on 07-Feb-2018 (Wed)

From a corporation's perspective, risks of poor governance include:

• weak control systems or inefficient monitoring tools;

• ineffective decision making;

• legal, regulatory, and reputational risks;

• default and bankruptcy risks.

Benefits of effective governance and stakeholder management include:

• better operational efficiency and control brought by effective monitoring tools and control mechanisms;

• better operating and financial performance;

• lower default risk and cost of debt.

Economic Ownership and Voting Control
What is the company's ownership and voting structure among shareholders?
Why do some shareholders own a small portion of a company's stock but get most of the voting power?
Does the practice really insulate managers from Wall Street's short-term mindset?

Dual-class structures create an inferior class of shareholders, and may allow management to make bad decisions with few consequences.

Board of Directors Representation
Analysts should assess whether the experience and skill sets of board members match the needs of the company.
Are they truly independent?
Are there inherent conflicts of interest?

Remuneration and Company Performance
What are the main drivers of the management team's remuneration and incentive structure?
Does the remuneration plan reward long-term or short-term growth?
Is it based on the performance of the company relative to its competitors or other peers?

Equity-based remuneration plans can offer the greatest incentives.
Are they linked to the long-term performance of the company?
What is the impact on the income statement?

Investors in the Company
What is the composition of investors in a company?
Are there any significant investors in the company?
Any sizable affiliated stockholders that can block the votes of the majority?
Any activist shareholders that could bring rapid changes for the company?

Strength of Shareholders' Rights
How robust are the shareholder rights at the company?
How robust compared to those of peers?

Managing Long-Term Risks
How effectively is the company managing long-term risks, such as securing access to necessary resources, managing human capital, exhibiting integrity and leadership, and strengthening the long-term sustainability of the enterprise?

ESG integration is the practice of considering environmental, social, and governance factors in the investment process. It can be implemented across all asset classes. ESG Factors in Investment Analysis Environmental factors include natural resource management, pollution prevention, water conservation, energy efficiency and reduced emissions, the existence of carbon assets, and adherence to environmental safety and regulatory standards. Social factors generally pertain to human rights and welfare concerns in the workplace, product development, and, in some cases, community impact. ESG Implementation Methods Asset managers and asset owners can incorporate ESG issues into the investment process in a variety of ways.

• Negative screening is a type of investment strategy that excludes certain companies or sectors from investment consideration because of their underlying business activities or other environmental or social concerns.

• Positive screening and best-in-class strategies focus on investments with favorable ESG aspects.

• Thematic investing focuses on a single factor, such as energy efficiency or climate change.

• Impact investing strategies are targeted investments, typically made in private markets, aimed at solving social or environmental problems.

The reading Financial Statement Analysis: An Introduction described a framework for conducting financial statement analysis. Consistent with that framework, prior to undertaking any analysis, an analyst should explore the purpose and context of the analysis. The purpose and context guide further decisions about the approach, the tools, the data sources, and the format in which to report results of the analysis, and also suggest which aspects of the analysis are most important. Having identified the purpose and context, the analyst should then be able to formulate the key questions that the analysis must address. The questions will suggest the data the analyst needs to collect to objectively address the questions. The analyst then processes and analyzes the data to answer these questions. Conclusions and decisions based on the analysis are communicated in a format appropriate to the context, and follow-up is undertaken as required. Although this reading will not formally present applications as a series of steps, the process just described is generally applicable.

Macroeconomic analysis examines a nation’s:

Aggregate output and income.

Competitive and comparative advantages

Productivity of its labor force.

Price level and inflation rate.

the actions of its national government and central bank.

An investment fund is a supply of capital belonging to numerous investors used to collectively purchase securities while each investor retains ownership and control of his own shares. An investment fund provides a broader selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own. Types of investment funds include mutual funds, exchange-traded funds, money market funds and hedge funds.

Derivatives are financial instruments that derive their values from the performance of these basic assets.

In a classified or staggered board, directors are typically elected in two or more classes, serving terms greater than one year. Proponents argue that by staggering the election of directors, a certain level of continuity and skill is maintained. However, staggered terms make it more difficult for shareholders to make fundamental changes to the composition and behavior of the board and could result in a permanent impairment of long-term shareholder value.

Stakeholder relationships and corporate governance are continually shaped and influenced by a variety of market and non-market factors.

