Screena's second service, the screena timer widget, has been released. It's designed to be used in watch parties, which are often organized by Twitch streamers! Screena Timer

Streaming Watchparty ?

Do you enjoy watching live streaming on Twitch or YouTube? There are many streamers hosting watch party. However, it is illegal to share the OTT screen itself! Due to copyright issues, many streamers display their sync location for watch together.(like the image below -15:27) Screena Solution for Timer

Screena Timer is an innovative timer widget that overcomes the existing shortcomings by synchronizing with the timer of the OTT (Netflix, Disney+.. etc) content being played on Screena.

To address the existing issue of having to manually set a timer at the end of each episode, we've launched the Screena Timer Beta.

**Follow the steps below to set up the timer widget. It's very easy!

**

1. allow permissions

2. Pick a Contents to Watch

3. Pick 'Screena Timer'

4. Copy Widget URL - Screena Timer Paste it into your broadcast program(ex.OBS), and you’re ready to go! 9. OBS source list -> Click Browser 10. Paste Widget URL... Done !

We’ll be adding more features in the future, **and will be available in English as soon as possible ! **Web3 Screena Watchparty

Bringing web3 to the screen near you 📽️ As a Web3 watch party platform, Screena is creating “the joy of watching together” based on video content in the Web3 space. We believe there is a future in connecting content and blockchain.

Official Website : screena.com Screena Link3 Profile : https://link3.to/screenaeth Screena NFT : https://www.oneplanetnft.io/collections/oknim

Updated October 24, 2022

Reviewed by JULIUS MANSA

Fact checked by SUZANNE KVILHAUG

What Is the Capital Asset Pricing Model?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk, or the general perils of investing, and expected return for assets, particularly stocks.1 It is a finance model that establishes a linear relationship between the required return on an investment and risk. The model is based on the relationship between an asset's beta, the risk-free rate (typically the Treasury bill rate), and the equity risk premium, or the expected return on the market minus the risk-free rate.

CAPM evolved as a way to measure this systematic risk. It 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.Understanding the Capital Asset Pricing Model (CAPM)

The formula for calculating the expected return of an asset, given its risk, is as follows:1

\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 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 with its expected return. In other words, by knowing the individual parts of the CAPM, it is possible to gauge whether the current price of a stock is consistent with its likely return.

CAPM and Beta

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 that they can use to find the value of an asset.

CAPM Example

For example, imagine an investor is contemplating a stock valued at $100 per share today that pays a 3% annual dividend. Say that this stock has a beta compared with the market of 1.3, which means it is more volatile than a broad market portfolio (i.e., the S&P 500 index). 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

Unrealistic Assumptions

Several assumptions behind the CAPM formula have been shown not to hold up in reality. Modern financial theory rests on two assumptions:

1. Securities markets are very competitive and efficient (that is, relevant information about the companies is quickly and universally distributed and absorbed).

2. These markets are dominated by rational, risk-averse investors, who seek to maximize satisfaction from returns on their investments.

The Volcker Rule is a federal regulation that generally prohibits banks from conducting certain investment activities with their own accounts and limits their dealings with hedge funds and private equity funds, also called covered funds.

KEY TAKEAWAYS

• The Volcker Rule prohibits banks from using their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments. 

• On June 25, 2020, Federal Deposit Insurance Corp. (FDIC) officials said the agency will loosen the restrictions of the Volcker Rule, allowing banks to more easily make large investments into venture capital and similar funds.1

• The main criticism of the Volcker Rule is that it will reduce liquidity due to a reduction in banks’ market-making activities.

Understanding the Volcker Rule

The Volcker Rule aims to protect bank customers by preventing banks from making certain types of speculative investments that contributed to the 2007–2008 financial crisis. Essentially, it prohibits banks from using their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments.

In August 2019, the U.S. Office of the Comptroller of the Currency (OCC) voted to amend the Volcker Rule in an attempt to clarify what securities trading was and was not allowed by banks.2 On June 25, 2020, Federal Deposit Insurance Corp. (FDIC) officials said the agency will loosen the restrictions of the Volcker Rule, allowing banks to more easily make large investments into venture capital and similar funds.31

The Volcker Rule aims to protect bank customers by preventing banks from making certain types of speculative investments that contributed to the 2007–2008 financial crisis.

In addition, banks will not have to set aside as much cash for derivatives trades among different units of the same firm. That requirement had been put in place in the original rule to ensure that banks wouldn’t get wiped out if speculative derivative bets went wrong. Loosening those requirements could free up billions of dollars in capital for the industry.

The Volcker Rule is named after economist and former Federal Reserve (Fed) Chair Paul Volcker, who died on Dec. 8, 2019, at age 92.4 The Volcker Rule refers to section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which sets forth rules for implementing section 13 of the Bank Holding Company Act of 1956.5

The Volcker Rule also bars banks, or insured depository institutions, from acquiring or retaining ownership interests in hedge funds or private equity funds, subject to certain exemptions.6 In other words, the rule aims to discourage banks from taking too much risk by barring them from using their own funds to make these types of investments to increase profits. The Volcker Rule relies on the premise that these speculative trading activities do not benefit banks’ customers.

The rule went into effect on April 1, 2014, with banks’ full compliance required by July 21, 2015—although the Fed has since set procedures for banks to request extended time to transition into full compliance for certain activities and investments.7 On May 30, 2018, Fed board members, led by Chair Jerome “Jay” Powell, voted unanimously to push forward a proposal to loosen the restrictions around the Volcker Rule and reduce the costs for banks that need to comply with it.8 The goal, according to Powell, was “...to replace overly complex and inefficient requirements with a more streamlined set of requirements.”9

The rule, as it exists, allows banks to continue market making, underwriting, hedging, trading government securities, engaging in insurance company activities, offering hedge funds and private equity funds, and acting as agents, brokers, or custodians. Banks may continue to offer these services to their customers to generate profits. However, banks cannot engage in these activities if doing so would create a material conflict of interest, expose the institution to high-risk assets or trading strategies, or generate instability within either the bank or the overall U.S. financial system.

Depending on their size, banks must meet varying levels of reporting requirements to disclose details of their covered trading activities to the government. Larger institutions must implement a program to ensure compliance with the new rules, and their programs are subject to independent testing and analysis. Smaller institutions are subject to lesser compliance and reporting requirements.10

Additional History of the Volcker Rule

The rule’s origins date back to 2009, when Volcker proposed a piece of regulation in response to the ongoing financial crisis (and after the nation’s largest banks accumulated large losses from their proprietary trading arms) that aimed to prohibit banks from speculating in the markets. Volcker ultimately hoped to reestablish the divide between commercial banking and investment banking—a division that once existed but was legally dissolved by a partial repeal of the Glass-Steagall Act in 1999.

Although not a part of then-President Barack Obama’s original proposal for financial overhaul, the Volcker Rule was endorsed by Obama and added to the proposal by Congress in January 2010.11

In December 2013, five federal agencies—the Board of Governors of the Fed; the FDIC; the OCC; the Commodity Futures Trading Commission (CFTC); and the Securities and Exchange Commission (SEC)—approved the final regulations that make up the Volcker Rule.7

A bank may be excluded from the Volcker Rule if it does not have more than $10 billion in total consolidated assets and does not have total trading assets and liabilities of 5% or more of total consolidated assets.

Criticism of the Volcker Rule

The Volcker Rule has been widely criticized from various angles. The U.S. Chamber of Commerce claimed in 2017 that a cost-benefit analysis was never done and that the costs associated with the Volcker Rule outweigh its benefits.12 That same year, the top risk official of the International Monetary Fund (IMF) said that regulations to prevent speculative bets are hard to enforce and that the Volcker Rule could unintentionally diminish liquidity in the bond market.13

The Fed’s Finance and Economics Discussion Series (FEDS) made a similar argument, saying that the Volcker Rule will reduce liquidity due to a reduction in banks’ market-making activities.14 Furthermore, in October 2017, a Reuters report revealed that the European Union (EU) had scrapped a drafted law that many characterized as Europe’s answer to the Volcker Rule, citing no foreseeable agreement in sight.15 Meanwhile, several reports have cited a lighter-than-expected impact on the revenues of big banks in the years following the rule’s enactment—although ongoing developments in the rule’s implementation could affect future operations.

Future of the Volcker Rule

In February 2017, then-President Donald Trump signed an executive order directing then-Treasury Secretary Steven Mnuchin to review existing financial system regulations.16 Since the executive order, Treasury officials have released multiple reports proposing changes to Dodd-Frank, including a recommended proposal to allow banks greater exemptions under the Volcker Rule.

In one of the reports, released in June 2017, the Treasury said it recommends significant changes to the Volcker Rule while adding that it does not support its repeal and “supports in principle” the rule’s limitations on proprietary trading. The report notably recommends exempting from the Volcker Rule banks with less than $10 billion in assets. The Treasury also cited regulatory compliance burdens created by the rule and suggested simplifying and refining the definitions of proprietary trading and covered funds on top of softening the regulation to allow banks to more easily hedge their risks.17

Since the June 2017 assessment, Bloomberg reported in January 2018 that the OCC has led efforts to revise the Volcker Rule in accordance with some of the Treasury’s recommendations.18 A time line for any proposed revisions to take effect remains unclear, though it would certainly take months or years. In June 2020, bank regulators loosened one of the Volcker Rule provisions to allow lenders to invest in venture capital funds and other assets.1

After the election of President Joseph Biden in 2020, the new administration signaled its support to reverse the Trump era diminutions to the financial system regulations.

What was the goal of the Volcker Rule?

The Volcker Rule’s origins date back to 2009, when economist and former Federal Reserve (Fed) Chair Paul Volcker proposed a piece of regulation in response to the ongoing financial crisis (and after the nation’s largest banks accumulated large losses from their proprietary trading arms). The aim was to protect bank customers by preventing banks from making certain types of speculative investments that contributed to the crisis.

Essentially, it prohibits banks from using their own accounts (customer funds) for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments.6 Volcker ultimately hoped to reestablish the divide between commercial banking and investment banking—a division that once existed but was legally dissolved by a partial repeal of the Glass-Steagall Act in 1999.

What are the main criticisms of the Volcker Rule?

The Volcker Rule has been widely criticized from various angles. The U.S. Chamber of Commerce claimed in 2017 that a cost-benefit analysis was never done and that the costs associated with the Volcker Rule outweigh its benefits.12 The Fed’s Finance and Economics Discussion Series (FEDS) argued that the Volcker Rule will reduce liquidity due to a reduction in banks’ market-making activities.14 Additionally, International Monetary Fund (IMF) analysts have argued that regulations to prevent speculative bets are hard to enforce.19

What was the Glass-Steagall Act?

Spurred by the failure of almost 5,000 banks during the Great Depression, the Glass-Steagall Act was passed by the U.S. Congress as part of the Banking Act of 1933. Sponsored by Sen. Carter Glass, a former Treasury secretary, and Rep. Henry Steagall, chair of the House Banking and Currency Committee, it prohibited commercial banks from participating in the investment banking business and vice versa.20 

The rationale was the conflict of interest that arose when banks invested in securities with their own assets, which of course were actually their account holders’ assets. Simply put, the bill’s proponents argued that banks had a fiduciary duty to protect these assets and not to engage in excessively speculative activity.

