​

Smug Music Show

• This was our exploration of Web3 music. The multilingual Twitter Space music show had more than 1.1k listeners, and we invited Grammy-nominated singer Shontelle to join us and gave an excellent performance. Our partners for the event included ALPACADABRAAZ, Nswap, AKCBcn, Theirsverse, bfrenz, WONDERPALS, and Mises Browser.

• The performance segments of the nine members were later produced into “exclusive mini-albums,” which accumulated 110k views, 6k likes, and 12k retweets on Twitter.

• The SmugMusic Twitter account also broke 10k followers in April.

​

​

Exhibition

• Smugbunny’s first offline exhibition was fully prepared in April. Our exhibition partner handcrafted a 60cm Smugbunny model, which will be located in the center of the exhibition venue. But that’s not all — it will also have a handcrafted diamond butterfly bow tie around its neck, sponsored by one of our community members who specialize in innovative diamond brands. The raw diamond materials are worth over $50,000.

The exhibition will officially open on May 2nd in Shanghai.

​

Physical Printing

• In April, our community tried to produce various Smugbunny IP design renderings and physical samples, including T-shirts, phone cases, blankets, masks, necklaces, bags, and stickers.

• You can get the latest experimental updates within the community on the product-lab channel on Discord, or follow us on Twitter @SmugBuilder for interesting build highlights.

​

​

AR

BD manager Gary is in talks with a strong AR production company, and the team plans to try some exciting things in Q2. However, since the plan is still in the promotion stage, we won’t provide detailed information yet. We will synchronize with the community when a part of the plan is specifically implemented.

​

Campaign

• G**iveaways: **In April, Smugbunny’s community giveaways included Cribbit Gang, Element, Cryptic Degens, VLVT, 4K Punks, MightyDinoz, Galactic Inmates, ACG WORLD, The Kid Next Door, Belong, Neo Speed Zoku, Stargate Universe, Yoppy, Spellbound’s, Project Yuki, Kokomi, XCMG, TIktokFi, Shiba Gangs, Uncharted, HypeBoy, Horeman’s Gambit, MutantDERClub, LIBERO, Robotic Angels, and Katana Inu.

• Partnerships: New partnerships in April included Mises: Mises Browser is the world’s first fast, secure, and extension-supported mobile Web3 browser.

App Demo

• We completed the MUSIC NFT 100 leaderboard demo for SmugMusic, as well as a no-code tool demo for NFT creators.

• We also completed several crucial product prototypes and UI designs for the SMUG app ecosystem.

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Next

We have identified breakthrough points for future development and are further organizing implementation logic and market pain points. We will gradually build a Web3 music ecosystem centered on products for real user groups.

The term discount rate refers to the interest rate charged to commercial banks and other financial institutions for short-term loans they take from the Federal Reserve Bank. The discount rate is applied at the Fed's lending facility, which is called the discount window. A discount rate can also refer to the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows. In this case, the discount rate can be used by investors and businesses for potential investments.How the Fed’s Discount Rate Works

Commercial banks in the U.S. have two primary ways to borrow money for their short-term operating needs. They can borrow and loan money to other banks without the need for any collateral using the market-driven interbank rate. They also can borrow money for their short-term operating requirements from the Federal Reserve Bank.

Federal Reserve loans are processed through 12 regional branches of the Fed. The loans are used by financial institutes to cover any cash shortfalls, head off any liquidity problems, or in the worst-case scenario, prevent the bank’s failure. This Fed-offered lending facility is known as the discount window.

The loans are extremely short-term: 24 hours or less. The rate of interest charged is the standard discount rate. This discount rate is set by the boards of the Federal Reserve Bank and is approved by its Board of Governors.1

The 3 Tiers of the Fed’s Discount Window Loans

The Fed's discount window program runs three tiers of loans, each of them using a separate but related rate.

• First Tier: Called the primary credit program, this tier provides capital to financially sound banks that have a good credit record. This primary credit discount rate is usually set above existing market interest rates which may be available from other banks or from other sources of similar short-term debt.

• Second Tier: Called the secondary credit program, it offers similar loans to institutions that do not qualify for the primary rate. It is usually set 50 basis points higher than the primary rate (one percentage point = 100 basis points). Institutions in this tier are smaller and may not be as financially healthy as the ones that use the primary tier.

• Third Tier: Called the seasonal credit program, this one serves smaller financial institutions which experience higher seasonal variations in their cash flows. Many are regional banks that serve the needs of the agriculture and tourism sectors. Their businesses are considered relatively risky, so the interest rates they pay are higher.1Use of the Fed’s Discount Rate

  Borrowing institutions use this facility sparingly, mostly when they cannot find willing lenders in the marketplace. The Fed-offered discount rates are available at relatively high-interest rates compared to the interbank borrowing rates.

  Discount loans are intended to be primarily an emergency option for banks in distress. Borrowing from the Fed discount window can even signal weakness to other market participants and investors. Its use peaks during periods of financial distress.

  Example of Fed Discount Rate

  The use of the Fed's discount window soared in late 2007 and in 2008, as financial conditions deteriorated sharply and the central bank took steps to inject liquidity into the financial system. The discount rates for the first two tiers are determined independently by the Fed. The rate for the third tier is based on the prevailing rates in the market.

  In August 2007, the Board of Governors cut the primary discount rate from 6.25% to 5.75%, reducing the premium over the Fed funds rate from 1% to 0.5%. In October 2008, the month after Lehman Brothers' collapse, discount window borrowing peaked at $403.5 billion against the monthly average of $0.7 billion from 1959 to 2006.

  Owing to the financial crisis, the board also extended the lending period from overnight to 30 days, and then to 90 days in March 2008.2 Once the economy regained control, those temporary measures were revoked, and the discount rate was reverted to overnight lending only.

  While the Fed maintains its own discount rate under the discount window program in the U.S., other central banks across the globe also use similar measures in different variants. For instance, the European Central Bank (ECB) offers standing facilities that serve as marginal lending facilities. Financial organizations can obtain overnight liquidity from the central bank against the presentation of sufficient eligible assets as collateral.3

The Uniform Gifts to Minors Act (UGMA), developed in 1956 and revised in 1966, allows individuals to give or transfer assets to underage beneficiaries; traditionally, parents and their children. The amount is free of gift tax, up to a certain amount. The assets are usually placed in UGMA accounts on behalf of minors, eliminating the need for an attorney to establish a special trust fund. UGMA funds are also subject to special tax treatment.1

KEY TAKEAWAYS

• The Uniform Gifts to Minors Act (UGMA) provides a way to transfer financial assets to a minor without the time-consuming and expensive establishment of a formal trust.

• A UGMA account is managed by an adult custodian until the minor beneficiary comes of age, at which point they assume control of the account.

• UGMA account-generated earnings are not tax-sheltered, but they are taxed at the minor's lower "kiddie tax" rate, up to a certain amount.

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Watch Now: What Is the Uniform Gifts to Minors Act?

How the Uniform Gifts to Minors Act (UGMA) Works

A UGMA account functions as a type of custodial account designed to hold and protect assets for the beneficiary. The donor can appoint themselves, another person, or a financial institution in the role of custodian.

The custodian—who has a fiduciary duty to manage the account in the beneficiary's best interest—can use the funds to buy stocks, bonds, mutual funds, and other securities on behalf of the minor. UGMAs are usually limited to these sorts of publicly-traded financial assets; they cannot invest in speculative instruments, like derivatives, or buy on margin.

UGMA accounts can be opened through a bank or brokerage institution. Friends and family can make contributions to the accounts, which carry no contribution limits or income limits. These deposits are irrevocable; they become permanent transfers to the minor and the minor's account.

Typically, UGMA assets are used to fund a child’s education, but the donor can make withdrawals for just about any expenses that benefit the minor. There are no withdrawal penalties. However, because UGMA assets are technically owned by the minor, they do count as assets if they apply for federal financial aid for college, possibly decreasing their eligibility.2

Once they reach the age of majority in their state, minors are granted full access to their UGMA account. At that point, they may use the funds as they please.1

Special Considerations

Contributions to UGMA accounts are made with after-tax dollars; the donor doesn't receive an income tax deduction for making them. However, up to $15,000 per individual, $30,000 for a married couple, (increasing to $16,000 per individual and $32,000 for a married couple in 2022) can be contributed free of gift tax for tax year 2021.3

For federal tax purposes, the minor or beneficiary is considered the owner of all assets in a UGMA account and the income they generate. But these accounts' earnings can be taxed either to the child or the parent. Reporting requirements depend on the amount of income the account generates and the beneficiary’s age.

