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Personal Finance Part 1

Personal Finance Part 1

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Published by Elizabeth Fernandez

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Published by: Elizabeth Fernandez on Mar 20, 2012
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Personal Finance part 1: Banks and investments Objectives Discuss banking – Its origin & role in modern society

Talk about services provided by banks – And their customers Identify different classes of investments – Some are well known – Others not so well known Understand how to make money! Where does the word “Bank” come from? From the Italian “Banco” meaning table In Renaissance Italy every town had a piazza Money lenders would setup tables there If you needed money You could visit the money lender’s table

And arrange a small, short term loan The tables are gone, but … The situation is still the same – Some people are borrowers – Other people are savers And the moneylenders are now “banks” So think about this A bank is nothing more than a place – where borrowers and savers meet Banks play a very important role Borrowers have a deficit of money Savers have a surplus of money Banks provide a distribution channel

– Money flows from surplus to deficit The bank takes a small portion as a fee – For their services in arranging the business (loans) Different services are arranged by different types of banks Types of banks – Retail banks We are familiar with this type of bank Services offered are varied but include • Savings • Loans – Credit cards – Personal loans – Mortgages Insurance products • Life insurance

• Pensions, annuities Types of banks – Investment Provide services to businesses Some of the same services as retail • Loans • Savings • Foreign exchange services • Investment advise But other services are very different • M&A • Raising capital And where is capital raised In the Financial Markets Like banks markets channel money – From a surplus to a deficit

Entities use markets to raise money – Selling shares (IPO) or bonds But who participates? – Institutional investors • Pensions, insurance, hedge funds – Retail investors • We invest to diversify our savings • And to do this we need different markets Types of Financial Markets Many different ways for us to invest But what can we invest in? – Shares • Equities, purchase partial ownership – Bonds • Debt, we lend companies money – Commodities • Oil, gold, silver and more !

Let’s look at each of these asset classes Equities: overview What do we mean by Equities? Instrument denoting ownership Entitles holder to claim on profits A way for entities to raise money Significant component of how firms raise money Equities: classes Ordinary (common) – Carries voting rights (but may be distorted) – Entitled to a dividend – High risk (what about reward?) Preference (preferred) – Debt equity hybrid

– Carries coupon – Can’t vote but higher in liquidation – Lower risk than common (and reward?) Equities: market characteristics Exchange Driven – US (NYSE, AMEX, NASDAQ) – UK (LSE, AIM) Some OTC – “dark pools of liquidity” Very centralised market Ample derivatives – “complete market” Equity market participants Varied needs – But looking for higher returns than investing in … Retail Institutional investors

– Unit trusts / investment trusts – pension funds, insurance companies Others? – Banks – Hedge funds Equities: making money Two components of return Capital gains or losses – difference between purchase and sale prices Dividends – not fixed – not guaranteed – might be zero Fixed Income: overview What is Fixed Income?

Investments with known returns over a specific period of time A way for entities to raise money At relatively low rates of interest Promise to pay Best viewed as a package of cash flows Fixed Income: market participants Best to understand their needs – low risk – predictable returns Retirees Institutional investors – pension funds – insurance companies Others? – Banks – Hedge funds

Fixed Income: issuers of debt Two distinct groups Governments – important source of funding – said to be "risk free" Businesses – both listed and private – relatively low cost of funds – offer tax shields – impacts gearing of firm Fixed Income: market characteristics Very decentralised Mostly OTC – Driven by customer flow – Proprietary trading But some exchanges based – NYSE - US corporate – LSE - UK corporate

Ample derivatives – “complete market”

Commodities : overview What do we mean by Commodities? Commodity a good or service That enjoys level of demand BUT can be sourced from MULTIPLE suppliers WITHOUT qualitative difference in other words – fungible Examples of commodities Basic metals – copper – silver – gold Finished products – paper

– milk – electronics Process of commoditisation New producer / new market – enjoys premium margins Over time – differentiation of supply is lost Driven by – diffusion of intellectual capital – new entrants Net result: margins shrink = COMMODITY Examples – Pharmaceuticals - generics – CPUs - clone producers Commodity market participants Producers Consumers Speculators

– Maligned, but provide a critical bridging role – Proprietary trading • Banks • Hedge funds – Institutional investors (last decade) – Retail money (ETFs such as USO, GLD, SLV) Commodity trading Very large number of participants Commodity pricing very efficient Exchange based trading large component Pricing: supply & demand but also – Time value of money – Storage & transportation costs Commodity value – derived from contract standard

– NOT by producers specific product offering shaping success in business and finance 24 Commodity market size Globally difficult to properly size – But we do know exports up 17% (2007) OTC (banks) – Notional value approached $9T (2007) Centres (exchange traded, 2007) – US / North America • 40% of trading – China • 25% of trading Commodity market characteristics Exchange driven

But significant overlap with OTC Market has both – centralised and decentralised components Participants will pick & choose Ample derivatives exist Both producer and users can mitigate risk Conclusion We looked at the history of banking And identified different speciality services Understood how banking works And why banks get paid for their services Finally look at different asset classes Possible places for us to save (invest)

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