The Bottom Line

The Volcker Rule is intended to restrict high-risk, speculative trading activity by banks, such as proprietary trading or investing in or sponsoring hedge funds or private equity funds. It maintains banks’ abilities to offer important customer-oriented financial services, such as underwriting, market making, and asset management services.

The regulations have been developed by five federal financial regulatory agencies, all described above: the Federal Reserve Board; the CFTC; the FDIC; the OCC; and the SEC.

Learn the Basics of Trading and Investing

Looking to learn more about trading and investing? No matter your learning style, there are more than enough courses to get you started. With Udemy, you’ll be able to choose courses taught by real-world experts and learn at your own pace, with lifetime access on mobile and desktop. You’ll also be able to master the basics of day trading, option spreads, and more. Find out more about Udemy and get started today.

The volume-weighted average price (VWAP) is a technical analysis indicator used on intraday charts that resets at the start of every new trading session.

It's a trading benchmark that represents the average price a security has traded at throughout the day, based on both volume and price.

VWAP is important because it provides traders with pricing insight into both the trend and value of a security.

KEY TAKEAWAYS

• The volume-weighted average price (VWAP) appears as a single line on intraday charts.

• It looks similar to a moving average line, but smoother.

• VWAP represents a view of price action throughout a single day's trading session.

• Retail and professional traders may use the VWAP to help them determine intraday price trends.

• VWAP typically is most useful to short-term traders.

0 seconds of 1 minute, 33 secondsVolume 75%

1:33

Volume Weighted Average Price

Understanding the Volume-Weighted Average Price

VWAP is calculated by totaling the dollars traded for every transaction (price multiplied by the volume) and then dividing by the total shares traded.

VWAP = Cumulative Typical Price x Volume/Cumulative Volume

Where Typical Price = High price + Low price + Closing Price/3

Cumulative = total since the trading session opened.

How to calculate VWAP

By adding the VWAP indicator to a streaming chart, the calculation will be made automatically. However, to calculate the VWAP yourself, follow the steps below.

Assume a 5-minute chart. The calculation is the same regardless of what intraday time frame is used.

1. Find the average price the stock traded at over the first 5-minute period of the day. To do this, add the high, low, and close, then divide by three. Multiply this by the volume for that period. Record the result in a spreadsheet, under column PV.

2. Divide PV by the volume for that period. This will produce the VWAP.

3. To maintain the VWAP throughout the day, continue to add the PV value from each period to the prior values. Divide this total by total volume up to that point.

To make Step 3 easier in a spreadsheet, create columns for cumulative PV and cumulative volume and apply the formula to them.

TradingView.

How Is VWAP Used?

VWAP is used in different ways by traders. Traders may use VWAP as a trend confirmation tool and build trading rules around it. For instance, they may consider stocks with prices below VWAP as undervalued and those with prices above it, overvalued. If prices below VWAP move above it, traders may go long the stock. If prices above VWAP move below it, they may sell their positions or initiate short positions.

Institutional buyers including mutual funds use VWAP to help move into or out of stocks with as small of a market impact as possible. Therefore, when they can, institutions will try to buy below the VWAP, or sell above it. This way their actions push the price back toward the average, instead of away from it.

VWAP's incorporation of volume is valuable to traders for what it can indicate about the degree of trading activity during short periods of time—whether the competition is taking or exiting positions.

What if you had started investing years ago?

Find out what a hypothetical investment would be worth today.

SELECT A STOCK

TSLA

TESLA INC

AAPL

APPLE INC

NKE

NIKE INC

AMZN

AMAZON.COM, INC

WMT

WALMART INC

SELECT INVESTMENT AMOUNT

$

SELECT A PURCHASE DATE

              2 years ago                      5 years ago                      10 years ago         

CALCULATE

Special Considerations

The Difference Between VWAP and a Simple Moving Average

On a chart, VWAP and a simple moving average (SMA) may look similar. However, these two indicators are calculated differently and represent different results.

VWAP is calculated by multiplying typical price by volume, and the dividing by total volume.

A simple moving average incorporates price but not volume. The SMA is calculated by totaling closing prices over a certain period (say 10 days) and then dividing the total by the number of periods (10).

Limitations of VWAP

VWAP is a single-day indicator and restarts at the open of each new trading day. Attempting to create an average VWAP over many days could distort it and result in an incorrect indicator.

While some institutions may prefer to buy when the price of a security is below the VWAP, or sell when it is above, VWAP is not the only factor to consider. In strong uptrends, the price may continue to move higher for many days without dropping below the VWAP at all or only occasionally. Therefore, waiting for the price to fall below VWAP could mean a missed opportunity if prices are rising quickly.

VWAP is based on historical values and does not inherently have predictive qualities or calculations. VWAP is anchored to the opening price range of the day. Therefore, the indicator increases its lag as the day goes on.

This can be seen in the way a 1-minute period VWAP calculation after 330 minutes (the length of a typical trading session) will often resemble a 390-minute moving average at the end of the trading day.

What Is the Volume-Weighted Average Price (VWAP)?

The volume-weighted average price (VWAP) is a measurement that shows the average price of a security, adjusted for its volume. It is calculated during a specific trading session by taking the total dollar value of trading in the security and dividing it by the volume of trades. The formula for calculating VWAP is cumulative typical price x volume divided by cumulative volume.

Why Is the Volume-Weighted Average Price Important?

VWAP gives traders a smoothed-out indication of a security’s price (adjusted for volume) over time. It is used by institutional traders to ensure that their trades do not move the price of the security they are trying to buy or sell too extremely.

For example, a hedge fund might refrain from submitting a buy order for a price above the security’s VWAP, in order to avoid artificially inflating the price of that security. Likewise, it might avoid submitting orders too far below the VWAP, so that the price is not dragged down by its sale.

What Is the Difference Between the Volume-Weighted Average Price and a Simple Moving Average (SMA)?

Like the VWAP, the simple moving average provides traders with a less volatile view of the recent price trend of a security. Unlike the VWAP, however, the simple moving average does not take into account the level of volume in that security’s trading.

VWAP weights each day’s price change by the amount of volume occurring in that day, whereas the simple moving average incorporates price and no volume.

Learn the Basics of Trading and Investing

Looking to learn more about trading and investing? No matter your learning style, there are more than enough courses to get you started. With Udemy, you’ll be able to choose courses taught by real-world experts and learn at your own pace, with lifetime access on mobile and desktop. You’ll also be able to master the basics of day trading, option spreads, and more. Find out more about Udemy and get started today.

ZZZZ Best was a carpet cleaning and restoration company founded by Barry Minkow that served as a front for a famous Ponzi scheme. The company went public in December 1986 and was quickly valued at over $300 million. Within just seven months of the initial public offering (IPO), however, ZZZZ Best was bankrupt and its assets were auctioned for approximately $64,000.1

KEY TAKEAWAYS

• ZZZZ Best was a company set up as a front for a Ponzi scheme.

• Its founder Barry Minkow engaged in a range of criminal acts including insurance scams and check kiting.

• Minkow and his business associate Tom Padgett set up a fake company called Interstate Appraisal to defraud financial institutions out of millions.

• Minkow was eventually sentenced to 25 years in prison for fraud. When released, he ended up convicted for fraud again and sentenced to five more years.

• The fraud was discovered by a woman who chased the paper trail, al due to an overcharge of only a few hundred dollars.

Understanding ZZZZ Best

Barry Minkow formed ZZZZ Best in his parents' garage. The business performed poorly and 15-year-old Minkow was often inundated with customer complaints and supplier collection requests. To create an illusion of a profitable business, Minkow began committing criminal acts, such as check kiting, theft, insurance scams, and fraud, to fund operations and pay suppliers.2

Within a few years of ZZZZ Best's inception, Minkow launched fictitious insurance restoration and appraisal businesses. While active, ZZZZ Best was at the center of a credit card scheme involving over $70,000 in fraudulent charges. Although Minkow assigned blame to contractors and employees, he repaid all of the victims except for one: a homemaker swindled out of a few hundred dollars.3

The Scheme and the Downfall

Minkow and business associate Tom Padgett created a fictitious company, Interstate Appraisal Service, to defraud banks and other lending institutions out of millions of dollars. Tom Padgett, an insurance claims adjuster, conspired with Minkow to forge documents crediting ZZZZ Best for restoration work and use Interstate Appraisal Services as the source to verify the claims. Increasingly, investors and bankers developed an interest in ZZZZ Best based on fraudulent financial statements produced by Minkow’s firm.2

Barry Minkow claimed his fraudulent actions were driven by a need to repay organized crime.

As the Ponzi scheme continued, ZZZZ Best experienced significant cash flow problems. As a solution, Minkow planned to acquire KeyServ, Sears' authorized carpet cleaner, for $25 million. According to Minkow, the revenues from KeyServ would provide enough cash flow to end the Ponzi scheme. Before the deal was closed, the jilted homemaker sparked a campaign against ZZZZ Best that would expose more than the fraud committed against her.4

The L.A. Times featured her story, which caused ZZZZ Best's stock price to decline sharply. Lenders began to call their loans and more investigations commenced, unraveling Minkow's dark web of deceit and fraud. Eventually, the truth behind the fictitious companies was revealed and the Ponzi scheme was exposed.

How Auditors Were Misled

To launch an IPO, the Securities and Exchange Commission (SEC) requires a firm to compile a prospectus, which must include a set of audited financial statements. Independent certified public accountant (CPA) firm Ernst & Whinney (now Ernst & Young) audited ZZZZ Best's financials to provide an opinion as to whether the financial statements were free of material misstatement. 

Assuming an independent third party provided the paperwork, the CPAs used false appraisal documents to perform its audit. When the CPA firm requested to visit a building refurbishing customer site, Minkow and his associates rented a building and created a bogus customer job site.5

Minkow After ZZZZ Best

In January 1988, Minkow and 11 other company insiders were indicted by a grand jury on counts of racketeering, money laundering, securities fraud, embezzlement, mail fraud, bank fraud, and tax evasion. Separately, Minkow was also indicted on counts of credit card fraud. Approximately a year later, Minkow was found guilty on all charges, was sentenced to 25 years in prison, and was ordered to pay over $26 million in restitution.5

After his early release in 1995, he became an ordained minister and served as a pastor of a church in California. Minkow informally investigated and reported other Ponzi schemes. From this success, he formed the fraudulent Fraud Discovery Institute.4

In 2011, he was again convicted for fraud and sentenced to five years in prison. It was discovered that while filming and producing his biography, he simultaneously was using his anti-fraud company to short stocks of companies he was investigating.6 A few years later, Minkow was sentenced to an additional five years in prison for defrauding his church and tax evasion. His restitution balance has increased ten-fold to $612 million.4

ZZZZ Best Frequently Asked Questions

What Accounting Procedures Did ZZZZ Best Fail to Follow?

ZZZZ Best failed because it was a Ponzi scheme so, in essence, the company followed almost no proper accounting procedures. However, it took the company going public before the fraud was discovered so there is an argument that exists that Minkow was quite skilled with his accounting.

How Was the ZZZZ Best Fraud Discovered?

Minkow was visited by his past when a homemaker who was overcharged just a few hundred dollars by Minkow tracked down a few others who Minkow had defrauded. When the homemaker located the others, she passed her findings onto the Los Angeles Times. The newspaper then ran a story exposing Minkow's relatively minor fraud. This caused a domino effect and ZZZZ Best was quickly outed as a Ponzi scheme.

When Did Barry Minkow Get Out of Prison?