Under certain circumstances, parents can elect to report their children’s UGMA accounts on their own tax returns, thereby taking advantage of the “kiddie tax” or "Tax on a Child's Investment and Other Unearned Income."4

This means that if the child’s unearned income, including UGMA earnings, was less than $2,200 in 2021 (increasing to $2,300 in 2022) and they were no older than 19 (or 24 if a full-time student) at the end of the corresponding tax year, parents can elect to report their child’s income on their own tax return.54

In this case, the first $1,100 of the child’s unearned income is treated as tax-free (increasing to $1,150 in 2022). The next $1,100 is taxed at the child’s tax rate. Anything exceeding $2,200 is taxed at the parent's tax rate. If such an election is not made or if the child’s unearned income exceeded $2,200 at the end of the tax year, the minor would have to file a tax return subject to “kiddie tax” rules.54

For tax purposes, a UGMA affects a donor’s lifetime gifting limits. Should a donor acting as the custodian die before the custodial property is transferred to the minor, the entire custodial property is included in the donor's taxable estate.

UGMA vs. UTMA

UGMA and the Uniform Transfers to Minors Act (UTMA) are usually used interchangeably, but the two do have some distinctions. Custodial accounts set up under the newer UTMA, which dates from 1986, can contain any kind of tangible or intangible asset, including real estate, works of art, and intellectual property. In contrast, UGMA accounts are limited to financial assets, such as cash, stocks, bonds, and insurance products (policies, annuities).1

How Are Gifts to Minors Taxed?

Gifts in the amount of up to $15,000 in 2021 are exempt from taxes. This increases to $16,000 in 2022. Gifts in any amount over this amount per year will be taxed. Couples can gift $30,000 in 2021 and $32,000 in 2022.3

What Is a Downside to the Uniform Gifts to Minors Act (UGMA)?

As the assets in a UGMA account are owned by the minor, even if they are not accessible till a certain date, this can reduce the amount of financial aid that a minor might have otherwise received, or make them ineligible for aid altogether. This is one of the downsides to the UGMA.

Where Can I Open a Uniform Gifts to Minors Account?

A Uniform Gifts to Minors account can be opened at a brokerage institution or a bank. Anyone can contribute the deposit amounts. These deposit amounts are irrevocable once made.

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The term Uniform Transfers to Minors Act (UTMA) refers to a law that allows a minor to receive gifts without the aid of a guardian or trustee. Gifts can include money, patents, royalties, real estate, and fine art.

A UTMA account allows the gift giver or an appointed custodian to manage the minor's account until the latter is of age. It also shields the minor from tax consequences on the gifts, up to a specified value.

KEY TAKEAWAYS

• The Uniform Transfers to Minors Act (UTMA) allows a minor to receive gifts without the aid of a guardian or trustee.

• The law is an extension of the Uniform Gift to Minors Act.

• The minor named in the UTMA can avoid tax consequences until they attain legal age for the state in which the account is set up.

• The donor can name a custodian, who has the fiduciary duty to manage and invest the property on behalf of the minor until they become of legal age.

• It is up to individual states to adopt or amend the UTMA for its residents.

Understanding the Uniform Transfers to Minors Act (UTMA)

The UTMA is similar to the original version of the Uniform Gift to Minors Act (UGMA). It allows minors to receive gifts and avoid tax consequences until they become of legal age in the state in which they live—typically 18 or 21 years of age. The UTMA incorporates the language of the UGMA and extends the original definition of gifts beyond cash and securities to include real estate, paintings, royalties, and patents.1

The UTMA provides a convenient way for children to save and invest without carrying the tax burden. The Internal Revenue Service (IRS) allows for an exclusion from the gift tax of up to $15,000 per person for 2021 ($16,000 for 2022) for a qualifying gift, including gifts to minors.2

The minor’s Social Security number (SSN) is used for tax reporting purposes on UTMA accounts. Because assets held in a UTMA account are owned by the minor, this may have a negative impact when the minor applies for financial aid or scholarships.

Each state has the option to adopt or amend the UTMA for its residents. For example, Florida passed a statute in 2015 that allows any property to be held by the UTMA custodian until the minor is 25 if desired.3

Any earnings that are generated within a UTMA are taxed at the kiddie tax rate by the IRS up to the allotted threshold of $2,200.4 Earnings after that are taxed at the adult donor's marginal tax rate.5

Special Considerations

The UTMA allows the donor to name a custodian, who has the fiduciary duty to manage and invest the property on behalf of the minor until that minor becomes of legal age. The property belongs to the minor from the time the property is gifted. If the donor dies while serving as custodian, the value of the custodianship property is included in the donor’s estate.

The assets in a UTMA are counted as part of the donor's taxable estate until the minor takes possession.6

Uniform Transfers to Minors Act (UTMA) vs. Uniform Gift to Minors Act (UGMA)

As noted above, the UTMA is just like an earlier version of the UGMA. In fact, it is an extension of the UGMA. The latter was developed in 1956 and revised in 1966. It was limited to the transfer of securities and was finalized in 1986 by the National Conference of Commissioners on Uniform State Laws and adopted by most of the 50 states.1

The UGMA provides a way to transfer property to a minor without the need for a formal trust. It allows assets or other property to be managed by a custodian who is appointed by the donor. The property is then turned over to the minor when they become of legal age in the state where the gift was made. As noted above, there are many types of property that can be transferred to minors, including:

• Cash

• Stocks and bonds

• Patents

• Royalties

• Real estate

• Fine art

• Mutual funds and other investments

• Intellectual property

Contributions to a UGMA are made using after-tax dollars, which means donors don't receive a tax deduction for making them. Just like a UTMA, gifts made to a UGMA are tax-free up to $15,000 per person for 2021 and $16,000 per person for 2022.2

Can a Minor Receive Gifts or Assets Without a Guardian or Trustee?

Yes, a minor can receive gifts or assets without a guardian or trustee as it is stipulated in the Uniform Transfers to Minors Act. The UTMA is a law that governs the transfer of assets from adults to minors. it provides parents and other adults with a tax-advantaged way to pass on gifts to minors without needing to create a formal trust. In doing so, the adult who donates the gift would typically act as the custodian for those assets until the minor reaches legal age. Alternatively, the donor can also appoint a third party to serve as the custodian of those assets.

What Is the Difference Between the UTMA and the Uniform Gift to Minors Act (UGMA)?

The UTMA and the UGMA serve similar purposes, but there are important differences between them. Most notably, the UTMA allows for a broader range of assets to be gifted, including financial securities such as stocks and bonds.

The UTMA also provides additional time for the assets being gifted to reach their maturity dates, such as in the case of a bond. By contrast, the UGMA requires the assets to be assumed by the minor once the minor reaches 18 years of age.

What Are the Pros and Cons of Using a UTMA Account?

The main advantage of using a UTMA account is that the money contributed to the account is exempted from paying a gift tax of up to a maximum of $15,000 per year for 2021 ($16,000 for 2022).2 Any income earned on the contributed funds is taxed at the tax rate of the minor who is being gifted the funds. Since the minor’s income is presumably significantly lower than that of the adult donor, this can lead to significant tax savings.

One of the drawbacks of using a UTMA account, however, is that it can make the recipient less eligible for need-based college scholarship programs and other such initiatives.

When Can a Child Claim Ownership of an UTMA Account?

Depending on the state a UTMA account is handed over to a child when they reach either age 18 or age 21. In some jurisdictions, at age 18 a UTMA account can only be handed over with the custodian's permission, and at 21 is transferred automatically. Enquire with the bank or brokerage where the UTMA is housed for clarification.

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A unilateral contract is a contract agreement in which an offeror promises to pay after the occurrence of a specified act. In general, unilateral contracts are most often used when an offeror has an open request in which they are willing to pay for a specified act.

An example of a unilateral contract is an insurance policy contract, which is usually partially unilateral. In a unilateral contract, the offeror is the only party with a contractual obligation.

Unilateral contracts are primarily one-sided.

Understanding Unilateral Contracts

Unilateral contracts specify an obligation from the offeror. In a unilateral contract, the offeror promises to pay for specified acts that can be open requests, random, or optional for other parties involved.

Unilateral contracts are considered enforceable by contract law. However, legal issues typically do not arise until the offeree claims to be eligible for remuneration tied to acts or occurrences.

As such, legal contestation generally involves cases where the offering party refuses to pay the offered sum. The determination of contract breach would then depend on whether or not the terms of the contract were clear and if it can be proven that the offeree is eligible for payment of specified acts based on the contract’s provisions.

KEY TAKEAWAYS

• Unilateral contracts are one-sided, requiring only a pre-arranged commitment from the offeror.

• Unilateral contracts are usually used to make open or optional offers.

Types of Unilateral Requests

Unilateral contracts are primarily one-sided without a significant obligation from the offeree. Open requests and insurance policies are two of the most common types of unilateral contracts.

Open Requests

In the open economy, offerors may use unilateral contracts to make a broad or optional request which is only paid for when certain specifications are met. If an individual or individuals fulfill the specified act, the offeror is required to pay. Rewards are a common type of unilateral contract request.

In criminal cases, a reward may be available for important information provided about the case. Reward funds can be paid to a single individual or several individuals offering information that meets specified criteria.

A unilateral contract could also involve an open request for labor. An individual or company could advertise a request that they agree to pay for if the task is completed. For example, Keith could advertise to pay $2,000 for safely moving his boat into storage. If Carla responds to the advertisement and takes the boat into storage then Keith would have to pay $2000.

