financial

Reviewed by JeFreda R. Brown

Semiconductor companies offer a lot of highly liquid securities that encourage risk-taking in all time frames, from intraday scalping to monthly market timing. The sector also supports various profit strategies, including momentum trading, basket allocations, and short selling. It acts independently in many market phases, going its own way while major indices push higher or lower. This divergent behavior brings additional opportunities, even in difficult macro conditions. There are many ways to trade the semiconductor space, from identifying particular stocks to investing in the sector as a whole using exchange-traded funds (ETFs).

Key Takeaways

• Semiconductor stocks play a key role in the global economy, driven by their integral use in electronic devices and technological advancements.
• The sector is highly cyclical, with supply-demand imbalances influencing stock performance, making it important for traders to be mindful of timing.
• Geopolitical factors, such as trade policies and global tensions, can significantly impact the semiconductor industry by affecting supply chains and market access.
• Technological advancements, including AI and 5G, drive demand for more sophisticated chips, presenting growth opportunities for semiconductor companies.
• Investors should carefully analyze financial metrics, market trends, and potential risks, including supply chain disruptions and regulatory changes, when trading semiconductor stocks.

Currency exchange rates (forex) impact broad sector performance, with just two of the top five highest capitalized components based in the United States: NVIDIA (NVDA) and Broadcom (AVGO). In addition, a strong U.S. dollar undermines chip makers with major overseas operations because their products become less competitively priced. This is especially true in mature sub-sectors that post lower profit margins, like memory chips and electronics used in audio parts. The specter of tariffs on Chinese exports to the United States also is of concern to investors in semiconductors where certain parts or assembly processes take place overseas.

Finding the Best Chip Trade

TOP SEMICONDUCTOR STOCKS

Stocks at all market capitalization levels can offer good trading opportunities but most market players stick with the most popular names, playing those issues against leading or lagging Nasdaq 100 performance. American semiconductor blue-chip companies impact that index to a greater degree than the S&P 500, where they share dual listings. These cross-market connections also support a variety of contrary strategies when stock performance diverges sharply from index performance.

Mid and small-cap semiconductors generate a steady stream of momentum and trend-following plays because they usually show the highest growth potential. Finding these hot plays requires a database that sorts first by capitalization and then by performance, looking for the strongest uptrends in technical strategies and the fastest revenue growth in fundamental strategies. The $500 million to $2 billion capitalization zone offers a sweet spot for emerging companies that have yet to attract broad public interest, making it an excellent focus for weekend study and preparation.

Semiconductor ETFs

TOP SEMICONDUCTOR EXCHANGE TRADED FUNDS (ETFs) FOR NOVEMBER 2024

Out of the non-leverage ETFs, VanEck Semiconductor ETF (SMH) attracts the most volume because it’s the oldest sector exchange-traded fund, with the newer iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) providing direct competition. SOXX has a higher expense ratio, holds more assets and tends to cover a greater percentage of ground in a typical trading day than SMH. SMH also has the largest open interest in its listed options compared to its peers.

Direxion Daily Semiconductor Bull 3X Shares (SOXL) and Daily Semiconductor Bear 3X Shares (SOXS) offer aggressive players much higher sector leverage, balanced with added risk and higher costs. These securities are designed to yield three times the movement of a typical sector index. This works well with multiday bets but intraday returns can vary greatly due to a periodic calculation of relative value, often generating chaotic late-day price action that diverges sharply from a non-leveraged sector ETF.

An ETF Trading Example

Here is a historical example of the iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) from the end of 2008 into 2009. As the chart above shows, SOXX shares broke out above the September high (blue line) in November and hit an all-time high at 96.03 in December. It sold off in a bull flag pattern (red lines) into February, testing support at the breakout level and 50-day EMA. The Nasdaq 100 took off on February 10 (black arrow)—in reaction to the positive overseas news—and rose more than 1.3%. That outperformed the S&P 500 and other large-cap indices. Semiconductors underpin that tech rally, with SOXX rising more than 3%, breaking out of the flag pattern and triggering a major buy signal. 

What Are Semiconductor Stocks?

Semiconductor stocks represent companies involved in the design, manufacturing, and distribution of semiconductor devices, which are essential components in modern electronics.

What Are the Risks Associated with Trading Semiconductor Stocks?

Trading semiconductor stocks involves risks such as market volatility, supply chain disruptions, and technological obsolescence. The semiconductor industry is highly cyclical, with periods of oversupply and undersupply affecting stock prices. Last, geopolitical tensions and regulatory changes can impact the operations and profitability of semiconductor companies.

How Do Interest Rates Affect Semiconductor Stocks?

Interest rates can affect semiconductor stocks by influencing consumer spending and corporate investment. If rates are higher, people may spend less (or borrow less), meaning less demand for products with semiconductors.

The Bottom Line

Chip stocks provide the biggest basket of technology companies listed on US exchanges. Major variations between sub-components offer an endless variety of trading and investment opportunities through divergent market conditions. Semiconductor ETFs also provide a good way to gain exposure to the sector.

Reviewed by Akhilesh Ganti
Fact checked by Vikki Velasquez

You do not need to be glued to your trading screen to take advantage of the strategies used by top market players to profit from stocks, futures and forex. Start with a giant step back, setting your focus on weekly patterns that carve out more reliable highs and lows than daily or intraday price action does. Then, build management rules that allow you to sleep at night, while the fast fingered crowd tosses and turns, fixated on the next opening bell.

Key Takeaways

• Weekly charts allow traders to focus on broader market trends by smoothing out the volatility seen in daily price movements, making it easier to spot long-term patterns.
• By analyzing weekly data, traders can reduce the noise created by short-term fluctuations, which often result from high-frequency trading and market news.
• This approach helps identify clear support and resistance levels, providing better insights into the overall market direction and potential trade opportunities.
• Weekly patterns encourage traders to step back from the immediate market reactions and consider a more strategic view of price movements over a longer period.
• Although weekly charts offer significant advantages, they should be used alongside other timeframes to capture a complete picture of market dynamics and avoid missing shorter-term trading signals.

Algorithms, also known as high-frequency trading (HFT) robots, have added considerable danger to intraday sessions in recent years, jamming prices higher and lower to ferret out volume clusters, stop losses and inflection points where human traders will make poor decisions. Focusing on weekly charts avoids this predatory behavior by aligning entry, exit and stop losses with the edges of longer-term uptrends, downtrends, support and resistance.

Another downside to daily charts is that they may encourage overtrading. The increased frequency of price movements on a daily scale can tempt traders to act impulsively, entering and exiting positions too frequently. This behavior often leads to higher transaction costs and can erode profits, especially when trades are based on short-term market noise rather than longer-term trends.

For these reasons, it may make more sense to sometimes take the big picture approach.

The Big Picture Approach

This big picture approach lowers noise levels considerably, allowing the weekly trader to see opportunities that are missed by short-term players flipping through their daily charts at night. Admittedly, these trade setups require patience and self discipline because it can take several months for weekly price bars to reach actionable trigger points.

However, higher reward potential makes up for this lower activity level, while total work effort allows the trader to have a real life away from the financial markets.