From a corporation's perspective, risks of poor governance include:

• weak control systems or inefficient monitoring tools;

• ineffective decision making;

• legal, regulatory, and reputational risks;

• default and bankruptcy risks.

Benefits of effective governance and stakeholder management include:

• better operational efficiency and control brought by effective monitoring tools and control mechanisms;

• better operating and financial performance;

• lower default risk and cost of debt.

Economic Ownership and Voting Control
What is the company's ownership and voting structure among shareholders?
Why do some shareholders own a small portion of a company's stock but get most of the voting power?
Does the practice really insulate managers from Wall Street's short-term mindset?

Dual-class structures create an inferior class of shareholders, and may allow management to make bad decisions with few consequences.

Board of Directors Representation
Analysts should assess whether the experience and skill sets of board members match the needs of the company.
Are they truly independent?
Are there inherent conflicts of interest?

Remuneration and Company Performance
What are the main drivers of the management team's remuneration and incentive structure?
Does the remuneration plan reward long-term or short-term growth?
Is it based on the performance of the company relative to its competitors or other peers?

Equity-based remuneration plans can offer the greatest incentives.
Are they linked to the long-term performance of the company?
What is the impact on the income statement?

Investors in the Company
What is the composition of investors in a company?
Are there any significant investors in the company?
Any sizable affiliated stockholders that can block the votes of the majority?
Any activist shareholders that could bring rapid changes for the company?

Strength of Shareholders' Rights
How robust are the shareholder rights at the company?
How robust compared to those of peers?

Managing Long-Term Risks
How effectively is the company managing long-term risks, such as securing access to necessary resources, managing human capital, exhibiting integrity and leadership, and strengthening the long-term sustainability of the enterprise?

ESG integration can be implemented across all asset classes.

ESG Factors in Investment Analysis
Environmental factors include natural resource management, pollution prevention, water conservation, energy efficiency and reduced emissions, the existence of carbon assets, and adherence to environmental safety and regulatory standards.

Social factors generally pertain to human rights and welfare concerns in the workplace, product development, and, in some cases, community impact.

ESG Implementation Methods Asset managers and asset owners can incorporate ESG issues into the investment process in a variety of ways.

• Negative screening is a type of investment strategy that excludes certain companies or sectors from investment consideration because of their underlying business activities or other environmental or social concerns.

• Positive screening and best-in-class strategies focus on investments with favorable ESG aspects.

• Thematic investing focuses on a single factor, such as energy efficiency or climate change.

• Impact investing strategies are targeted investments, typically made in private markets, aimed at solving social or environmental problems.

The collection of languages associated with context-free grammars are called the context-free languages

A grammar consists of a collection of substitution rules, also called produc- tions. Each rule appears as a line in t he grammar, comprising a symbol and a string separated by an arrow. The symbol is c alled a variable. The s tring consists of variables and other symbols called terminals. T he variable symbols often a re represented by capit al letters. The terminals are analogous to the in- put alphabet and often are represented by lowercase letters, numbers, or special symbols. One variable is designated as the start variable. It usually occurs on the left-hand side of the topmost rule

You can convert any DFA into an equivalent CFG as follows. Make a variable R i for each state q i of the DFA. Add the rule R i → aR j to the CFG if δ(q i , a) = q j is a transition in the DFA. Add the rule R i → ε if q i is an acc ept state of the DFA. Make R 0 the start variable of the grammar, where q 0 is the start state of the machine. Verify o n your own that the resulting CFG generates the same language that the DFA recognizes

If a grammar generates the same string in several different ways, we say that the string is derived ambiguously in that grammar

In a general sense, economics is the study of production, distribution, and consumption and can be divided into two broad areas of study: macroeconomics and microeconomics.

Macroeconomics deals with aggregate economic quantities, such as national output and national income, and is rooted in microeconomics , which deals with markets and decision making of individual economic units, including consumers and businesses. Microeconomics is a logical starting point for the study of economics.

Fundamental analysis uses information about the economy, industry, and company as the basis for investment decisions. Examples of fundamentals are unemployment rates, gross domestic product (GDP) growth, industry growth, and quality of and growth in company earnings.

Whereas technical analysts use information to predict price movements and base investment decisions on the direction of predicted change in prices, fundamental analysts use information to estimate the value of a security and to compare the estimated value to the market price and then base investment decisions on that comparison.