Insurance

Insurance policies have unilateral contract characteristics. In the case of an insurance contract, the insurer promises to pay if certain acts occur under the terms of a contract’s coverage. In an insurance contract, the offeree pays a premium specified by the insurer to maintain the plan and receive an insurance allotment if a specified event occurs.

Insurance companies use statistical probabilities to determine the reserves they need to cover the payouts of the clients they insure. Some insurance cases may never include an occurrence leading to liability by the insurer while extreme cases require the insurance company to pay out large sums of money for an occurrence covered under a client’s insurance plan.

Unilateral Contracts vs. Bilateral Contracts

Contracts can be unilateral or bilateral. In a unilateral contract, only the offeror has an obligation. In a bilateral contract, both parties agree to an obligation. Typically, bilateral contracts involve equal obligation from the offeror and the offeree. In general, the primary distinction between unilateral and bilateral contracts is a reciprocal obligation from both parties.

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A tariff is a tax imposed by one country on the goods and services imported from another country.

KEY TAKEAWAYS

• Governments impose tariffs to raise revenue, protect domestic industries, or exert political leverage over another country.

• Tariffs often result in unwanted side effects, such as higher consumer prices.

• Tariffs have a long and contentious history and the debate over whether they represent a good or bad policy rages on to this day.

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Tariffs

Understanding a Tariff

Tariffs are used to restrict imports. Simply put, they increase the price of goods and services purchased from another country, making them less attractive to domestic consumers.

A key point to understand is that the tariff imposed affects the exporting country indirectly as the domestic consumer might shy away from their product due to the increase in price. If the domestic consumer still chooses the imported product then the tariff has essentially raised the cost for the domestic consumer.

There are two types of tariffs:

• A specific tariff is levied as a fixed fee based on the type of item, such as a $1,000 tariff on a car.

• An ad-valorem tariff is levied based on the item's value, such as 10% of the value of the vehicle.

Why Governments Impose Tariffs

Governments may impose tariffs to raise revenue or to protect domestic industries—especially nascent ones—from foreign competition. By making foreign-produced goods more expensive, tariffs can make domestically produced alternatives seem more attractive.

Governments that use tariffs to benefit particular industries often do so to protect companies and jobs. Tariffs can also be used as an extension of foreign policy as their imposition on a trading partner's main exports may be used to exert economic leverage.

Unintended Side Effects of Tariffs

Tariffs can have unintended side effects:

• They can make domestic industries less efficient and innovative by reducing competition.

• They can hurt domestic consumers since a lack of competition tends to push up prices.

• They can generate tensions by favoring certain industries, or geographic regions, over others. For example, tariffs designed to help manufacturers in cities may hurt consumers in rural areas who do not benefit from the policy and are likely to pay more for manufactured goods.

• Finally, an attempt to pressure a rival country by using tariffs can devolve into an unproductive cycle of retaliation, commonly known as a trade war.

History of Tariffs

Pre-Modern Europe

In pre-modern Europe, a nation's wealth was believed to consist of fixed, tangible assets, such as gold, silver, land, and other physical resources. Trade was seen as a zero-sum game that resulted in either a clear net loss or a clear net gain of wealth. If a country imported more than it exported, a resource, mainly gold, would flow abroad thereby draining its wealth. Cross-border trade was viewed with suspicion, and countries much preferred to acquire colonies with which they could establish exclusive trading relationships, rather than trading with each other. 

This system, known as mercantilism, relied heavily on tariffs and even outright bans on trade. The colonizing country, which saw itself as competing with other colonizers, would import raw materials from its colonies, which were generally barred from selling their raw materials elsewhere. The colonizing country would convert the materials into manufactured wares, which it would sell back to the colonies. High tariffs and other barriers were put in place to make sure that colonies purchased manufactured goods only from their colonizers. 

New Economic Theories

The Scottish economist Adam Smith was one of the first to question the wisdom of this arrangement. His Wealth of Nations was published in 1776, the same year that Britain's American colonies declared independence in response to high taxes and restrictive trade arrangements.

Later writers, such as David Ricardo, further developed Smith's ideas, leading to the theory of comparative advantage. It maintains that if one country is better at producing a certain product, while another country is better at producing another, each should devote its resources to the activity at which it excels. The countries should then trade with one another, rather than erecting barriers that force them to divert resources toward activities they do not perform well. Tariffs, according to this theory, are a drag on economic growth, even if they can be deployed to benefit certain narrow sectors under some circumstances.

These two approaches—free trade based on the idea of comparative advantage, on the one hand, and restricted trade based on the idea of a zero-sum game, on the other—have experienced ebbs and flows in popularity.

Late 19th and Early 20th Centuries

Relatively free trade enjoyed a heyday in the late 19th and early 20th centuries when the idea took hold that international commerce had made large-scale wars between nations so expensive and counterproductive that they were obsolete. World War I proved that idea wrong, and nationalist approaches to trade, including high tariffs, dominated until the end of World War II.

From that point on, free trade enjoyed a 50-year resurgence, culminating in the creation in 1995 of the World Trade Organization (WTO), which acts as an international forum for settling disputes and laying down ground rules.1 Free trade agreements, such as the North American Free Trade Agreement (NAFTA)—now known as the United States-Mexico-Canada Agreement (USMCA)2—and the European Union (EU), also proliferated.

The 2010s

Skepticism of this model—sometimes labeled neoliberalism by critics, who tie it to 19th-century liberal arguments in favor of free trade—grew, however, and Britain in 2016 voted to leave the European Union. That same year Donald Trump won the U.S. presidential election on a platform that included a call for tariffs on Chinese and Mexican imports, which he implemented when he took office.

Critics of tariff-free multilateral trade deals, who come from both ends of the political spectrum, argue that they erode national sovereignty and encourage a race to the bottom in terms of wages, worker protections, and product quality and standards. The defenders of such deals, meanwhile, counter that tariffs lead to trade wars, hurt consumers, hamper innovation, and encourage xenophobia.

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A quasi contract is a retroactive arrangement between two parties who have no previous obligations to one another. It is created by a judge to correct a circumstance in which one party acquires something at the expense of the other.1

The contract aims to prevent one party from unfairly benefiting from the situation at the other party's expense. These arrangements may be imposed when goods or services are accepted, though not requested, by a party. The acceptance then creates an expectation of payment.1

KEY TAKEAWAYS

• A quasi contract is a retroactive arrangement between two parties who have no previous obligations to one another.

• It is created by a judge to correct a circumstance in which one party acquires something at the expense of the other.

• The plaintiff must have furnished a tangible item or service to another party with the expectation or implication that payment would be given.

• The defendant must have accepted, or acknowledged receipt of, the item but made no effort or offer to pay for it.

Understanding Quasi Contracts

Quasi contracts outline the obligation of one party to another when the latter is in possession of the original party's property. These parties may not necessarily have had a prior agreement with one another. The agreement is imposed by law through a judge as a remedy when Person A owes something to Person B because they come into possession of Person A's property indirectly or by mistake. The contract becomes enforceable if Person B decides to keep the item in question without paying for it.

Because the agreement is constructed in a court of law, it is legally enforceable, so neither party has to agree to it.1 The purpose of the quasi contract is to render a fair outcome in a situation where one party has an advantage over another. The defendant—the party who acquired the property—must pay restitution to the plaintiff who is the wronged party to cover the value of the item.

A quasi contract is also known as an implied contract. It would be handed down ordering the defendant to pay restitution to the plaintiff. The restitution, known in Latin as quantum meruit, or the amount earned*,* is calculated according to the amount or extent to which the defendant was unjustly enriched.21

These contracts are also referred to as constructive contracts as they are created when there is no existing contract between the two parties involved. If there is an agreement already in place, though, a quasi contract generally cannot be enforced.

A quasi contract is a court-imposed document designed to prevent one party from unfairly benefiting at another party's expense, even though no contract exists between them.1

Example of a Quasi Contract

A classic quasi contract circumstance may be created by the delivery of a pizza to the wrong address—that is, not to the person who paid for it. If the individual at the incorrect address fails to fess to the error and instead keeps the pizza, they could be seen as having accepted the food, and thus be obliged to pay for it. A court could then rule to issue a quasi contract that requires the pizza recipient to pay back the cost of the food to the party who purchased it or to the pizzeria if it subsequently delivered a second pie to the purchaser. The restitution mandated under the quasi contract aims for a fair resolution of the situation.

Requirements for a Quasi Contract

Certain aspects must be in place for a judge to issue a quasi contract:

• One party, the plaintiff, must have furnished a tangible item or service to another party, or the defendant, with the expectation or implication that payment would be given.

• The defendant must have accepted—or acknowledged receipt of—the item of value, but made no effort or offer to pay for it.

• The plaintiff must then express why it is unjust for the defendant to receive the good or service without paying for it. In other words, the plaintiff must establish that the defendant received unjust enrichment.3

Considering the example above, the individual who ordered the pizza and paid for it would have every right to demand payment from the individual who actually received the pizza—the first individual being the plaintiff, the latter being the defendant.