Using Weekly Charts

Weekly charts utilize specific risk management rules to avoid getting caught in big losses:

1. Lower position size and avoid the overuse of margin. A few hundred shares will do the work of a thousand or more when you let prices travel many points before taking your profit or loss.
2. Be selective in position choice. As a general rule, highly capitalized equities and the most popular exchange-traded funds (ETF) generate better weekly trades than small cap darlings or high flying biotechs that can drop 30% to 50% after an adverse FDA decision.
3. Focus on the edges of long-term ranges and moving averages. Opening a weekly trade in the middle of a 15- or 20-point sideways pattern is a sure-fire way to lose money, while buying a pullback to the 50-week EMA can produce outstanding results.
4. Respect the power of opportunity cost. The capital you set aside for a weekly trade that lasts several months cannot be used for a higher reward setup that magically appears while you are managing the other position.

Feel free to add fundamental techniques to your weekly technical trade criteria. For example, solid earnings growth will increase your confidence when buying a stock that is nearing a weekly support level after a sell-off. Moreover, dollar cost averaging can be utilized aggressively, adding to positions as they approach and test these action levels. But do not get blinded by the company’s balance sheet if support breaks because you will need to take your loss aggressively.

A Historical Example

Let’s look at an example from the past using four weekly trade setups carved out by Powershares QQQ Trust (QQQ). Note that these numbers are historical are do not reflect live or current prices.

The fund entered a weekly trading range, with support near 85 in November. It rallied above 90 at the start of the next year and sold off, returning to long-term range support in April. Weekly traders could build low-risk positions at that level (1), ahead of a 7-week bounce that added more than 7 points. In addition, a second buy signal erupted when it rallied above January resistance (2), favoring a new entry or continuation of the first position, which is now held at a substantial profit.

While positions should be taken as close to weekly support as possible, stops and other unprofitable exits need to avoid intraday volatility, which means one should defer exit decisions until the weekend or until support is breached by several percentage points.

The steep October slide set up a third weekly trade entry when it descended to support above 91 (3), created by the June breakout. That level also aligned perfectly with support at the 50-week moving average, significantly raising odds for a bullish outcome. The fund went vertical off that support zone, testing the yearly high and breaking out into year’s end. A final buy signal goes off when it breaks out into triple digits in November (4).

April and October pullbacks into weekly support (red circles) raise an important issue in the execution of weekly trades. Both declines violated support mid-week and bounced, closing Friday’s session above those contested levels.

What Are Weekly Trading Patterns?

Weekly trading patterns involve analyzing price movements and trends on weekly charts, where each candlestick or bar represents one week of trading activity. This approach helps traders identify longer-term trends and potential entry or exit points, reducing the noise and volatility often present in daily charts.

How Do Weekly Charts Differ From Daily Charts?

Weekly charts aggregate daily price movements into a single bar or candlestick per week, providing a broader view of market trends. This consolidation smooths out short-term volatility, making it easier to identify significant support and resistance levels.

Why Should Traders Consider Using Weekly Charts?

Weekly charts help traders avoid the erratic price movements caused by high-frequency trading algorithms in daily sessions. By focusing on longer-term trends, traders might be able to reduce the impact of short-term market noise.

What Are the Risks of Relying Solely on Weekly Patterns?

While weekly patterns provide a broader market perspective, they may overlook short-term events or news that could impact prices. For instance, after a week has passed related to a press release or earnings call, it’ll be too late to respond to any immediate price movement.

The Bottom Line

Trading with weekly charts allows traders to focus on long-term trends, helping to avoid the short-term volatility and noise seen in daily price movements. By concentrating on broader market directions, traders can make more informed decisions that align with the overall market momentum. This method also minimizes the influence of high-frequency trading algorithms that often distort daily charts, providing clearer signals for trade planning.

Reviewed by Thomas Brock
Fact checked by Suzanne Kvilhaug

Companies issue stock in order to raise money to fund their operations. These shares represent and entitle the holder to a stake of ownership in the company. By purchasing shares, the shareholder is given a certain amount of rights. Depending on the type of share, the holder may be able to share in the company’s profitability. This comes in the form of dividends, which are paid at regular intervals during the year. Other shareholders are allowed the right to have a say in the direction of the company. This is true of companies all around the world, whether they’re in the United States, Canada, or the United Kingdom.

What kind of shares do companies in the U.K. sell to their stakeholders? Learn more about public limited companies and the different types of shares they issue.

Key Takeaways

• PLCs issue many different kinds of stock such as ordinary shares, cumulative preference shares, preference shares, and redeemable shares.
• Ordinary shares are similar to common stock, giving the shareholder the right to vote.
• Dividends are paid to cumulative preference and preference shareholders before anyone else.
• Companies are able to buy back redeemable shares from stockholders at fixed dates or when management chooses.
• Bearer shares, which came in the form of warrants, are no longer issued.

What Is a Public Limited Company (PLC)?

A public limited company (PLC) is a legal corporate structure in the United Kingdom or the Republic of Ireland that is essentially similar to a publicly-traded company in the United States. Although a PLC may sometimes be constituted as a privately-held company, it is most often a public company. Company shares are freely traded on exchanges. In accordance with U.K. company law, a PLC must have a minimum share capital of £50,000 and the PLC designation after the company name.

Much like public companies in the U.S., PLCs usually pay out dividends to shareholders at regular intervals as long as the company generates a profit. Stock shares also confer voting rights to the shareholder at a company’s annual general meeting, although voting rights may vary according to the type of shares owned. Ordinarily, the amount of voting power that an investor has corresponds to the amount of stock shares owned.

A PLC is allowed to issue many different kinds of stock shares such as ordinary shares, cumulative preference shares, preference shares, bearer shares, and redeemable shares.

Ordinary Shares

This is the most common type of share issued by a PLC. It is essentially the same as common stock in U.S. equities. Ordinary shares may be subdivided into different classes such as A or B and have different share prices.

These shares allow shareholders the right to vote on issues relating to the corporate policy as well as the make up of a company’s board of directors. This is why they are also sometimes referred to as voting shares. Shareholders get one vote per share. Other than that, ordinary shares carry no other special rights for the shareholder.

Ordinary shareholders are considered last in line when it comes to repaying their initial investment back. This is especially true when and if a company shuts down or goes bankrupt.

Important

Ordinary shares, like common stock in the U.S., give shareholders the right to vote, but no other special rights.

Cumulative Preference Shares

This share type roughly corresponds to the preferred stock shares of U.S. companies. Like U.S. preferred stock, these shares come with the stipulation that any scheduled dividends that cannot be paid when due are carried forward and must be paid before the company can pay out ordinary share dividends. These shareholders receive their dividends in arrears before preferred stockholders. This applies to any dividends that are paid late or any amount that is not paid in full when due.

Preference Shares

Preference shareholders have the right to be paid dividends prior to owners of other share types. The dividends they receive are at a fixed rate. This means if the company profits and raises its dividend, preference stockholders don’t get a raise.

This is a slightly less preferred share type, though. Preference shares do not typically carry voting rights, and generally do not share any of the company’s success.

Redeemable Shares

As the name implies, redeemable shares are issued with the shareholder agreeing that the shares can be redeemed, or bought back by the company, either after a certain time period or on a given date. Dates may be fixed or at the discretion of the company’s management team.

Redeemable shares may vary according to which party—either the company or the shareholder—has the option to exercise the company buyback provision.

Non-Voting Shares

These shares are like ordinary shares except they carry no voting rights. Non-voting shareholders are also not given the opportunity to attend annual or general meetings.

This type of share is usually issued to employees so that part of their compensation can be paid in the form of dividends. This arrangement usually provides tax benefits for the company and employees. Non-voting shares may also be given to family members of upper management.

Bearer Shares

Bearer shares were another form of shares issued by PLCs in the U.K. but were abolished following the Small Business, Enterprise, and Employment Act (SBEE) of 2015.