Barry Minkow was released from prison most recently in 2018 after serving time for insider trading and embezzlement from his church. Before that conviction, he served a significant jail sentence from 1989 to 1995, being released only six years into his 25-year sentence.

Is There a Barry Minkow Movie Being Made?

There was a Barry Minkow movie made in 2011 that was eventually released in 2018, titled Con-Man. During the filming, Barry was arrested and pleaded guilty to insider trading charges. In January of 2022, a docuseries titled King of the Con was released on Discovery+.

The Bottom Line

Barry Minkow's company ZZZZ Best committed serious fraud and is one of the best-known Ponzi schemes in history. Even though Barry was released from prison early, he squandered the second chance and eventually ended up in much bigger trouble and ended up back in prison. Although there are multiple cinematic versions of his story, he is by no means a role model. ZZZZ Best was an excellent company on paper and at one point was valued over a quarter billion dollars, then bankrupted shortly afterward.

Learn the Basics of Trading and Investing

Looking to learn more about trading and investing? No matter your learning style, there are more than enough courses to get you started. With Udemy, you’ll be able to choose courses taught by real-world experts and learn at your own pace, with lifetime access on mobile and desktop. You’ll also be able to master the basics of day trading, option spreads, and more. Find out more about Udemy and get started today.

Stockbrokers in the United States need to pass the Series 7 exam to obtain a license to trade. The Series 7 exam focuses on investment risk, taxation, equity, and debt instruments; packaged securities, options, retirement plans, and interactions with clients for prospective securities industry professionals.2 This introductory-level exam assesses a candidate’s knowledge of basic securities industry information including concepts fundamental to working in the industry.1

The purpose of the Series 7 license is to set a level of competency for a registered representative or stockbroker to work in the securities industry. The Series 7 license is an essential requirement for an entry-level broker. The licensing exam covers an extensive range of financial terms and topics as well as securities regulations.1

KEY TAKEAWAYS

• The Series 7 is an exam and license that entitles the holder to sell all types of securities products except commodities and futures.1

• The Series 7 exam covers topics on investment risk, taxation, equity and debt instruments, packaged securities, options, and retirement plans.12

• The purpose of the Series 7 license is to establish a level of competency for registered representatives in the securities industry.1

Candidates who pass the Series 7 exam can trade many securities, such as stocks, mutual funds, options, municipal securities, and variable contracts. The Series 7 license does not cover selling real estate or life insurance products.1 In addition to obtaining the Series 7 license, many states require that registered representatives pass the Series 63 exam, also called the Uniform Securities Agent State Law Exam.34

Series 7 Requirements

Since Oct. 1, 2018, Series 7 candidates are required to pass the Securities Industry Essentials (SIE) exam as well as the Series 7 exam in order to receive the General Securities registration.15 According to FINRA, the SIE is an introductory-level exam that "assesses a candidate’s knowledge of basic securities industry information including concepts fundamental to working in the industry, such as types of products and their risks; the structure of the securities industry markets, regulatory agencies and their functions; and prohibited practices." If you need more information on the SIE, FINRA's SIE exam content outline provides more details.6

Candidates who want to take the Series 7 exam must be sponsored by a FINRA member firm or other applicable self-regulatory organization (SRO) member firm. The member firm must file a Form U4 (Uniform Application for Securities Industry Registration or Transfer Form) for the candidate to be registered for the licensing exam. Non-FINRA members should use the Test Enrollment Services System (TESS) in order to register for the exam.7 FINRA governs the activities of securities firms and registered brokers, ensuring that anyone who sells securities products is qualified and tested.1

Candidates who want to take the Series 7 exam must be sponsored by a FINRA member firm or other applicable self-regulatory organization (SRO) member firm.1

Series 7 Exam Structure

The Series 7 is structured as follows:

1. Seeks Business for the Broker-Dealer from Customers and Potential Customers: 9 questions

2. Opens Accounts after Obtaining and Evaluating Customers’ Financial Profile and Investment Objectives: 11 questions

3. Provides Customers with Information about Investments, Makes Suitable Recommendations, Transfers Assets, and Maintains Appropriate Records: 91 questions

4. Obtains and Verifies Customers’ Purchase and Sales Instructions and Agreements; Processes, Completes, and Confirms Transactions: 14 questions1

The Series 7 exam has 125 multiple choice questions, lasts 225 minutes, and cost $300. The passing score is 72%.1

Prior to Oct. 1, 2018, the Series 7 exam contained 250 questions covering five major job functions.8 The exam duration was six hours, had no prerequisites, and cost $305. A score of 72% was required to pass.

FINRA does not provide candidates with any physical certificate as proof of exam completion. Current or potential employers who wish to view proof of completion must access this information through FINRA's Central Registration Depository (CRD).9

Completion of the Series 7 exam is a prerequisite for many other securities licenses, such as the Series 24, which permits the candidate to supervise and manage broker activities.10

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A put option (or “put”) is a contract giving the option buyer the right, but not the obligation, to sell—or sell short—a specified amount of an underlying security at a predetermined price within a specified time frame. This predetermined price at which the buyer of the put option can sell the underlying security is called the strike price.

Put options are traded on various underlying assets, including stocks, currencies, bonds, commodities, futures, and indexes. A put option can be contrasted with a call option, which gives the holder the right to buy the underlying security at a specified price, either on or before the expiration date of the option contract.

KEY TAKEAWAYS

• Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.

• Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.

• Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.

• Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.

• Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.

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Put Option Basics

How a Put Option Works

A put option becomes more valuable as the price of the underlying stock or security decreases. Conversely, a put option loses its value as the price of the underlying stock increases. As a result, they are typically used for hedging purposes or to speculate on downside price action.

Investors often use put options in a risk management strategy known as a protective put, which is used as a form of investment insurance or hedge to ensure that losses in the underlying asset do not exceed a certain amount. In this strategy, the investor buys a put option to hedge downside risk in a stock held in the portfolio. If and when the option is exercised, the investor would sell the stock at the put’s strike price. If the investor does not hold the underlying stock and exercises a put option, this would create a short position in the stock.

Factors That Affect a Put’s Price

In general, the value of a put option decreases as its time to expiration approaches because of the impact of time decay. Time decay accelerates as an option’s time to expiration draws closer since there’s less time to realize a profit from the trade. When an option loses its time value, the intrinsic value is left over. An option’s intrinsic value is equivalent to the difference between the strike price and the underlying stock price. If an option has intrinsic value, it is referred to as in the money (ITM).

Option Intrinsic Value = Difference between Market Price of Underlying Security and Option Strike Price (For Put Option, IV = Strike Price minus Market Price of Underlying Security; for Call Option, IV = Market Price of Underlying Security minus Strike Price)

Out of the money (OTM) and at the money (ATM) put options have no intrinsic value because there is no benefit in exercising the option. Investors have the option of short-selling the stock at the current higher market price, rather than exercising an out-of-the-money put option at an undesirable strike price. However, outside of a bear market, short selling is typically riskier than buying put options.

Time value, or extrinsic value, is reflected in the premium of the option. If the strike price of a put option is $20, and the underlying is stock is currently trading at $19, there is $1 of intrinsic value in the option. But the put option may trade for $1.35. The extra $0.35 is time value, since the underlying stock price could change before the option expires. Different put options on the same underlying asset may be combined to form put spreads.

There are several factors to keep in mind when it comes to selling put options. It’s important to understand an option contract’s value and profitability when considering a trade, or else you risk the stock falling past the point of profitability.

The payoff of a put option at expiration is depicted in the image below:

Image by Sabrina Jiang © Investopedia 2020

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Where to Trade Options

Put options, as well as many other types of options, are traded through brokerages. Some brokers have specialized features and benefits for options traders. For those who have an interest in options trading, there are many brokers that specialize in options trading. It’s important to identify a broker that is a good match for your investment needs.

Alternatives to Exercising a Put Option

The buyer of a put option does not need to hold an option until expiration. As the underlying stock price moves, the premium of the option will change to reflect the recent underlying price movements. The option buyer can sell their option and either minimize loss or realize a profit, depending on how the price of the option has changed since they bought it.

Similarly, the option writer can do the same thing. If the underlying price is above the strike price, they may do nothing. This is because the option may expire at no value, and this allows them to keep the whole premium. But if the underlying price is approaching or dropping below the strike price, then to avoid a big loss, the option writer may simply buy the option back (which gets them out of the position). The profit or loss is the difference between the premium collected and the premium paid to get out of the position.

Example of a Put Option

Assume an investor buys one put option on the SPDR S&P 500 ETF (SPY), which was trading at $445 (January 2022), with a strike price of $425 expiring in one month. For this option, they paid a premium of $2.80, or $280 ($2.80 × 100 shares or units).

If units of SPY fall to $415 prior to expiration, the $425 put will be “in the money” and will trade at a minimum of $10, which is the put option’s intrinsic value (i.e., $425 - $415). The exact price for the put would depend on a number of factors, the most important of which is the time remaining to expiration. Assume that the $425 put is trading at $10.50.

Since the put option is now “in the money,” the investor has to decide whether to (a) exercise the option, which would confer the right to sell 100 shares of SPY at the strike price of $425; or (b) sell the put option and pocket the profit. We consider two cases: (i) the investor already holds 100 units of SPY; and (ii) the investor does not hold any SPY units. (The calculations below ignore commission costs, to keep things simple).

Let’s say the investor exercises the put option. If the investor already holds 100 units of SPY (assume they were purchased at $400) in their portfolio and the put was bought to hedge downside risk (i.e., it was a protective put), then the investor’s broker would sell the 100 SPY shares at the strike price of $425.

The net profit on this trade can be calculated as:

[(SPY Sell Price - SPY Purchase Price) - (Put Purchase Price)] × Number of shares or units

Profit = [($425 - $400) - $2.80)] × 100 = $2,220

What if the investor did not own the SPY units, and the put option was purchased purely as a speculative trade? In this case, exercising the put option would result in a short sale of 100 SPY units at the $425 strike price. The investor could then buy back the 100 SPY units at the current market price of $415 to close out the short position.

The net profit on this trade can be calculated as:

[(SPY Short Sell Price - SPY Purchase Price) - (Put Purchase Price)] × Number of shares or units

Profit = [($425 - $415) - $2.80)] × 100 = $720

Exercising the option, (short) selling the shares and then buying them back sounds like a fairly complicated endeavor, not to mention added costs in the form of commissions (since there are multiple transactions) and margin interest (for the short sale). But the investor actually has an easier “option” (for lack of a better word): Simply sell the put option at its current price and make a tidy profit. The profit calculation in this case is:

[Put Sell Price - Put Purchase Price] × Number of shares or units = [10.50 - $2.80] × 100 = $770

There’s a key point to note here. Selling the option, rather than going through the relatively convoluted process of option exercise, actually results in a profit of $770, which is $50 more than the $720 made by exercising the option. Why the difference? Because selling the option enables the time value of $0.50 per share ($0.50 × 100 shares = $50) to be captured as well. Thus, most long option positions that have value prior to expiration are sold rather than exercised.

For a put option buyer, the maximum loss on the option position is limited to the premium paid for the put. The maximum gain on the option position would occur if the underlying stock price fell to zero.

SELLING VS. EXERCISING AN OPTION

The majority of long option positions that have value prior to expiration are closed out by selling rather than exercising, since exercising an option will result in loss of time value, higher transaction costs, and additional margin requirements.

