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Personal Finance part 1: Banks and investments Objectives  Discuss banking – Its origin & role

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 Bankcome 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 lenders 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 !

Lets 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 Cant 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)