Quasi Contract History

Under common-law jurisdictions, quasi contracts originated in the Middle Ages under a form of action known in Latin as indebitatus assumpsit, which translates to being indebted or to have undertaken a debt.3 This legal principle was the courts' way of making one party pay the other as if a contract or agreement already existed between them. So the defendant’s obligation to be bound by the contract is seen as implied by law. From its earliest uses, the quasi contract was typically imposed to enforce restitution obligations.

Unjust enrichment is what happens when an individual benefits from a situation inappropriately, either because of luck or because of another person's bad fortune.4

Quasi Contract FAQs

What Is a Quasi Contract in Law?

A quasi contract is an after-the-fact contract between two parties who were otherwise not in a legal commitment to one another. This kind of contract is mandated by a judge seeking to address a situation where one party benefited from something at the expense of the other.

What Are the Elements of a Quasi Contract?

The plaintiff has to have provided an item or service to either the defendant or another party with the expectation of getting paid. The defendant has to have accepted the item or service without attempting to pay for it. Finally, the plaintiff must establish that the defendant should not have received the item for free and that doing so constitutes "unjust enrichment."

What Are the Kinds of Quasi Contracts?

A quasi contract is also known as an "implied contract," in which a defendant is ordered to pay restitution to the plaintiff, or a constructive contract, meaning a contract that is put into existence when no such contract between the parties exists.

What Is a Quasi Contract Example?

An example might be if Person A offers to pay Person B to help them move to a new apartment, and agrees to pay the $100 for the help. The agreement is verbal and not a formal contract. Person B commits to the job, turns down a different job, and shows up on the required day to help with the move. But when Person B shows up, Person A tells them that they are not needed after all and that the job is canceled. Person B files a civil suit to have the missing money paid and a quasi contract might be instituted, if the judge agrees that money is owed.

What Is a Quasi Delict Example?

A quasi delict is when a wrong occurs accidentally, such as negligence, versus a true delict, which is when a wrong occurs deliberately.5

The Bottom Line

With a quasi contract, a defendant is required to behave as if there was a legal contract with the plaintiff. It is designed so that one party is not unjustly enriched at the expense of the other. Unjust enrichment is when someone benefits unfairly, either due to circumstance or the other party's misfortune. A quasi contract is rendered by a judge, as a settlement, after the fact, when a formal contract otherwise did not exist.

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Novation is the replacement of one of the parties in an agreement between two parties, with the agreement of all three parties involved. To novate is to replace an old obligation with a new one.

For example, a supplier who wants to relinquish a business customer might find another source for the customer. If all three agree, the contract can be torn up and replaced with a new contract that differs only in the name of the supplier. The old supplier relinquishes all rights and obligations of the contract to the new supplier.

KEY TAKEAWAYS

• To novate is to replace an old obligation with a new one.

• In contract law, a novation is the replacement of one of the parties in a two-party agreement with a third party, with the agreement of all three parties.

• In a novate, the original contract is void. The party that drops out has given up both its benefits and its obligations.

• In an assignment, the original party to the agreement retains ultimate responsibility. The original contract remains in place.

• In the financial markets, the use of a clearinghouse to vet a transaction between two parties is known as a novation.

How a Novation Works

In legal language, novation is a transfer of both the "benefits and the burdens" of a contract to another party.1 The benefits may be payments. The burdens are the obligations being taken on to earn the payment. One party to the contract is willing to forgo the benefits and relinquish the burdens.

Canceling a contract can be messy, expensive, and bad for the business reputation. Arranging for another party to fulfill the contract on the same terms, with the agreement of all parties, is better business.

Novations are often seen in the construction industry, where subcontractors may be juggling several jobs at once. Contractors may transfer certain jobs to other contractors, with the consent of the client.

Novations are most frequently used when a business is sold or a corporation is taken over. The new owner wants to retain the contractual obligations of the business. The other parties to the contracts want to continue their agreements without interruption. Novations smooth the transition.

Novation vs. Assignment

A novation is an alternative to the procedure known as an assignment.

In an assignment, one person or business transfers rights or property to another person or business. But the assignment passes along only the benefits, while any obligations remain with the original contract party. Novations pass along both benefits and potential liabilities to the new party.2

For example, a sub-lease is an assignment. The original rental contract remains in place. The landlord can hold the primary leaseholder responsible for damage or non-payment by the sub-letter.

In a novation, the original party to the contract hands over both the rights and the obligations and walks away. The original contract has been nullified.

In property law, novation occurs when a tenant signs a lease over to another party, who assumes both the responsibility for the rent and the liability for any subsequent damages to the property, as indicated in the original lease.

Generally, both an assignment and a novation require the approval of all three parties involved.

A novation is not a unilateral contract mechanism. All concerned parties may negotiate the terms until a consensus is reached.

Novations in Financial Markets

In the derivatives markets, a bilateral transaction done through a clearinghouse, which essentially functions as an intermediary, is known as a novation.

In this case, buyers and sellers do not do business directly with each other. Instead, the sellers transfer their securities to the clearinghouse, which in turn sells the securities to the buyers. The clearinghouse assumes the counterparty risk of one party defaulting.

The clearinghouse is responsible for vetting the potential counterparty for creditworthiness.

Both the buying and selling parties bear the extremely modest risk that the clearinghouse will become insolvent before the process is completed.

A sub-lease agreement is usually an assignment, not a novation. The primary leaseholder remains responsible for non-payment or damage.

Example of a Novation

Consider the following example of novation. Maria owes Chris $200, while Chris, in turn, owes Uni $200. These debt obligations may be simplified through a novation. By agreement of all three parties, Maria pays Uni $200. Chris receives (and pays) nothing.

Novations also may allow for payment terms to be revised as long as the parties involved agree. In this example, Uni may agree to accept a piece of Maria's original artwork, which has an approximate value of $200, in lieu of the cash they are owed. The transfer of property constitutes novation and effectively jettisons the original cash obligation.

Novation FAQs

Here are the answers to some commonly asked questions about novations.

What Is the Difference Between a Novation and an Assignment?

In a novation, one party in a two-party agreement gives up all rights and obligations outlined in a contract to a third party. The original contract is canceled. In an assignment, one party gives up all rights outlined in the contract but remains responsible for the fulfillment of its terms. The original contract remains in place.

What Is Transferred in a Novation?

In a novation, both the rights and the obligations of one party to a two-party contract are transferred to a third party, with the agreement of all three parties.

For example, say that an ice cream vendor agrees to supply a supermarket with 100 gallons of chocolate ice cream a week. Down the road, the vendor decides that the supermarket is too far out of its area to service efficiently. It locates another vendor who is willing to take over the customer. All three parties agree to a new contract with identical terms, except for the name of the ice cream supplier. If the supermarket manager is dissatisfied with the new service, the legal recourse lies with the new vendor. The old vendor has no obligation to fix the problem.

What Are the Risks of a Novation?

Novations are a relatively easy, quick way to solve an immediate problem with no legal wrangling. In many cases, they may be virtually a formality, such as in the case of a newly acquired company revising its existing contracts to reflect a name change.

Novations, however, require the agreement of three parties: the transferor, the transferee, and the counterparty.3

A risk for the counterparty occurs if it is uncertain that the new party to the contract (the transferee) can adequately meet the terms of the contract.

In this case, the more cautious approach would be an assignment. Then, the original party to the contract must ensure that the terms of the contract are met.

Then, there's a risk to the transferor. If the transferee fails to meet the new contract terms, the transferor remains responsible.

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A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.

KEY TAKEAWAYS

• A liability (generally speaking) is something that is owed to somebody else.

• Liability can also mean a legal or regulatory risk or obligation.

• In accounting, companies book liabilities in opposition to assets.

• Current liabilities are a company's short-term financial obligations that are due within one year or a normal operating cycle (e.g. accounts payable).

• Long-term (non-current) liabilities are obligations listed on the balance sheet not due for more than a year.

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What's a Liability?

How Liabilities Work

In general, a liability is an obligation between one party and another not yet completed or paid for. In the world of accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales, exchange of assets or services, or anything that would provide economic benefit at a later date. Current liabilities are usually considered short-term (expected to be concluded in 12 months or less) and non-current liabilities are long-term (12 months or greater).

Liabilities are categorized as current or non-current depending on their temporality. They can include a future service owed to others (short- or long-term borrowing from banks, individuals, or other entities) or a previous transaction that has created an unsettled obligation. The most common liabilities are usually the largest like accounts payable and bonds payable. Most companies will have these two line items on their balance sheet, as they are part of ongoing current and long-term operations.

Liabilities are a vital aspect of a company because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Rather, it invoices the restaurant for the purchase to streamline the drop-off and make paying easier for the restaurant.

The outstanding money that the restaurant owes to its wine supplier is considered a liability. In contrast, the wine supplier considers the money it is owed to be an asset.

Liability may also refer to the legal liability of a business or individual. For example, many businesses take out liability insurance in case a customer or employee sues them for negligence.