Writing Put Options

In the previous section, we discussed put options from the perspective of the buyer, or an investor who has a long put position. We now turn our attention to the other side of the option trade: the put option seller or the put option writer, who has a short put position.

Contrary to a long put option, a short or written put option obligates an investor to take delivery, or purchase shares, of the underlying stock at the strike price specified in the option contract.

Assume an investor is bullish on SPY, which is currently trading at $445, and does not believe it will fall below $430 over the next month. The investor could collect a premium of $3.45 per share (× 100 shares, or $345) by writing one put option on SPY with a strike price of $430.

If SPY stays above the $430 strike price over the next month, the investor would keep the premium collected ($345) since the options would expire out of the money and be worthless. This is the maximum profit on the trade: $345, or the premium collected.

Conversely, if SPY moves below $430 before option expiration in one month, the investor is on the hook for purchasing 100 shares at $430, even if SPY falls to $400, or $350, or even lower. No matter how far the stock falls, the put option writer is liable for purchasing the shares at the strike price of $430, meaning they face a theoretical risk of $430 per share, or $43,000 per contract ($430 × 100 shares) if the underlying stock falls to zero.

For a put writer, the maximum gain is limited to the premium collected, while the maximum loss would occur if the underlying stock price fell to zero. The gain/loss profiles for the put buyer and put writer are thus diametrically opposite.

Is Buying a Put Similar to Short Selling?

Buying puts and short selling are both bearish strategies, but there are some important differences between the two. A put buyer’s maximum loss is limited to the premium paid for the put, while buying puts does not require a margin account and can be done with limited amounts of capital. Short selling, on the other hand, has theoretically unlimited risk and is significantly more expensive because of costs such as stock borrowing charges and margin interest (short selling generally needs a margin account). Short selling is therefore considered to be much riskier than buying puts.

Should I Buy In the Money (ITM) or Out of the Money (OTM) Puts?

It really depends on factors such as your trading objective, risk appetite, amount of capital, etc. The dollar outlay for in the money (ITM) puts is higher than for out of the money (OTM) puts because they give you the right to sell the underlying security at a higher price. But the lower price for OTM puts is offset by the fact that they also have a lower probability of being profitable by expiration. If you don’t want to spend too much for protective puts and are willing to accept the risk of a modest decline in your portfolio, then OTM puts might be the way to go.

Can I Lose the Entire Amount of the Premium Paid for My Put Option?

Yes, you can lose the entire amount of premium paid for your put, if the price of the underlying security does not trade below the strike price by option expiry.

I’m New to Options and Have Limited Capital; Should I Consider Writing Puts?

Put writing is an advanced option strategy meant for experienced traders and investors; strategies such as writing cash-secured puts also need a significant amount of capital. If you’re new to options and have limited capital, put writing would be a risky endeavor and not a recommended one.

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Negative correlation is a relationship between two variables in which one variable increases as the other decreases, and vice versa.

In statistics, a perfect negative correlation is represented by the value -1.0, while a 0 indicates no correlation, and +1.0 indicates a perfect positive correlation. A perfect negative correlation means the relationship that exists between two variables is exactly opposite all of the time.

KEY TAKEAWAYS

• Negative or inverse correlation describes when two variables tend to move in opposite size and direction from one another, such that when one increases the other variable decreases, and vice-versa.

• Negative correlation is put to use when constructing diversified portfolios, so that investors can benefit from price increases in certain assets when others fall.

• Correlation between two variables can vary widely over time. Stocks and bonds generally have a negative correlation, but in the 10 years to 2018, their measured correlation has ranged from -0.8 to +0.2.

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Correlation

Understanding Negative Correlation

Negative correlation or inverse correlation indicates that two individual variables have a statistical relationship such that their prices generally move in opposite directions from one another. If, for instance, variables X and Y have a negative correlation (or are negatively correlated), as X increases in value, Y will decrease; similarly, if X decreases in value, Y will increase.

The degree to which one variable moves in relation to the other is measured by the correlation coefficient, which quantifies the strength of the correlation between two variables. For example, if variables X and Y have a correlation coefficient of -0.1, they have a weak negative correlation, but if they have a correlation coefficient of -0.9, they would be regarded as having a strong negative correlation.

The higher the negative correlation between two variables, the closer the correlation coefficient will be to the value -1. By the same token, two variables with a perfect positive correlation would have a correlation coefficient of +1, while a correlation coefficient of zero implies that the two variables are uncorrelated and move independently of each other.

The correlation coefficient, usually denoted by "r" or "R", can be determined by regression analysis. The square of the correlation coefficient (generally denoted by "R2", or R-squared) represents the degree or extent to which the variance of one variable is related to the variance of the second variable, and is typically expressed in percentage terms.

For example, if a portfolio and its benchmark have a correlation of 0.9, the R-squared value would be 0.81. The interpretation of this figure is that 81% of the variation in the portfolio (the dependent variable in this case) is related to—or can be explained by—the variation of the benchmark (the independent variable).

The degree of correlation between two variables is not static, but can swing over a wide range—or from positive to negative, and vice versa—over time.

Graphs showing positive, negative, and no correlation. Illustration by Hugo Lin. © 2018 ThoughtCo.

The Importance of Negative Correlation

The concept of negative correlation is a key one in portfolio construction. Negative correlation between sectors or geographies enables the creation of diversified portfolios that can better withstand market volatility and smooth out portfolio returns over the long term.

The building of large and complex portfolios where the correlations are carefully balanced to provide more predictable volatility is generally referred to as the discipline of strategic asset allocation.

Consider the long-term negative correlation between stocks and bonds. Stocks generally outperform bonds during periods of strong economic performance, but as the economy slows down and the central bank reduces interest rates to stimulate the economy, bonds may outperform stocks.

As an example, assume you have a $100,000 balanced portfolio that is invested 60% in stocks and 40% in bonds. In a year of strong economic performance, the stock component of your portfolio might generate a return of 12%, while the bond component may return -2% because interest rates are on a rising trend. Thus, the overall return on your portfolio would be 6.4% ((12% x 0.6) + (-2% x 0.4).

The following year, as the economy slows markedly and interest rates are lowered, your stock portfolio might generate -5% while your bond portfolio may return 8%, giving you an overall portfolio return of 0.2%.

What if, instead of a balanced portfolio, your portfolio was 100% equities? Using the same return assumptions, your all-equity portfolio would have a return of 12% in the first year and -5% in the second year, which are more volatile than the balanced portfolio's returns of 6.4% and 0.2%.

Equities and bonds generally have a negative correlation, but in the 10 years to 2018, their correlation has ranged from approximately -0.8 to +0.2, according to BlackRock.

Examples of Negative Correlation

Examples of negative correlation are common in the investment world. A well-known example is the negative correlation between crude oil prices and airline stock prices. Jet fuel, which is derived from crude oil, is a large cost input for airlines and has a significant impact on their profitability and earnings.

If the price of crude oil spikes up, it could have a negative impact on airlines' earnings and hence on the price of their stocks. But if the price of crude oil trends lower, this should boost airline profits and therefore their stock prices.

Here's how the existence of this phenomenon can help in the construction of a diversified portfolio. As the energy sector has a substantial weight in most equity indices, many investors have significant exposure to crude oil prices, which are typically quite volatile. As the energy sector, for obvious reasons, has a positive correlation with crude oil prices, investing part of one's portfolio in airline stocks would provide a hedge against a decline in oil prices.

Special Considerations

It should be noted that this investment thesis may not work all of the time, as the typical negative correlation between oil prices and airline stocks might occasionally turn positive. For example, during an economic boom, oil prices and airline stocks may both rise; conversely, during a recession, oil prices and airline stocks could slide in tandem.

When negative correlation between two variables breaks down, it can play havoc with investment portfolios. For example, US equity markets experienced their worst performance in a decade in the fourth quarter of 2018, partly fueled by concerns that the Federal Reserve (Fed) would continue to raise interest rates.

Fears of rising rates also took their toll on bonds, leading their normally negative correlation with stocks to fall to the weakest levels in decades. At such times, investors often discover to their chagrin that there is no place to hide.

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The Know Your Client or Know Your Customer is a standard in the investment industry that ensures investment advisors know detailed information about their clients' risk tolerance, investment knowledge, and financial position. KYC protects both clients and investment advisors. Clients are protected by having their investment advisor know what investments best suit their personal situations. Investment advisors are protected by knowing what they can and cannot include in their client's portfolio. KYC compliance typically involves requirements and policies such as risk management, customer acceptance policies, and transaction monitoring.

KEY TAKEAWAYS

• Know Your Customer (KYC) are a set of standards used within the investment and financial services industry to verify customers, their risk profiles, and financial profile.

• In the investment industry, KYC stipulates that every broker-dealer should use reasonable effort regarding client accounts.

• The Financial Crimes Enforcement Network (FinCEN) established minimum KYC requirements, including verifying beneficial owners and setting standards for dealing with third parties.

• The SEC requires that a new customer provide detailed financial information before opening an account.

• The cryptocurrency market is not required to employ KYC standards, although some have.

Understanding Know Your Client (KYC)

The Know Your Client (KYC) rule is an ethical requirement for those in the securities industry who are dealing with customers during the opening and maintaining of accounts. There are two rules which were implemented in July 2012 that cover this topic together: Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability). These rules are in place to protect both the broker-dealer and the customer and so that brokers and firms deal fairly with clients.

The Know Your Customer Rule 2090 essentially states that every broker-dealer should use reasonable effort when opening and maintaining client accounts. It is a requirement to know and keep records on the essential facts of each customer, as well as identify each person who has authority to act on the customer’s behalf.

The KYC rule is important at the beginning of a customer-broker relationship to establish the essential facts of each customer before any recommendations are made. The essential facts are those required to service the customer’s account effectively and to be aware of any special handling instructions for the account. Also, the broker-dealer needs to be familiar with each person who has the authority to act on behalf of the customer and needs to comply with all the laws, regulations, and rules of the securities industry.

Suitability Rule

As found in the FINRA Rules of Fair Practices, Rule 2111 goes in tandem with the KYC rule and covers the topic of making recommendations. The suitability Rule 2111 notes that a broker-dealer must have reasonable grounds when making a recommendation that is suitable for a customer based on the client’s financial situation and needs. This responsibility means that the broker-dealer has done a complete review of the current facts and profile of the customer, including the customer’s other securities before making any purchase, sale, or exchange of a security.

Requirements for KYC Compliance

The U.S. Financial Crimes Enforcement Network (FinCEN) has set baseline requirements for KYC in conjunction with the core requirements for the due diligence program. To prevent money laundering, financial institutions are required to conduct deeper assessments of their clients' risk profiles.

FinCEN requires that financial institutions verify the identities of their customers and their respective beneficial owners⁠—owners with at least 25% ownership⁠.1 For entities with a high anti-money laundering and terrorism finance (AML) risk, additional scrutiny is required and the threshold for ownership is lowered.

FinCEN requires financial institutions to understand the type and purpose of the customer relationship when developing the customer risk profile. This risk profile is created when the customer relationship is established and is used as a baseline for detecting suspicious activities.

When using third parties to collect and verify customer profiles, financial institutions must verify that the third party employs specific risk controls and has an appropriate governance structure. To remain in compliance, they must secure AML and customer identification program (CIP) certificates from a third party each year.

Lastly, financial institutions must also maintain current and accurate customer information and continue to monitor their accounts for suspicious and illegal activities.2 When detected, they are required to promptly report their findings.

