Posts Tagged ‘Securities’

How to Use RRG Charts in Trading

Written by admin. Posted in Technical Analysis

[ad_1]

The relative rotation graph (RRG) is a sophisticated tool in technical analysis to help investors decide which sectors, individual stocks, and other assets to pursue. Investors can use it to visually compare the performance and momentum of securities and asset classes against a benchmark. RRGs plot assets on a two-dimensional graph, with the x-axis representing the relative strength ratio and the y-axis for relative strength momentum. This format enables traders and investors to visually assess the relative strength and trendline of different securities, making it valuable for trading, rotation, and asset allocation strategies.

Key Takeaways

  • The relative rotation graph (RRG) is a chart used in technical analysis to test the performance and momentum of securities or asset classes against a benchmark.
  • RRGs provide a comprehensive view of the market, helping investors to spot trends, compare multiple securities simultaneously, and make more informed decisions when rebalancing portfolios.
  • RRGs should be used with other forms of analysis since they are a partial view of the market.
  • Several tools and resources are available to create and analyze RRGs, ranging from professional-grade software from Bloomberg and Optuma to more accessible platforms like StockCharts.com.

What is the Relative Rotation Graph?

RRGs are used to identify which stocks or sectors are underperforming and outperforming a market index or benchmark. The RRG has four quadrants: leading, weakening, lagging, and improving. Each quadrant is for different stages of an asset’s performance cycle, providing insights into the rotation of market leadership. This movement of securities through the quadrants helps to spotting trends and potential reversals and could provide investors with a strategic advantage in both short-term and long-term trading.

RRGs were created by Julius de Kempenaer in the early 1990s to visualize the relative performance of stocks and other securities against a benchmark and each other. De Kempenaer’s work has been valuable for helping investors make more informed decisions about trading, rotation, and asset allocation.

RRGs are an excellent visual way of analyzing market trends and relative performance. However, like all technical tools, they should be used with other techniques for a more comprehensive approach to trading and investing.

Understanding the Parts of the Relative Rotation Graph

The key elements of RRG and how they indicate relative strength and momentum are as follows:

  • Axes: The x-axis is the relative strength ratio. This axis measures the performance of a security relative to a benchmark (hence, the strength is “relative”). A value more than 100 indicates outperformance, while a value less than 100 indicates underperformance. The y-axis represents the momentum of the relative strength. This axis shows the rate of change in the relative performance. It is essentially the momentum of the relative strength ratio,
  • Top right quadrant: The top right quadrant in the RRG is the leading quadrant. Securities in this quadrant are outperforming the benchmark, and their momentum is positive. This indicates strong and improving performance.
  • Bottom right quadrant: The bottom right quadrant is the weakening quadrant. Here, securities are still outperforming the benchmark, but their momentum is decreasing. Being here suggests that while they are strong, they might be losing their edge.
  • Bottom left quadrant: This is the lagging quadrant. Securities in this area are underperforming the benchmark with negative momentum. It is a sign of weakness.
  • Top left quadrant: This is the improving quadrant. This quadrant contains securities that are underperforming the benchmark but show increasing momentum. Being here suggests the potential for a turnaround.
  • Data points and movement: Each security or asset is represented as a data point on the graph. The position of a data point within the graph indicates its relative strength and momentum. The movement of these data points is tracked over time, usually in a clockwise direction through the quadrants, which illustrates the evolution of their relative performance.

RRGs help investors spot trends and compare several securities at once. However, RRGs should be used with other forms of analysis since they provide a relative, not absolute, view.

How to Interpret Relative Rotation Graphs

Interpreting RRGs involve analyzing the patterns and movements of securities on this chart to identify market leaders, laggards, and potential rotation opportunities.


Weekly Relative Rotation Graph of Magnificent Seven Stocks as at 18th December 2023.

stockcharts.com


Movements and Patterns in RRGs

Securities in the RRG generally move clockwise through the four quadrants. This rotation reflects the natural ebb and flow of securities’ relative strength and momentum relative to a benchmark. In addition, the further a security is from the center, the stronger its relative strength or weakness is compared with the benchmark. A security far out in the leading or lagging quadrant has a strong trend, whether positive or negative.

