Financial Statements and Analysis

Intro:

         Financial statement analysis is a process of applying analytical tools and techniques to financial statements(like Balance sheet, P&L statement, Cash Flow statements).


     the intention behind the analysis of financial statements is to relate the data to derive estimates and inferences useful in taking critical business decisions.

Features of Financial analysis:
1. It is used as a screening tool to identify potential companies, with excellent prospect for investment, mergers & acquisitions.
2. To forecast future financial conditions of the entity.

Users of Financial Statements:

1) Internal users: mangers in the company.

An Introduction To Hedge Funds

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Standard Definitions of a Hedge Fund:

                                A hedge fund can be defined as an actively managed, pooled investment vehicle that is open to only a limited group of investors and whose performance is measured in absolute return units.

Explanation:


To “hedge” is to lower overall risk by taking on an asset position that offsets an existing source of risk.

 For example, an investor holding a large position in foreign equities can hedge the portfolio’s currency risk by going short currency futures.
A trader with a large inventory position in an individual stock can hedge the market component of the stock’s risk by going short equity index futures.


Alternatively, a hedge fund can be defined theoretically as the “purely active”
component of a traditional actively-managed portfolio whose performance is
measured against a market benchmark.

Illustration:

 Let w denote the portfolio weights of the traditional actively-managed equity portfolio. Let b denote the market benchmark weights for the passive index used to gauge the performance of this fund. Consider the active weights, h, defined as the differences between the portfolio weights and the benchmark weights:

 h = w – b

A traditional fund has no short positions, so w has all non negative weights; most market benchmarks also have all nonnegative weights. So w and b are nonnegative in all components but the “active weights portfolio”, h, has an equal percentage of short positions as long positions.

 Theoretically, one can think of the portfolio h as the hedge fund implied by the traditional active
portfolio w.

The following two strategies are equivalent:
1. Hold the traditional actively-managed portfolio w
2. Hold the passive index b plus invest in the hedge fund h.

Derivative basics

Derivative is a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying asset class  include stocks, bonds, commodities, currencies, interest rates and market indexes.

Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes.
   

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Credit derivatives

        A credit derivative is simply a financial instrument that allows one to assume or cede credit risk exposure. Credit derivatives can be based on corporate debt, government debt, residential or commercial real estate mortgages, or other types of loans.

        Credit risk is transferred with a traded insurance-like contract between two parties, neither of which need be the issuer nor the holder of the actual bonds or loans at risk. The value of the contract is “derived” primarily as a function of the default risk profile of the debtor, which leads to the term, credit “derivative.”

Credit derivatives are fundamentally divided into two categories: funded credit derivatives and unfunded credit derivatives.

An unfunded credit derivative is a bilateral contract between two counterparties, where each party is responsible for making its payments under the contract, i.e. payments of premiums and any cash or physical settlement amount itself without recourse to other assets.

A funded credit derivative involves the protection seller (the party that assumes the credit risk) making an initial payment that is used to settle any potential credit events. The protection buyer, however, still may be exposed to the credit risk of the protection seller itself. This is known as counterparty risk.