This reading introduces equity valuation models used to estimate the intrinsic value (synonym: fundamental value ) of a security; intrinsic value is based on an analysis of investment fundamentals and characteristics.

In a top-down approach, an analyst examines the economic environment, identifies sectors that are expected to prosper in that environment, and analyzes securities of companies from previously identified attractive sectors.

In a bottom-up approach, an analyst typically follows an industry or industries and forecasts fundamentals for the companies in those industries in order to determine valuation.

Whatever the approach(Top-Down or Bottom-up), an analyst who estimates the intrinsic value of an equity security is implicitly questioning the accuracy of the market price as an estimate of value.

Valuation is particularly important in active equity portfolio management, which aims to improve on the return–risk trade-off of a portfolio’s benchmark by identifying mispriced securities.

Credit analysis has a crucial function in the debt capital markets—efficiently allocating capital by properly assessing credit risk, pricing it accordingly, and repricing it as risks change. How do fixed-income investors determine the riskiness of that debt, and how do they decide what they need to earn as compensation for that risk?

Structured finance, a segment of the debt markets that includes securities backed by pools of assets, such as residential and commercial mortgages as well as other consumer loans, will not be covered here.

The reading focuses primarily on analysis of corporate debt; however, credit analysis of sovereign and non-sovereign, particularly municipal, government bonds will also be addressed.

This reading presents the basics of describing and analyzing data, the branch of statistics known as descriptive statistics. The reading supplies a set of useful concepts and tools, illustrated in a variety of investment contexts.

Decisions of households or single business don't affect much but, the decisions made by governments can have an enormous impact on even the largest and most developed of economies for two main reasons. First, the public sectors of most developed economies normally employ a significant proportion of the population, and they are usually responsible for a significant proportion of spending in an economy. Second, governments are also the largest borrowers in world debt markets.

Understanding the industry in which a company operates provides an essential framework for the analysis of the individual company

Given the globalization of the world economy, most large companies depend heavily on their foreign operations (for example, by some estimates about 40 percent of S&P 500 Index earnings are from outside the United States).

The cash-based information provided by the cash flow statement contrasts with the accrual-based information from the income statement. For example, the income statement reflects revenues when earned rather than when cash is collected; in contrast, the cash flow statement reflects cash receipts when collected as opposed to when the revenue was earned.

A reconciliation between reported income and cash flows from operating activities provides useful information about when, whether, and how a company is able to generate cash from its operating activities.

Although income is an important measure of the results of a company’s activities, cash flow is also essential. As an extreme illustration, a hypothetical company that makes all sales on account, without regard to whether it will ever collect its accounts receivable, would report healthy sales on its income statement and might well report significant income; however, with zero cash inflow, the company would not survive.

The cash flow statement provides a reconciliation of the beginning and ending cash on the balance sheet.

The reading Financial Statement Analysis: An Introduction described a framework for conducting financial statement analysis. Consistent with that framework, prior to undertaking any analysis, an analyst should explore the purpose and context of the analysis.

The purpose and context of the Analysis guide further decisions about the approach, the tools, the data sources, and the format in which to report results of the analysis, and also suggest which aspects of the analysis are most important. Having identified the purpose and context, the analyst should then be able to formulate the key questions that the analysis must address. The questions will suggest the data the analyst needs to collect to objectively address the questions. The analyst then processes and analyzes the data to answer these questions. Conclusions and decisions based on the analysis are communicated in a format appropriate to the context, and follow-up is undertaken as required.

Some investors hope alternative investments will provide positive returns throughout the economic cycle; this goal is an absolute return objective.

Alternative investments are not free of risk, however, and their returns may be negative and/or correlated with other investments, including traditional investments, especially in periods of financial crisis.

Some investors in alternative investments have a relative return objective. A relative return objective, which is often the objective of portfolios of traditional investment, seeks to achieve a return relative to an equity or fixed-income benchmark.

The cost of this capital is an important ingredient in both investment decision making by the company’s management and the valuation of the company by investors.

If a company invests in projects that produce a return in excess of the cost of capital, the company has created value; in contrast, if the company invests in projects whose returns are less than the cost of capital, the company has actually destroyed value.

An investment fund is a supply of capital belonging to numerous investors used to collectively purchase securities while each investor retains ownership and control of his own shares.

An investment fund provides a broader selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own.