These shares commonly came in the form of warrants—legal documents entitling the bearer to own the shares designated in the warrant. The warrants normally came with vouchers enabling the bearer to claim any due dividends. Completely transferable, there was no record kept saying who owned the warrant. This meant the owner was able to deal with the shares anonymously. Problems arose, though, if the owner lost the certificate or it was stolen, making legal entitlement difficult to establish.

Once the SBEE was established, companies were not allowed to issue new bearer shares. Those with existing bearer shares were required to cancel them or transfer them to non-bearer shares.

Downsides to PLC Shares

In the article above, we touched on the types of share PLCs can issue and why they may choose to do so. However, there are some downsides to consider for each type of share. For the main types of share they can offer, keep in mind that:

• Ordinary Shares: Ordinary shareholders are last in line when it comes to receiving dividends or recovering their investment if the company liquidates or goes bankrupt. While they grant voting rights, these shares offer no guaranteed returns, making them riskier, especially for income-focused investors.
• Cumulative Preference and Preference Shares: Cumulative preference shares guarantee dividend arrears but limit investors to fixed returns. You might miss out on higher dividends if the company performs exceptionally well.
• Redeemable Shares: Redeemable shares offer companies the flexibility to buy back shares, but this can disadvantage shareholders if redemption occurs during unfavorable market conditions.
• Non-Voting Shares: Non-voting shares strip shareholders of decision-making power and exclude them from influencing company policies or attending meetings.
• Bearer Shares: Though they can not be used in many contexts, bearer shares substantially increased ownership risk as ownership was tied to the physical ownership of the documents.

What Are the Main Types of Shares a PLC Can Issue?

Public limited companies can issue ordinary shares, preference shares, deferred shares, and redeemable shares. Ordinary shares typically provide voting rights and dividends, while preference shares offer fixed dividends and priority during liquidation. Other specialized shares, like employee shares or tracking shares, may also be issued based on the company’s needs.

What Is the Difference Between Ordinary Shares and Preference Shares?

Ordinary shares give holders ownership in the company, voting rights, and variable dividends based on profitability. Preference shares provide fixed dividends and have priority in dividend payments and liquidation proceeds, but usually lack voting rights. 

What Are Deferred Shares, and Why Might a PLC Issue Them?

Deferred shares are usually paid dividends only after ordinary shareholders receive a specific amount, often making them unattractive. They are issued to founders or early investors to align incentives with long-term performance. Companies might use deferred shares to manage cash flow or reward initial stakeholders later.

The Bottom Line

Public limited companies can issue many different types of shares. These could include but aren’t necessarily limited to ordinary, preference, redeemable/bearer, non-bearing, and employee shares. Regulatory requirements ensure transparency and fairness in share issuance, safeguarding shareholder interests and compliance with laws.

Fact checked by Yarilet Perez
Reviewed by Samantha Silberstein

Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific period. Swaps offer great flexibility in designing and structuring contracts based on mutual agreement. This flexibility generates many swap variations, with each serving a specific purpose.

There are multiple reasons why parties agree to such an exchange:

• Investment objectives or repayment scenarios may have changed.
• There may be increased financial benefit in switching to newly available or alternative cash flow streams.
• The need may arise to hedge or mitigate risk associated with a floating rate loan repayment.

Key Takeaways

• Swaps are financial agreements where two parties exchange cash flows for investment and risk management purposes.
• Interest rate swaps help parties convert floating-rate loans to fixed ones (and vice versa) to achieve cost-effective borrowing.
• Currency swaps allow companies in different countries to access lower-cost loans and hedge against foreign exchange rate fluctuations.
• Credit default swaps offer insurance protection against borrower defaults, while total return swaps allow investors to benefit from securities without needing to own them.

Interest Rate Swaps

The most popular types of swaps are plain vanilla interest rate swaps. They allow two parties to exchange fixed and floating cash flows on an interest-bearing investment or loan. 

Businesses or individuals attempt to secure cost-effective loans but their selected markets may not offer preferred loan solutions. For instance, an investor may get a cheaper loan in a floating rate market, but they prefer a fixed rate. Interest rate swaps enable the investor to switch the cash flows, as desired.

Assume Paul prefers a fixed-rate loan and has loans available at a floating rate (SOFR + 0.5%) or at a fixed rate (10.75%). Mary prefers a floating rate loan and has loans available at a floating rate (SOFR + 0.25%) or at a fixed rate (10%).

Due to a better credit rating, Mary has the advantage over Paul in both the floating rate market (by 0.25%) and the fixed rate market (by 0.75%). Her advantage is greater in the fixed rate market so she picks up the fixed rate loan.

However, since she prefers the floating rate, she gets into a swap contract with a bank to pay SOFR and receive a 10% fixed rate.

Paul borrows at a floating (SOFR + 0.5%), but since he prefers a fixed, he enters into a swap contract with the bank to pay a fixed 10.10% and receive the floating rate. 

Benefits

Paul pays (SOFR + 0.5%) to the lender and 10.10% to the bank, and receives SOFR from the bank. His net payment is 10.6% (fixed). The swap effectively converted his original floating payment to a fixed rate, getting him the most economical rate.

Similarly, Mary pays 10% to the lender and SOFR to the bank and receives 10% from the bank. Her net payment is SOFR (floating).

The swap effectively converted her original fixed payment to the desired floating, getting her the most economical rate. The bank takes a cut of 0.10% from what it receives from Paul and pays to Mary.

Currency Swaps

The transactional value of capital that changes hands in currency markets surpasses that of all other markets. Currency swaps offer efficient ways to hedge forex risk.

Assume an Australian company is setting up a business in the U.K. and needs GBP 10 million. Assuming the AUD/GBP exchange rate is at 0.5, the total comes to AUD 20 million. Similarly, a U.K.-based company wants to set up a plant in Australia and needs AUD 20 million.

The cost of a loan in the U.K. is 10% for foreigners and 6% for locals, while in Australia it’s 9% for foreigners and 5% for locals. Apart from the high loan cost for foreign companies, it might be difficult to get a loan easily due to procedural difficulties.

Both companies have a competitive advantage in their domestic loan markets. The Australian firm can take a low-cost loan of AUD 20 million in Australia, while the English firm can take a low-cost loan of GBP 10 million in the U.K. Assume both loans need six monthly repayments.

Both companies then execute a currency swap agreement. At the start, the Australian firm gives AUD 20 million to the U.K. firm and receives GBP 10 million, enabling both firms to start a business in their respective foreign lands.

Every six months, the Australian firm pays the English firm the interest payment for the English loan = (notional GBP amount * interest rate * period) = (10 million * 6% * 0.5) = GBP 300,000 while the English firm pays the Australian firm the interest payment for the Australian loan = (notional AUD amount * interest rate * period) = (20 million * 5% * 0.5) = AUD 500,000.

Interest payments continue until the end of the swap agreement, at which time the original notional forex amounts will be exchanged back to each other.

Benefits

By getting into a swap, both firms were able to secure low-cost loans and hedge against interest rate fluctuations. Variations also exist in currency swaps, including fixed versus floating and floating versus floating. In sum, parties are able to hedge against volatility in forex rates, secure improved lending rates, and receive foreign capital.

Important

Swaps can involve counterparty risk because they are over-the-counter (OTC) transactions but many are now cleared through central counterparties (CCPs) to ensure both parties fulfill their obligations.