The speed at which a security moves through the quadrants can indicate the stability of its trend. Rapid movements might suggest more volatile or less stable trends. Indeed, many RRGs show tails behind the data points, representing their historical path. Longer tails provide more context on historical performance and trend stability.

Identifying Market Leaders and Laggards

Securities in the leading quadrant are outperforming the benchmark with positive momentum and are considered market leaders. A security with a presence or movement deeper into this quadrant suggests a strong and stable outperformance. Meanwhile, securities in the lagging quadrant are underperforming and have negative momentum. These are the laggards of the market. A security that is continuously in or moving deeper into this quadrant has a strong downtrend relative to the benchmark.


Monthly US Sector Rotation as at December 1 2023.

stockcharts.com


Identifying Rotational Opportunities

A security moving from the improving quadrant into the leading quadrant can be an opportunity. This shift indicates a security is starting to outperform the benchmark with increasing momentum. Similarly, a security moving from the weakening to the lagging quadrant suggests that its previous outperformance is deteriorating, and it is now starting to underperform. This could signal a selling opportunity or a warning to avoid new investments.

Meanwhile, a move from lagging to improving suggests that a security is beginning to reverse its underperformance. This indicates an early stage of recovery, a potential buying opportunity for contrarian investors. Also, securities shifting from leading to weakening are still outperforming but are losing momentum. This could be a signal to take the profits or closely watch the situation to see if it continues losing steam.

Using Relative Rotation Graphs with Other Technical Tools

RRGs can be more effective when put together with other charts in the technical analyst’s toolkit. For example, once an RRG helps determine sectors or stocks that are showing relative strength, you can then review stocks in those sectors in greater depth. Candlestick patterns and volume analysis can give more details on the trading behavior for specific stocks, clueing you in about potential reversals in price trends. Indicators like moving averages, the relative strength index (RSI), and Bollinger Bands can also be used to assess the momentum and volatility of these stocks, helping you decide on entries and exits.

In addition, the RRG’s ability to depict sector rotation can provide great help for those using a top-down investment approach. When showing the sectors moving into the leading quadrant, you might allocate more to sectors poised for growth and reduce your exposure to those going into the lagging quadrant. This sector rotation strategy can be particularly useful during different phases of the economic cycle, as certain sectors tend to do better than others based on the economic conditions. This then points to how fundamental analysis can be used with RRG for a fuller picture of particular sectors and their prospects.

Benefits and Limitations of Relative Rotation Graphs

RRGs offer several advantages and limitations when used in trading, analysis, and portfolio management. Understanding these can help make better use of them for investing.

Benefits and Limitations of Relative Rotation Graphs

Benefits

  • Easy Visualization of Market Dynamics

  • Comparison Tool

  • Helps Identify Trends

  • Helps with Timely Decision Making

  • Complements Other Analysis

  • Helps with Deciding Asset Allocation

Limitations

  • Shows Relative, Not Absolute Rotation

  • Lagging Indicator

  • Requires a Benchmark

  • Not a Standalone Tool

  • Provides no Indication of Value

Benefits of Relative Rotation Graphs

Here are some benefits of RRGs:

  • Visualizing market dynamics: RRGs provide a clear, visual representation of the relative strength and momentum of various securities or sectors, making it easier to understand complex market moves.
  • Comparison tool: With RRGs, you can compare several securities simultaneously against a benchmark, which can be valuable for portfolio diversification and sector rotation strategies.
  • Identifying trends: RRGs help pick out leaders, laggards, and emerging trends by observing the movement of securities through different quadrants.
  • Timely decision-making: The dynamic nature of RRGs aids investors in making timely decisions by highlighting changes in momentum and strength before they become evident through price movements alone.
  • Complementing other analyses: RRGs can be used alongside other technical, fundamental, and quantitative analysis tools, providing a more holistic view of the market.
  • Sector and asset allocation: RRGs are particularly useful for sector analysis and distributing assets since they help identify industries or asset classes likely to outperform or underperform.

