans, but by lower level ( BBB or A ) tranches recycled from other asset-backed securities, whose assets were usually non-prime mortgages. These CDOs have been called "the engine that powered the mortgage supply chain" for nonprime mortgages, and are credited with giving lenders greater incentive to make non-prime loans leading up to

6588-485: The efficacy of social impact bonds concludes that social finance draws capital away from productive investment opportunities and exacerbates allocative inefficiencies caused by excessive existing government regulation. Separate studies reaffirm these claims and argue that improved efficiencies are needed before social finance is marketized. Proponents of social finance concede that while its intent overlaps with that of corporate social responsibility, social finance provides

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6696-487: The elite retail (or "Private Client") divisions of firms such as Goldman Sachs or Morgan Stanley (before the Dean Witter Reynolds merger of 1997), to distinguish those divisions' services from mass-market offerings, but has since spread throughout the financial-services industry. Family offices that had formerly served just one family opened their doors to other families, and the term Multi-family office

6804-507: The exchange. A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the trade to act as a guarantee. The world's largest derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of

6912-531: The field calls for increasing the role of government in social finance to help overcome the challenges the industry currently faces, including the struggle to produce desirable returns for investors, high start-up and regulatory costs, neglect from mainstream banks, and a lack of access to retail investors. Proponents of social finance argue that until these gaps are addressed, mass participation in social finance will be prevented. The history of social finance has its origins in 20th-century neoliberal economics and

7020-560: The first commercial bank to raise a social investment fund, in 2012 Goldman Sachs floated Social Impact Bonds in the US, and in 2012 the European Investment Fund made a direct investment into the UK social finance marketplace. Explanation of the post-crisis popularization of social finance is the subject of extensive academic research. Social theorist Bill Maurer explains it as the result of shifts in investor sentiment in

7128-492: The first goal of their capital allocation strategies, channelling investors’ funds directly to organisations that prioritise projects with socially positive outcomes. In his opening chapter in the Routledge Handbook of Social and Sustainable Finance , he proposes social finance as a new source of capital to supplement existing sources, such as charitable donations and philanthropic grants, which have historically been

7236-467: The following: A collateralized debt obligation ( CDO ) is a type of structured asset-backed security (ABS) . An "asset-backed security" is used as an umbrella term for a type of security backed by a pool of assets—including collateralized debt obligations and mortgage-backed securities (MBS) (Example: "The capital market in which asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs". )—and sometimes for

7344-421: The future at a specified price according to the futures contract. Of course, this allows the individual or institution the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market's current assessment of the future value of the asset. Derivatives trading of this kind may serve the financial interests of certain particular businesses. For example,

7452-421: The futures exchange requires both parties to put up an initial amount of cash (performance bond), the margin . Margins, sometimes set as a percentage of the value of the futures contract, need to be proportionally maintained at all times during the life of the contract to underpin this mitigation because the price of the contract will vary in keeping with supply and demand and will change daily and thus one party or

7560-430: The futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss. A mortgage-backed security ( MBS ) is an asset-backed security that

7668-445: The ideas of neoliberal markets (in creating a profit and financial return) with taking care of social needs (in the way that a charity would), social finance secures its own sustainability by being profitable for those who fund these organisations. It is funded by investors, who receive a return on their investment, rather than donors, who forgo their contribution at the time of donation. The ‘ blended’ social and financial returns are

7776-465: The ideas that it proposed, such as an emphasis on the role of the free market in society. The concept itself first came in to use in the 1970s in the United States, where it emerged as an innovative approach to solve social problems while creating economic value. The appeal to government was clear: access to swaths of private capital to fund social programs at a time of deep austerity and retrenchment of state programs under neoliberal politics. In 1977 in

7884-678: The latter offers managers and investors a risky opportunity to increase profit, which may not be properly disclosed to stakeholders. Along with many other financial products and services, derivatives reform is an element of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission (CFTC) and those details are not finalized nor fully implemented as of late 2012. To give an idea of

7992-556: The loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction ; the payment received is usually substantially less than the face value of the loan. Credit default swaps have existed since the early 1990s, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $ 62.2 trillion, falling to $ 26.3 trillion by mid-year 2010 but reportedly $ 25.5  trillion in early 2012. CDSs are not traded on an exchange and there

8100-503: The loan defaults. It was invented by Blythe Masters from JP Morgan in 1994. In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan. However, anyone with sufficient collateral to trade with a bank or hedge fund can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in

8208-411: The lower-priority, higher-interest tranches—of an MBS are/were often further repackaged and resold as collaterized debt obligations. These subprime MBSs issued by investment banks were a major issue in the subprime mortgage crisis of 2006–2008 . The total face value of an MBS decreases over time, because like mortgages, and unlike bonds , and most other fixed-income securities, the principal in an MBS

