A WALK THROUGH THE FINANCIAL MARKETS
A host of people fail in investment because of a lack of understanding of the financial markets. Knowing how the markets work and the kind of instruments available is a prerequisite for triumph in investment, just as knowledge of an alphabet is needed for excellence in a language. The UK financial market can be split into two: the Money Market and the Stock Exchange Market.
The Money Market is dominated by the high street banks and Building Societies. It deals mainly in short-term loans (normally between 3 to 6 months). The banks and Building Societies serve as intermediaries to funnel aggregates of deposits from individuals (who have excess money to save) to companies who want to borrow extra funds to support their operations.
Conversely, the Stock Exchange Market has to do with securities that are negotiable – can be bought and sold before the redemption time. The Stock Exchange Market can be essentially divided into the Primary Market and the Secondary Market. The Primary Market has to do with new issues of shares, gilts and bonds, whereas the Secondary Market is involved in the buying and the selling of second-hand shares, gilts and bonds. In fact, a greater majority of the transactions that occur on the Stock Exchange Market relate to the Secondary Market. Arguably, the Secondary Market is the linchpin of the Primary Market. This is because the main reason why investors buy shares and bonds in the first place, is because they can sell it on the Secondary Market, whenever they want to. It must, however, be noted that a sale of a gilt or bond prior to its redemption is most likely to result in some amount of loss due to possible changes in interest rates.
It is advisable for investors considering long-term savings (between 20 and 30 years) to put their money in shares through Pension Funds and Insurance Policies. Those interested in earning fixed interests on their investments can consider gilts, which are relatively safe instruments by which the government usually borrows to help pay off its deficits. There are short gilts, with a maturity up to 5 years; medium gilts with a maturity between 5 and 15 years, and long gilts with a maturity of 15 years and above. Undated gilts are those without a redemption date; the interest payment goes on non-stop, without a redemption of the principal invested. Index-linked gilts have their interest payments and redemption amounts based on the level of inflation.
Bonds are another class of interest earning instruments that are traded on the Stock Exchange Market. They are issued by companies in order to raise extra loans to top up loans that their level of credibility could help raise from the money market – the banks and so on. They have redemption dates and pay interest greater than that paid on gilts, because investing in such bonds have a much higher default risk than investing in government gilts. In the worst case scenario, the government can print money to pay off principal and interest on the issued gilts.
Whether you find yourself dealing in the Money Market or the Stock Exchange Market, the rule of thumb is to exercise great caution and to shop around as much as possible. Stock prices change very fast and timing, as well as awareness are of great essence.