Limitations of Relative Rotation Graphs

Here are some limitations of RRGs:

  • Relative, not absolute, rotation: RRGs illustrate the performance relative to a benchmark, not the absolute performance. A security in the leading quadrant could still be losing value in a bear market.
  • Lagging indicator: RRGs inherently lag. They reflect past performance and trends, which may not always predict future movements.
  • Requires a benchmark: The effectiveness of RRGs depends on the choice of an appropriate benchmark, which can vary based on the assets.
  • Not a stand-alone tool: RRGs should not to be used in isolation. They do not deliver insights into company fundamentals, macroeconomic conditions, or market sentiment.
  • No indication of value: RRGs do not provide information about the value of securities. A stock might be moving into the leading quadrant but still be overpriced.

While RRGs are powerful for visualizing and analyzing market trends and relative performance, they are most effective when used as part of a broader, diversified approach to investment analysis and decision-making. Understanding their limitations is crucial to avoid overestimating their relevance.

Differences Between the Relative Rotation Graph and the Relative Strength Index

The Relative Rotation Graph vs. the Relative Strength Index

Relative Rotation Graph (RRG)

  • Scope: RRG is used to compare several securities against a benchmark.

  • Dimensions: RRG provides a two-dimensional view.

  • Interpretation: RRG is better for relative performance and identifying trends.

  • Usage: RRG is typically used for asset allocation and sector rotation.

Relative Strength Index (RSI)

  • Scope: The RSI is used for analyzing the price momentum of a single security.

  • Dimensions: The RSI is a one-dimensional oscillator.

  • Interpretation: The RSI illustrates momentum and potential price reversals.

  • Usage: RSI is commonly used to identify potential entries and exits.

The RRG and the relative strength index (RSI) are both used in technical analysis, but serve different purposes and provide different kinds of information. RRGs are used for comparing several securities against a benchmark, while the RSI is for analyzing the price momentum of a single security. In addition, RRGs offer a two-dimensional view (strength and momentum), while the RSI is a one-dimensional oscillator (it constructs high and low bands and provides a trend indicator).

RRG is best used for relative performance and identifying trends. Meanwhile, the RSI is best for ascertaining momentum and potential price reversals. Another set of differences is that RRG is often used for asset allocation and sector rotation, while the RSI commonly helps identify potential entries and exits.

As such, RRG is more for visualizing and comparing the relative strength and trends of multiple securities, and the RSI sets out the momentum of individual securities and can help identify when there are overbought or oversold conditions.

Resources for Creating Relative Rotation Graphs

Making your RRGs requires specialized tools and resources, as these graphs involve complex calculations and dynamic visuals. Here are some great tools to use:

  • RRG Research: Founded by Julius de Kempenaer, the creator of RRGs, the firm’s site provides tools and insights related to RRGs. The website offers educational resources, analysis, and access to RRGs.
  • Bloomberg Professional Services Software: The Bloomberg Professional Services software, a leading financial data and analytics platform, offers RRG charts as part of its services. It provides functions for creating and customizing RRGs, making it a popular choice among professional investors and analysts.
  • Refinitiv Eikon: This platform is another leading financial data and analytics provider that offers RRG charts as part of its services.
  • StockCharts.com: This online platform offers various chart tools, including RRGs. It has a user-friendly interface for creating RRGs, suitable for professionals and individual investors.
  • Optuma: Optuma is a professional-level technical analysis software that includes RRGs among its features. Known for its advanced analysis tools, Optuma caters to professional traders and analysts.

The tool you choose depends on your needs, skill level, and access to resources.

Which Technical Analysis Indicators Work Well with Relative Rotation Graphs?

Combining RRGs with other indicators can provide a more comprehensive view of the market and help refine investment strategies. Some indicators include moving averages, the RSI, the moving average convergence divergence, Bollinger Bands, support and resistance levels, and other chart patterns.

What Asset Groups Work Well with Relative Rotation Graphs?

RRGs are best used to analyze asset groups when relative performance is key. These can include equity sectors and industries, exchange-traded funds, indexes, benchmarks, fixed-income securities, commodities, and currencies. RRGs’ ability to compare several assets simultaneously makes them invaluable for a wide range of investment strategies from picking individual stocks to deciding on broad asset allocations. However, with all financial and investment tools, they should be used as part of a broader, diversified approach to market analysis and not relied upon in isolation.

Which Benchmarks Work Well with Relative Rotation Graphs?

