Name: Steven P Sanderson II Date: 7/18/06 Class: Intro to Business BA11 5040 Professor: McNamara This reaction paper is in regards

to chapter 21 which deals with money and financial institutions and how they work. First of all we need to know what money is. Money is anything that people generally accept as payment for goods and services. Money to be useful must be portable, divisible, stable, durable, and unique. Money has since become a very graduated system since the times of the conch shell. Money is now managed by a very complex global system. When something is consistently used as an intermediate object of trade, as opposed to direct barter, then it is regarded as a medium of exchange. Such a thing simplifies the process of trade by allowing trade to take place without the need for double coincidences. A double coincidence is defined in the following manner: The coincidence of wants problem is an important category of transaction costs that impose severe limitations on economies lacking money and thus dominated by barter or other in-kind transactions. The problem is caused by the improbability of the wants, needs or events that cause or motivate a transaction occurring at the same time and the same place. In-kind transactions have several problems, most notably timing constraints. If you wish to trade fruit for wheat, you can only do this when the fruit and wheat are both available at the same time and place. That may be a very brief time, or it may be never. With money, (broadly speaking, any commodity used as a medium of exchange) you can sell your fruit when it is ripe and take the money. You can then use the money to buy wheat when the wheat harvest comes in. Thus the use of money makes all commodities become more liquid. Besides barter, other kinds of inkind transactions also suffer from the coincidence of wants problem in the absence of money. For example, when wealth is transferred during marriage, divorce, inheritance, and other crucial life events, or during the collection of taxes or tribute, it is improbable that this event will coincide with the recipient's desire for the commodities the payor can readily obtain, unless they are intermediate commodities, i.e. money. In the absence of money, all of these transactions suffer from the basic problem of barter -- they require an improbable coincidence of wants and events. Because of the severe costs imposed by the coincidence of wants in an in-kind economy, money tends to emerge naturally as some form of commodity money. When the value of a market good is frequently used to measure or compare the value of other goods or where its value is used to denominate debts then it is functioning as a unit of account. A debt or an IOU can not serve as a unit of account because its value is specified by comparison to some external reference value, some actual unit of account that may be used for settlement. Unless, of course, the debt or IOU is also an accepted medium of exchange, in which case we have money. For example, if in some culture people are inclined to measure the worth of things with reference to goats then we would regard goats as the dominant unit of account in that culture. For instance we may say that today a horse is worth 10 goats and a good hut is worth 45 goats. We would also say that an IOU denominated in goats would change value at much the same rate as real goats.

When something is purchased primarily to store value for future trade then it is being used as a store of value. For example, a sawmill might maintain an inventory of lumber that has market value. Likewise it might keep a cash box that has some currency that holds market value. Both would represent a store of value because through trade they can be reliably converted to other goods at some future date. Most non-perishable goods have this quality. Most goods are capable of possessing all of the characteristics outlined above to a greater or lesser degree. However, the more successful a money is the greater the degree in which it will typically satisfy all three criteria. There is also a global exchange where money is traded like a commodity. Financial institutions are responsible for the transactions and keeping the market liquid. There is no single unified foreign exchange market. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currency instruments are traded. This implies that there is no such thing as a single dollar rate - but rather a number of different rates (prices), depending on what bank or market maker are trading. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs. The main trading centers are in London, New York, and Tokyo, but banks throughout the world participate. As the Asian trading session ends, the European session begins, then the US session, and then the Asian begin in their turns. Traders can react to news when it breaks, rather than waiting for the market to open. There is little or no 'inside information' in the foreign exchange markets. Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, and other macroeconomic conditions. Major news is released publicly, often on scheduled dates; so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow. Trading legend Richard Dennis has accused central bankers of leaking information to hedge funds. Now we are going to take a look at hedge funds and how they operate. A hedge fund generally refers to a lightly regulated private investment fund sometimes characterized by unconventional strategies (e.g., strategies other than investing long only in bonds, equities or money markets). They are primarily organized as limited partnerships, and previously were often simply called "limited partnerships" and were grouped with other similar partnerships such as those that invested in oil development. The term hedge fund dates back to the first such fund founded by Alfred Winslow Jones in 1949. Jones' innovation was to sell short some stocks while buying others, thus some of the market risk was hedged. While most of today's hedge funds still trade stocks both long and short, many do not trade stocks at all. For U.S.-based managers and investors, hedge funds are simply structured as limited partnerships or limited liability companies. The hedge fund manager is the general partner or manager and the investors are the limited partners or members respectively. The funds are pooled together in the partnership or company and the general partner or manager makes all the investment decisions based on the strategy it outlined in the offering documents. In return for managing the investors' funds, the hedge fund manager will receive a management fee and a performance or incentive fee. The management fee is computed as a percentage of assets under management, and the incentive fee is computed as a percentage of the fund's profits. A "high water mark" may be specified,

under which the manager does not receive incentive fees unless the value of the fund exceeds the highest value it has achieved. The "high water mark" is intended to encourage fund managers to recoup losses, but is viewed by critics as encouraging laggard funds to close, to the detriment of investors. The fee structures of hedge funds vary, but the annual management fee is typically 20% of the profits of the fund plus 2% of assets under management. Certain highly regarded managers demand higher fees. In particular, Steven Cohen's SAC Capital Partners charge a 50% incentive fee (but no management fee) and Jim Simons’ Renaissance Technologies Corp. charges a 5% management fee and a 44% incentive fee. The typical hedge fund management firm includes both the domestic U.S. hedge fund and the offshore hedge fund. This allows hedge fund managers to attract capital from all over the world. Both funds will trade 'Pari passu' based on the strategy outlined in the offering documents. Now we will take a look at one hedge fund and some of the success that they have enjoyed. James Harris Simons, Ph.D. is a cryptanalyst, mathematical physicist, academic, investment advisor, billionaire and philanthropist. In 1982, Simons founded Renaissance Technologies Corporation, a private investment firm based in New York with over $12 billion under management; Simons is still at the helm, as president, of what is now one of the world's most successful hedge funds. According to Institutional Investor magazine, Simons earned an estimated $1.5 billion in 2005 and $670 million in 2004. Simons' most influential research involved the discovery and application of certain geometric measurements, and resulted in the Chern-Simons form (aka Chern-Simons invariants, or Chern-Simons theory). In 1974, his theory was published in Characteristic Forms and Geometric Invariants, co-authored with the differential geometer Shiing-Shen Chern. The theory has wide use in theoretical physics, particularly string theory. For over two decades, the Renaissance Technologies investment firm, which trades in markets around the world, has been at the forefront of research in mathematics and economic analysis. Renaissance uses computer-based models to predict price changes in easily-traded financial instruments. These models are based on analyzing as much data as can be gathered, then looking for non-random movements to make predictions. Renaissance employs more than 60 top scientific specialists, including mathematicians, physicists, astrophysicists and statisticians, who review market data to find statistical relationships that, predict the price movements of commodities, currencies and stocks. Its $5 billion Medallion Fund has averaged 35% annual returns, after fees, since 1989, and is considered in the industry to be the most successful hedge fund, yielding returns ten percentage points higher than investors Bruce Kovner, George Soros, Paul Tudor Jones, Louis Bacon, Mark Kingdon or Monroe Trout. Renaissance is currently gearing up to launch a fund designed to handle upwards of $100 billion, one that could become the industry's largest. This is just one example of how financial institutions can work and how money can be made. Much of this material was obtained from our text and an online source Wikipedia.org

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