Commodity Swaps

Commodity swaps are common among individuals or companies that use raw materials to produce goods or finished products. Profit from a finished product may suffer if commodity prices vary, as output prices may not change in sync with commodity prices. A commodity swap allows the receipt of payment linked to the commodity price against a fixed rate.

Assume two parties get into a commodity swap over one million barrels of crude oil. One party agrees to make six-monthly payments at a fixed price of $60 per barrel and receive the existing (floating) price. The other party will receive the fixed rate and pay the floating.

If crude oil rises to $62 at the end of six months, the first party will be liable to pay the fixed ($60 *1 million) = $60 million and receive the variable ($62 * 1 million) = $62 million from the second party.

Net cash flow in this scenario will be $2 million transferred from the second party to the first. Alternatively, if crude oil drops to $57 in the next six months, the first party will pay $3 million to the second party. 

Benefits

The first party has locked in the price of the commodity by using a currency swap, achieving a price hedge. Commodity swaps are effective hedging tools against variations in commodity prices or against variations in spreads between the final product and raw material prices.

Credit Default Swaps

The credit default swap offers insurance in case of default by a third-party borrower. Assume Peter bought a 15-year-long bond issued by ABC, Inc. The bond is worth $1,000 and pays an annual interest of $50 (i.e., a 5% coupon rate).

Peter worries that ABC, Inc. may default so he executes a credit default swap contract with Paul. Under the swap agreement, Peter (CDS buyer) agrees to pay $15 per year to Paul (CDS seller). Paul trusts ABC, Inc. and is ready to take the default risk on its behalf.

For the $15 receipt per year, Paul will offer insurance to Peter for his investment and returns. If ABC, Inc. defaults, Paul will pay Peter $1,000 plus any remaining interest payments. If ABC, Inc. does not default during the 15-year long bond duration, Paul benefits by keeping the $15 per year without any payables to Peter.

Benefits

The CDS works as insurance to protect lenders and bondholders from borrowers’ default risk.

Zero-Coupon Swaps

Similar to the interest rate swap, the zero-coupon swap offers flexibility to one of the parties in the swap transaction. In a fixed-to-floating zero coupon swap, the fixed rate cash flows are not paid periodically, but just once at the end of the maturity of the swap contract.

The other party who pays the floating rate keeps making regular periodic payments following the standard swap payment schedule.

A fixed-fixed zero coupon swap is also available, wherein one party does not make any interim payments, but the other party keeps paying fixed payments as per the schedule.

Benefits

The zero coupon swap (ZCS) is primarily used by businesses to hedge a loan in which interest is paid at maturity or by banks that issue bonds with end-of-maturity interest payments.

Note

Swaps are sometimes used in tax arbitrage, allowing parties to reduce tax liabilities by moving cash flows between jurisdictions with different tax rates, though these are subject to regulatory scrutiny.

Total Return Swaps

A total return swap gives an investor the benefits of owning securities without actual ownership. A TRS is a contract between a total return payer and a total return receiver.

The payer usually pays the total return of the agreed security to the receiver and receives a fixed/floating rate payment in exchange. The agreed (or referenced) security can be a bond, index, equity, loan, or commodity. The total return will include all generated income and capital appreciation.

Assume Paul (the payer) and Mary (the receiver) enter into a TRS agreement on a bond issued by ABC Inc. If ABC Inc.’s share price rises (capital appreciation) and pays a dividend (income generation) during the swap’s duration, Paul will pay Mary those benefits. In return, Mary has to pay Paul a pre-determined fixed/floating rate during the duration.

Benefits

Mary receives a total rate of return (in absolute terms) without owning the security and has the advantage of leverage. She represents a hedge fund or a bank that benefits from the leverage and additional income without owning the security. 

Paul transfers the credit risk and market risk to Mary in exchange for a fixed/floating stream of payments. He represents a trader whose long positions can be converted to a short-hedged position while also deferring the loss or gain to the end of swap maturity.

What Is a Bullet Swap?

A bullet swap is a type of interest rate swap where the principal amount is exchanged at the end of the swap rather than throughout its duration. This involves a lump sum payment at the end of the swap contract. Bullet swaps are used to align the swap with a future cash flow event or financial need and help with managing liquidity and hedging risk.

What Is the Difference Between Swaps and Options?

Swaps and options are both financial derivatives but they function differently. Swaps are contracts that allow parties to exchange cash flows over a specific period, usually to hedge or speculate on interest rates, commodities, or currencies. An option, on the other hand, gives the holder the right to buy or sell (but not the obligation) an asset at a set price before or on a specific date. Swaps involve ongoing exchanges while options need to be exercised (or not).

Is a Swap an Asset or a Liability?

Whether a swap is an asset or a liability will depend on its value relative to the market. If the swap has a positive value for one party, then it is an asset, if it has a negative value, then it is a liability. A negative value for a party is not necessarily bad as swaps are used to hedge risk, so even with an initial negative value, the swap serves a purpose. For accounting purposes, swaps need to be recorded as derivatives, which must be recognized on the balance sheet at fair value on the reporting date.

The Bottom Line

Swap contracts can be easily customized to meet the needs of all parties. They offer win-win agreements for participants, including intermediaries like banks that facilitate the transactions. Even so, participants should be aware of potential pitfalls as many of these contracts are executed over the counter without regulations.

Reviewed by Samantha Silberstein
Fact checked by Kirsten Rohrs Schmitt

There are several differences that make renting and owning property distinctly different. Renting a property doesn’t come with all of the responsibilities associated with homeownership. You also have more flexibility, as you aren’t necessarily tied down to your property. Owning your home, on the other hand, gives you a sizeable investment, but it does come at a big cost—both upfront and over the long run.

Owning a home isn’t always better than renting, and renting isn’t always as simple as it seems. Here, we highlight some of the key differences between renting and buying a home.

Key Takeaways

• Whether you choose to rent or buy your home depends on your financial situation, lifestyle, and personal goals.
• Renting offers flexibility, predictable monthly expenses, and someone to handle repairs.
• Homeownership brings intangible benefits, such as a sense of stability and pride of ownership, along with the tangible ones of tax deductions and equity.
• Renting doesn’t mean you’re throwing away money every month, and owning doesn’t always help you build wealth in the long run.

Renting a Home

The biggest myth about renting is that you’re throwing away money every month. This is not true. After all, you need a place to live, and that always costs money in one way or another. While it’s true that you aren’t building equity with monthly rent payments, not all of the costs of homeownership go toward building equity.

When you rent, you know exactly what your housing costs are each month. This amount is indicated on your lease so you can plan accordingly. In some cases, your landlord may also include other costs within that amount, such as utilities, storage, and homeowner association (HOA) fees if you live in a condominium.

As a renter, you may face rent increases each time your lease is up for renewal. These rent increases can be even steeper if you live in certain parts of town. This may not be the case if you live in an area with rent ceilings and rent control, which limit how much a landlord can increase the rent, if at all.

Renting means you’re able to move whenever your lease ends. However, it also means you could have to move suddenly if your landlord decides to sell the property or turn your apartment complex into condos. Or they could bump up the rent to more than you can afford.

Important

Although not as universal as homeowners’ insurance, renters’ insurance is often recommended (and sometimes required by landlords) for those leasing homes or apartments.

Owning a Home

Homeownership brings tangible and intangible benefits. Not only do you have your own home, but you can make decisions about the look and design of your space. You also get a sense of stability and pride of ownership.

