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Savings and investment (Equities (The most common form of stock in the UK,…
Savings and investment
Savings
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Not usually an intention to obtain large returns, rather the money is put aside for a specific purpose
This money may be deposited in any number of low yielding bank or building society savings accounts. The saver is more concerned with security of capital in order to make their purchase in due course
Do not have to be placed in any form of bank account, the saver may decide to keep them in the form of cash
May not be interest focused or concerned with the fact that inflation may erode their money's real value
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Cash savings
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If interest is not withdrawn, then the amount grows not only by the interest earned on the original amount but also on the added interest that has become part of the savings. This is known as compound interest
There are many different types of deposit accounts available from building societies and banks. These deposit takers receive spare cash from people and pay interest on it. They then lend this money to borrowers who have to pay a higher charge to the deposit takers for the amount they borrow, thereby allowing the deposit takers to earn a fee based on the differences between these two rates
Investment
Investors will not tend to keep money in the form of cash and instead will put money into something with the hope of returns in excess of infaltion
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More disposable income than savers and use this to generate additional returns in either income or capital appreciation or both
Investment products
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Alternative investments eg wine, art or vintage cars
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Two key principles
Diversification Do not put all your money in one asset class such as ordinary shares or a single stock. A diversified portfolio will include property, equities, corporate bonds and gilts. Well diversified portfolios will be spread over a number of geographical regions
Liquidity It is absolutely imperative that investors retain enough spare capital to meet near term requirements to avoid having to sell any investments in a depressed or falling market
Speculation
Tend to use financial instruments where there is an increased risk of some loss, total loss or even losses representing multiples of their initial outlay
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Reasons for investing
To make profit
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Investors in bonds receive coupon payments and would receive a higher yield if they purchased junk bonds rather than investment grade bonds
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Regulation of investment
The Financial Conduct Authority has the responsibility for the financial conduct of over 58,000 financial services firms and financial markets
Prudential Regulation Authority has responsibility for 18,000 banks, insurance companies, building societies and major investment firms. Its general objective is to promote the safety and soundness of the firms that it regulates
Authorities will try to ensure that financial markets are not only honest and fair but also effective
Try to ensure that markets work well for not only individuals and businesses but also the economy as a whole
The pensions regulator has a wide range of powers that it can implement to protect workplace pensions. These will enable it to deal effectively with risks associated with workplace pension schemes and members' savings. The regulator aims to prevent issues from occurring in the first instance through a risk based approach. The regulator tries to anticipate potential problems through education, enablement or enforcement
In 2018, under Basel III, the liquidity coverage ratio will be made mandatory. This standard aims to ensure that a bank has an unencumbered stock of high quality liquid assets (HQLA) comprising of cash or near cash assets that can be converted into cash at little or no loss of value in private markets in order to meet its liquify needs for a 30 days liquidity stress scenario. At a minimum, this stock of unencumbered HQLA should enable a bank to survive until the end of these 30 days, by which time it is assumed that appropriate corrective action will have been undertaken by management
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Equities
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Fixed units of the share capital of a company and are the most important component of a company's capital structure
The funds raised from issuing equities are used not only to finance expansion but also to reduce debt
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The stakeholders are entitled after prior charges such as preference share dividends and bank interest to all distributed profit
If liquidation should occur, the ordinary shareholders will be entitled to any residual assets but only after all other creditors have been satisfied
Ordinary shares are also referred to as voting shares. Although there may be some classed of ordinary share that have no voting rights, each ordinary share represents an equal share in the company. These may be designated as either A or B shares
Each ordinary share of the company will have the same nominal value; consequently all shareholders are on an equal footing which is directly proportional to their total holding
Having initially been issued in the primary market, ordinary shares may subsequently be traded freely in the secondary market, enabling investors to make a profit, break even or limit their loss
The ordinary shareholders will provide capital in exchange for their shares. From the company's perspective, this will its issued share capital and forms the equity capital of the company
Equities versus bonds
Equities
There should be dividend payments, the level of which will be dependent on the company's profitability
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In good years dividends may be excellent however in poor years, there may be no dividend at all
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If shareholders want a return of capital, they will have to sell in the secondary market to other shareholders
Bonds
Contractual obligation for the company itself to return the capital back to the investor at maturity date
If an investor wants a return of capital the bond may be sold in the secondary market at a profit or loss
Obligation for the bond issuer to pay a fixed coupon payment based on the nominal amount to the bond holder
Whether the company makes huge profits or incurs losses, the bondholder is only entitled to the fixed coupon payment
If a bondholder does sell in the secondary market, the new owner is entitled to the return of capital and maturity and coupon payments
There are situations when companies use their excess cash balances in order to repurchase their own shares in order to increase the value of the share price to the benefit of remaining shareholders
A key disadvantage is that in an economic downturn if the company subsequently has insufficient cash reserves to repay bank loans or if borrowing is cancelled, it may provide very difficult to source finance from other sources. A company should always ensure that it has sufficient cash reserves to protect itself and allow for expansion when a recovery starts
The difference between the yield on equities and interest on government bonds was known as the yield gap, this changed when companies were revalued, introducing the so called cult of the equity
Dividend yields fell below the level of interest yield and the gap became known as the reverse yield gap
Commodities
Including minerals, precious metals (palladium and gold) and crops are a more specialised form of investment.
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Alternative investments
Such as arts, antiques, fine wines and woodlands
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Some of the more successful investment returns have been made by members of the same family over several generations
Other problems to consider include difficultly in selling, especially during an economic downturn and maintenance costs of the items for exams the cost of providing insurance cover