Interesting Concepts in Finance

Original version

I am fascinated with an interest rate, a short sale, and an arbitrage. I want to introduce why I am fascinated with those concepts.

First and the most interesting concept for me is an interest rate. Interest rate has two categories, simple interest rate and compound interest rate. The difference is quite simple. In simple interest, only the principal in your account yields interest. Otherwise, in compound interest, not only the principal but also the interest which is yielded already itself yields interest. Of course, you guys already know this concept. I have known it from childhood, too. Why I am abruptly fascinated with interest rate? Because I just start feeling the true power and meaning of compound interest rate. When I expected the results of the compound interest during studying finance, I was always wrong. The results of the compound interest rate always exceed my expectations. Seeing the incredible results of the magical concept, I sometimes said that “How crazy it is!” There is a interesting story about Albert Einstein and compound interest rate. When asked to name the greatest invention in human history, he simply replied “compound interest.” He also called compound interest the greatest mathematical discovery of all time and 8th wonder. When I first heard that he said like that, I didn’t feel anything special. But I now fully agree with that.

Second is short sale. It’s a reverse money stream. Think about it; you borrow some money from bank, buy machine, make money using that machine, and finally repay the debt using the profit. However, in short sale, you borrow machine, not money. The next step is selling that machine to other person, investing that money from sale to other financial instruments, receiving the principal and interest from the investment, and finally buying a machine same as the original machine and returning it. Why people do this? Because the borrower expects the future price of the machine to decrease, so he bet on the price movement. The lender doesn’t have anything to do using the machine in a short period. Therefore, the borrower and lender together have a desire to enter into short sale. However, it is very dangerous investment technique and the return is generally high. Do you know George Soros? In 1992, he betted on the decrease of pound, English currency, and earned 1 billion dollars just in a week.

When I first knew the arbitrage, I was very shocked. The basic principal is the prices of the same value must be equal. However, the price is hardly same with its value. Using very complex mathematical formulas on the price of many financial instruments and derivatives, some company find inequalities among financial products and achieve unbelievable profit. You may read the article about fund manager whose salary is above 1 billion. He uses the statistical arbitrage to make money.

Edited version by my writing teacher

I am fascinated with interest rate, short sale, and arbitrage. I want to introduce why I am fascinated with those concepts.

First and the most interesting concept for me is interest rate. Interest rate has two categories, simple interest rate and compound interest rate. The difference is quite simple. In simple interest, only the principal in your account yields interest. Otherwise, in compound interest, not only the principal but also the interest that has been generated yields interest. Of course, you guys already know this concept. I have known it from childhood, too. What’s the reason for my abrupt fascination with interest rate? Because I have just begun to feel the true power and meaning of compound interest rate. When I predicted the results of compound interest while studying finance, I was always wrong. The results of compound interest rate always exceed my expectations. Seeing the incredible results of the magical concept, I sometimes said exclaimed, “How crazy!” There is an interesting story about Albert Einstein and compound interest rate. When asked to name the greatest invention in human history, he simply replied “compound interest.” He also called compound interest the greatest mathematical discovery of all time and the 8th wonder. When I first heard that he said that, I didn’t feel it was anything special. But now I have to fully agree with that.

Second is short sale. It’s a reverse money stream. Think about it; you borrow some money from the bank, buy a machine, make money using that machine, and finally repay the debt using the profit. However, in short sale, you borrow the machine instead of money. The next step is to sell that machine to another person, investing that money from sale to other financial instruments, receiving the principal and interest from investment, and finally buying the same machine as the original and returning it. Why do people do this? Because the borrower expects the future price of the machine to decrease, so he makes a bet on the price movement. The lender doesn’t have anything to do using the machine in a short period. Therefore, the borrower and lender have a common desire to enter into short sale. However, it is a very dangerous investment technique and the return is generally high. Do you know George Soros? In 1992, he betted on the decrease of the English pound and earned 1 billion dollars within a week.

When I first learnt of arbitrage, I was very shocked. The basic principal is that prices of the same value must be equal. However, the price hardly matches its value. Using very complex mathematical formulas on the price of many financial instruments and derivatives, some company find inequalities among financial products and achieve an unbelievable profit. You may read the article about a fund manager whose salary is above 1 billion. He uses statistical arbitrage to make money.