Other Definitions of Liability

Generally, liability refers to the state of being responsible for something, and this term can refer to any money or service owed to another party. Tax liability, for example, can refer to the property taxes that a homeowner owes to the municipal government or the income tax he owes to the federal government. When a retailer collects sales tax from a customer, they have a sales tax liability on their books until they remit those funds to the county/city/state.

Types of Liabilities

Businesses sort their liabilities into two categories: current and long-term. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period. For example, if a business takes out a mortgage payable over a 15-year period, that is a long-term liability. However, the mortgage payments that are due during the current year are considered the current portion of long-term debt and are recorded in the short-term liabilities section of the balance sheet.

Current Liabilities

Ideally, analysts want to see that a company can pay current liabilities, which are due within a year, with cash. Some examples of short-term liabilities include payroll expenses and accounts payable, which include money owed to vendors, monthly utilities, and similar expenses. Other examples include:

• Wages Payable: The total amount of accrued income employees have earned but not yet received. Since most companies pay their employees every two weeks, this liability changes often.

• Interest Payable: Companies, just like individuals, often use credit to purchase goods and services to finance over short time periods. This represents the interest on those short-term credit purchases to be paid.

• Dividends Payable: For companies that have issued stock to investors and pay a dividend, this represents the amount owed to shareholders after the dividend was declared. This period is around two weeks, so this liability usually pops up four times per year, until the dividend is paid.

• Unearned Revenues: This is a company's liability to deliver goods and/or services at a future date after being paid in advance. This amount will be reduced in the future with an offsetting entry once the product or service is delivered.

• Liabilities of Discontinued Operations: This is a unique liability that most people glance over but should scrutinize more closely. Companies are required to account for the financial impact of an operation, division, or entity that is currently being held for sale or has been recently sold. This also includes the financial impact of a product line that is or has recently been shut down.

Non-Current Liabilities

Considering the name, it’s quite obvious that any liability that is not current falls under non-current liabilities expected to be paid in 12 months or more. Referring again to the AT&T example, there are more items than your garden variety company that may list one or two items. Long-term debt, also known as bonds payable, is usually the largest liability and at the top of the list.

Companies of all sizes finance part of their ongoing long-term operations by issuing bonds that are essentially loans from each party that purchases the bonds. This line item is in constant flux as bonds are issued, mature, or called back by the issuer.

Analysts want to see that long-term liabilities can be paid with assets derived from future earnings or financing transactions. Bonds and loans are not the only long-term liabilities companies incur. Items like rent, deferred taxes, payroll, and pension obligations can also be listed under long-term liabilities. Other examples include:

• Warranty Liability: Some liabilities are not as exact as AP and have to be estimated. It’s the estimated amount of time and money that may be spent repairing products upon the agreement of a warranty. This is a common liability in the automotive industry, as most cars have long-term warranties that can be costly.

• Contingent Liability Evaluation: A contingent liability is a liability that may occur depending on the outcome of an uncertain future event.

• Deferred Credits: This is a broad category that may be recorded as current or non-current depending on the specifics of the transactions. These credits are basically revenue collected before it being earned and recorded on the income statement. It may include customer advances, deferred revenue, or a transaction where credits are owed but not yet considered revenue. Once the revenue is no longer deferred, this item is reduced by the amount earned and becomes part of the company's revenue stream.

• Post-Employment Benefits: These are benefits an employee or family members may receive upon his/her retirement, which are carried as a long-term liability as it accrues. In the AT&T example, this constitutes one-half of the total non-current total second only to long-term debt. With rapidly rising health care and deferred compensation, this liability is not to be overlooked.

• Unamortized Investment Tax Credits (UITC): This represents the net between an asset's historical cost and the amount that has already been depreciated. The unamortized portion is a liability, but it is only a rough estimate of the asset’s fair market value. For an analyst, this provides some details of how aggressive or conservative a company is with its depreciation methods.

Liabilities vs. Assets

Assets are the things a company owns—or things owed to the company—and they include tangible items such as buildings, machinery, and equipment as well as intangible items such as accounts receivable, interest owed, patents, or intellectual property.

If a business subtracts its liabilities from its assets, the difference is its owner's or stockholders' equity. This relationship can be expressed as follows:

\text{Assets}-\text{Liabilities}=\text{Owner's Equity}Assets−Liabilities=Owner’s Equity

However, in most cases, this accounting equation is commonly presented as such:

\text{Assets} = \text{Liabilities} + \text{Equity}Assets=Liabilities+Equity

Liabilities vs. Expenses

An expense is the cost of operations that a company incurs to generate revenue. Unlike assets and liabilities, expenses are related to revenue, and both are listed on a company's income statement. In short, expenses are used to calculate net income. The equation to calculate net income is revenues minus expenses.

For example, if a company has more expenses than revenues for the past three years, it may signal weak financial stability because it has been losing money for those years.

Expenses and liabilities should not be confused with each other. One is listed on a company's balance sheet, and the other is listed on the company's income statement. Expenses are the costs of a company's operation, while liabilities are the obligations and debts a company owes. Expenses can be paid immediately with cash, or the payment could be delayed which would create a liability.

Example of Liabilities

As a practical example of understanding a firm's liabilities, let's look at a historical example using AT&T's (T) 2020 balance sheet.1 The current/short-term liabilities are separated from long-term/non-current liabilities on the balance sheet.

AT&T clearly defines its bank debt that is maturing in less than one year under current liabilities. For a company this size, this is often used as operating capital for day-to-day operations rather than funding larger items, which would be better suited using long-term debt.

Like most assets, liabilities are carried at cost, not market value, and under generally accepted accounting principle (GAAP) rules can be listed in order of preference as long as they are categorized. The AT&T example has a relatively high debt level under current liabilities. With smaller companies, other line items like accounts payable (AP) and various future liabilities like payroll, taxes will be higher current debt obligations.

AP typically carries the largest balances, as they encompass the day-to-day operations. AP can include services, raw materials, office supplies, or any other categories of products and services where no promissory note is issued. Since most companies do not pay for goods and services as they are acquired, AP is equivalent to a stack of bills waiting to be paid.

How Do I Know If Something Is a Liability?

A liability is something that is owed to or obligated to someone else. It can be real (e.g. a bill that needs to be paid) or potential (e.g. a possible lawsuit).

How Are Current Liabilities Different From Long-Term (Noncurrent) Ones?

Companies will segregate their liabilities by their time horizon for when they are due. Current liabilities are due with a year and are often paid for using current assets. Non-current liabilities are due in more than one year and most often include debt repayments and deferred payments.

How Do Liabilities Relate to Assets and Equity?

The accounting equation states that—assets = liabilities + equity. As a result, we can re-arrange the formula to read liabilities = assets - equity. Thus, the value of a firm's total liabilities will equal the difference between the values of total assets and shareholders' equity. If a firm takes on more liabilities without accumulating additional assets, it must result in a reduction in the value of the firm's equity position.

What Is a Contingent Liability?

A contingent liability is an obligation that might have to be paid in the future, but there are still unresolved matters that make it only a possibility and not a certainty. Lawsuits and the threat of lawsuits are the most common contingent liabilities, but unused gift cards, product warranties, and recalls also fit into this category.

What Are Examples of Liabilities That Individuals or Households Have?

Like businesses, an individual's or household's net worth is taken by balancing assets against liabilities. For most households, liabilities will include taxes due, bills that must be paid, rent or mortgage payments, loan interest and principal due, and so on. If you are pre-paid for performing work or a service, the work owed may also be construed as a liability.

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The Jones Act is a federal law that regulates maritime commerce in the United States. The Jones Act requires goods shipped between U.S. ports to be transported on ships that are built, owned, and operated by United States citizens or permanent residents. The Jones Act is Section 27 of the Merchant Marine Act of 1920, which provided for the maintenance of the American merchant marine.12

Understanding the Jones Act

Considered protectionist legislation, the Jones Act focuses on issues related to maritime commerce, including cabotage, which is the transport of people or goods between ports in the same country. It also provides sailors with additional rights, including the ability to seek damages from the crew, captain, or ship owner in the case of injury.3 Perhaps its most lasting effect is its requirement that goods shipped between U.S. ports be transported on ships built, owned, and operated by United States citizens or permanent residents.2

The Jones Act increases the cost of shipping to Hawaii, Alaska, Puerto Rico, and other non-continental U.S. lands that rely on imports by restricting the number of vessels that can legally deliver goods. The supply of American-built, -owned, and -operated vessels is relatively small compared to the global supply of ships, while the demand for basic goods tends to remain constant or grow. This creates a scenario in which shipping companies can charge higher rates because of a lack of competition, with the increased costs passed on to consumers. This may lead to consumers taking on more debt in order to finance purchases, which can have a negative effect on government finances.

The Jones Act is a piece of protectionist legislation that considerably increases the costs of shipping goods between two U.S. ports.

