The Essential Financial Primer

by Jim Samson

If you’re new to investing or a season trader, a solid foundational knowledge of the basics of finance is essential to success. For the newbie, these terms can become confusing very fast. For the veteran, it’s easy to lose track of the basics, what with all the new terminologies and references and acronyms that crop up daily in the financial sector.

So here, in a simple and easy to follow format, are the essential terms and concepts you need to know to succeed in finance.

Types of Companies

A parent company  is a company that holds the majority of voting stock in another company (the subsidiary). They can control the management and other major decisions through electing a board of directors.

A holding company is a company that does not actually produce any products, services, or goods. Its sole purpose is to hold stock of other companies. Berkshire Hathaway is the largest holding company in the United States, owning stocks in various insurance, manufacturing, and retail businesses.

A conglomerate is a company that owns two or more companies that are engaged in different businesses. Often very large, a conglomerate can own many parent companies, as well as their subsidiaries. They are also often multinational. General Electric is a good example, as it owns companies involved in such diverse sectors as financial services and television studios. A holding company can also be considered a conglomerate, such as in the case of Berkshire Hathaway, which owns stock in a variety of different businesses.

A subsidiary company is one that is owned partly or entirely by a larger company, the parent company. A subsidiary never has a majority of company stock and is under the control of the parent company. Subsidiaries can be structured in different tiers, as well. For example, Ford Component Sales Limited is a fourth-tier subsidiary of Ford Motor Company, the top parent company.

A shell corporation is a company that have any significant assets or business operations; rather, they serve as a vehicle for business operations. Shell corporations are not illegal themselves, but they are, however, often used to avoid paying tax. An example of a legal shell corporation would be a supplier of store brand medicines that uses a shell corporation when dealing with a retailer. A Shell corporation is a term also used by the Securities and Exchange Commission to refer to a company that has no assets other than money.

A dummy company is a company that may have the appearance of a real company – complete with logo, website, and minimal staff – but is more often than not used to disguise criminal activity. A notable exception is the large number of dummy companies used by the Walt Disney World Corporation to buy the land where the Walt Disney World Resort now sits.

Types of Funds

Mutual funds are funds that are used to invest in securities such as equity, debt, or real estate. Setting up a mutual fund allows outside investors to buy shares in the fund and collect the profits. Sometimes referred to as “investment companies”, mutual funds come in three different varieties: open-end, unit investment trust, and close-end. Open-end mutual funds are the most common and with these, investors can sell their shares at any time.

Hedge funds are similar to mutual funds, except they are privately held. As such, they are less regulated, they do not need to disclose as much information, and they are allowed to invest in more exotic types of investment opportunities. Managers of hedge funds typically will invest their own money into the fund, ensuring that their interests are in line with the rest of the investors. Also, a hedge fund manager is paid a management fee, which is a percentage of the fund’s assets, as well as a performance fee, if the fund does well and its assets increase. Hedge fund managers have gotten in trouble in the past; the most notable example being Bernie Madoff, who ran a $50 billion Ponzi scheme and is now spending the rest of his days in a tiny jail cell.

Vulture funds are not as nefarious as they may sound at first. Vulture funds invest in debt that is considered high-risk and on the brink of defaulting. Investors essentially buy the debt at a discounted rate from a secondary market and then sue the original debtors for a higher price than what they bought it at. If done successfully, it is possible to profit from buying debt in this way.

 

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