An arbitrageur is a type of investor who attempts to profit from market inefficiencies. These inefficiencies can relate to any aspect of the markets, whether it is price, dividends, or regulation. The most common form of arbitrage is price.
Arbitrageurs exploit price inefficiencies by making simultaneous trades that offset each other to capture risk-free profits. An arbitrageur would, for example, seek out price discrepancies between stocks listed on more than one exchange by buying the undervalued shares on one exchange while short selling the same number of overvalued shares on another exchange, thus capturing risk-free profits as the prices on the two exchanges converge.
In some instances, they also seek to profit by arbitraging private information into profits. For example, a takeover arbitrageur may use information about an impending takeover to buy up a company’s stock and profit from the subsequent price appreciation.
Key Takeaways
Arbitrageurs are investors who exploit market inefficiencies of any kind. They are necessary to ensure that inefficiencies between markets are ironed out or remain at a minimum.
Arbitrageurs tend to be experienced investors, and need to be detail-oriented and comfortable with risk.
Arbitrageurs most commonly benefit from price discrepancies between stocks or other assets listed on multiple exchanges.
In such a scenario, the arbitrageur might buy the issue on one exchange and short sell it on the second exchange, where the price is higher.
Understanding an Arbitrageur
Arbitrageurs are typically very experienced investors since arbitrage opportunities are difficult to find and require relatively fast trading. They also need to be detail-oriented and comfortable with risk. This is because most arbitrage plays involve a significant amount of risk. They are also bets with regards to the future direction of markets.
Arbitrageurs play an important role in the operation of capital markets, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be.
Examples of Arbitrageur Plays
As a simple example of what an arbitrageur would do, consider the following.
The stock of Company X is trading at $20 on the New York Stock Exchange (NYSE) while, at the same moment, it is trading for the equivalent of $20.05 on the London Stock Exchange (LSE). A trader can buy the stock on the NYSE and immediately sell the same shares on the LSE, earning a total profit of 5 cents per share, less any trading costs. The trader exploits the arbitrage opportunity until the specialists on the NYSE run out of inventory of Company X’s stock, or until the specialists on the NYSE or LSE adjust their prices to wipe out the opportunity.
An example of an information arbitrageur was Ivan F. Boesky. He was considered a master arbitrageur of takeovers during the 1980s. For example, he minted profits by buying stocks of Gulf oil and Getty oil before their purchases by California Standard and Texaco respectively during that period. He is reported to have made between $50 million to $100 million in each transaction.
The rise of cryptocurrencies offered another opportunity for arbitrageurs. As the price of Bitcoin reached new records, several opportunities to exploit price discrepancies between multiple exchanges operating around the world presented themselves. For example, Bitcoin traded at a premium at cryptocurrency exchanges situated in South Korea as compared to the ones located in the United States. The difference in prices, also known as the Kimchi Premium, was mainly because of the high demand for crypto in these regions. Crypto traders profited by arbitraging the price difference between the two locations in real-time.
The Australian Securities Exchange is headquartered in Sydney, Australia. The Exchange in its current form was created through the merger of the Australian Stock Exchange and Sydney Futures Exchange in 2006. The ASX acts as a market operator, clearing house, and payments facilitator. It also provides educational materials to retail investors.
Understanding the Australian Securities Exchange (ASX)
ASX is consistently ranked among the top exchanges globally. Other major exchanges include the Tokyo Stock Exchange or TSE, the New York Stock Exchange (NYSE), the Nasdaq, and the London Stock Exchange (LSE). Each exchange has specific listing requirements that include regular financial reports and minimum capital requirements. For example, in 2021, the NYSE has a key listing requirement that stipulated aggregate shareholders equity for last three fiscal years of greater than or equal to $10 million, a global market capitalization of $200 million, and a minimum share price of $4. In addition, for initial public offerings and secondary issuers must have 400 shareholders.
Australian Securities Exchange (ASX) and Electronic Trading
As with the majority of international exchanges, ASX’s relies on a hefty data center to help connect it to leading financial hubs and facilitate electronic trading. Electronic trading gained strong traction with NYSE’s 2005 acquisition of rival market the Archipelago Exchange—a fully electronic exchange that listed new and fast-growing companies. NYSE Arca was the new name following the acquisition. Cybersecurity is an increasing concern as exchanges become more interconnected via the internet.