Keep in mind, though, that changing your mind about where you’re living can be very expensive since real estate is an illiquid asset. You may not be able to sell when you want. And even if you do, you may not get the price you want, especially if the housing market is down. Even if it’s up, there are significant transaction costs associated with selling your property.

The overall cost of homeownership tends to be higher than renting even if your mortgage payment is lower than the rent. Here are some expenses you’ll be spending money on as a homeowner that you generally do not have to pay as a renter:

• Property taxes
• Trash pickup (some landlords require renters to pay this)
• Water and sewer service (some landlords require renters to pay this)
• Pest control
• Tree trimming
• Homeowners insurance
• Pool cleaning (if you have one)
• Lender-required flood insurance (in some areas)
• Earthquake insurance (in some areas)

Mortgage interest can make up nearly all of your monthly payments in the early years of a long-term mortgage. It can take as many as 13 years before more of your payment goes toward the principal balance in a 30-year home loan. You’ll spend about $72,000 in interest for a $100,000 loan at 4% for 30-years. However, you’ll recoup some of that in tax deductions if you can itemize.

And let’s not forget repairs and maintenance, which can be very costly. You may find yourself with an unexpected leak in the roof. Replacing your roof could cost an additional, say, $12,000, which may not be covered under your home insurance policy.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, file a report with the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

Key Differences

Property Values

Homeownership is often touted as a way to build wealth. But like any other investment, certain factors can positively or negatively affect the value of your home, including:

• Economic issues
• Maintenance
• Environmental concerns, such as nearby landfills and hazardous waste sites
• Outdated interiors
• Exterior conditions
• Housing surpluses

These factors can, of course, affect you as a renter, too. For instance, negative factors may help lower your rental costs. After all, the landlord may be desperate for income and may end up slashing the monthly price.

Tax Benefits

Homeowners may benefit from certain tax benefits. The home mortgage interest deduction reduces any out-of-pocket expenses during the early life of the loan, as long as deductions are itemized.

Of course, if you rent, you get no mortgage tax deduction at all. Keep in mind, that you can still take the standard deduction that’s available to all taxpayers. The same is true for homeowners who don’t have enough deductions to itemize individually.

Repairs and Maintenance

Being a homeowner means you’re responsible for maintenance and regular upkeep. This can be very costly. And renovation projects don’t often increase your home’s value by more than what you spend on them. According to Remodeling magazine, project costs continue to outweigh values, with an estimated 60 cents recouped for every dollar spent on repairs and renovations.

If you live in a community with an HOA, it may take some homeownership chores off your plate. That will usually cost a few hundred dollars a month. But beware of the headaches that association membership can entail. If you rent, your landlord will take care of all the repairs and maintenance, though of course they may not be done as quickly or as well as you would like.

The projects that recoup the most are not glamorous things you’ll be excited about doing. The best return (and the only one on Remodeling’s list that comes close to recouping its entire cost) comes from replacing a garage door.

Time Commitment

The time commitment that comes with homeownership may be more than you want to take on. There are always projects that you will need or want to take care of.

After factoring in the costs of homeownership, you may find that renting may make more financial sense, allowing you to invest the money you would have put into a home into a retirement account.

Special Considerations

The decision to rent or own depends on your financial situation. But it’s also about your comfort and vision for your future. Ignore people who tell you that owning always makes more sense in the long run or that renting is throwing away money. Disregard anyone who says that buying makes more sense if your monthly mortgage payment is more cost-efficient than your monthly rent payment. Housing markets and life circumstances are too varied to make blanket statements like these.

Before you do anything, be sure to weigh the risks involved, especially with buying a home. Getting a mortgage often requires using a large amount of financial leverage. If housing prices go up, people with mortgages can make extraordinary gains. But you also stand to lose if prices plummet. During the subprime meltdown, an unprecedented number of Americans ended up with underwater mortgages. The key is to pay attention to housing prices by looking at the Case-Shiller Index. If prices seem too high, renting for a few years may make more sense.

Still, despite the risk, added expense, and extra chores associated with owning a home, many people choose it over renting. It provides a more permanent place to raise children. It is also frequently the only way to have, or create, the sort of residence people want. Ultimately, the decision to rent or to own is not just financial. It’s also emotional.

Is It Better to Rent or Buy a Home?

There’s no definitive answer about whether renting or owning a home is better. The answer depends on your own personal situation—your finances, lifestyle, and personal goals. You need to weigh out the benefits and the costs of each based on your income, savings, and how you live.

Is Renting Cheaper Than Owning a Home?

Renting can be a very predictable expense. You know what your costs are upfront and can plan accordingly. On the other hand, if you enjoy a lavish lifestyle, you may find renting to be more expensive than owning a home, even if there are repairs and regular maintenance you have to make with purchasing real estate.

Is Homeownership a Good Investment?

Buying a home can be a very good investment. You may be able to build equity. But as with any investment, just how well your investment performs depends on a number of factors. When it comes to real estate, factors like location, the economy, maintenance, and environmental concerns can affect the overall value.

The Bottom Line

Buying a home is a huge part of the American Dream. Choosing to buy or rent, though, is a major decision that affects your financial health, lifestyle, and personal goals. Whichever option you choose depends entirely on your lifestyle and financial situation. Both require a regular income and may also require a certain degree of effort to maintain. Whatever you do, when you’re weighing your options, take your time. It’s a big decision.

Reviewed by Margaret James

Microsoft Corporation (NASDAQ: MSFT) is a large software company known for its Windows operating system and Microsoft Office suite of products. The company’s capital structure relies more heavily on equity capital than debt for financing, though debt has grown to play an increasingly large role. In this capital structure analysis of Microsoft, we’ll review the company’s equity capital, debt capital, financial leverage, and enterprise value.

Key Takeaways

• There are four factors we can review when analyzing Microsoft’s capital structure: equity capital, debt capital, financial leverage, and enterprise value.
• Microsoft’s shareholders’ equity increased from $118.3 billion in 2020 to $268.5 billion in 2024.
• Microsoft’s long-term debt decreased from $59.6 billion in 2020 to $42.7 billion in 2024.
• Microsoft’s enterprise value has grown from $1.66 trillion in September 2020 to almost $3.27 trillion as of September 2024.

Microsoft Equity Capital

Equity capital refers to the financing a business receives from the sale of equity and the net profits attributable to equity holders. It can include balance sheet items such as common stock at par value, retained earnings, additional paid-in capital, and accumulated other comprehensive income. As of June 30, 2024, Microsoft’sshareholders’ equity was approximately $268.5 billion, consisting of about $100.9 billion of common stock, about $173.1 billion in retained earnings, and roughly $5.6 billion of negative equity.

Microsoft’s total shareholder equity from about $118.3 billion in 2020 to about $268.5 billion in 2024. The increase in Microsoft’s shareholder equity value has been driven primarily by increased retained earnings. Although Microsoft was generating positive net earnings over those years, significant amounts of capital were returned to shareholders in the form of cash dividends and share repurchases.

In fiscal 2021, the company spent nearly $16.8 billion on buybacks and issued nearly $16.9 billion in dividends. In fiscal 2018, the company repurchased $10.72 billion of common stock and paid $12.69 billion in dividends. In fiscal 2019, Microsoft spent $19.5 billion on share repurchases and paid $13.8 billion on dividends.

Microsoft Debt Capital

Debt capital includes short- and long-term debt such as bonds, unsecured notes, and term loans. Over the past three years, Microsoft has significantly reduced its amount of short-term debt. In its 2017 annual report, the company listed $9.07 billion in short-term debt. In 2018 and 2019, the company reported no short-term liabilities.

