July 7, 2013

On money

Seth Godin has a great post on money. Just go there and read it. He also mentions the need to learn a few concepts, and here’s the short, simple explanation for them:

Opportunity cost: the value of the best alternative forgone, in a situation in which a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the “cost” incurred by not enjoying the benefit that would be had by taking the second best choice available. Opportunity cost is what you must forgo in order to get something.

Investment: putting money into an asset with the expectation of capital appreciation, usually over the long-term future.

Debt: A debt is created when a creditor agrees to lend a sum of assets to a debtor. Debt is usually granted with expected repayment; in modern society, in most cases, this includes repayment of the original sum, plus interest.

Leverage: a general term for any technique to multiply gains and losses. If I have stocks for 10,000 US$, but use leverage of 5, it is as if I had 50,000 US$ when it comes to gains and losses. If my stock loses 10%, without leverage I lose only 1,000 US$, with leverage of 5 I lose 1,000 US$ times five.

Basis points: A basis point (often denoted as bp, colloquially referred to in the plural as “bips”, also known as a “beep”) is a unit equal to one hundredth of a percentage point, or one part per ten thousand, 110000. Basis points are used as a convenient unit of measurement in contexts where percentage differences of less than 1% are discussed. The most common example is interest rates.

Sunk costs: In economics and business decision-making, a sunk cost is a retrospective (past) cost that has already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken. Hope this helps.