The benchmark chosen is critical in interpreting RRGs, setting the standard against which the other securities or asset classes are measured. The benchmark to use depends on the type of assets being analyzed and the specific goals of the analysis. Some commonly used benchmarks include broad market, sector, fixed-income, commodity, regional, country-specific, currency, real estate, and thematic indexes.

How Can the Reliability of Relative Rotation Graphs Be Improved?

Increasing the reliability of RRGs involves choosing the right benchmarks, using quality data, understanding the tool’s limitations, and integrating it with other forms of analysis. Regular reviews, adaptation to changing market conditions, and ongoing education are essential for effectively using RRGs in trading and investments.

The Bottom Line

RRGs are vital for some types of technical analysis, offering a way to visualize the relative performance and momentum of different securities against a chosen benchmark. Its design, characterized by placing securities in four distinct quadrants—labeled leading, weakening, lagging, and improving—allows traders and investors to quickly grasp shifts in the market and identify assets gaining or losing strength against others. This makes RRGs particularly useful for strategies involving sector rotation, asset allocation, and portfolio diversification.

For traders, RRGs provide a strategic edge by enabling a clear understanding of various market segments’ relative trends and strengths. By integrating RRG analysis with other technical indicators and fundamental insights, traders can identify potential entry and exit points more effectively.

[ad_2]

Source link

2000 Investor Limit

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

What Is the 2000 Investor Limit?

The 2,000 Investor Limit is a stipulation required by the Securities & Exchange Commission (SEC) that mandates a company that exceeds 2,000 individual investors, and with more than $10 million in combined assets, must file its financials with the commission. According to SEC rules, a company that meets these criteria has 120 days to file following its fiscal year’s end.

Key Takeaways

  • The 2,000 investor limit or rule is a key threshold for private businesses that do not wish to disclose financial information for public consumption.
  • A business with more than 2,000 distinct shareholders, totaling $10 million or more in capital, must file with the SEC even if it is a privately-held company.
  • Congress raised the limit from 500 individual investors to 2,000 investors in 2016 as part of the JOBS and FAST Acts.
  • The increased investor limit has opened greater possibility for equity crowdfunding.

Understanding the 2000 Investor Limit

The 2,000 investor limit or rule is a key threshold for private businesses that do not wish to disclose financial information for public consumption. Congress raised the limit from 500 individual investors in 2016 as part of the Jumpstart Our Business Startups (JOBS) Act and Title LXXXV of the Fixing America’s Surface Transportation (FAST) Act. The revised rules also specify a limit of 500 persons who are not accredited investors before public filing is required.

The prior threshold had been 500 holders of record without regard to accredited investor status. Congress began debating an increase in the limit in the wake of the 2008 recession and an explosion in online businesses (some of which complained that they were growing so fast that the disclosure rules had become a burden at too early a stage of their lifecycle). 

The JOBS Act also set up a separate registration threshold for banks and bank holding companies, allowing them to terminate the registration of securities or suspend reporting if that class of shares is held by less than 1,200 people.

Investor Thresholds and Equity Crowdfunding

The JOBS Act revisions to SEC rules helped facilitate the growth of crowdfunding platforms. These platforms are able to raise money from individual investors online without providing detailed financial data. The rules established limits on how much individuals can invest in SEC-approved crowdfunding platforms as a percent of the lesser of their annual income or net worth. 

The individual limits for crowdfunding, through an investment portal approved by the SEC, as of May 2017: 

  • If either your annual income or your net worth is under $107,000, during any 12-month period, you can invest up to the greater of either $2,200 or 5 percent of the lesser of your annual income or net worth. 
  • If both your annual income and net worth are $107,000 or more during any 12-month period, you can invest up to 10 percent of your annual income or net worth, whichever is less, not to exceed $107,000. 

These calculations don’t include the value of your home.

Example

For example, suppose that your annual income is $150,000 and your net worth is $80,000. JOBS Act crowdfunding rules allow you to invest the greater of $2,200—or 5% of $80,000 ($4,000)—during a 12-month period. So in this case, you can invest $4,000 over a 12-month period.

[ad_2]

Source link

altcoin, Pros and Cons, Types, and Future

Written by admin. Posted in A, Financial Terms Dictionary

Pros and Cons, Types, and Future

[ad_1]

Investopedia / Michela Buttignol


What Is Altcoin?