History of the Jones Act

The Jones Act was enacted by the United States Congress in order to stimulate the shipping industry in the wake of the World War I. The requirement about shipping cargo between American ports only on American ships benefited the constituents of Wesley Jones, the U.S. Senator from the state of Washington who introduced the act. Washington had a large shipping industry, and the act was designed to give the state a monopoly on shipping to Alaska. While the act benefited Jones’ constituents, it increased the shipping costs of other states and U.S. territories.4

On several occasions, the U.S. government has granted temporary waivers on Jones Act requirements. This is typically done in the wake of a natural disaster, such as a hurricane, in order to increase the number of ships that can legally supply goods to an affected area.4

Criticism of the Jones Act

The act has been criticized for restricting who can conduct trade with Puerto Rico, and it has been cited as a factor leading to the island’s economic and budgetary troubles. A study released by the New York Federal Reserve in 2012 found that the cost of transporting a shipping container to Puerto Rico from the mainland was twice as high as shipping the same container from a foreign port.5

A 2019 report prepared by the New York City-based economic consulting firm John Dunham and Associates found that for Puerto Rico the "the differentials between US- and foreign-flagged carriers range from about 41.0 percent to as high as 62.0 percent for bulk cargo and between 29 percent and 89 percent for containerized freight.” It calculated the additional costs caused by the act for the island’s economy to be nearly $1.2 billion, which comes to roughly $374 per resident.6

Opponents of the act want it repealed, hoping that this will result in decreased shipping costs, lower prices, and less strain on government budgets. Proponents of the act include states with owners of navy yards, defense firms, and shipping industries, as well as the longshoremen and other personnel who work in ports. Scrapping the law will likely reduce the number of U.S. maritime jobs while lowering shipping costs.

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An individual who needs to secure health insurance may find a variety of health insurance providers with unique features. One type of insurance provider that is popular in the health insurance marketplace is a health maintenance organization (HMO), an insurance structure that provides coverage through a network of physicians.

KEY TAKEAWAYS

• A health maintenance organization (HMO) is a network or organization that provides health insurance coverage for a monthly or annual fee.

• An HMO is made up of a group of medical insurance providers that limit coverage to medical care provided through doctors and other providers who are under contract with the HMO.

• These contracts allow for premiums to be lower—since the healthcare providers have the advantage of having patients directed to them—but they also add additional restrictions to HMO members.

• HMO plans require that participants first receive medical care services from an assigned provider known as the primary care physician (PCP).

• Preferred provider organizations (PPOs) and point-of-service plans (POS) are two types of healthcare plans that are alternatives to HMOs.

How a Health Maintenance Organization (HMO) Works

Health maintenance organizations (HMOs) provide health insurance coverage for a monthly or annual fee. An HMO limits member coverage to medical care provided through a network of doctors and other healthcare providers who are under contract with the HMO.1 These contracts allow for premiums to be lower than for traditional health insurance—since the health providers have the advantage of having patients directed to them. They also add additional restrictions to the HMO's members.2

When deciding whether to choose an HMO insurance plan, you should take into consideration the cost of premiums, out-of-pocket costs, any requirements you may have for specialized medical care, and whether it's important to you to have your own primary care provider.

An HMO is an organized public or private entity that provides basic and supplemental health services to its subscribers. The organization secures its network of health providers by entering into contracts with primary care physicians, clinical facilities, and specialists. The medical entities that enter into contracts with the HMO are paid an agreed-upon fee to offer a range of services to the HMO’s subscribers. The agreed payment allows an HMO to offer lower premiums than other types of health insurance plans while retaining a high quality of care from its network.

The HMO as it exists today was established under the Health Maintenance Organization Act of 1973. Passed by former President Richard Nixon, the Act clarified the definition of HMOs as "a public or private entity organized to provide basic and supplemental health services to its members."3 The law further requires that plans provide insured individuals with basic healthcare in exchange for regular, fixed premiums that are established "under a community rating."3

Rules for HMO Subscribers

HMO subscribers pay a monthly or annual premium to access medical services in the organization’s network of providers, but they are limited to receiving their care and services from doctors within the HMO network. However, some out-of-network services, including emergency care and dialysis, can be covered under the HMO.2

Those who are insured under an HMO may have to live or work in the plan's network area to be eligible for coverage.1 In cases where a subscriber receives urgent care while out of the HMO network region, the HMO may cover the expenses. But HMO subscribers who receive non-emergency, out-of-network care have to pay for it out-of-pocket.4

In addition to low premiums, there are typically low or no deductibles with an HMO. Instead, the organization charges a co-pay for each clinical visit, test, or prescription. Co-pays in HMOs are typically low—usually, $5, $10, or $20 per service—thereby minimizing out-of-pocket expenses and making HMO plans affordable for families and employers.5

The Role of the Primary Care Physician

The insured party must choose a primary care physician (PCP) from the network of local healthcare providers under an HMO plan. A primary care physician is typically an individual’s first point of contact for all health-related issues. This means that an insured person cannot see a specialist without first receiving a referral from their PCP.2

However, certain specialized services, such as screening mammograms, do not require referrals.6 Specialists to whom PCPs typically refer insured members are within the HMO coverage, so their services are covered under the HMO plan after co-pays are made. If a primary care physician leaves the network, subscribers are notified and are required to choose another PCP from within the HMO plan.

HMO vs. Preferred Provider Organization (PPO)

A preferred provider organization (PPO) is a medical care plan in which health professionals and facilities provide services to subscribed clients at reduced rates. PPO medical and healthcare providers are called preferred providers.

PPO participants are free to use the services of any provider within their network.4 Out-of-network care is available, but it costs more to the insured. In contrast to a PPO, HMO plans require that participants receive healthcare services from an assigned provider. PPO plans usually have deductibles while HMOs usually do not.5

Both programs allow for specialist services. However, the designated primary care physician must provide a referral to a specialist under an HMO plan. PPO plans are the oldest and—due to their flexibility and relatively low out-of-pocket costs—have been the most popular managed healthcare plans. That has been changing, however, as plans have reduced the size of their provider networks and taken other steps to control costs.

HMO vs. Point-of-Service (POS)

A point-of-service (POS) plan is like an HMO in that it requires a policyholder to choose an in-network primary care doctor and get referrals from that doctor if they want the plan to cover a specialist’s services.4 A point-of-service plan is also like a PPO in that it still provides coverage for out-of-network services, but the policyholder has to pay more for those services than if they used in-network providers.

However, a POS plan will pay more toward an out-of-network service if the policyholder gets a referral from their primary care physician than if they don't secure a referral. The premiums for a POS plan fall in between the lower premiums offered by an HMO and the higher premiums of a PPO.7

POS plans require the policyholder to make co-pays, but in-network co-pays are often just $10 to $25 per appointment. POS plans also do not have deductibles for in-network services, which is a significant advantage over PPOs.

Also, POS plans offer nationwide coverage, which benefits patients who travel frequently. A disadvantage is that out-of-network deductibles tend to be high for POS plans, so patients who use out-of-network services will pay the full cost of care out of pocket until they reach the plan’s deductible. However, a patient who never uses a POS plan’s out-of-network services would probably be better off with an HMO because of its lower premiums.

If you don't travel frequently, you'll be better off with an HMO rather than a point-of-service plan because of the lower costs.

Advantages and Disadvantages of HMOs

It's important to weigh the advantages and disadvantages of HMOs before you choose a plan, just as you would with any other option. We've listed some of the most common pros and cons of the program below.

Advantages of HMOs

The first and most obvious advantage of participating in an HMO is the low cost. You'll pay fixed premiums on a monthly or annual basis that are lower than traditional forms of health insurance. These plans tend to come with low or no deductibles and your co-pays are generally lower than other plans. Your out-of-pocket costs will also be lower for your prescription.8 Billing also tends to be less complicated for those with an HMO.9

There's also a very good likelihood that you'll have to deal with the insurer itself. That's because you have a primary care doctor you must choose from who is responsible to manage your treatment and care. This professional will also advocate for services on your behalf.8 This includes making referrals for specialty services for you.

The quality of care is generally higher with an HMO. The reason is that patients are encouraged to get annual physicals and to seek out treatment early.9

Disadvantages of HMOs

If you're paying for an HMO, you're restricted on how you can use the plan. You'll have to designate a doctor, who will be responsible for your healthcare needs, including your primary care and referrals. This doctor, though, must be part of the network.7 This means you are responsible for any costs incurred if you see someone out of the network, even if there's no contracted doctor in your area.9

You'll need referrals for any specialists if you want your HMO to pay for any visits. So if you need to visit a rheumatologist or a dermatologist, your primary doctor must make a referral before you can see one for the plan to pay for your visit. If not, you're responsible for the entire cost.10

There are very specific conditions that you must meet for certain medical claims, such as emergencies. For instance, there are usually very strict definitions of what constitutes an emergency. If your condition doesn't fit the criteria, then the HMO plan won't pay.9

Pros

• Lower out-of-pocket costs, including lower premiums, low or no deductibles, and low co-pays.

• Your primary care physician will direct your treatment and advocate on your behalf.

• Higher quality of care.

Cons

• Medical professionals must be part of the plan's network.