Establishing a Customer Profile

Investment advisors and firms are responsible for knowing each customer's financial situation by exploring and gathering the client's age, other investments, tax status, financial needs, investment experience, investment time horizon, liquidity needs, and risk tolerance. The SEC requires that a new customer provide detailed financial information that includes name, date of birth, address, employment status, annual income, net worth, investment objectives, and identification numbers before opening an account.

KYC and Cryptocurrency

Cryptocurrency is wildly praised for being decentralized and a medium of exchange that promotes confidentiality; however, these benefits also present challenges in preventing money laundering. Criminals see cryptocurrency as a means of furthering their illegal activities and as a vehicle to launder money; as a result, governing bodies are looking for ways to impose KYC on cryptocurrency markets, requiring cryptocurrency platforms to verify their customers much like financial institutions. Although not yet required, many platforms have implemented KYC practices.

Exchanges are classified as either crypto-to-crypto or fiat-to-crypto.3 Because crypto-to-crypto exchanges don't deal with traditional currency, they do not have the same pressures to employ KYC standards as with exchanges that deal with fiat currencies.

Fiat-to-crypto exchanges facilitate transactions involving fiat currencies and cryptocurrencies. Since fiat currency is the official currency of a nation, most of these exchanges employ some measure of KYC. Fortunately, financial institutions should have already vetted their customers according to KYC requirements.

$60 million

The penalty assessed against Bitcoin mixer Larry Dean Harmon for violating anti-money laundering laws.4

In early 2021, FinCEN proposed that cryptocurrency and digital asset market participants submit, maintain, and verify customers' identities. 5 This proposal would classify certain cryptocurrencies as monetary instruments, subjecting them to KYC requirements.

KYC FAQs

What Is KYC Verification?

The Know Your Client or Know Your Customer (KYC) verification are a set of standards and requirements used in the investment and financial services industries to ensure they have sufficient information about their clients, their risk profiles, and financial position.

What Is KYC in the Banking Sector?

KYC in the banking sector involves bankers and advisors identifying their customers, beneficial owners of businesses, and the nature and purpose of customer relationships, as well as reviewing customer accounts for suspicious and illegal activity. Banks must also maintain and ensure the accuracy of customer accounts.

What Are KYC Documents?

Requirements differ in different jurisdictions. However, account owners generally must provide a government-issued ID as proof of identity. Some institutions require two forms of ID, such as a driver's license, birth certificate, social security card, or passport. In addition to confirming identity, the address must be confirmed. This can be done with proof of ID or with an accompanying document confirming the address of the record.

The Bottom Line

Know Your Customer (KYC) are a set of standards and requirements investment and financial services companies use to verify the identity of their customers and any associated risks with the customer relationship. KYC also ensures investment advisors know detailed information about their clients' risk tolerance and financial position. The U.S. Financial Crimes Enforcement Network (FinCEN) prescribed rules financial institutions must follow when verifying the identity of customers and their beneficial owners, if any. They must verify the circumstances around the customer relationship, as well as monitor and report any suspicious or illegal activity. Focus is shifting to cryptocurrency markets as pressures to conform to KYC standards increase.

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The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.

IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is not the actual dollar value of the project. It is the annual return that makes the NPV equal to zero.

Generally speaking, the higher an internal rate of return, the more desirable an investment is to undertake. IRR is uniform for investments of varying types and, as such, can be used to rank multiple prospective investments or projects on a relatively even basis. In general, when comparing investment options with other similar characteristics, the investment with the highest IRR probably would be considered the best.

KEY TAKEAWAYS

• The internal rate of return (IRR) is the annual rate of growth that an investment is expected to generate.

• IRR is calculated using the same concept as net present value (NPV), except it sets the NPV equal to zero.

• IRR is ideal for analyzing capital budgeting projects to understand and compare potential rates of annual return over time.

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WATCH: What is Internal Rate of Return?

Formula and Calculation for IRR

The formula and calculation used to determine this figure are as follows:

\begin{aligned} &\text{0}=\text{NPV}=\sum_{t=1}^{T}\frac{C_t}{\left(1+IRR\right)^t}-C_0\\ &\textbf{where:}\\ &C_t=\text{Net cash inflow during the period t}\\ &C_0=\text{Total initial investment costs}\\ &IRR=\text{The internal rate of return}\\ &t=\text{The number of time periods}\\ \end{aligned}​0=NPV=t=1∑T​(1+IRR)tCt​​−C0​where:Ct​=Net cash inflow during the period tC0​=Total initial investment costsIRR=The internal rate of returnt=The number of time periods​

How to Calculate IRR

1. Using the formula, one would set NPV equal to zero and solve for the discount rate, which is the IRR.

2. The initial investment is always negative because it represents an outflow.

3. Each subsequent cash flow could be positive or negative, depending on the estimates of what the project delivers or requires as a capital injection in the future.

4. However, because of the nature of the formula, IRR cannot be easily calculated analytically and instead must be calculated iteratively through trial and error or by using software programmed to calculate IRR (e.g., using Excel).1

How to Calculate IRR in Excel

Using the IRR function in Excel makes calculating the IRR easy. Excel does all the necessary work for you, arriving at the discount rate you are seeking to find. All you need to do is combine your cash flows, including the initial outlay as well as subsequent inflows, with the IRR function.1 The IRR function can be found by clicking on the Formulas Insert (fx) icon.2

Here is a simple example of an IRR analysis with cash flows that are known and annually periodic (one year apart). Assume a company is assessing the profitability of Project X. Project X requires $250,000 in funding and is expected to generate $100,000 in after-tax cash flows the first year and grow by $50,000 for each of the next four years.

Image by Sabrina Jiang © Investopedia 2020

In this case, the IRR is 56.72%, which is quite high.

Excel also offers two other functions that can be used in IRR calculations: the XIRR, and the MIRR. XIRR is used when the cash flow model does not exactly have annual periodic cash flows.3 The MIRR is a rate-of-return measure that includes the integration of cost of capital and the risk-free rate.4

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How to Calculate IRR in Excel

Understanding IRR

The ultimate goal of IRR is to identify the rate of discount, which makes the present value of the sum of annual nominal cash inflows equal to the initial net cash outlay for the investment. Several methods can be used when seeking to identify an expected return, but IRR is often ideal for analyzing the potential return of a new project that a company is considering undertaking.

Think of IRR as the rate of growth that an investment is expected to generate annually. Thus, it can be most similar to a compound annual growth rate (CAGR). In reality, an investment will usually not have the same rate of return each year. Usually, the actual rate of return that a given investment ends up generating will differ from its estimated IRR.

What Is IRR Used for?

In capital planning, one popular scenario for IRR is comparing the profitability of establishing new operations with that of expanding existing operations. For example, an energy company may use IRR in deciding whether to open a new power plant or to renovate and expand an existing power plant. While both projects could add value to the company, it is likely that one will be the more logical decision as prescribed by IRR. Note that because IRR does not account for changing discount rates, it’s often not adequate for longer-term projects with discount rates that are expected to vary.

IRR is also useful for corporations in evaluating stock buyback programs. Clearly, if a company allocates substantial funding to repurchasing its shares, then the analysis must show that the company’s own stock is a better investment—that is, has a higher IRR—than any other use of the funds, such as creating new outlets or acquiring other companies.

Individuals can also use IRR when making financial decisions—for instance, when evaluating different insurance policies using their premiums and death benefits. The general consensus is that policies that have the same premiums and a high IRR are much more desirable. Note that life insurance has a very high IRR in the early years of policy—often more than 1,000%. It then decreases over time. This IRR is very high during the early days of the policy because if you made only one monthly premium payment and then suddenly died, your beneficiaries would still get a lump sum benefit.

Another common use of IRR is in analyzing investment returns. In most cases, the advertised return will assume that any interest payments or cash dividends are reinvested back into the investment. What if you don’t want to reinvest dividends but need them as income when paid? And if dividends are not assumed to be reinvested, are they paid out, or are they left in cash? What is the assumed return on the cash? IRR and other assumptions are particularly important on instruments like annuities, where the cash flows can become complex.

Finally, IRR is a calculation used for an investment’s money-weighted rate of return (MWRR). The MWRR helps determine the rate of return needed to start with the initial investment amount factoring in all of the changes to cash flows during the investment period, including sales proceeds.

Using IRR With WACC

Most IRR analyses will be done in conjunction with a view of a company’s weighted average cost of capital (WACC) and NPV calculations. IRR is typically a relatively high value, which allows it to arrive at an NPV of zero. Most companies will require an IRR calculation to be above the WACC. WACC is a measure of a firm’s cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.

In theory, any project with an IRR greater than its cost of capital should be profitable. In planning investment projects, firms will often establish a required rate of return (RRR) to determine the minimum acceptable return percentage that the investment in question must earn to be worthwhile. The RRR will be higher than the WACC.

Any project with an IRR that exceeds the RRR will likely be deemed profitable, although companies will not necessarily pursue a project on this basis alone. Rather, they will likely pursue projects with the highest difference between IRR and RRR, as these likely will be the most profitable.

IRR may also be compared against prevailing rates of return in the securities market. If a firm can’t find any projects with IRR greater than the returns that can be generated in the financial markets, then it may simply choose to invest money in the market. Market returns can also be a factor in setting an RRR.

Analyses will also typically involve NPV calculations at different assumed discount rates.

IRR vs. Compound Annual Growth Rate

The CAGR measures the annual return on an investment over a period of time. The IRR is also an annual rate of return. However, the CAGR typically uses only a beginning and ending value to provide an estimated annual rate of return.

IRR differs in that it involves multiple periodic cash flows—reflecting that cash inflows and outflows often constantly occur when it comes to investments. Another distinction is that CAGR is simple enough that it can be calculated easily.

IRR vs. Return on Investment (ROI)

Companies and analysts may also look at the return on investment (ROI) when making capital budgeting decisions. ROI tells an investor about the total growth, start to finish, of the investment. It is not an annual rate of return. IRR tells the investor what the annual growth rate is. The two numbers normally would be the same over the course of one year but won’t be the same for longer periods of time.

ROI is the percentage increase or decrease of an investment from beginning to end. It is calculated by taking the difference between the current or expected future value and the original beginning value, divided by the original value and multiplied by 100.

ROI figures can be calculated for nearly any activity into which an investment has been made and an outcome can be measured. However, ROI is not necessarily the most helpful for lengthy time frames. It also has limitations in capital budgeting, where the focus is often on periodic cash flows and returns.

Limitations of the IRR

IRR is generally most ideal for use in analyzing capital budgeting projects. It can be misconstrued or misinterpreted if used outside of appropriate scenarios. In the case of positive cash flows followed by negative ones and then by positive ones, the IRR may have multiple values. Moreover, if all cash flows have the same sign (i.e., the project never turns a profit), then no discount rate will produce a zero NPV.

Within its realm of uses, IRR is a very popular metric for estimating a project’s annual return. However, it is not necessarily intended to be used alone. IRR is typically a relatively high value, which allows it to arrive at an NPV of zero. The IRR itself is only a single estimated figure that provides an annual return value based on estimates. Since estimates in IRR and NPV can differ drastically from actual results, most analysts will choose to combine IRR analysis with scenario analysis. Scenarios can show different possible NPVs based on varying assumptions.

As mentioned, most companies do not rely on IRR and NPV analyses alone. These calculations are usually also studied in conjunction with a company’s WACC and an RRR, which provides for further consideration.