Altcoins are generally defined as all cryptocurrencies other than Bitcoin (BTC). However, some people consider altcoins to be all crytocurrencies other than Bitcoin and Ethereum (ETH) because most cryptocurrencies are forked from one of the two. Some altcoins use different consensus mechanisms to validate transactions and open new blocks, or attempt to distinguish themselves from Bitcoin and Ethereum by providing new or additional capabilities or purposes.

Most altcoins are designed and released by developers who have a different vision or use for their tokens or cryptocurrency. Learn more about altcoins and what makes them different from Bitcoin.

Key Takeaways

  • The term altcoin refers to all cryptocurrencies other than Bitcoin (and for some people, Ethereum).
  • There are tens of thousands of altcoins on the market.
  • Altcoins come in several types based on what they were designed for.
  • The future value of altcoins is impossible to predict, but if the blockchain they were designed for continues to be used and developed, the altcoins will continue to exist.

Click Play to Learn All About Altcoins

Understanding Altcoins

“Altcoin” is a combination of the two words “alternative” and “coin.” It is generally used to include all cryptocurrencies and tokens that are not Bitcoin. Altcoins belong to the blockchains they were explicitly designed for. Many are forks—a splitting of a blockchain that is not compatible with the original chain—from Bitcoin and Ethereum. These forks generally have more than one reason for occurring. Most of the time, a group of developers disagree with others and leave to make their own coin.

Many altcoins are used within their respective blockchains to accomplish something, such as ether, which is used in Ethereum to pay transaction fees. Some developers have created forks of Bitcoin and re-emerged as an attempt to compete with Bitcoin as a payment method, such as Bitcoin Cash.

Others fork and advertise themselves as a way to raise funds for specific projects. For example, the token Bananacoin forked from Ethereum and emerged in 2017 as a way to raise funds for a banana plantation in Laos that claimed to grow organic bananas.

Dogecoin, the popular meme coin, was apparently created as somewhat of a joke. It forked from Litecoin, which itself forked from Bitcoin in 2011. Whatever the intent behind its creation, it was still designed to be a digital payment method.

Altcoins attempt to improve upon the perceived limitations of whichever cryptocurrency and blockchain they are forked from or competing with. The first altcoin was Litecoin, forked from the Bitcoin blockchain in 2011. Litecoin uses a different proof-of-work (PoW) consensus mechanism than Bitcoin, called Scrypt (pronounced es-crypt), which is less energy-intensive and quicker than Bitcoin’s SHA-256 PoW consensus mechanism.

Ether is another altcoin. However, it did not fork from Bitcoin. It was designed by Vitalik Buterin, Dr. Gavin Wood, and a few others to support Ethereum, the world’s largest blockchain-based scalable virtual machine. Ether (ETH) is used to pay network participants for the transaction validation work their machines do.

Types of Altcoins

Altcoins come in various flavors and categories. Here’s a brief summary of some of the types of altcoins and what they are intended to be used for.

It is possible for an altcoin to fall into more than one category, such as TerraUSD, which is a stablecoin and utility token.

Payment Token

As the name implies, payment tokens are designed to be used as currency—to exchange value between parties. Bitcoin is the prime example of a payment token.

Stablecoins

Cryptocurrency trading and use have been marked by volatility since launch. Stablecoins aim to reduce this overall volatility by pegging their value to a basket of goods, such as fiat currencies, precious metals, or other cryptocurrencies. The basket is meant to act as a reserve to redeem holders if the cryptocurrency fails or faces problems. Price fluctuations for stablecoins are not meant to exceed a narrow range.

Notable stablecoins include Tether’s USDT, MakerDAO’s DAI, and the USD Coin (USDC). In March 2021, payment processing giant Visa Inc. (V) announced that it would begin settling some transactions on its network in USDC over the Ethereum blockchain, with plans to roll out further stablecoin settlement capacity later in 2021.

Security Tokens

Security tokens are tokenized assets offered on stock markets. Tokenization is the transfer of value from an asset to a token, which is then made available to investors. Any asset can be tokenized, such as real estate or stocks. For this to work, the asset must be secured and held. Otherwise, the tokens are worthless because they wouldn’t represent anything. Security tokens are regulated by the Securities and Exchange Commission because they are designed to act as securities.