ASX and Education
The Australian Securities Exchange has a strong emphasis on educating visitors to its website, the investing public, and current and potential listers. For example, for first-time investors, ASX offers free resources for understanding the public markets, exploring different asset classes, and developing a personal investment strategy. Visitors can download a series of tutorials and guidebooks. In addition, ASX offers a game-version of trading where players do not have to risk real money; instead, they can learn the basics in a risk-free environment.
An annual report is a document that public corporations must provide annually to shareholders that describes their operations and financial conditions. The front part of the report often contains an impressive combination of graphics, photos, and an accompanying narrative, all of which chronicle the company’s activities over the past year and may also make forecasts about the future of the company. The back part of the report contains detailed financial and operational information.
Key Takeaways
An annual report is a corporate document disseminated to shareholders that spells out the company’s financial condition and operations over the previous year.
It was not until legislation was enacted after the stock market crash of 1929 that the annual report became a regular component of corporate financial reporting.
Registered mutual funds must also distribute a full annual report to their shareholders each year.
What Is an Annual Report?
Understanding Annual Reports
Annual reports became a regulatory requirement for public companies following the stock market crash of 1929 when lawmakers mandated standardized corporate financial reporting. The intent of the required annual report is to provide public disclosure of a company’s operating and financial activities over the past year. The report is typically issued to shareholders and other stakeholders who use it to evaluate the firm’s financial performance and to make investment decisions.
Typically, an annual report will contain the following sections:
Current and prospective investors, employees, creditors, analysts, and any other interested party will analyze a company using its annual report.
In the U.S., a more detailed version of the annual report is referred to as Form 10-K and is submitted to the U.S. Securities and Exchange Commission (SEC). Companies may submit their annual reports electronically through the SEC’s EDGAR database. Reporting companies must send annual reports to their shareholders when they hold annual meetings to elect directors. Under the proxy rules, reporting companies are required to post their proxy materials, including their annual reports, on their company websites.
Special Considerations
The annual report contains key information on a company’s financial position that can be used to measure:
A company’s ability to pay its debts as they come due
Whether a company made a profit or loss in its previous fiscal year
A company’s growth over a number of years
How much of earnings are retained by a company to grow its operations
The proportion of operational expenses to revenue generated
The annual report also determines whether the information conforms to the generally accepted accounting principles (GAAP). This confirmation will be highlighted as an “unqualified opinion” in the auditor’s report section.
Fundamental analysts also attempt to understand a company’s future direction by analyzing the details provided in its annual report.
Mutual Fund Annual Reports
In the case of mutual funds, the annual report is a required document that is made available to a fund’s shareholders on a fiscal year basis. It discloses certain aspects of a mutual fund’s operations and financial condition. In contrast to corporate annual reports, mutual fund annual reports are best described as “plain vanilla” in terms of their presentation.
A mutual fund annual report, along with a fund’s prospectus and statement of additional information, is a source of multi-year fund data and performance, which is made available to fund shareholders as well as to prospective fund investors. Unfortunately, most of the information is quantitative rather than qualitative, which addresses the mandatory accounting disclosures required of mutual funds.
All mutual funds that are registered with the SEC are required to send a full report to all shareholders every year. The report shows how well the fund fared over the fiscal year. Information that can be found in the annual report includes:
Table, chart, or graph of holdings by category (e.g., type of security, industry sector, geographic region, credit quality, or maturity)
Audited financial statements, including a complete or summary (top 50) list of holdings
Condensed financial statements
Table showing the fund’s returns for 1-, 5- and 10-year periods
Management’s discussion of fund performance
Management information about directors and officers, such as name, age, and tenure
Remuneration or compensation paid to directors, officers, and others
How Do You Write an Annual Report?
An annual report has a few sections and steps that must convey a certain amount of information, much of which is legally required for public companies. Most public companies hire auditing companies to write their annual reports. An annual report begins with a letter to the shareholders, then a brief description of the business and industry. Following that, the report should include the audited financial statements: balance sheet, income statement, and statement of cash flows. The last part will typically be notes to the financial statements, explaining certain facts and figures.
Is an Annual Report the Same as a 10-K Filing?
In general, an annual report is similar to the 10-K filing in that both report on the company’s performance for the year. Both are considered to be the last financial filing of the year and summarize how the company did for that period. Annual reports are much more visually friendly. They are designed well and contain images and graphics. The 10-K filing only reports numbers and other qualitative information without any design elements or additional flair.