According to its annual report for fiscal year 2015, Microsoft had long-term debt of $17.9 billion. Since then, the company has significantly increased its amount of long-term debt, some of which can be attributed to its acquisition of LinkedIn for $26.2 billion in 2016. In its 2017 annual report, the company listed $22.1 billion in long-term debt. The company had long-term debt of $31 billion at the end of the fiscal year 2018 and $32.5 billion at the end of the fiscal year 2019. 

Microsoft Financial Leverage

To analyze the amount of debt in a company’s capital structure, it is necessary to use a financial leverage ratio, such as the total debt-to-capital ratio. This allows investors to track debt relative to equity capital over time and in comparison to other firms. Microsoft’s debt-to-capital ratio was 7.8% as of June 2019, down from 10.5% at the end of the fiscal year June 2018 and 13.9% in June 2017. The company’s declining use of leverage indicates that management is reducing its use of debt capital.

Microsoft Enterprise Value

Enterprise value (EV) is a measurement of total firm value based on the market values of equity and debt, less cash and investments. As of June 2020, Microsoft had an EV of almost $1.5 trillion. The company’s EV grew from $968 billion in June 2019 and $705 billion in June 2018. EV growth for Microsoft has been driven by market price appreciation of equity.

Reviewed by Thomas Brock

Collateralized debt obligations (CDOs) are a type of structured investment finance product that contain various assets and loan products. Investment banks package bank loans, mortgages, and other assets into collateralized debt obligations—similar to funds—for institutional investors to buy.

Key Takeaways

• Collateralized debt obligations (CDOs) are structured investment products that contain various assets and loan products.
• The credit products are repackaged and grouped into tranches based on the credit risk appetite of the investors buying the CDO.
• The goal of creating CDOs is to use the debt repayments—which would typically be made to the banks—as collateral for the investment.
• Standard & Poor’s (S&P) is one of the companies that provide investors with independent credit ratings on CDOs.
• If the loans within a CDO are mortgage loans, the product is often referred to as a mortgage-backed security (MBS).

Understanding CDOs and the Mortgage Market

The goal of creating CDOs is to use the debt repayments—which that would typically be made to the banks—as collateral for the investment. In other words, the promised repayments of the loans and bonds give the CDOs their value.

As a result, CDOs are cash flow-generating assets for investors. Although CDOs are typically associated with the mortgage market, they can include various types of investments and debt—such as mortgages, corporate bonds, lines of credit, auto loans, and credit card payments. All of these credit products are repackaged and grouped into tranches based on the credit risk appetite for the investors buying the CDO.

If the loans within a CDO are mortgage loans, the product is often referred to as a mortgage-backed security (MBS). If the mortgage loans in the CDO were made to borrowers with less than stellar credit or no credit history, they’re called subprime mortgages. Although the term “subprime” often pertains to mortgages, other credit products have subprime categories, including auto loans, credit lines, and credit card receivables that are higher risk.

CDO Credit Structure

Initially, all the cash flows from a CDO’s collection of assets are pooled together. This pool of payments is separated into rated tranches. Each tranche also has a perceived (or stated) debt rating to it. Credit and debt products are assigned credit ratings, which measure their likelihood of default. Default occurs when a party can’t pay back interest and principal amounts from a loan or financial instrument.

Standard & Poor’s (S&P) is one of the companies that provide investors with independent credit ratings as well as being the provider of the S&P 500 Index. The top tier rating is usually “AAA” rated senior tranche. The middle tranches are generally referred to as mezzanine tranches and generally carry ‘AA’ to ‘BB’ ratings, and the lowest junk or unrated tranches are called the equity tranches. Each specific rating determines how much principal and interest each tranche receives.

The AAA-rated senior tranche is generally the first to absorb cash flows and the last to absorb mortgage defaults or missed payments. As such, it has the most predictable cash flow and is usually deemed to carry the lowest risk. On the other hand, the lowest-rated tranches usually only receive principal and interest payments after all other tranches are paid.

Furthermore, they are also first in line to absorb defaults and late payments. Depending on how spread out the entire CDO structure is and depending on the loan composition, the equity tranche can generally become the “toxic waste” portion of the issue.

Investing in CDOs

Typically, retail investors can’t buy a CDO directly. Instead, they’re purchased by insurance companies, banks, pension funds, investment managers, investment banks, and hedge funds. These institutions look to outperform the interest paid from bonds, such as Treasury yields. However, these companies assume an added level of risk with buying CDOs that accompanies the additional rate of return.

Of course, the added risk levels that CDOs exhibit might adequately be compensated by the higher returns in a stable economic environment; however, if the economy falls into a recession, the risk of default on the mortgage loans that act as collateral for CDOs can rise dramatically. The result can lead to losses for CDO investors.

Asset Composition Complications

To make matters a bit more complicated, CDOs can be made up of a collection of prime loans, near-prime loans (called Alt.-A loans), risky subprime loans, or some combination of the above. These are terms that usually pertain to the mortgage structures.

If a buyer of a CDO believes the underlying credit risk of the loans is investment grade, the firm would likely accept a lower yield that’s only slightly higher than a U.S. Treasury. Debt instruments with a low risk of default typically pay a lower interest rate while riskier debts command a higher rate by investors to compensate for the added risk of default.

Note

The Federal Reserve purchased trillions worth of MBSs as part of the quantitative easing program during the Great Recession.

However, the issuer of the CDO can come under pressure if it turns out that the underlying mortgages were much riskier than the yield would dictate. Whether the underlying CDO loans are rated properly is one of the hidden risks in more complicated CDO structures. In other words, the risk of investing in CDOs can increase if the loans made to the borrowers weren’t as prime as the lenders had initially believed.

Other Complications

Other than asset composition, other factors can cause CDOs to be more complicated. For starters, some structures use leverage and credit derivatives that can trick even the senior tranche out of being deemed safe.

These structures can become synthetic CDOs that are backed merely by derivatives and credit default swaps made between lenders and in the derivative markets. A credit default swap is essentially used by buyers of CDOs as insurance against non-payment. The buyer shifts the risk of the CDO’s non-payment by buying the CDS through an insurance company or other CDS seller in exchange for a fee.

Many CDOs get structured such that the underlying collateral is cash flows from other CDOs, and these become leveraged structures. This increases the level of risk because the analysis of the underlying collateral (the loans) may not yield anything other than basic information found in the prospectus.

Care must be taken regarding how these CDOs are structured because if enough debt defaults or debts are prepaid too quickly, the payment structure on the prospective cash flows will not hold and some of the tranche holders will not receive their designated cash flows. Adding leverage to the equation will magnify any and all effects if an incorrect assumption is made.

The simplest CDO is a ‘single structure CDO,’ which poses less risk since it’s usually based solely on one group of underlying loans. It makes the analysis straightforward because it is easier to determine the expected cash flows and the likelihood of defaults.

Special Considerations

The CDO market exists since there’s a market of investors who are willing to buy tranches–or cash flows–in what they believe will yield a higher return to their fixed income portfolios with the same implied maturity schedule.

Unfortunately, there can be a huge discrepancy between perceived risks and actual risks in investing. Although CDO buyers may believe that the product will perform as expected, credit defaults can happen, and there is often very little recourse.

It may become difficult to unwind a position to stop the losses if the credit markets are deteriorating and loan losses are increasing. In such an environment, the market can dry up, meaning there could be no liquidity. The result can lead to investors trying to sell their CDO positions, only to find there are no buyers.