Companies usually compare IRR analysis to other tradeoffs. If another project has a similar IRR with less up-front capital or simpler extraneous considerations, then a simpler investment may be chosen despite IRRs.

In some cases, issues can also arise when using IRR to compare projects of different lengths. For example, a project of a short duration may have a high IRR, making it appear to be an excellent investment. Conversely, a longer project may have a low IRR, earning returns slowly and steadily. The ROI metric can provide some more clarity in these cases, although some managers may not want to wait out the longer time frame.

Investing Based on IRR

The internal rate of return rule is a guideline for evaluating whether to proceed with a project or investment. The IRR rule states that if the IRR on a project or investment is greater than the minimum RRR—typically the cost of capital, then the project or investment can be pursued.

Conversely, if the IRR on a project or investment is lower than the cost of capital, then the best course of action may be to reject it. Overall, while there are some limitations to IRR, it is an industry standard for analyzing capital budgeting projects.

IRR Example

Assume a company is reviewing two projects. Management must decide whether to move forward with one, both, or neither. Its cost of capital is 10%. The cash flow patterns for each are as follows:

Project A

• Initial Outlay = $5,000

• Year one = $1,700

• Year two = $1,900

• Year three = $1,600

• Year four = $1,500

• Year five = $700

Project B

• Initial Outlay = $2,000

• Year one = $400

• Year two = $700

• Year three = $500

• Year four = $400

• Year five = $300

The company must calculate the IRR for each project. Initial outlay (period = 0) will be negative. Solving for IRR is an iterative process using the following equation:

$0 = Σ CFt ÷ (1 + IRR)t

where:

• CF = net cash flow

• IRR = internal rate of return

• t = period (from 0 to last period)

-or-

$0 = (initial outlay * −1) + CF1 ÷ (1 + IRR)1 + CF2 ÷ (1 + IRR)2 + ... + CFX ÷ (1 + IRR)X

Using the above examples, the company can calculate IRR for each project as:

IRR Project A:

$0 = (−$5,000) + $1,700 ÷ (1 + IRR)1 + $1,900 ÷ (1 + IRR)2 + $1,600 ÷ (1 + IRR)3 + $1,500 ÷ (1 + IRR)4 + $700 ÷ (1 + IRR)5

IRR Project A = 16.61 %

IRR Project B:

$0 = (−$2,000) + $400 ÷ (1 + IRR)1 + $700 ÷ (1 + IRR)2 + $500 ÷ (1 + IRR)3 + $400 ÷ (1 + IRR)4 + $300 ÷ (1 + IRR)5

IRR Project B = 5.23 %

Given that the company’s cost of capital is 10%, management should proceed with Project A and reject Project B.

What Does Internal Rate of Return Mean?

The internal rate of return (IRR) is a financial metric used to assess the attractiveness of a particular investment opportunity. When you calculate the IRR for an investment, you are effectively estimating the rate of return of that investment after accounting for all of its projected cash flows together with the time value of money. When selecting among several alternative investments, the investor would then select the investment with the highest IRR, provided it is above the investor’s minimum threshold. The main drawback of IRR is that it is heavily reliant on projections of future cash flows, which are notoriously difficult to predict.

Is IRR the Same as ROI?

Although IRR is sometimes referred to informally as a project’s “return on investment,” it is different from the way most people use that phrase. Often, when people refer to ROI, they are simply referring to the percentage return generated from an investment in a given year or across a stretch of time. But that type of ROI does not capture the same nuances as IRR, and for that reason, IRR is generally preferred by investment professionals.

Another advantage of IRR is that its definition is mathematically precise, whereas the term ROI can mean different things depending on the context or the speaker.

What Is a Good Internal Rate of Return?

Whether an IRR is good or bad will depend on the cost of capital and the opportunity cost of the investor. For instance, a real estate investor might pursue a project with a 25% IRR if comparable alternative real estate investments offer a return of, say, 20% or lower. However, this comparison assumes that the riskiness and effort involved in making these difficult investments are roughly the same. If the investor can obtain a slightly lower IRR from a project that is considerably less risky or time-consuming, then they might happily accept that lower-IRR project. In general, though, a higher IRR is better than a lower one, all else being equal.

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Generation X, which is sometimes shortened to Gen X, is the name given to the generation of Americans born between the mid-1960s and the early-1980s. The exact years that comprise Gen X vary. Some researchers—demographers William Strauss and Neil Howe, for example—place the exact birth years from 1961 to 1981, whereas Gallup places the birth years between 1965 and 1979. But all agree that Gen X follows the baby boom generation and precedes Generation Y or the millennial generation.12

KEY TAKEAWAYS

• Generation X, or Gen X, refers to the generation of Americans born between the mid-1960s and the early-1980s.

• Gen Xers, which fall between baby boomers and millennials, number around 65 million.3

• Members of this group are approaching the middle of their working careers and potential peak-earning years.

• The generation is on track to become the first generation to be worse off in terms of being prepared for retirement than their parents.

Understanding Generation X

The name "Generation X" comes from a novel by Douglas Coupland, Generation X: Tales for an Accelerated Culture, published in 1991.4 Though it's more useful for marketing than sociology, generational theory—the assumption that people born within the same time frame can be considered a group with similar views, values, tastes, and habits—and the idea of a generation gap has gained broad acceptance in the U.S.2

The American generations covered in the theory are:

• Greatest Generation (born circa 1901 to 1924)

• Silent Generation (circa 1925 to 1945)

• Baby Boomers (circa 1946 to 1964)

• Generation X (circa 1965 to 1985)

• Millennial Generation (circa 1985 to 2000)

Those born after around 2000 and later are generally considered Generation Z or post-millennial.

Gen X numbers around 65 million, while the baby boomers and the millennials each have around 72 million members. Gen X is also sometimes referred to as the “latchkey generation” as they were often left unsupervised at home after school until their parents came home from work.3

Like the silent generation, Generation X has been defined as an "in-between" generation. The group's earning power and savings were compromised first by the dotcom bust, and second by the financial crisis of 2008 and the Great Recession. In terms of social and political power, Generation X is sandwiched between the baby boomers, who came of age during the Vietnam and Reagan eras and the millennials of the Obama era.

Gen X overlaps with another group called the sandwich generation. Each modern generation has gotten its time in this slot, which is used to characterize middle-aged individuals who—due to longer life spans and having children later in life—find themselves supporting both aging parents and growing children simultaneously.

Gen X vs. Baby Boomers and Millennials

The 20th Annual Transamerica Retirement Survey of Workers, published in 2020, compares Gen X, baby boomers, and millennials. Among its findings:

• Gen Xers believe that they will have a much harder time achieving financial security than their parents (80%), compared to millennials (77%) and baby boomers (73%).

• Across the three generations, Generation X is significantly more likely to be carrying credit card debt (52%), millennials are more likely to have student loans (26%), and boomers are more likely to be debt free (25%).

• Gen X is the least likely to use a financial advisor (37%), compared to millennials (42%) and baby boomers (45%).5

Gen X's Financial Situation

Over the next few decades there will be a major transfer of wealth—collectively, around $48 trillion—from baby boomers to younger generations including their Gen X children.6 And they're going to need it.

Gen X accounts for just 29% of the nation’s wealth, while baby boomers hold just over half (51%), according to the latest data from the Federal Reserve. In 2008, at a median age of 35, Gen Xers owned just 7.4% of the nation’s wealth, less than half of what baby boomers had when they were 35.7

Notable members of Generation X include Jeff Bezos, Tiger Woods, and the late Kurt Cobain.

Retirement Savings

Almost 60% of Gen X respondents to the Transamerica survey “strongly agree” or “somewhat agree” that they are creating a sizable enough nest egg. Gen X has an average of $64,000 in retirement savings. Not surprisingly baby boomers have the most, $144,000, and millennials the least, $23,000. Nine percent of Gen Xers have no retirement savings at all.8

This falls far short of what the generations each expect they will need to retire. Gen X and baby boomers estimate that to feel financially secure they will need $500,000, and millennials $300,000.8

Effects of Market Timing on Gen X

On average, Gen X households began working, saving, and investing during a period of lower investment returns than the baby boomers. Many Gen X households began building their savings in periods of high market valuations, such as the technology bubble and dotcom bubble of the late-1990s and in the run-up to the global financial crisis of 2008. The effects of the ensuing bear markets still weigh heavily on their portfolios.

Only 44% of Gen X workers said they have fully recovered or were not impacted by the Great Recession, compared to 50% of baby boomers, according to the Transamerica survey.5

Additionally, Gen Xer's have experienced an especially low-interest-rate environment which has had an adverse impact on their ability to increase the value of their financial assets. Meanwhile, the early experiences of Gen X investors with major market declines seem to have made them more risk averse.

Other Challenges Faced by Gen X

Gen Xers' relatively lower levels of wealth will make it difficult for them to maintain their parents' consumption patterns, rising costs of education, healthcare, and property. And then there's the sandwich syndrome—the fact that this generation has reached the age when they are supporting and educating children while also providing care for aging parents.

Gen Xers now have the highest average debt of any generation, according to research by Experian. They increased their average debt by about 3.5%, or $4,802, between 2019 and 2020 reaching $140,643. Mortgage debt accounted for the highest proportion, followed by HELOC loans, student loans, car loans, personal loans, and credit card debt.9

Reinventing Retirement for Gen X

The retirement landscape is different for Gen X than for their parents. Once common, pension plans in the private sector are rare and have been replaced by defined-contribution plans, such as a 401(k). And Gen Xers aren’t counting on Social Security to fund their retirement either.

Baby boomers (37%) are much more likely to expect Social Security to be their primary source of retirement income, compared with just 26% of Gen X, according to the Transamerica survey. In fact, 41% of Gen X "strongly agree" that Social Security might not be around when they retire, while 26% of baby boomers feel the same.”8

Transamerica found that, overall, workers across the three generations share financial and healthy aging-related reasons for working past age 65. But baby boomers are more likely than the other generations to do so because they want the income. Generation X will continue working as they can’t afford to retire because they haven’t saved enough.10

Financial Planning for Gen X

The potential for financial duress can be substantial, but steps can be taken to reduce stress, balance budgets, and mitigate the effects of unplanned life events. Here are some recommendations for Gen X to get their financial lives in order and deal with all layers of that generational sandwich: Children, parents, and themselves.

Make an Estate Plan

This is vitally important if you have dependent children and do not yet have a will or other necessary documents. You do not want the fate of your dependents or your belongings to be decided by a judge in probate court. So, now is the time to make an appointment with an estate planning attorney to get your will, living will, medical, and durable powers of attorney—and perhaps a living trust—created to ensure the smooth and quick transference of all of your dependents, possessions, and responsibilities to your heirs.

And because estate settlement can be an emotionally delicate process, doing this now can allow you and your family to think through how this should be done from a calm, logical perspective.

Get a Comprehensive Financial Plan

When you were in your 20s, managing your finances was a fairly simple matter of getting into good financial habits, such as saving and budgeting. Now you are at the point where your finances are probably a bit more complicated and one financial variable, such as the amount that you contribute to your company’s 401(k) plan, can affect several other areas in ways that are becoming difficult to compute or predict with any accuracy.

This variable impact probably means that it is time to enlist a professional financial planner or financial advisor who can plug your cash flow, balance sheet, risk tolerance, investment objectives, time horizon, and tax bracket into a sophisticated financial-planning program. This can give you at least some idea of where you really are financially and what you need to do going forward to get where you want to be by retirement age. Just be prepared to see some unpleasant numbers at the end, numbers that may indicate that you will not be able to retire as soon as you hoped.