What Is a 10-Q Filing?
A 10-Q filing is a form that is filed with the Securities and Exchange Commission (SEC) that reports the quarterly earnings of a company. Most public companies have to file a 10-Q with the SEC to report their financial position for the quarter.
The Bottom Line
Public companies must produce annual reports to show their current financial conditions and operations. Annual reports can be used to examine a company’s financial position and, possibly, understand what direction it will move in the future. These reports function differently for mutual funds; in this case, they are made available each fiscal year and are typically simpler.
The term “annuity” refers to an insurance contract issued and distributed by financial institutions with the intention of paying out invested funds in a fixed income stream in the future. Investors invest in or purchase annuities with monthly premiums or lump-sum payments. The holding institution issues a stream of payments in the future for a specified period of time or for the remainder of the annuitant’s life. Annuities are mainly used for retirement purposes and help individuals address the risk of outliving their savings.
Key Takeaways
Annuities are financial products that offer a guaranteed income stream, usually for retirees.
The accumulation phase is the first stage of an annuity, whereby investors fund the product with either a lump sum or periodic payments.
The annuitant begins receiving payments after the annuitization period for a fixed period or for the rest of their life.
Annuities can be structured into different kinds of instruments, which gives investors flexibility.
These products can be categorized into immediate and deferred annuities and may be structured as fixed or variable.
How an Annuity Works
Annuities are designed to provide a steady cash flow for people during their retirement years and to alleviate the fears of outliving their assets. Since these assets may not be enough to sustain their standard of living, some investors may turn to an insurance company or other financial institution to purchase an annuity contract.
As such, these financial products are appropriate for investors, who are referred to as annuitants, who want stable, guaranteed retirement income. Because invested cash is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product.
An annuity goes through several different phases and periods. These are called:
The accumulation phase, the period of time when an annuity is being funded and before payouts begin. Any money invested in the annuity grows on a tax-deferred basis during this stage.
The annuitization phase, which kicks in once payments commence.
These financial products can be immediate or deferred. Immediate annuities are often purchased by people of any age who have received a large lump sum of money, such as a settlement or lottery win, and who prefer to exchange it for cash flows into the future. Deferred annuities are structured to grow on a tax-deferred basis and provide annuitants with guaranteed income that begins on a date they specify.
Annuities often come with complicated tax considerations, so it’s important to understand how they work. As with any other financial product, be sure to consult with a professional before you purchase an annuity contract.
Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.
Special Considerations
Annuities usually have a surrender period. Annuitants cannot make withdrawals during this time, which may span several years, without paying a surrender charge or fee. Investors must consider their financial requirements during this time period. For example, if a major event requires significant amounts of cash, such as a wedding, then it might be a good idea to evaluate whether the investor can afford to make requisite annuity payments.
Contracts also have an income rider that ensures a fixed income after the annuity kicks in. There are two questions that investors should ask when they consider income riders:
At what age do they need the income? Depending on the duration of the annuity, the payment terms and interest rates may vary.
What are the fees associated with the income rider? While there are some organizations that offer the income rider free of charge, most have fees associated with this service.
Many insurance companies will allow recipients to withdraw up to 10% of their account value without paying a surrender fee. However, if you withdraw more than that, you may end up paying a penalty, even if the surrender period has already lapsed. There are also tax implications for withdrawals before age 59 and a half.
Because of the potentially high cost of withdrawals, some hard-up annuitants may opt to sell their annuity payments instead. This is similar to borrowing against any other income stream: the annuitant receives a lump sum, and in exchange gives up their right to some (or all) of their future annuity payments.
Individuals who invest in annuities cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that they are trading a liquid lump sum for a guaranteed series of cash flows, the product is appropriate. Some purchasers hope to cash out an annuity in the future at a profit, however, this is not the intended use of the product.
Types of Annuities
Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. As mentioned above, annuities can be created so that payments continue so long as either the annuitant or their spouse (if survivorship benefit is elected) is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives.
Immediate and Deferred Annuities
Annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits. The immediate payment annuity begins paying immediately after the annuitant deposits a lump sum. Deferred income annuities, on the other hand, don’t begin paying out after the initial investment. Instead, the client specifies an age at which they would like to begin receiving payments from the insurance company.
