What is a negative wear?

Negative wear is a term used to describe a scenario in which a yield generated on a certain type of futures position is lower than the costs associated with the arrangement of this position. This situation may develop when the security or asset purchased cannot generate revenues that were originally expected. As a result, the buyer or investor does not earn any profit from the investment, but instead ends up losing money when the futures position matures.

One of the simplest ways to understand how negative transmission is evolving is to consider buying a bond problem that is structured with floating or variable interest rate. The investor borrows money for the purchase of a bond for a fixed interest rate, which he believes in ultimately applies to revenues generated by a bond. Perception is based on predictions that the average interest rate will actually increase significantly during the life of this bond. Instead of the average rate in fact Slip below and remains lower than fixedThe rate that the investor pays from the loan used to finance the purchase of bonds. As a result, negative transmission develops, which means that once the bond reaches its due date and the director and the accumulated interest is provided to the investor, it will not be enough to compensate the total cost of financing the loan.

There are other situations in which it may be a negative wear. Financial institutions that can provide loans may find that interest income obtained from a given loan is not enough to cover all costs associated with the granting and management of this loan, resulting in what is called the negative shipping costs. Similarly, the debtor can buy a property with the intention of performing and selling real estate for profit, only to find that the market will not adapt the selling price sufficient to compensate for a combination of principal and interest used to buy real estate initially and improve costsof it. In general, negative transmission develops whenever the amount of resources spent on entering the investment does not completely include revenues generated by this investment.

Avoiding the negative transport of any investment opportunity is important for the success of almost any kind of trade agreement. Investors want to make sure that any investment will provide a yield that exceeds the total sources spent to secure and maintain the asset. Similarly, banks and other financial institutions set interest rates and other fees to make the chances of losing money for the loan paid by the debtor are extremely low.