Types of investment funds include:

1. mutual funds (Splinter)
2. exchange-traded funds (Mystique)
3. money market funds (Santana Americano Yo)
4. hedge funds. (Sony the Hedgehog)

A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund's investments and attempt to produce capital gains and/or income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities

Mutual funds are operated by professional money managers, who allocate the fund's investments and attempt to produce capital gains and/or income for the fund's investors.

A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Equity, fixed-income, currency, and commodity are said to trade in cash markets or spot markets and their prices are sometimes referred to as cash prices or spot prices , though we usually just refer to them as stock prices, bond prices, exchange rates, and commodity prices. These markets exist around the world and receive much attention in the financial and mainstream media. Hence, they are relatively familiar not only to financial experts but also to the general population.

In a classified or staggered board, directors are typically elected in two or more classes, serving terms greater than one year.

Proponents of classified or staggered boards argue that by staggering the election of directors, a certain level of continuity and skill is maintained.

All businesses and investors manage risk in the choices they make, even if not conciously. Business and investing are about allocating resources and capital to chosen risks. In their decision process, businesses and investors may take steps to avoid some risks, pursue the risks that provide the highest rewards, and measure and mitigate their exposure to these risks as necessary. Risk management processes and tools make difficult business and financial problems easier to address.

Risk is not just a matter of fate; it can be actively controled with decisions, within a risk management framework. Risk is an integral part of the business or investment process.

Even in the earliest models of modern portfolio theory, such as mean–variance portfolio optimization and the capital asset pricing model, investment return is linked directly to risk but requires that risk be managed optimally.

Proper identification and measurement of risk, and keeping risks aligned with the goals of the enterprise, are key factors in managing businesses and investments. Good risk management results in a higher chance of a preferred outcome—more value for the company or portfolio or more utility for the individual.

The principles underlying portfolio risk management are generally applicable to the risk management of financial and non-financial institutions as well.

Although many large entities formally practice risk management, most individuals practice it informally and disorderly, oftentimes responding to risk events after they occur, and they ignore more subtle risks often.

Although often viewed as defensive, risk management is a valuable offensive weapon in the manager’s arsenal. In the quest for preferred outcomes, such as higher profit, returns, or share price, management does not usually get to choose the outcomes but does choose the risks it takes in pursuit of those outcomes.

The choice of which risks to undertake through the allocation of its scarce resources is the key tool available to management. An organization with a comprehensive risk management culture in place, in which risk is integral to every key strategy and decision, should perform better in the long-term, in good times and bad, as a result of better decision making.

Credit risk refers to the risk that a borrower may not repay a loan and that the lender may lose the principal of the loan or the interest associated with it.

Credit risk arises because borrowers expect to use future cash flows to pay current debts; it's almost never possible to ensure that borrowers will definitely have the funds to repay their debts. Interest payments from the borrower or issuer of a debt obligation are a lender's or investor's reward for assuming credit risk.

Readers will be introduced to:

1. The definition of credit risk.
2. The interpretation of credit ratings,
3. The four Cs of traditional credit analysis.
4. Key financial measures and ratios used in credit analysis.

The reading explains, among other things, how to compare bond issuer creditworthiness within a given industry as well as across industries and how credit risk is priced in the bond market.

Fiscal policy refers to the use of government expenditure, tax, and borrowing activities to achieve economic goals. Monetary policy refers to central bank activities to control the supply of money. Their goals are maximum employment, stable prices, and moderate long-term interest rates.

The Functions of Money

Money performs three basic functions.

• It serves as a medium of exchange to buy and sell goods and services. Money simplifies and reduces the costs of transactions.

In the absence of money, a barter economy would exist. Acquiring a belt, for example, would entail finding a belt maker who happened to want what you had to offer in exchange, making transactions tedious, enormously costly, and inefficient.

Money permits us to realize the enormous gains from the specialization, division of labor, and mass-production processes that underlie our modern standard living.

• It is used as an accounting unit to compare the value and cost of things. As a unit of measurement, like a centimeter, money is used by people to post prices and keep track of revenues and costs.

• It provides a way of storing value to allow the movement of purchasing power from one period to another. Although it is not the only way of storing value, it is the most liquid of all assets, due to its function as the medium of exchange. However, many methods of holding money do not yield an interest return and the purchase power of money will decline during a time of inflation.
  