Depending on the type of annuity you choose, the annuity may or may not be able to recover some of the principal invested in the account. In the case of a straight, lifetime payout, there is no refund of the principal–the payments simply continue until the beneficiary dies. If the annuity is set for a fixed period of time, the recipient may be entitled to a refund of any remaining principal–or their heirs, if the annuitant has deceased.
Fixed and Variable Annuities
Annuities can be structured generally as either fixed or variable:
Fixed annuities provide regular periodic payments to the annuitant.
Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly, which provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund’s investments.
While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts—usually for an extra cost. This allows them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value.
Other riders may be purchased to add a death benefit to the agreement or to accelerate payouts if the annuity holder is diagnosed with a terminal illness. The cost of living rider is another common rider that will adjust the annual base cash flows for inflation based on changes in the consumer price index (CPI).
Criticism of Annuities
One criticism of annuities is that they are illiquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched.
These periods can last anywhere from two to more than 10 years, depending on the particular product. Surrender fees can start out at 10% or more and the penalty typically declines annually over the surrender period.
Annuities vs. Life Insurance
Life insurance companies and investment companies are the two primary types of financial institutions offering annuity products. For life insurance companies, annuities are a natural hedge for their insurance products. Life insurance is bought to deal with mortality risk, which is the risk of dying prematurely. Policyholders pay an annual premium to the insurance company that will pay out a lump sum upon their death.
If the policyholder dies prematurely, the insurer pays out the death benefit at a net loss to the company. Actuarial science and claims experience allow these insurance companies to price their policies so that on average insurance purchasers will live long enough so that the insurer earns a profit. In many cases, the cash value inside of permanent life insurance policies can be exchanged via a 1035 exchange for an annuity product without any tax implications.
Annuities, on the other hand, deal with longevity risk, or the risk of outliving one’s assets. The risk to the issuer of the annuity is that annuity holders will survive to outlive their initial investment. Annuity issuers may hedge longevity risk by selling annuities to customers with a higher risk of premature death.
Example of an Annuity
A life insurance policy is an example of a fixed annuity in which an individual pays a fixed amount each month for a pre-determined time period (typically 59.5 years) and receives a fixed income stream during their retirement years.
An example of an immediate annuity is when an individual pays a single premium, say $200,000, to an insurance company and receives monthly payments, say $5,000, for a fixed time period afterward. The payout amount for immediate annuities depends on market conditions and interest rates.
Annuities can be a beneficial part of a retirement plan, but annuities are complex financial vehicles. Because of their complexity, many employers don’t offer them as part of an employee’s retirement portfolio.
However, the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law by President Donald Trump in late December 2019, loosens the rules on how employers can select annuity providers and includes annuity options within 401(k) or 403(b) investment plans. The easement of these rules may trigger more annuity options open to qualified employees in the near future.
Who Buys Annuities?
Annuities are appropriate financial products for individuals seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product. Annuity holders cannot outlive their income stream, which hedges longevity risk.
What Is a Non-Qualified Annuity?
Annuities can be purchased with either pre-tax or after-tax dollars. A non-qualified annuity is one that has been purchased with after-tax dollars. A qualified annuity is one that has been purchased with pre-tax dollars. Qualified plans include 401(k) plans and 403(b) plans. Only the earnings of a non-qualified annuity are taxed at the time of withdrawal, not the contributions, as they are after-tax money.
What Is an Annuity Fund?
An annuity fund is the investment portfolio in which an annuity holder’s funds are invested. The annuity fund earns returns, which correlate to the payout that an annuity holder receives. When an individual buys an annuity from an insurance company, they pay a premium. The premium is invested by the insurance company into an investment vehicle that contains stocks, bonds, and other securities, which is the annuity fund.
What Is the Surrender Period?
The surrender period is the amount of time an investor must wait before they can withdraw funds from an annuity without facing a penalty. Withdrawals made before the end of the surrender period can result in a surrender charge, which is essentially a deferred sales fee. This period generally spans several years. Investors can incur a significant penalty if they withdraw the invested amount before the surrender period is over.
What Are Common Types of Annuities?
Annuities are generally structured as either fixed or variable instruments. Fixed annuities provide regular periodic payments to the annuitant and are often used in retirement planning. Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund’s investments.