In 2021, the Bitcoin wallet firm Exodus successfully completed a Securities and Exchange Commission-qualified Reg A+ token offering, allowing for $75 million shares of common stock to be converted to tokens on the Algorand blockchain. This was a historic event because it was the first digital asset security to offer equity in a United States-based issuer.

Utility Tokens

Utility tokens are used to provide services within a network. For example, they might be used to purchase services, pay network fees, or redeem rewards. Filecoin, which is used to buy storage space on a network and secure the information, is an example of a utility token.

Ether (ETH) is also a utility token. It is designed to be used in the Ethereum blockchain and virtual machine to pay for transactions. The stable coin USTerra uses utility tokens to attempt to maintain its peg to the dollar—which it lost on May 11, 2022—by minting and burning two utility tokens to create downward or upward pressure on its price.

Utility tokens can be purchased on exchanges and held, but they are meant to be used in the blockchain network to keep it functioning.

Meme Coins

As their name suggests, meme coins are inspired by a joke or a silly take on other well-known cryptocurrencies. They typically gain popularity in a short period of time, often hyped online by prominent influencers or investors attempting to exploit short-term gains.

Many refer to the sharp run-up in this type of altcoins during April and May 2021 as “meme coin season,” with hundreds of these cryptocurrencies posting enormous percentage gains based on pure speculation.

An initial coin offering (ICO) is the cryptocurrency industry’s equivalent of an initial public offering (IPO). A company looking to raise money to create a new coin, app, or service launches an ICO to raise funds.

Governance Tokens

Governance tokens allow holders certain rights within a blockchain, such as voting for changes to protocols or having a say in decisions of a decentralized autonomous organization (DAO). Because they are generally native to a private blockchain and used for blockchain purposes, they are utility tokens but have come to be accepted as a separate type because of their purpose.

Pros and Cons of Altcoins

Cons

  • Lower popularity and smaller market cap

  • Less liquid than Bitcoin

  • Difficult to determine use cases

  • Many altcoins are scams or lost developer and community interest

Pros of Altcoins Explained

  • Altcoins are “improved versions” of the cryptocurrency they derived from because they aim to plug perceived shortcomings.
  • Altcoins with more utility have a better chance of surviving because they have uses, such as Ethereum’s ether.
  • Investors can choose from a wide variety of altcoins that perform different functions in the crypto economy.

Cons of Altcoin Explained

  • Altcoins have a smaller investment market compared to Bitcoin. Bitcoin has generally hovered around 40% of the global cryptocurrency market since May of 2021.
  • The altcoin market is characterized by fewer investors and less activity, resulting in thin liquidity.
  • It is not always easy to distinguish between different altcoins and their respective use cases, making investment decisions even more complicated and confusing.
  • There are several “dead” altcoins that ended up sinking investor dollars.

Future of Altcoins

Discussions about the future for altcoins and cryptocurrencies have a precedent in the circumstances that led to a federally issued dollar in the 19th century. Various forms of local currencies circulated in the United States. Each had unique characteristics and was backed by a different instrument.

Local banks were also issuing currency, in some cases backed by fictitious reserves. That diversity of currencies and financial instruments parallels the current situation in altcoin markets. There are thousands of altcoins available in the markets today, each one claiming to serve a different purpose and market.

The current state of affairs in the altcoin markets is unlikely to consolidate into a single cryptocurrency. But it is also likely that a majority of the thousands of altcoins listed in crypto markets will not survive. The altcoin market will likely coalesce around a bunch of altcoins—those with strong utility, use cases, and a solid blockchain purpose—which will dominate the markets.

If you’re looking to diversify within the cryptocurrency market, altcoins can be less expensive than Bitcoin. However, the cryptocurrency market, regardless of the type of coin, is young and volatile. Cryptocurrency is still finding its role in the global economy, so it’s best to approach all cryptocurrencies cautiously.

What Is the Best Altcoin to Invest in?

The best altcoin to invest in depends on your financial situation, goals, risk tolerance, and the market’s circumstances. It’s best to speak to a financial advisor to help you decide which one is best for you.