• You can't visit a specialist without a referral from your family doctor.

• Emergencies must meet certain conditions before the plan pays.

HMO Questions and Answers

What is HMO Insurance?

HMO or health maintenance organization insurance provides covered individuals with health insurance in exchange for monthly or annual fees. People pay lower premiums than those with other forms of health insurance when they visit doctors and other providers who are part of the HMO's network.

What Are HMO Examples?

Almost every major insurance company provides an HMO plan. For instance, Cigna and Humana provide their own versions of the HMO. Aetna also offers individuals two options, including the Aetna HMO and the Aetna Health Network Only plan.11

What Are the Benefits of an HMO?

The main benefits are cost and quality of care. People who purchase HMO plans benefit from lower premiums than traditional forms of health insurance. This allows insured parties to get a higher quality of care from providers who are contracted with the organization. HMOs typically come with low or no deductibles and only charge relatively low co-pays. HMO participants also don't need referrals to get specialty services such as mammograms.

What Is the Difference Between an HMO and Health Insurance?

Coverage under an HMO is generally pretty restrictive and comes at a lower cost to insured parties. Traditional health insurance, on the other hand, charges higher premiums, higher deductibles, and higher co-pays. But health insurance plans are much more flexible. People with health insurance don't need to have a primary care physician to outline treatment. Health insurance also pays some of the costs for out-of-network providers.

Why Do HMOs Have a Bad Reputation?

There are several restrictions for those covered under HMOs, which is why these plans have such a bad reputation. For instance, HMOs only allow insured parties to see individuals in their own network, which means they are responsible for the full amount of a visit to any doctor or specialist outside this group. The plan may also require individuals to live in a certain area, This means someone who receives medical service out of the HMO's network must pay for it themselves. The plans also require individuals to choose a primary doctor who determines the kind of treatment patients need.

The Bottom Line

Health insurance is an important consideration for every individual. Choosing the right plan depends on your personal situation, including your health, finances, and quality of life. You can choose from traditional health insurance, such as the preferred provider organization, or the HMO, also known as the health maintenance organization. The HMO provides insured individuals with lower out-of-pocket costs, but more restrictive conditions, including the doctor you see. Make sure you weigh out the benefits and disadvantages of the plan, regardless of what you choose.

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KEY TAKEAWAYS Enterprise value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company's balance sheet. Enterprise value is used as the basis for many financial ratios that measure the performance of a company. 2:01 Introduction To Enterprise Value Formula and Calculation for Enterprise Value (EV) \begin{aligned} &EV=MC+Total~Debt-C\ &\textbf{where:}\ &MC=\text{\small Market capitalization; equal to the current stock}\ &\text{\small price multiplied by the number of outstanding stock shares}\ &Total~debt =\text{\small Equal to the sum of short-term and}\ &\text{\small long-term debt}\ &C=\text{\small Cash and cash equivalents; the liquid assets of}\ &\text{\small a company, but may not include marketable securities}\ \end{aligned} ​

EV=MC+Total Debt−C where: MC=Market capitalization; equal to the current stock price multiplied by the number of outstanding stock shares Total debt=Equal to the sum of short-term and long-term debt C=Cash and cash equivalents; the liquid assets of a company, but may not include marketable securities ​

To calculate the market capitalization if not readily available you would multiply the number of outstanding shares by the current stock price. Next, total all debt on the company's balance sheet including both short-term and long-term debt. Finally, add the market capitalization to the total debt and subtract any cash and cash equivalents from the result.

What Does EV Tell You? Enterprise value (EV) could be thought of like the theoretical takeover price if a company were to be bought. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid off by the buyer when taking over a company. As a result, enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.

Why doesn't market capitalization properly represent a firm's value? It leaves a lot of important factors out, such as a company's debt on the one hand and its cash reserves on the other. Enterprise value is basically a modification of market cap, as it incorporates debt and cash for determining a company's valuation.

Market capitalization is not intended to represent a company's book value. Instead, it represents a company's value as determined by market participants. EV as a Valuation Multiple Enterprise value is used as the basis for many financial ratios that measure the performance of a company. An enterprise multiple that contains enterprise value relates the total value of a company as reflected in the market value of its capital from all sources to a measure of operating earnings generated, such as earnings before interest, taxes, depreciation, and amortization (EBITDA).

EBITDA is a measure of a company's ability to generate revenue and is used as an alternative to simple earnings or net income in some circumstances. EBITDA, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment. Another figure, EBIT, can be used as a similar financial metric without the drawback of removing depreciation and amortization expenses related to property, plant, and equipment (PP&E). EBITDA is calculated using the following formula:

EBITDA = recurring earnings from continuing operations + interest + taxes + depreciation + amortization The enterprise value/EBITDA metric is used as a valuation tool to compare the value of a company, debt included, to the company’s cash earnings less non-cash expenses. It's ideal for analysts and investors looking to compare companies within the same industry.

EV/EBITDA is useful in a number of situations:

The ratio may be more useful than the P/E ratio when comparing firms with different degrees of financial leverage (DFL). EBITDA is useful for valuing capital-intensive businesses with high levels of depreciation and amortization. EBITDA is usually positive even when earnings per share (EPS) is not. EV/EBITDA also has a number of drawbacks, however:

If working capital is growing, EBITDA will overstate cash flows from operations (CFO or OCF). Further, this measure ignores how different revenue recognition policies can affect a company's OCF. Because free cash flow to the firm captures the number of capital expenditures (CapEx), it is more strongly linked with valuation theory than EBITDA. EBITDA will be a generally adequate measure if capital expenses equal depreciation expenses. Another commonly used multiple for determining the relative value of firms is the enterprise value to sales ratio or EV/sales. EV/sales is regarded as a more accurate measure than the price/sales ratio since it takes into account the value and amount of debt a company must repay at some point.

Generally, the lower the EV/sales multiple, the more attractive or undervalued the company is believed to be valued. The EV/sales ratio can actually be negative at times when the cash held by a company is more than the market capitalization and debt value, implying that the company can essentially be by itself with its own cash.

P/E Ratio vs. EV The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple. The P/E ratio doesn't consider the amount of debt that a company has on its balance sheet.

However, EV includes debt when valuing a company and is often used in tandem with the P/E ratio to achieve a comprehensive valuation.

Limitations of Using EV As stated earlier, EV includes total debt, but it's important to consider how the debt is being utilized by the company's management. For example, capital-intensive industries such as the oil and gas industry typically carry significant amounts of debt, which is used to foster growth. The debt could be used to purchase plant and equipment. As a result, the EV would be skewed for companies with a large amount of debt as compared to industries with little or no debt.

As with any financial metric, it's best to compare companies within the same industry to get a better sense of how the company is valued relative to its peers.

Example of EV As stated earlier, the formula for EV is essentially the sum of the market value of equity (market capitalization) and the market value of debt of a company, less any cash. The market capitalization of a company is calculated by multiplying the share price by the number of shares outstanding. The net debt is the market value of debt minus cash. A company acquiring another company keeps the cash of the target firm, which is why cash needs to be deducted from the firm's price as represented by the market cap.

Let's calculate the enterprise value for Macy's (M). For its 2020 fiscal year, Macy's recorded the following:

Macy's Data Pulled from 2020 10-K Statement 1 # Outstanding Shares 308.5 million 2 Share Price close on 1/29/21 $20.22 3 Market Capitalization $7.79 billion Item 1 x 2 4 Short-Term Debt $452 million 5 Long-Term Debt $4.41 billion 6 Total Debt $4.86 billion Item 4+ 5 7 Cash and Cash Equivalents $1.58 billion Enterprise Value $8.086 billion Item 3 + 6 - 7 We can calculate Macy's market cap from the information above. Macy's has 308.5 million outstanding shares valued at $20.22 per share:1

Macy's market capitalization was $7.79 billion (308.5 million x $20.22). Macy's had short-term debt of $452 million and long-term debt of $4.41 billion for a total debt of $4.86 billion. Macy's had $1.58 billion in cash and cash equivalents. Macy's enterprise value is calculated as $4.806 billion (market cap) + $4.86 billion (debt) - $1.58 billion (cash). Macy's EV = $8.086 billion Enterprise value is considered comprehensive when valuing a company because, if a company were to purchase Macy's outstanding shares for $4.8 billion, it would also have to settle Macy's outstanding debts.

In total, the acquiring company will spend closer to $10 billion to purchase Macy's. However, since Macy's has $1.3 billion in cash, this amount can be added to repay the debt.

What Is Enterprise Value and How Does It Differ From Market Capitalization? Enterprise value is a popular measurement of the total value of a company. It can be seen as the theoretical price that would need to be paid in order to fully acquire a company in a going-private transaction. Unlike market capitalization, which reflects only the value of the company’s equity, enterprise value reflects the size of the company’s debts as well as its cash reserves. It is a popular figure among investors and analysts and is often used in financial ratios.

