Element 2-Introduction to Saving and Borrowing

Question 1

How the financial services sector can be viewed as linking those with surplus money(savers) and those who needs the money(borrowers) in the following ways:

Via banks (deposits, loans)
Via equities (ownership stake)
Via bonds (IOU’s)

Answer 1

Via Banks
Banks making a profit on the difference between what they pay to savers and what they charge borrowers.

Via Equities
For businesses looking to raise money, an alternative to borrowing from the banks is for the business to sell equity. Equity is alternatively referred to as shares or stock and it represents ownership. The holders of the equity in a company own that company. The difference between are that interest needs to be paid on borrowing, and the money borrowed has to be repaid. There is no interest paid on equity and equity does not need to be repaid.

Via Bonds
IOUs issued directly to the investors, missing out the banks. Borrowing money by issuing bonds is another form of debt on which the borrower will pay interest and which needs to be repaid.

Question 2

Borrowers include companies and governments and that governments issue bonds rather than equity.

Answer 2

Borrowers are the companies that are looking to finance either start up or to grow from an already established base.

Also individuals can be borrowers who are looking to finance high-cost items.

Government borrowing tends not to come from banks but from individuals and firms in the form of regular issues of bonds.

Question 3

The relationship between the level of risk and the prospect of reward.

Answer 3

Risk and reward run hand in hand.
More risky and less risky investments are sometimes straightforward to identify. Such as buying shares in a well established company than if to invest in a loss-making, early-stage company.
Generally equities are more risky than bonds. This is because equities do not specify a percentage of return that will be paid each year and do not have set date at which they are repaid. If something goes wrong, it is the equities that are the last in the queue when it comes to getting any money back.

Question 4

Know that the financial services sector also includes markets to enable investors in equities and bonds to buy or sell investments.

Answer 4

Facilities to sell equities are provided by the equity markets and include most famous exchanges like NYSE, ADX, LSE.

Bonds are traded via electronic facilities that are generally described as over-the-counter (OTC)

Question 5

Know that the financial services sector also includes insurance providers to enable financial risks to be managed

Answer 5

To manage the risk, insurance companies can, and do, take out insurance themselves and this is generally referred to as reinsurance. Reinsurance allows the risk taken on by insurance companies to be shared (syndication).

Question 6

Know that the financial services sector also includes foreign exchange dealers to allow one currency to be exchanged for another to facilitate international trade.

Answer 6

Foreign exchange or Forex or FX is simply changing a particular quantity of one currency to another.