The Emergence of CDOs

CDOs came into existence in order for banks to sell off their loans, creating room on their balance sheets, so that they could take on more loans. It is a way to generate more profits by (1) selling off current loans and (2) making money from new loans.

CDOs were a niche product in the early 2000s but quickly grew to become widespread through Wall Street and beyond.They created many jobs as they required quantitative analysts and computer programmers to model the valuations of the loans that made up the CDO. In addition, CDOs needed to be marketed and sold to investors, which required hiring salespeople to sell them.

CDOs, particularly mortgage-backed securities (MBSs), contributed to the subprime meltdown in 2007/2008 that led to the Great Recession. Many of the mortgages were valued incorrectly and many of the bundles were rated inaccurately as they did not appropriately factor in some of the less creditworthy loans. After the recession, CDOs fell out of favor, however, started making a comeback a few years later.

The Collapse of CDOs and the Great Recession

The banks that packaged CDOs and sold them to investors were not extremely thorough in their analysis of the people they were making loans to. As the banks sold off the loans, so too did they sell off their risk. The quality of the borrower wasn’t a huge concern to them and so banks were making loans to people with poor credit and people were taking out mortgages that they couldn’t afford.

The amount of liquidity in the market eventually created a bubble that was apparent in the housing market, credit cards, and the automobile market. As housing prices increased, people kept buying houses, quite often to flip them and turn a quick profit.

Important

The government brought some stability to the financial markets by purchasing CDOs.

In addition, investors purchasing CDOs weren’t aware of the quality of all the loans in the CDOs. They trusted banks to price the risk appropriately and for rating agencies to rate the CDOs appropriately, neither of which was happening.

Eventually, housing prices fell and individuals weren’t able to make payments on their mortgages. When people defaulted, this caused the income streams in CDOs to decrease or cease, impacting the investors that bought them, causing losses. These investments were spread widely throughout the financial markets; in mutual funds, pension funds, and corporations. The losses spread quickly.

Will CDOs Ever Disappear?

Regardless of what occurs in the economy, CDOs are likely to exist in some form, because the alternative can be problematic. If loans cannot be carved up into tranches, the end result will be tighter credit markets with higher borrowing rates.

As long as there is a pool of borrowers and lenders out there, you will find financial institutions that are willing to take risks on parts of the cash flows. Each new decade is likely to bring out new structured products, with new challenges for investors and the markets.

What Is a Bespoke Tranche Opportunity (BTO)?

A bespoke tranche opportunity (BTO) is a structured financial product that is tailored to an investor’s interest in purchasing a specific tranche of a CDO for a specific asset. For example, if an investor wanted to purchase BBB auto loans in a specific region, they would be able to do that through a BTO.

Why Can CDOs Be Risky Investments?

CDOs can be risky because they are complex products. As they are an amalgamation of various loans, understanding the credit quality of those loans is of utmost importance. Most investors rely on the credit ratings issued by rating agencies to understand the quality of the investment, and if those ratings are inaccurate like they were during the subprime meltdown, investors could be purchasing low-quality assets without realizing.

What Is a Synthetic CDO and Do They Still Exist?

Synthetic CDOs are an advanced form of CDOs. While the underlying assets of regular CDOs are traditional fixed-income assets, such as loans, mortgages, and bonds, synthetic CDOs use non-cash assets as the underlying asset, such as credit default swaps, options, and other such contracts. Synthetic CDOs typically offer higher yields than traditional CDOs. And yes, synthetic CDOs still exist.

The Bottom Line

Collateralized debt obligations (CDOs) are structured financial products that allow investors access to non-traditional investments that they would otherwise have a difficult time gaining exposure to, such as mortgage and auto loans. A CDO whose underlying assets are mortgages is known as a mortgage-backed security (MBS).

MBSs take numerous mortgages and package them into one product with various tranches. The tranches are of varying risk depending on the risk of the underlying mortgage. Investors receive income payments from the MBS that are derived from the mortgage payments on the loan.

Global presence for online and in-store apparel and footwear

Reviewed by Somer Anderson

Foot Locker Inc. (FL) is a sneaker and athletics apparel retailer with about 2,500 locations worldwide. The first Foot Locker retail location opened in California in 1974. The company is the remaining operating entity of the F.W. Woolworth Company, founded in 1879. In the mid-20th century, Woolworths bought G.R. Kinney, a shoemaker that owned the Foot Locker brand. As Woolworths saw its flagship stores decline, the company changed its name, eventually becoming Foot Locker Inc. in 2001.

Foot Locker operates numerous subsidiaries and brand names, including Foot Locker, Kids Foot Locker, Champs Sports, atmos, and WSS. In 2023, the company generated nearly $8.2 billion in sales and boasted a market cap of about $1.95 billion as of January 2025.

WSS

• Type of Business: Retail Footwear and Apparel
• Acquisition Price: $750 million
• Date of Purchase: September 20, 2021
• Revenue: $640 million in 2023

WSS is best known for its neighborhood-based store presence and deep connection within Latino communities. Foot Locker finalized its acquisition of WSS, a West Coast presence, in 2021. In 2023, Foot Locker appointed Blanca Gonzalez as Senior Vice President and General Manager of WSS.

atmos

• Type of Business: Digital Global Footwear Retailer
• Acquisition Price: $360 million
• Date of Purchase: November 1, 2021
• Revenue: $31.5 million in 2023

In 2021, Foot Locker acquired atmos, a digitally-led, global retailer headquartered in Japan. The purchase price was $360 million. Atmos expanded Foot Locker’s global reach in the Asia-Pacific market, with a presence in Japan.

GOAT Group

• Type of Business: Secondary Sneaker Marketplace
• Acquisition Price: $100 million minority investment
• Date of Investment: February 7, 2019

GOAT is a managed secondary marketplace for sneakers under the GOAT and Flight Club brands. Foot Locker made a “strategic minority investment” in GOAT rather than buying the company outright. As a secondary sneaker marketplace, GOAT allows Foot Locker access to a new niche market in e-commerce.

Fact checked by Ryan Eichler
Reviewed by Lea D. Uradu

For many Americans, saving and investing for retirement can be a stressful undertaking. According to a study from the American Association of Retired Persons (AARP), one in five American workers over the age of 50 report having no retirement savings, with 70% of workers worrying that prices will rise faster than their incomes.

At the same time, about 65% of Americans own their own home. And with home prices rising significantly in recent years, home equity may increasingly seem like an attractive and necessary source of wealth for planning your retirement. Like everything in finance, however, there are pros and cons to using your home equity to fund your retirement and investment goals. Whether or not you should use a home equity loan for retirement purposes depends on your personal finance situation (and propensity for risk).

Key Takeaways

• Many Americans have significant home equity while struggling to save for their retirement.
• Home equity loans, home equity lines of credit (HELOCs), and reverse mortgages can help bridge this gap.
• However, these products have pros and cons, and they may not be suitable for all homeowners.

The Basics of Home Equity

To start with, it’s important to get a handle on what home equity really means. Essentially, home equity just refers to how much of your home you really own. If, for example, you could sell your home for $350,000, but you have a mortgage for $250,000, then your home equity would be the difference between the sale price and the mortgage—$100,000 in this example.

Homeowners will naturally see the equity in their home rise over time because they pay off a portion of their mortgage principal with each payment. Eventually, their mortgage is paid off and their home equity will be equal to the value of their home.