Why Is Cash Deducted From Enterprise Value? To understand why cash is deducted from enterprise value, suppose that you are a private investor wishing to purchase 100% of a publicly-traded company. When planning your purchase, you note that the company’s market capitalization is $100 million, meaning you will need $100 million to buy all the shares from its existing shareholders. But what if the company also has $20 million in cash? In that scenario, your real “cost” for purchasing the company would only be $80 million, since buying the company would immediately give you access to its $20 million in cash. All else being equal, a higher cash balance leads to a lower enterprise value, and vice-versa.

Why Is Debt Added to Enterprise Value? Higher debt leads to a higher enterprise value because it represents an added cost that must be paid by any would-be acquirer. For instance, in our previous example, suppose that the company has $10 million in debt. With that in mind, you now know that in addition to the $100 million you need to purchase the shares from its existing shareholders, you also need an additional $10 million to pay off the company’s debts. Putting these figures together, your total enterprise value would be $100 million in market capitalization, plus $10 million in debt, minus $20 million in cash, for a total of $90 million.

Correction—March 12, 2022: A previous version of this article quoted incorrect numbers from the Macy's 10-K filing.

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The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks.1 CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

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Capital Asset Pricing Model - CAPM

Understanding the Capital Asset Pricing Model (CAPM)

The formula for calculating the expected return of an asset given its risk is as follows:

\begin{aligned} &ER_i = R_f + \beta_i ( ER_m - R_f ) \\ &\textbf{where:} \\ &ER_i = \text{expected return of investment} \\ &R_f = \text{risk-free rate} \\ &\beta_i = \text{beta of the investment} \\ &(ER_m - R_f) = \text{market risk premium} \\ \end{aligned}​ERi​=Rf​+βi​(ERm​−Rf​)where:ERi​=expected return of investmentRf​=risk-free rateβi​=beta of the investment(ERm​−Rf​)=market risk premium​

Investors expect to be compensated for risk and the time value of money. The risk-free rate in the CAPM formula accounts for the time value of money. The other components of the CAPM formula account for the investor taking on additional risk.

The beta of a potential investment is a measure of how much risk the investment will add to a portfolio that looks like the market. If a stock is riskier than the market, it will have a beta greater than one. If a stock has a beta of less than one, the formula assumes it will reduce the risk of a portfolio.

A stock’s beta is then multiplied by the market risk premium, which is the return expected from the market above the risk-free rate. The risk-free rate is then added to the product of the stock’s beta and the market risk premium. The result should give an investor the required return or discount rate they can use to find the value of an asset.

The goal of the CAPM formula is to evaluate whether a stock is fairly valued when its risk and the time value of money are compared to its expected return.

For example, imagine an investor is contemplating a stock worth $100 per share today that pays a 3% annual dividend. The stock has a beta compared to the market of 1.3, which means it is riskier than a market portfolio. Also, assume that the risk-free rate is 3% and this investor expects the market to rise in value by 8% per year.

The expected return of the stock based on the CAPM formula is 9.5%:

\begin{aligned} &9.5\% = 3\% + 1.3 \times ( 8\% - 3\% ) \\ \end{aligned}​9.5%=3%+1.3×(8%−3%)​

The expected return of the CAPM formula is used to discount the expected dividends and capital appreciation of the stock over the expected holding period. If the discounted value of those future cash flows is equal to $100 then the CAPM formula indicates the stock is fairly valued relative to risk.

Problems With the CAPM

There are several assumptions behind the CAPM formula that have been shown not to hold in reality. Modern financial theory rests on two assumptions: One, securities markets are very competitive and efficient (that is, relevant information about the companies is quickly and universally distributed and absorbed) and two, these markets are dominated by rational, risk-averse investors, who seek to maximize satisfaction from returns on their investments.

Despite these issues, the CAPM formula is still widely used because it is simple and allows for easy comparisons of investment alternatives.

Including beta in the formula assumes that risk can be measured by a stock’s price volatility. However, price movements in both directions are not equally risky. The look-back period to determine a stock’s volatility is not standard because stock returns (and risk) are not normally distributed.

The CAPM also assumes that the risk-free rate will remain constant over the discounting period. Assume in the previous example that the interest rate on U.S. Treasury bonds rose to 5% or 6% during the 10-year holding period. An increase in the risk-free rate also increases the cost of the capital used in the investment and could make the stock look overvalued.

The market portfolio that is used to find the market risk premium is only a theoretical value and is not an asset that can be purchased or invested in as an alternative to the stock. Most of the time, investors will use a major stock index, like the S&P 500, to substitute for the market, which is an imperfect comparison.

The most serious critique of the CAPM is the assumption that future cash flows can be estimated for the discounting process. If an investor could estimate the future return of a stock with a high level of accuracy, the CAPM would not be necessary.

The CAPM and the Efficient Frontier

Using the CAPM to build a portfolio is supposed to help an investor manage their risk. If an investor were able to use the CAPM to perfectly optimize a portfolio’s return relative to risk, it would exist on a curve called the efficient frontier, as shown in the following graph.

Image by Julie Bang © Investopedia 2019

The graph shows how greater expected returns (y-axis) require greater expected risk (x-axis). Modern Portfolio Theory (MPT) suggests that starting with the risk-free rate, the expected return of a portfolio increases as the risk increases. Any portfolio that fits on the Capital Market Line (CML) is better than any possible portfolio to the right of that line, but at some point, a theoretical portfolio can be constructed on the CML with the best return for the amount of risk being taken.

The CML and efficient frontier may be difficult to define, but it illustrates an important concept for investors: there is a trade-off between increased return and increased risk. Because it isn’t possible to perfectly build a portfolio that fits on the CML, it is more common for investors to take on too much risk as they seek additional return.

In the following chart, you can see two portfolios that have been constructed to fit along the efficient frontier. Portfolio A is expected to return 8% per year and has a 10% standard deviation or risk level. Portfolio B is expected to return 10% per year but has a 16% standard deviation. The risk of portfolio B rose faster than its expected returns.

Image by Julie Bang © Investopedia 2019

The efficient frontier assumes the same things as the CAPM and can only be calculated in theory. If a portfolio existed on the efficient frontier it would be providing the maximal return for its level of risk. However, it is impossible to know whether a portfolio exists on the efficient frontier or not because future returns cannot be predicted.

This trade-off between risk and return applies to the CAPM and the efficient frontier graph can be rearranged to illustrate the trade-off for individual assets. In the following chart, you can see that the CML is now called the Security Market Line (SML). Instead of expected risk on the x-axis, the stock’s beta is used. As you can see in the illustration, as beta increases from one to two, the expected return is also rising.

Image by Julie Bang © Investopedia 2019

The CAPM and SML make a connection between a stock’s beta and its expected risk. A higher beta means more risk but a portfolio of high beta stocks could exist somewhere on the CML where the trade-off is acceptable, if not the theoretical ideal.

The value of these two models is diminished by assumptions about beta and market participants that aren’t true in the real markets. For example, beta does not account for the relative riskiness of a stock that is more volatile than the market with a high frequency of downside shocks compared to another stock with an equally high beta that does not experience the same kind of price movements to the downside.

Practical Value of the CAPM

Considering the critiques of the CAPM and the assumptions behind its use in portfolio construction, it might be difficult to see how it could be useful. However, using the CAPM as a tool to evaluate the reasonableness of future expectations or to conduct comparisons can still have some value.

Imagine an advisor who has proposed adding a stock to a portfolio with a $100 share price. The advisor uses the CAPM to justify the price with a discount rate of 13%. The advisor’s investment manager can take this information and compare it to the company’s past performance and its peers to see if a 13% return is a reasonable expectation.

Assume in this example that the peer group’s performance over the last few years was a little better than 10% while this stock had consistently underperformed with 9% returns. The investment manager shouldn’t take the advisor’s recommendation without some justification for the increased expected return.

An investor can also use the concepts from the CAPM and efficient frontier to evaluate their portfolio or individual stock performance compared to the rest of the market. For example, assume that an investor’s portfolio has returned 10% per year for the last three years with a standard deviation of returns (risk) of 10%. However, the market averages have returned 10% for the last three years with a risk of 8%.

The investor could use this observation to reevaluate how their portfolio is constructed and which holdings may not be on the SML. This could explain why the investor’s portfolio is to the right of the CML. If the holdings that are either dragging on returns or have increased the portfolio’s risk disproportionately can be identified, the investor can make changes to improve returns.

The Bottom Line

The CAPM uses the principles of Modern Portfolio Theory to determine if a security is fairly valued. It relies on assumptions about investor behaviors, risk and return distributions, and market fundamentals that don’t match reality. However, the underlying concepts of CAPM and the associated efficient frontier can help investors understand the relationship between expected risk and reward as they make better decisions about adding securities to a portfolio.

The Fundamentals of Corporate Finance and Accounting

Whatever your learning style, understanding corporate finance and accounting is easy when you can choose from 183,000 online video courses. With Udemy, you’ll be able to learn accounting terminology and how to prepare financial statements and analyze business transactions. What’s more, each course has new additions published every month and comes with a 30-day money-back guarantee. Learn more about Udemy and sign up today.