Manage Your Debt

If you are thinking about buying a house, it will probably be wise to look first at a 15-year fixed-rate mortgage. Interest rates may never be this low again, at least in a Gen Xer's lifetime, and a 15-year loan only charges a third as much interest as a 30-year mortgage. If your debt load has become unmanageable, find one of the legitimate debt-management firms that will help you get it under control.

Get a Head Start on College Planning

Although most experts warn parents about diverting retirement savings into their kids’ college funds, this is the time to open a Coverdell Educational Savings Account or a 529 plan fund if none exists. Your kids can contribute to these funds as well as you, and money that you inherit from deceased parents or other relatives can also be college-funding sources. Opening an individual retirement account for them can be another good choice, as long as you’re confident that they will not withdraw the contributions for other purposes.

Get a Financial Picture From Parents

Granted, conversations about money between parents and their children can be awkward. But if you have not spoken with your parents about the state of their health and finances, then it’s probably time to get the ball rolling in this area. If your parents’ health is failing and they have no estate plan in place, then it may be wise to fork over the cash yourself to pay to have this done if they consent.

Consult an elder law attorney for advice if you need help dealing with managed-care issues and choose a designated sibling to be the point person for dealing with these matters. A common mistake the children of aging parents make is the overestimation of Medicare, Medigap, and Medicaid coverage. Having an understanding of what needs to be paid for out-of-pocket can determine if purchasing long-term care insurance (if that's still feasible) and supplemental insurance policies may be beneficial.

Have Returning Children Contribute

The pressure of caring for aging parents can be multiplied by the expense of supporting grown children. Requiring offspring who return home after college to help with household expenses— including paying rent, buying groceries, or assisting with the elders' care—can relieve some of the pressure associated with supporting multiple generations. It can also provide children with some life lessons in financial and fiscal responsibility.

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The dividend payout ratio is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company. It is the percentage of earnings paid to shareholders via dividends. The amount that is not paid to shareholders is retained by the company to pay off debt or to reinvest in core operations. It is sometimes simply referred to as simply the payout ratio.

KEY TAKEAWAYS

• The dividend payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. 

• Some companies pay out all their earnings to shareholders, while some only pay out a portion of their earnings.

• If a company pays out some of its earnings as dividends, the remaining portion is retained by the business—to measure the level of earnings retained, the retention ratio is calculated.

• Several considerations go into interpreting the dividend payout ratio, most importantly the company's level of maturity.

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Dividend Payout Ratio

Formula and Calculation of Dividend Payout Ratio

The dividend payout ratio can be calculated as the yearly dividend per share divided by the earnings per share (EPS), or equivalently, the dividends divided by net income (as shown below).

\begin{aligned} &\text{Dividend Payout Ratio} = \frac{ \text{Dividends Paid} }{ \text{Net Income} } \\ \end{aligned}​Dividend Payout Ratio=Net IncomeDividends Paid​​

Alternatively, the dividend payout ratio can also be calculated as:

\begin{aligned} &\text{Dividend Payout Ratio} = 1 - \text{Retention Ratio} \\ \end{aligned}​Dividend Payout Ratio=1−Retention Ratio​

On a per-share basis, the retention ratio can be expressed as:

\begin{aligned}&\text{Retention Ratio} = \frac{ \text{EPS}-\text{DPS} }{ \text{EPS} } \\&\textbf{where:}\\&\text{EPS}=\text{Earnings per share} \\&\text{DPS}=\text{Dividends per share}\end{aligned}​Retention Ratio=EPSEPS−DPS​where:EPS=Earnings per shareDPS=Dividends per share​

The dividend payout ratio provides an indication of how much money a company is returning to shareholders versus how much it is keeping on hand to reinvest in growth, pay off debt, or add to cash reserves (retained earnings). 

What the Dividend Payout Ratio Tells You

Several considerations go into interpreting the dividend payout ratio, most importantly the company's level of maturity. A new, growth-oriented company that aims to expand, develop new products, and move into new markets would be expected to reinvest most or all of its earnings and could be forgiven for having a low or even zero payout ratio. The payout ratio is 0% for companies that do not pay dividends and is 100% for companies that pay out their entire net income as dividends.

On the other hand, an older, established company that returns a pittance to shareholders would test investors' patience and could tempt activists to intervene. In 2012 and after nearly twenty years since its last paid dividend, Apple (AAPL) began to pay a dividend when the new CEO felt the company's enormous cash flow made a 0% payout ratio difficult to justify.12 Since it implies that a company has moved past its initial growth stage, a high payout ratio means share prices are unlikely to appreciate rapidly.

Dividend Sustainability

The payout ratio is also useful for assessing a dividend's sustainability. Companies are extremely reluctant to cut dividends since it can drive the stock price down and reflect poorly on management's abilities. If a company's payout ratio is over 100%, it is returning more money to shareholders than it is earning and will probably be forced to lower the dividend or stop paying it altogether. That result is not inevitable, however.

A company endures a bad year without suspending payouts, and it is often in their interest to do so. It is therefore important to consider future earnings expectations and calculate a forward-looking payout ratio to contextualize the backward-looking one.

Long-term trends in the payout ratio also matter. A steadily rising ratio could indicate a healthy, maturing business, but a spiking one could mean the dividend is heading into unsustainable territory.

The retention ratio is a converse concept to the dividend payout ratio. The dividend payout ratio evaluates the percentage of profits earned that a company pays out to its shareholders, while the retention ratio represents the percentage of profits earned that are retained by or reinvested in the company.

Dividends Are Industry Specific

Dividend payouts vary widely by industry, and like most ratios, they are most useful to compare within a given industry. Real estate investment partnerships (REITs), for example, are legally obligated to distribute at least 90% of earnings to shareholders as they enjoy special tax exemptions.3 Master limited partnerships (MLPs) tend to have high payout ratios, as well. 

Dividends are not the only way companies can return value to shareholders; therefore, the payout ratio does not always provide a complete picture. The augmented payout ratio incorporates share buybacks into the metric; it is calculated by dividing the sum of dividends and buybacks by net income for the same period. If the result is too high, it can indicate an emphasis on short-term boosts to share prices at the expense of reinvestment and long-term growth.

Another adjustment that can be made to provide a more accurate picture is to subtract preferred stock dividends for companies that issue preferred shares.

How to Calculate the Payout Ratio in Excel

First, if you are given the sum of the dividends over a certain period and the outstanding shares, you can calculate the dividends per share (DPS). Suppose you are invested in a company that paid a total of $5 million last year and it has 5 million shares outstanding. On Microsoft Excel, enter "Dividends per Share" into cell A1. Next, enter "=5000000/5000000" in cell B1; the dividend per share in this company is $1 per share.

Then, you need to calculate the earnings per share (EPS) if it is not given. Enter "Earnings per Share" into cell A2. Suppose the company had a net income of $50 million last year. The formula for earnings per share is (net income - dividends on preferred stock) ÷ (shares outstanding). Enter "=(50000000 - 5000000)/5000000" into cell B2. The EPS for this company is $9.

Finally, calculate the payout ratio: Enter "Payout Ratio" into cell A3. Next, enter "=B1/B2" into cell B3; the payout ratio is 11.11%. Investors use the ratio to gauge whether dividends are appropriate and sustainable. The payout ratio depends on the sector; for example, startup companies may have a low payout ratio because they are more focused on reinvesting their income to grow the business.

Example of How to Use the Payout Ratio

Companies that make a profit at the end of a fiscal period can do several things with the profit they earned. They can pay it to shareholders as dividends, they can retain it to reinvest in the growth of its business, or they can do both. The portion of the profit that a company chooses to pay out to its shareholders can be measured with the payout ratio.

For example, Apple (AAPL) has paid $0.87 per share in dividends over the trailing 12 months (TTM) as of Jan. 3, 2022.1 Apple's EPS over the TTM has been as follows:

• Q1 2021: $1.704

• Q2 2021: $1.415

• Q3 2021: $1.316

• Q4 2021: $1.257

The TTM EPS for Apple is $5.67 as of Jan. 3, 2022. Thus, its payout ratio is 15.3%, or $0.87 divided by $5.67.

Dividend Payout vs. Dividend Yield

When comparing these two measures, it's important to know that the dividend yield tells you what the simple rate of return is in the form of cash dividends to shareholders, but the dividend payout ratio represents how much of a company's net earnings are paid out as dividends.

While the dividend yield is the more commonly known and scrutinized term, many believe the dividend payout ratio is a better indicator of a company's ability to distribute dividends consistently in the future. The dividend payout ratio is highly connected to a company's cash flow.

The dividend yield shows how much a company has paid out in dividends over the course of a year about the stock price. The yield is presented as a percentage, not as an actual dollar amount. This makes it easier to see how much return per dollar invested the shareholder receives through dividends.

The yield is calculated as:

\begin{aligned} &\text{Dividend Yield} = \frac{ \text{Annual Dividends per Share} }{ \text{Price per Share} } \end{aligned}​Dividend Yield=Price per ShareAnnual Dividends per Share​​

For example, a company that paid out $10 in annual dividends per share on a stock trading at $100 per share has a dividend yield of 10%. You can also see that an increase in share price reduces the dividend yield percentage and vice versa for a price decline.

Why Is the Dividend Payout Ratio Important?

The dividend payout ratio is a key financial metric used to determine the sustainability of a company’s dividend payment program. It is the amount of dividends paid to shareholders relative to the total net income of a company. 

How Do You Calculate the Dividend Payout Ratio?

It is commonly calculated on a per-share basis by dividing annual dividends per common share by earnings per share (EPS).

Is a High Dividend Payout Ratio Good?

A high dividend payout ratio is not always valued by active investors. An unusually high dividend payout ratio can indicate that a company is trying to mask a bad business situation from investors by offering extravagant dividends, or that it simply does not plan to aggressively use working capital to expand.

What Is the Difference Between the Dividend Payout Ratio and Dividend Yield?

When comparing the two measures of dividends, it's important to know that the dividend yield tells you what the simple rate of return is in the form of cash dividends to shareholders, but the dividend payout ratio represents how much of a company's net earnings are paid out as dividends.

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Bernard Lawrence "Bernie" Madoff was an American financier who executed the largest Ponzi scheme in history, defrauding thousands of investors out of tens of billions of dollars over the course of at least 17 years, and possibly longer. He was also a pioneer in electronic trading and chair of the Nasdaq in the early 1990s. He died in prison on April 14, 2021 while serving a 150-year sentence for money laundering, securities fraud and several other felonies.

KEY TAKEAWAYS

• Bernie Madoff was a money manager responsible for one of the largest financial frauds to date.

• Bernie Madoff's Ponzi scheme, which likely ran for decades, defrauded thousands of investors out of tens of billions of dollars.

• Investors put their trust in Madoff because he created a front of respectability, his returns were high but not outlandish, and he claimed to use a legitimate strategy.

• In 2009 Madoff was sentenced to 150 years in prison and forced to forfeit $170 billion.

• As of December 2018, the Madoff Victims Fund had distributed more than $2.7 billion to 37,011 victimized investors in the U.S. and around the world.

Investopedia / Ellen Lindner

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What Is A Ponzi Scheme?