Home equity can help you invest for retirement because you can use it to raise cash in a number of ways. For instance, you can save the money or invest it. Although many options are available, what works best will depend on your personal financial situation, goals, and risk tolerance.

Ways to Raise Cash from Your Home

The simplest way to raise cash from your home is, of course, to sell the home and simply pay off your mortgage. The advantage of this approach is that it can provide a large lump sum, especially if your house has appreciated in value. The disadvantage is that it can lead to significant transaction costs and capital gains.

Typically, homeowners pair this strategy with a downsizing approach, purchasing a smaller and less expensive home and pocketing the difference between their original sale proceeds and the cost of their new down payment. This strategy is popular among elderly homeowners, who may find their original property is larger than necessary or difficult for them to navigate physically.

If you don’t want to sell your home, another option is to borrow against your home equity. There are many ways to do this, but three popular approaches are getting a home equity loan, taking out a home equity line of credit (HELOC), or using a reverse mortgage.

Home Equity Loans

When you take out a home equity loan, you receive a lump-sum payment that is equal to a certain percentage of your home equity. The loan is repaid on a fixed term, where each includes both interest and principal. Essentially, it is the same basic structure as a typical mortgage except that you receive the proceeds as cash rather than having it applied toward the purchase of a home.

Home equity loans typically use fixed interest rates, with much lower rates of interest than unsecured loans such as credit cards. That’s because home equity loans are secured by your home, meaning that if you fail to make your payments, you could face foreclosure.

Home equity loans could be used to fund your retirement by either saving the cash to fund your lifestyle or investing some or all of the cash in other income-generating investments. For example, a retiree could take out a home equity loan and use it to purchase a second property that could help fund their retirement through rental income.

Home Equity Lines of Credit (HELOCs)

HELOCs are similar to home equity loans but have a few key differences. First, HELOCs carry variable interest rates, which means you could see your payments increase if interest rates rise during the life of your loan. Second, HELOCs allow you to borrow or repay funds whenever you wish, only requiring you to pay the interest on the funds borrowed.

Eventually, however, the HELOC loan will require you to repay the principal as well, so it’s important to understand and plan for this beforehand. Also, bear in mind that HELOCs are (just like home equity loans) secured by your home, meaning that there is still the risk of foreclosure.

Reverse Mortgage

For some homeowners, borrowing against their home might be scary, especially if there is a chance that they might not be able to make their payments. This is particularly understandable for retirees who may have no income at all aside from their pensions, and especially for those who may not have a pension at all. For people in that situation, reverse mortgages could be an attractive option.

These are a type of loan in which you do not make any monthly payments. Instead, you receive a pension-like stream of payments that are paid for by gradually deducting a portion of your home equity. When you die or sell your home, the lender is repaid for the value of all those payments, plus interest. In that sense, a reverse mortgage is similar to selling your home gradually, while still allowing you to live in and retain title to your home while you are alive.

There are many types of reverse mortgages, and some can include complex terms and fee structures. All of this makes it very important to carefully study the specific products and lenders in question. In some cases, however, this type of product can provide a “one-stop” solution for a homeowner’s retirement savings needs.

Can You Use a Home Equity Loan for Anything You Want?

Yes, you can use a home equity loan any way you wish. Keep in mind, however, that there can be tax benefits to using a home equity loan for purposes that enhance the value of your home, such as paying for renovations, including accessibility improvements.

Can a Home Equity Line of Credit (HELOC) Be Used for Investing?

Yes, the proceeds from a home equity line of credit (HELOC) can be used for investing. In fact, many real estate investors use their HELOC to cover the down payment on new properties. However, there are risks involved in doing so, so it is important to always act according to your own means and risk tolerance.

Where Can I Find Reliable Information on Home Equity Loans?

There are many resources available online that provide reliable information on home equity loans. One notable example is the Consumer Advice website operated by the Federal Trade Commission (FTC). This website offers a range of articles on financial products, including home equity loans, HELOCs, and reverse mortgages.

The Bottom Line

The question of what is the right way to use home equity to achieve your retirement goals—or whether to even do so at all—will always depend on your specific personality and goals. Realistically, there is simply no one right answer, as what works for one person may not be well suited for another.

However, if you are comfortable with making and managing investments, and if you are willing to get creative, there are likely ways to effectively use your home equity as part of your retirement plan. For example, instead of simply selling your home and downsizing to a smaller property, you could instead keep your home and use your home equity to purchase a second property. You could then either live in the second property and rent out your first home or take the opposite approach, renting out the second property.

On the other hand, if you are conservative financially and have limited risk tolerance, you may prefer an approach that keeps things as simple as possible. In that scenario, a well-chosen reverse mortgage could be a good fit, as long as it is chosen from a trusted provider. In either case, enlisting the help of a qualified and reputable financial professional may be well worth the cost.

Fact checked by Yarilet Perez
Reviewed by Erika Rasure

Simple or individual supply describes the amount of a good or service available to consumers from an individual producer. Aggregate supply is the total quantity produced by all the companies supplying that product or service. While one is based on an individual level, the other is based on a
combination. The same can be said of simple or individual demand and aggregate demand.

In economics, the law of supply and demand is a common term and one of the fundamentals of economic theory. Supply and demand express a direct relationship between what producers supply and what consumers demand in an economy and how that relationship affects the price of a specific product or service.

Aggregate supply and aggregate demand are the total supply and total demand in an economy at a particular period of time and a particular price threshold. Aggregate supply is an economy’s gross domestic product (GDP), the total amount a nation produces and sells. Aggregate demand is the total amount spent on domestic goods and services in an economy. Aggregate supply and aggregate demand convey how much firms are willing to produce and how much consumers are willing to demand at a specific price point.

Note

Aggregate demand is the total expenditure of a company, which includes consumer consumption, investments, government spending, and net exports.

Understanding Aggregate Supply and Aggregate Demand

Aggregate supply and demand are represented separately by their own curves. Aggregate supply is a response to increasing prices that drive firms to utilize more inputs to produce more output. The incentive is that if the price of inputs remains the same and the price of outputs increases, the firm will generate larger profits and margins by producing and selling more.

The aggregate supply curve is represented by a curve that slopes upward, which indicates that as the price per unit goes up, a firm will supply more. The supply curve eventually becomes vertical, indicating that at a certain price point a firm cannot produce anymore, as they are limited by certain inputs, e.g. number of employees and number of factories.

Aggregate demand is the total expenditure of a company, which includes consumer consumption, investments, government spending, and net exports. The aggregate demand curve is a downward sloping curve, indicating that when the price level increases, the total spending of an economy decreases.

Consumption levels fall because people spend less as higher prices have reduced their purchasing power. As outputs rise, there is an increase in demand for money and credit to produce them, which leads to higher interest rates. Higher interest rates lead to lower investments. Furthermore, if prices in one nation go up, making their goods more expensive relative to other nations, that will reduce exports.

Supply and Demand Fluctuations and Curves

Increased supply generally occurs in response to a demand increase and results in lower prices over time. The amount of time required for businesses to respond to an increase in demand by increasing production varies significantly, depending on the product and industry.

If materials are difficult to obtain, the length of time required to bring additional products to market may increase in an economic model that is less responsive to demand changes. Price increases may result in reduced demand and cause too much supply.

The Bottom Line

As discussed, this relationship between supply and demand can be expressed using an aggregate supply or aggregate demand curve. Using this economic law, businesses create better forecasts for future production needs to improve profitability. Pricing and marketing considerations are also directly impacted by supply and demand and represent another facet of this economic modeling.