The Money Creation Process

Reserves are the cash in a bank's vault and deposits at Federal Reserve Banks. Under the fractional reserve banking system, a bank is obligated to hold a minimum amount of reserves to back up its deposits. Reserves held for that purpose, which are expressed as a percentage of a bank's demand deposits, are called required reserves. Therefore, the required reserve ratio is the percentage of a bank's deposits that are required to be held as reserves.

Banks create deposits when they make loans; the new deposits created are new money.

Example

Suppose the required reserve ratio in the U.S. is 20%, and then suppose that you deposit $1,000 cash with Citibank. Citibank keeps $200 of the $1,000 in reserves. The remaining $800 of excess reserves can be loaned out to, say, John. After the loan is made, the money supply increases by $800 (your $1,000 + John's $800). After getting the loan, John deposits the $800 with Bank of America (BOA). BOA keeps $160 of the $800 in reserves and can now loan out $640 to another person. Thus, BOA creates $640 of money supply. The process goes on and on. With each deposit and loan, more money is created. However, the money creation process does not create an infinite amount of money.

The money multiplier is the amount by which a change in the monetary base is multiplied to calculate the final change in the money supply. Money Multiplier = 1/b, where b is the required reserve ratio. In our example, b is 0.2, so money multiplier = 1/0.2 = 5.

Definitions of Money

There are different definitions of money. The two most widely used measures of money in the U.S. are:

• The M1 Money Supply: cash, checking accounts and traveler's checks. This is the narrowest definition of the money supply. This definition focuses on money's function as a medium of exchange.

• The M2 Money Supply: M1 + savings + small time deposits + retail money funds. This definition focuses on money's function as a medium of exchange and store of value.

Credit cards are not purchasing power, but instead are a convenient means of arranging a loan. Credit is a liability acquired when one borrows funds, while money is a financial asset that provides the holder with future purchasing power. However, the widespread use of credit cards will tend to reduce the a

...

Fiscal policy refers to the use of government expenditure, tax, and borrowing activities to achieve economic goals. Monetary policy refers to central bank activities to control the supply of money. Their goals are maximum employment, stable prices, and moderate long-term interest rates.

The Functions of Money

Money performs three basic functions.

• It serves as a medium of exchange to buy and sell.

• It is used as an measurement unit to compare the value and cost of things.

• It provides a way of storing value to allow the movement of purchasing power from one period to another. Although it is not the only way of storing value, it is the most liquid of all assets, due to its function as the medium of exchange.
  
  If both Y and V are constant, then the equation indicates that an increase in money supply will lead to a proportional increase in price level.
  This equation of exchange leads to the quantity theory of money, which hypothesizes that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money.

If both Y and V are constant, then the equation indicates that an increase in money supply will lead to a proportional increase in price level.
This equation of exchange leads to the quantity theory of money, which hypothesizes that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money.

Money performs three basic functions.

• It serves as a medium of exchange to buy and sell.

• It is used as an measurement (Accounting) unit to compare the value and cost of things.

• It provides a way of storing value to allow the movement of purchasing power from one period to another. Although it is not the only way of storing value, it is the most liquid of all assets, due to its function as the medium of exchange.

The Money Creation Process

Reserves are the cash in a bank's vault and deposits at Federal Reserve Banks. Under the fractional reserve banking system, a bank is obligated to hold a minimum amount of reserves to back up its deposits. Reserves held for that purpose, which are expressed as a percentage of a bank's demand deposits, are called required reserves. Therefore, the required reserve ratio is the percentage of a bank's deposits that are required to be held as reserves.

Banks create deposits when they make loans; the new deposits created are new money.

Example

Suppose the required reserve ratio in the U.S. is 20%, and then suppose that you deposit $1,000 cash with Citibank. Citibank keeps $200 of the $1,000 in reserves. The remaining $800 of excess reserves can be loaned out to, say, John. After the loan is made, the money supply increases by $800 (your $1,000 + John's $800). After getting the loan, John deposits the $800 with Bank of America (BOA). BOA keeps $160 of the $800 in reserves and can now loan out $640 to another person. Thus, BOA creates $640 of money supply. The process goes on and on. With each deposit and loan, more money is created. However, the money creation process does not create an infinite amount of money.

The money multiplier is the amount by which a change in the monetary base is multiplied to calculate the final change in the money supply. Money Multiplier = 1/b, where b is the required reserve ratio. In our example, b is 0.2, so money multiplier = 1/0.2 = 5.