What Are the Top 3 Altcoins?

By market cpacity, the top three altcoins are Ethereum, USD Coin, Tether (USDT).

Is It Better to Invest in Bitcoin or Altcoins?

Which cryptocurrency is better is a subjective argument based on an investor’s financial circumstances, investing goals, risk tolerance, and beliefs. You should talk to a professional financial advisor about investing in cryptocurrency before buying any.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions.

[ad_2]

Source link

48-Hour Rule

Written by admin. Posted in #, Financial Terms Dictionary

[ad_1]

What Is the 48-Hour Rule?

The 48-hour rule is a requirement that sellers of to-be-announced (TBA) mortgage-backed securities (MBS) communicate all pool information regarding the MBS to buyers before 3 p.m. Eastern Time, 48 hours before the settlement date of the trade. The Securities Industry and Financial Markets Association (SIFMA) enforces this rule. SIFMA was formerly known as the Public Securities Association or Bond Market Association.

Key Takeaways

  • The 48-hour rule refers to a part of the mortgage allocation process related to the buying and selling of to-be-announced (TBA) mortgage-backed securities (MBS).
  • The 48-hour rule stipulates that the seller of an MBS notifies the buyer with the details of the underlying mortgages that make up the MBS by 3 p.m. Eastern Time, 48 hours before the settlement date.
  • The Securities Industry and Financial Markets Association (SIFMA) enforces the 48-hour rule.
  • When an MBS is traded in the secondary market, the underlying mortgages are not known, which helps facilitate trading and liquidity.
  • Certain information is agreed upon when an MBS trade is made, such as the price, par, and coupon, but not the underlying mortgages.
  • The TBA market is the second most traded secondary market after the U.S. Treasury market.

Understanding the 48-Hour Rule

An MBS is a bond that is secured, or backed, by mortgage loans. Loans with similar traits are grouped to form a pool. The pool is then sold as a security to investors. The issuance of interest and principal payments to investors is at a rate based on the principal and interest payments made by the borrowers of the underlying mortgages. Investors receive interest payments monthly rather than semiannually.

A to-be-announced (TBA) trade is effectively a contract to buy or sell mortgage-backed securities (MBS) on a specific date. It does not include information regarding the pool number, the number of pools, or the exact amount involved in the transaction, which means the underlying mortgages are not known to the parties. This exclusion of data is due to the TBA market assuming that MBS pools are more or less interchangeable. This interchangeability helps facilitate trading and liquidity.

The 48-hour rule is part of the mortgage allocation process, the period when the underlying mortgages will be assigned and made available to a specific MBS, which was created to bring transparency to TBA trade settlements.

The 48-hour rule states that the seller of a specific MBS must make the buyer of that MBS aware of the mortgages that make up the MBS 48 hours prior to the trade settling. Because of the standard T+3 settlement date, this usually occurs on the day after the trade is executed.

The 48-Hour Rule as Part of the TBA Process

The TBA process benefits buyers and sellers because it increases the liquidity of the MBS market by taking thousands of different mortgage-backed securities with different characteristics and trading them through a handful of contracts.

Buyers and sellers of TBA trades agree on a few necessary parameters such as issuer maturity, coupon, price, par amount, and settlement date. The specific securities involved in the trade are announced 48 hours before the settlement.

The TBA market was established in the 1970s to facilitate the trading of MBS issued by Fannie Mae, Freddie Mac, and Ginnie Mae. It allows mortgage lenders to hedge their origination pipelines.

The TBA market is the most liquid secondary market for mortgage loans, resulting in high levels of market activity. In fact, the amount of money traded on the TBA market is second only to the U.S. Treasury market.

Example of the 48-Hour Rule

Company ABC decides to sell a mortgage-backed security (MBS) to Company XYZ and Company XYZ accepts. The sale will take place on Tuesday. On Tuesday, when the sale is made, neither Company ABC nor Company XYZ knows the underlying mortgages that make up the mortgage-backed security (MBS).

The standard industry settlement is T+3 days, meaning this trade will settle on Friday. According to the 48-hour rule, on Wednesday before 3 p.m. Eastern Time, Company ABC will have to notify Company XYZ of the mortgage allocations it will receive when the trade settles.

[ad_2]

Source link