Understanding Bernie Madoff

Despite claiming to generate large, steady returns through an investing strategy called split-strike conversion, which is an actual trading strategy, Madoff simply deposited client funds into a single bank account that he used to pay existing clients who wanted to cash out. He funded redemptions by attracting new investors and their capital, but was unable to maintain the fraud when the market turned sharply lower in late 2008. He confessed to his sons—who worked at his firm but, he claims, were not aware of the scheme—on Dec. 10, 2008. They turned him in to the authorities the next day. The fund's last statements indicated it had $64.8 billion in client assets.

In 2009, at age 71, Madoff pleaded guilty to 11 federal felony counts, including securities fraud, wire fraud, mail fraud, perjury, and money laundering. The Ponzi scheme became a potent symbol of the culture of greed and dishonesty that, to critics, pervaded Wall Street in the run-up to the financial crisis. Madoff was sentenced to 150 years in prison and ordered to forfeit $170 billion in assets, but no other prominent Wall Street figures faced legal ramifications in the wake of the crisis.

Madoff has been the subject of numerous articles, books, movies, and an ABC biopic miniseries.

A Brief Biography of Bernie Madoff

Bernie Madoff was born in Queens, New York, on April 29, 1938, and began dating his future wife, Ruth (née Alpern), when both were in their early teens. Speaking by phone from prison, Madoff told journalist Steve Fishman that his father, who had run a sporting goods store, went out of business due to steel shortages during the Korean War: "You watch that happen and you see your father, who you idolize, build a big business and then lose everything." Fishman says that Madoff was determined to achieve the "lasting success" his father hadn't, "whatever it took," but Madoff's career had its ups and downs.

Madoff's Early Days of Investing

He started his company, Bernard L. Madoff Investment Securities LLC, in 1960, at age 22. At first, he traded penny stocks with $5,000 (worth around $41,000 in 2017) he had earned installing sprinklers and working as a lifeguard. He soon persuaded family friends and others to invest with him. When the "Kennedy Slide" lopped 20% off the market in 1962, Madoff's bets soured and his father-in-law had to bail him out.

Madoff had a chip on his shoulder and felt constantly reminded that he was not part of the Wall Street in-crowd. "We were a small firm, we weren't a member of the New York Stock Exchange," he told Fishman. "It was very obvious." According to Madoff, he began to make a name for himself as a scrappy market maker. "I was perfectly happy to take the crumbs," he told Fishman, giving the example of a client who wanted to sell eight bonds; a bigger firm would disdain that kind of order, but Madoff's would complete it.

Recognition

Success finally came when he and his brother Peter began to build electronic trading capabilities—"artificial intelligence" in Madoff's words—that attracted massive order flow and boosted the business by providing insights into market activity. "I had all these major banks coming down, entertaining me," Madoff told Fishman. "It was a head trip."

He and four other Wall Street mainstays processed half of the New York Stock Exchange's order flow—controversially, he paid for much of it—and by the late 1980s, Madoff was making in the vicinity of $100 million a year. He would become chair of the Nasdaq in 1990, and also served in 1991 and 1993.

Bernie Madoff's Ponzi Scheme

It is not certain exactly when Madoff's Ponzi scheme began. He testified in court that it started in 1991, but his account manager, Frank DiPascali, who had been working at the firm since 1975, said the fraud had been occurring "for as long as I remember."

Even less clear is why Madoff carried out the scheme at all. "I had more than enough money to support any of my lifestyle and my family's lifestyle. I didn't need to do this for that," he told Fishman, adding, "I don't know why." The legitimate wings of the business were extremely lucrative, and Madoff could have earned the Wall Street elites' respect solely as a market maker and electronic trading pioneer.

Madoff repeatedly suggested to Fishman that he was not entirely to blame for the fraud. "I just allowed myself to be talked into something and that's my fault," he said, without making it clear who talked him into it. "I thought I could extricate myself after a period of time. I thought it would be a very short period of time, but I just couldn't."

The so-called Big Four— Carl Shapiro, Jeffry Picower, Stanley Chais, and Norm Levy—have attracted attention for their long and profitable involvement with Bernard L. Madoff Investment Securities LLC. Madoff's relationships with these men go back to the 1960s and 1970s, and his scheme netted them hundreds of millions of dollars each.

"Everybody was greedy, everybody wanted to go on and I just went along with it," Madoff told Fishman. He has indicated that the Big Four and others—a number of feeder funds pumped client funds to him, some all but outsourcing their management of clients' assets—must have suspected the returns he produced or at least should have. "How can you be making 15 or 18% when everyone is making less money?" Madoff said.

How Madoff Got Away with It for So Long

Madoff's apparently ultra-high returns persuaded clients to look the other way. In fact, he simply deposited their funds in an account at Chase Manhattan Bank—which merged to become JPMorgan Chase & Co. in 2000—and let them sit. The bank, according to one estimate, may have made as much as $483 million from those deposits, so it, too, was not inclined to inquire.

When clients wished to redeem their investments, Madoff funded the payouts with new capital, which he attracted through a reputation for unbelievable returns and grooming his victims by earning their trust. Madoff also cultivated an image of exclusivity, often initially turning clients away. This model allowed roughly half of Madoff's investors to cash out at a profit. These investors have been required to pay into a victims' fund to compensate defrauded investors who lost money.

Madoff created a front of respectability and generosity, wooing investors through his charitable work. He also defrauded a number of nonprofits, and some had their funds nearly wiped out, including the Elie Wiesel Foundation for Peace and the global women's charity Hadassah. He used his friendship with J. Ezra Merkin, an officer at Manhattan's Fifth Avenue Synagogue, to approach congregants. By various accounts, Madoff swindled between $1 billion and $2 billion from its members.

Madoff's plausibility to investors was based on several factors:

1. His principal, public portfolio appeared to stick to safe investments in blue-chip stocks.

2. His returns were high (10 to 20% per annum) but consistent, and not outlandish. As the Wall Street Journal reported in a now-famous interview with Madoff, from 1992: "[Madoff] insists the returns were really nothing special, given that the Standard & Poor's 500-stock index generated an average annual return of 16.3% between November 1982 and November 1992. 'I would be surprised if anybody thought that matching the S&P over 10 years was anything outstanding,' he says."

3. He claimed to be using a collar strategy, also known as a split-strike conversion. A collar is a way of minimizing risk, whereby the underlying shares are protected by the purchase of an out-of-the-money put option.

The Securities and Exchange Commission Investigation

The SEC had been investigating Madoff and his securities firm on and off since 1999—a fact that frustrated many after he was finally prosecuted, since it was felt that the biggest damage could have been prevented if the initial investigations had been rigorous enough.

Financial analyst Harry Markopolos was one of the earliest whistleblowers. In 1999, he calculated in the space of an afternoon that Madoff had to be lying. He filed his first SEC complaint against Madoff in 2000, but the regulator ignored him.

In a scathing 2005 letter to the Securities and Exchange Commission (SEC), Markopolos wrote, "Madoff Securities is the world's largest Ponzi Scheme. In this case, there is no SEC reward payment due to the whistle-blower so basically I'm turning this case in because it's the right thing to do."

Many felt that Madoff's worst damage could have been prevented if the SEC had been more rigorous in its initial investigations.

Using what he called a "Mosaic Method," Markopolos noted a number of irregularities. Madoff's firm claimed to be making money even when the S&P was falling, which made no mathematical sense, based on what Madoff claimed he was investing in. The biggest red flag of all, in Markopolos's words, was that Madoff Securities was earning "undisclosed commissions" instead of the standard hedge fund fee (1% of the total plus 20% of the profits).

The bottom line, concluded by Markopolos, was that "the investors that pony up the money don't know that BM [Bernie Madoff] is managing their money." Markopolos also learned Madoff was applying for huge loans from European banks (seemingly unnecessary if Madoff's returns were as high as he said).

It was not until 2005—shortly after Madoff nearly went belly-up due to a wave of redemptions—that the regulator asked Madoff for documentation on his trading accounts. He made up a six-page list, the SEC drafted letters to two of the firms listed but didn't send them, and that was that. "The lie was simply too large to fit into the agency's limited imagination," writes Diana Henriques, author of the book "The Wizard of Lies: Bernie Madoff and the Death of Trust*,"* which documents the episode.

The SEC was excoriated in 2008 following the revelation of Madoff's fraud and their slow response to act on it.

Bernie Madoff Confession and Sentencing

In November 2008, Bernard L. Madoff Investment Securities LLC reported year-to-date returns of 5.6%; the S&P 500 had dropped 39% percent over the same period. As the selling continued, Madoff became unable to keep up with a cascade of client redemption requests and, on Dec. 10, according to the account he gave Fishman, Madoff confessed to his sons Mark and Andy, who worked at their father's firm. "The afternoon I told them all, they immediately left, they went to a lawyer, the lawyer said, 'You gotta turn your father in,' they went, did that, and then I never saw them again." Bernie Madoff was arrested Dec. 11, 2008.

Madoff has insisted he acted alone, though several of his colleagues were sent to prison. His elder son Mark Madoff committed suicide exactly two years after his father's fraud was exposed. Several of Madoff's investors also killed themselves. Andy Madoff died of cancer in 2014.

Madoff was sentenced to 150 years in prison and forced to forfeit $170 billion in 2009. His three homes and yacht were auctioned off by the U.S. Marshals. He resided at the Butner Federal Correctional Institution in North Carolina, where he was prisoner No. 61727-054.

On February 5th, 2020, Madoff's lawyers requested that Madoff be released early from prison claiming that he is suffering from a terminal kidney disease that may kill him within 18 months. Madoff is ten years into his 150 year sentence.

Aftermath of the Bernie Madoff Ponzi Scheme

The paper trail of victims' claims displays the complexity and sheer size of Madoff's betrayal of investors. According to documents, Madoff's scam ran more than five decades, beginning in the 1960s. His final account statements, which include millions of pages of fake trades and shady accounting, show that the firm had $47 billion in "profit."

While Madoff pleaded guilty in 2009 and will spend the rest of his life in prison, thousands of investors lost their life savings, and multiple tales detail the harrowing sense of loss victims endured.

Investors victimized by Madoff have been helped by Irving Picard, a New York lawyer overseeing the liquidation of Madoff's firm in bankruptcy court. Picard has sued those who profited from the Ponzi scheme; by December 2018 he had recovered $13.3 billion.

In addition, a Madoff Victim Fund (MVF) was created in 2013 to help compensate those Madoff defrauded, but the Department of Justice didn't start paying out any of the roughly $4 billion in the fund until late 2017. Richard Breeden, a former SEC chair who is overseeing the fund, noted that thousands of the claims were from "indirect investors"—meaning people who put money into funds that Madoff had invested in during his scheme.

Since they were not direct victims, Breeden and his team had to sift through thousands and thousands of claims, only to reject many of them. Breeden said he based most of his decisions on one simple rule: Did the person in question put more money into Madoff's funds than they took out? Breeden estimated that the number of "feeder" investors was north of 11,000 individuals.

In a November 2018 update for the Madoff Victim Fund, Breeden wrote, "We have now paid over 27,300 victims an aggregate recovery of 56.65% of their losses, with thousands more set to recover the same amount in the future." With the completion of a third distribution of funds in December 2018, in excess of $2.7 billion had been distributed to 37,011 Madoff victims in the U.S. and around the world. Breeden noted that the fund expected to make "at least one more significant distribution in 2019" and hoped to resolve all open claims.

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