The money multiplier is the amount by which a change in the monetary base is multiplied to calculate the final change in the money supply. Money Multiplier = 1/b, where b is the required reserve ratio. In our example, b is 0.2, so money multiplier = 1/0.2 = 5.

Reserves are the cash in a bank's vault and deposits at Federal Reserve Banks. Under the fractional reserve banking system, a bank is obligated to hold a minimum amount of reserves to back up its deposits. Reserves held for that purpose, which are expressed as a percentage of a bank's demand deposits, are called required reserves. Therefore, the required reserve ratio is the percentage of a bank's deposits that are required to be held as reserves.

Banks create deposits when they make loans; the new deposits created are new money.

Suppose the required reserve ratio in the U.S. is 20%, and then suppose that you deposit $1,000 cash with Citibank. Citibank keeps $200 of the $1,000 in reserves. The remaining $800 of excess reserves can be loaned out to, say, John. After the loan is made, the money supply increases by $800 (your $1,000 + John's $800). After getting the loan, John deposits the $800 with Bank of America (BOA). BOA keeps $160 of the $800 in reserves and can now loan out $640 to another person. Thus, BOA creates $640 of money supply. The process goes on and on. With each deposit and loan, more money is created. However, the money creation process does not create an infinite amount of money.

Definitions of Money

There are different definitions of money. The two most widely used measures of money in the U.S. are:

• The M1 Money Supply: cash, checking accounts and traveler's checks. This is the narrowest definition of the money supply. This definition focuses on money's function as a medium of exchange.

• The M2 Money Supply: M1 + savings + small time deposits + retail money funds. This definition focuses on money's function as a medium of exchange and store of value.

Credit cards are not purchasing power, but instead are a convenient means of arranging a loan. Credit is a liability acquired when one borrows funds, while money is a financial asset that provides the holder with future purchasing power. However, the widespread use of credit cards will tend to reduce the average quantity of money people hold.

Deposits are money, but checks are not - a check is an instruction to a bank to transfer money.

The Quantity Theory of Money

Money Supply (M) x Velocity of Money (V) = Price (P) x Real Output (Y)

• The velocity of money is the average number of times a dollar is used to purchase final goods and services during a year. It is computed as V = GDP/Money Supply = PY/M. In essence, it is the turnover rate of money. For example, if the nominal GDP is $200 billion and the money supply is $40 billion: V = 200/40 = 5.

• The equation of exchange reflects two ways of viewing GDP: the left side reflects the monetary flow of expenditures on final products and the right side reflects the sum of the price (P) times the output (Y) of each final product purchased during the period.

If both Y and V are constant, then the equation indicates that an increase in money supply will lead to a proportional increase in price level.
This equation of exchange leads to the quantity theory of money, which hypothesizes that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money.

Current estimates put daily turnover at approximately USD4 trillion for 2010

Daily turnover if FX is about 10 to 15 times larger than daily turnover in global fixed-income markets and about 50 times larger than global turnover in equities.

The cost of capital is not observable but, rather, must be estimated.

Arriving at a cost of capital estimate requires a host of assumptions and estimates.

A drawbacks to a barter economy is that the exchange of goods for other goods would require both economic agents in the transaction to want what the other is selling. This means that there has to be a double coincidence of wants

A drawback to a barter economy is that it might also be impossible to undertake transactions where the goods are indivisible—that is, where one agent wishes to buy a certain amount of another’s goods, but that agent only has one indivisible unit of another good that is worth more than the good that the agent is trying to buy.

A problem occurs in a Barter Economy if economic agents do not wish to exchange all of their goods on other goods and services. This may not be a problem, however, when the goods they have to sell can be stored safely so that they retain their value for the future. But if these goods are perishable, they will not be able to store value for their owner.

Finally, in a barter economy, there are many measures of value: the price of oranges in terms of pears; of pears in terms of bread; of bread in terms of milk; or of milk in terms of oranges.

A barter economy has no common measure of value that would make multiple transactions simple.

Because precious metals like gold had a high value relative to their bulk and were not perishable, they could act as a store of wealth .

The ability of precious metals, like gold, to act as a store of wealth not only depended on the fact that they did not perish physically over time, but also on the belief that others would always value precious metals.

The value from year to year of precious metals depended on people’s continued demand for them in ornaments, jewellery, and so on.

People were willing to use gold as a store of wealth because they believed that it would remain highly valued.