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3rd Market Leader intermediate
2 course
Business Brief
Unit 6
MONEY
One of the main features of globalisation is that capital can flow freely to and from almost everywhere. People are always looking to place money where it will be most profitable and earn the greatest return on investment. As an individual, you can put your money on deposit in a bank and you will get interest. Your money is lent out to people, businesses and governments who need it to finance their own projects, and the bank will make its money on the difference between what it pays out in interest on deposits and what it gets in interest from loans.
You could buy some bonds and, as long as the organisation or country you've invested in by lending it money doesn't default, you will get your interest payments, and later your bonds will eventually be repaid. Or you could buy some shares and share in the profitability of your chosen company. In good times, the dividends will be more than what you would get from bonds. In addition, the shares themselves will increase in value, giving you a capital gain if you sell them. But if the company runs into trouble and goes bankrupt, you will be among the last to be paid back and you may get only part of what you put in or you may lose all your money.
This is the trade-off between risk and return. The higher the risk of your investment not being repaid, the more you will want it to pay back in return on investment. Investors use the world's financial markets to channel money into profitable investment activities and projects. Borrowers, such as companies and governments, use them to find capital on the best terms.
Most investors are not private individuals but institutions like banks, insurance companies, mutual funds (unit trusts in Britain) and pension funds, who are, of course, investing the money of private individuals indirectly. The markets they invest in include the money and currency markets, stock markets for shares (also known as equities), commodities markets for anything from gold to pork bellies (used for making bacon), and property (buildings and land).
There are also markets for futures in currencies, equities, bonds and commodities: a future is a fixed-price contract to buy a certain amount of something for delivery at a fixed future date. There are markets for options in currencies, equities and bonds. Here, an investor buys the right to buy or sell a certain amount of these things at a certain price on a particular date in the future. This is a form of betting on how prices will move.
Options and futures are types of derivatives. It was with derivatives that the credit crunch of 2007-8 began. Loans to borrowers in the US housing market were resold or securitised by the banks who made the original loans: interest payments on the loans were used to pay investors who were buying the related derivatives. But sub-prime borrowers were unable to repay the original loans, and this led to the collapse of a large number of banks and other financial institutions, with governments having to bail out (rescue and assist) many of the remaining banks. Following their traumatic experience, many banks are very reluctant to start lending again, leading to dire consequences for economic activity.