8316-473: The main source of financing social change, from poverty alleviation to international development and income inequality. Social theorists Jed Emerson and Alex Nicholls reaffirm these claims by suggesting that social finance provides the greater direct investment required to address various social challenges and fill the capital gap that currently exists, given that many social needs have increased in severity, complexity, and scale, while charitable donations are on

8424-401: The market in which they trade (such as exchange-traded or over-the-counter ); and their pay-off profile. Derivatives may broadly be categorized as "lock" or "option" products. Lock products (such as swaps , futures , or forwards ) obligate the contractual parties to the terms over the life of the contract. Option products (such as interest rate swaps ) provide the buyer the right, but not

8532-424: The market price risk of the underlying asset can be controlled in almost every situation. There are two groups of derivative contracts: the privately traded over-the-counter (OTC) derivatives such as swaps that do not go through an exchange or other intermediary, and exchange-traded derivatives (ETD) that are traded through specialized derivatives exchanges or other exchanges. Derivatives are more common in

8640-409: The market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $ 600 trillion, the value of the market was estimated to be much lower, at $ 21 trillion. The credit-risk equivalent of the derivative contracts was estimated at $ 3.3 trillion. Still, even these scaled-down figures represent huge amounts of money. For perspective,

8748-674: The media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by credit rating agencies . U.S. courts may soon be following suit. Most CDSs are documented using standard forms drafted by the International Swaps and Derivatives Association (ISDA), although there are many variants. In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes ), as well as loan-only credit default swaps (LCDS). In addition to corporations and governments,

8856-578: The modern era, but their origins trace back several centuries. One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century. Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as forward , option , swap ); the type of underlying asset (such as equity derivatives , foreign exchange derivatives , interest rate derivatives , commodity derivatives, or credit derivatives );

8964-471: The more common derivatives include forwards , futures , options , swaps , and variations of these such as synthetic collateralized debt obligations and credit default swaps . Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange , while most insurance contracts have developed into a separate industry. In the United States , after

9072-443: The mortgage and mortgage-backed security (MBS) markets. Like other private-label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. The CDO is "sliced" into "tranches" , which "catch" the cash flow of interest and principal payments in sequence based on seniority. If some loans default and

9180-626: The most used and developed is the Social impact bond (SIB). SIBs are structured financial instruments that raise private capital to fund prevention and early intervention programs in areas of pressing social need, reducing the need for expensive safety net services in the future. Investors provide up-front capital to fund these programs and receive a prearranged amount of money (including the principal plus some financial return) if performance results are achieved. Funds from SIBs are spent on services like counselling , health care , and detention , with

9288-438: The number of affluent investors in recent years, there has been an increasing demand for sophisticated financial solutions and expertise throughout the world. The CFA Institute curriculum on private-wealth management indicates that two primary factors distinguish the issues facing individual investors from those facing institutions: The term "wealth management" occurs at least as early as 1933. It came into more general use in

9396-425: The obligation to enter the contract under the terms specified. Derivatives can be used either for risk management (i.e. to " hedge " by providing offsetting compensation in case of an undesired event, a kind of "insurance") or for speculation (i.e. making a financial "bet"). This distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries;

9504-416: The option purchaser typically pays an up front premium. Just like for lock products, movements in the underlying asset will cause the option's intrinsic value to change over time while its time value deteriorates steadily until the contract expires. An important difference between a lock product is that, after the initial exchange, the option purchaser has no further liability to its counterparty; upon maturity,

9612-460: The other party's thus ensuring that the correct daily loss or profit is reflected in the respective account. If the margin account goes below a certain value set by the Exchange, then a margin call is made and the account owner must replenish the margin account. This process is known as "marking to market". Thus on the delivery date, the amount exchanged is not the specified price on the contract but

9720-440: The other will theoretically be making or losing money. To mitigate risk and the possibility of default by either party, the product is marked to market on a daily basis whereby the difference between the prior agreed-upon price and the actual daily futures price is settled on a daily basis. This is sometimes known as the variation margin where the futures exchange will draw money out of the losing party's margin account and put it into

9828-416: The outset because they provide specified protection ( intrinsic value ) over a given time period ( time value ). One common form of option product familiar to many consumers is insurance for homes and automobiles. The insured would pay more for a policy with greater liability protections (intrinsic value) and one that extends for a year rather than six months (time value). Because of the immediate option value,

9936-437: The parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded over the counter ( OTC ), forward contracts specification can be customized and may include mark-to-market and daily margin calls. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure

10044-469: The parties. Based upon movements in the underlying asset over time, however, the value of the contract will fluctuate, and the derivative may be either an asset (i.e., " in the money ") or a liability (i.e., " out of the money ") at different points throughout its life. Importantly, either party is therefore exposed to the credit quality of its counterparty and is interested in protecting itself in an event of default . Option products have immediate value at

10152-399: The party at gain. In other words, the terms of the forward contract will determine the collateral calls based upon certain "trigger" events relevant to a particular counterparty such as among other things, credit ratings, value of assets under management or redemptions over a specific time frame (e.g., quarterly, annually). In finance , a 'futures contract' (more colloquially, futures ) is

10260-479: The post-crisis United States, document similar findings in the North American case. Their study, which synthesizes interviews with executives from North American social finance organizations, confirms that demonstration of commercial viability by current actors in the North American social finance market since 2008 has proved themselves to mainstream financiers, enabled the scaling up of operations, and created

10368-410: The price specified in the contract (thereby losing additional income that he could have earned). The miller, on the other hand, acquires the risk that the price of wheat will fall below the price specified in the contract (thereby paying more in the future than he otherwise would have) and reduces the risk that the price of wheat will rise above the price specified in the contract. In this sense, one party

10476-400: The purchaser will execute the option if it has positive value (i.e., if it is "in the money") or expire at no cost (other than to the initial premium) (i.e., if the option is "out of the money"). Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another. For example, a wheat farmer and a miller could sign a futures contract to exchange

10584-610: The purchasing party. Forwards, like other derivative securities, can be used to hedge risk (typically currency or exchange rate risk), as a means of speculation , or to allow a party to take advantage of a quality of the underlying instrument which is time-sensitive. A closely related contract is a futures contract ; they differ in certain respects . Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets. Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures—such that

10692-454: The reference entity can include a special-purpose vehicle issuing asset-backed securities . Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency. A CDS can be unsecured (without collateral) and be at higher risk for a default. In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or to sell an asset at

10800-653: The size of the derivative market, The Economist has reported that as of June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $ 700 trillion, and the size of the market traded on exchanges totaled an additional $ 83 trillion. For the fourth quarter 2017 the European Securities Market Authority estimated the size of European derivatives market at a size of €660 trillion with 74 million outstanding contracts. However, these are "notional" values, and some economists say that these aggregated values greatly exaggerate

10908-429: The type of financial instruments involved. For example, in the case of a swap involving two bonds , the benefits in question can be the periodic interest ( coupon ) payments associated with such bonds. Specifically, two counterparties agree to the exchange one stream of cash flows against another stream. These streams are called the swap's "legs". The swap agreement defines the dates when the cash flows are to be paid and

11016-429: The underlying asset in the future, the "buyer" of the contract, is said to be " long ", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be " short ". While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange is to act as intermediary and mitigate the risk of default by either party in the intervening period. For this reason,

11124-473: The underlying being the firm's assets, but this is unusual outside of technical contexts. From the economic point of view, financial derivatives are cash flows that are conditioned stochastically and discounted to present value. The market risk inherent in the underlying asset is attached to the financial derivative through contractual agreements and hence can be traded separately. The underlying asset does not have to be acquired. Derivatives therefore allow

11232-485: The way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate , foreign exchange rate , equity price, or commodity price. Social finance Social finance is a category of financial services that aims to leverage private capital to address challenges in areas of social and environmental need. Having gained popularity in

11340-559: The world as of 2018 are as follows: Derivative (finance) In finance , a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset , index , currency , or interest rate , and is often simply called the underlying . Derivatives can be used for a number of purposes, including insuring against price movements ( hedging ), increasing exposure to price movements for speculation , or getting access to otherwise hard-to-trade assets or markets. Some of

11448-487: Was coined. Accounting firms and investment advisory boutiques created multi-family offices as well. Certain larger firms ( UBS , Morgan Stanley and Merrill Lynch ) have "tiered" their platforms – with separate branch systems and advisor-training programs, distinguishing "Private Wealth Management" from "Wealth Management", with the latter term denoting the same type of services but with a lower degree of customization and delivered to mass affluent clients. At Morgan Stanley,

11556-604: Was first published in 1973. Options contracts have been known for many centuries. However, both trading activity and academic interest increased when, as from 1973, options were issued with standardized terms and traded through a guaranteed clearing house at the Chicago Board Options Exchange . Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges , while other over-the-counter options are written as bilateral, customized contracts between

11664-448: Was this type of derivative that investment magnate Warren Buffett referred to in his famous 2002 speech in which he warned against "financial weapons of mass destruction". CDS notional value in early 2012 amounted to $ 25.5 trillion, down from $ 55 trillion in 2008. Derivatives are used for the following: Lock products are theoretically valued at zero at the time of execution and thus do not typically require an up-front exchange between

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