2) Saving And Borrowing

Question 1

What is a saver?

Answer 1

• someone that has more money than they actually need so can afford to do so can do something - like invest - with their surplus money
• can be individuals, companies or governments
• those that have a lot of surplus money are considered to be high net worth individuals (HNWIs)

Question 2

How does a bank create a link between a saver and a borrower?

Answer 2

1) the savers deposit their surplus money into the bank, for which the saver gets interest maybe at 5%
2) then the bank lends the deposited money to the borrowers, who would have to repay it at 8%

Question 3

How does a banks gain a surplus?

Answer 3

• if a bank attracted a combined 100 million in deposits then it would need to pay 5 million interest for the year (5% x 100mil)
• but then if the bank managed to lend a 100 million, it would receive 8 million in interest (8% x 100mil)
• by gaining 8 mil in interests and only having to pay 5 mil of it, they have a 3 mil surplus
• they can use this surplus to pay off various costs: wages etc

Question 4

What is equity?

Answer 4

• referred to as the shares or stock and represents the ownership so the holders of equity in a company own that company
• for businesses seeking to raise money, an alternative to borrowing from banks is for the business to sell equity -> raising money by selling shares

Question 5

Why might an equity be preferred as a source of finance to borrowing?

Answer 5

• when borrowing, an interest needs to be made on top of that but not for equity
• an equity does not need to be repaid like money borrowed does

Question 6

What is an initial public offering (IPO)?

Answer 6

• big quantities of equity sold by large companies so that they can raise money
• an example of this is the Zoom IPO, which floated in April 2019

Question 7

How did the Zoom IPO fair in 2019?

Answer 7

• zoom sold 20.1 million shares at 36 per share - they raised over 725m in total and valuing the company at 9bn
• on the first day of trading, the shares doubled to 72
• during the pandemic, when the business expanded, the share price reached 250 in June 2020, which prompted investors to sell their shares for a higher gain
• but then in oct 2020, zoom’s share price was almost 16x its original IPO price at 575
• but then fell at the end of 2022 for 83 each

Question 8

What are bonds or IOUs?

Answer 8

• they are issued directly to investors, rather than through the bank
• like a loan, borrowing a money by issuing a bond is another form of debt on which the borrower will pay interest and which needs to be repaid

Question 9

How do bonds work?

Answer 9

• if a borrower wants to raise 100 million, it could subdivide the amount into 1 million IOUs, each representing 100 - each of which are called bonds
• the borrower may agree to pay the holders of the bonds their 100 back in 10 years, and until that point agree to pay them a rate of interest each year

Question 10

What are personal loans?

Answer 10

• money borrowed by individuals to purchase a consumer item like a TV or washing machine

Question 11

What is overdraft?

Answer 11

• a form of a loan on which the bank can demand repayment immediately, unlike a mortgage which may not be totally repaid for 25/30 years

Question 12

What do governments borrow?

Answer 12

• many governments collect sums of money by imposing taxes on citizens so that they can spend on items like: roads, hospitals, defence and education
• in some cases, govt expenditure > govt revenue -> the difference must be financed and is the amount that is usually borrowed

Question 13

Who do governments borrow from? And what is an example of key government borrowing?

Answer 13

• not from banks, but individuals and firms in the form of regular issues of bonds
• in summer 2022, the UK had outstanding bonds that added up to 2.4 trillion - aka as the national debt

Question 14

What are some cases in which a government may not be a borrower?

Answer 14

• in countries like Norway they do not have to borrow due to an abundance of natural resources like oil and gas
• in singapore it is because they have a very successful economy and government that is careful about how it spends its revenue

Question 15

What is the relationship between risk and reward?

Answer 15

• the greater the risk, the greater the reward

Question 16

Why would an equity be more risky than a bond?

Answer 16

• unlike bonds, equities do not specify a percentage of return that will be paid each year, nor a set date at which they are repaid
• also, if something goes wrong, it is the equities that are last in the queue to get any money back
• all in all, bonds or equities issued by smaller, less financially secure entities are likely to be much riskier

Question 17

Why would investors put money into equities?

Answer 17

• they hope that the company will do well and generate profits
• a share of these profits will then be paid by the company to the shareholders in the form of dividends
• but ultimately, the main aim is to be able to sell the equities they own to someone else, which will enable them to realise their investment, potentially for more money than they paid for

Question 18

What are the facilities to sell equities?

Answer 18

Equity markets, such as:
- LSE !!!!
- NYSE
- ADX
- TSE
- SSE

Question 19

What is a market/stock exchange?

Answer 19

• where deals (purchases or sales of stock) are exchanged

Question 20

Where are bonds sold? UNFINISHED

Answer 20

• like equities, they can be sold before they reach their repayment dates
• but they are often bought or sold away from the big stock exchanges

Question 21

What is insurance?

Answer 21

• a form of risk control - the insurance companies will take on specified risk in exchange for a series of premium payments
• if the risk materialises then the company will pay it out

Question 22

What is reinsurance?

Answer 22

• insurancing of an insurance company
• this allows the risk that is taken on by an insurance company to be shared

Question 23

What is foreign exchange trading?

Answer 23

• exchanging a particular quantity of one currency for an equivalent amount of another currency
• often takes place in when people exchange money to go on holiday

Question 24

Why is most forex done in US dollars?

Answer 24

• because the dollar is regarded as the most important currency in the world and therefore it is typical that foreign exchange is often quoted by the number of a particular currency that the US dollar is worth

Question 25

Why do banks and dealers want to offer foreign exchange?

Answer 25

• they earn fees in the form of commission and also have the potential to make money from the exchange rate differences
• in 2022, the activity in foreign exchange exceeded a massive 7.5 trillion