In recent years, investment in property has hit the headlines. Two sites that I use to keep up to date with property investment are:-
1. http://www.housepricecrash.co.uk which focuses on the UK property market, ostensibly highlighting news that would be negative on the market but covers all angles. It comes complete with charts showing how the property market has worked over the last 25 years (includes 2 cycles) and there is a link to the Nationwide site where property prices are recorded going back to 1952.
2. http://www.globalpropertyguide.com/ covers how well most of the world's property markets have done in the last few years as well as potential rental yields, legal issues, strength of the market etc.
The good things about property investment, as opposed to stock trading, for example, is that the market moves in cycles so at least you know if the market's frothy or bearish (at the moment, it's average but likely to drop further based on historical evidence). The bad things include:-
1. It's generally a leveraged investment i.e. most property is bought with a mortgage.
2. There are relatively high initial costs e.g. solicitor, estate agent.
3. You are taxed on your gains
4. It's an illiquid asset i.e. it's hard to shift when the market turns.
5. When buying abroad, you'll have to deal with different legal systems and planning laws, potentially more illiquid markets than the UK with less information available, you may also be reliant on airlines to take you to your property.
Monday, 19 October 2009
Friday, 16 October 2009
Foreign Exchange/Forex/FX
Foreign exchange trading refers to converting money in to other currencies on the basis that you expect that currency to strengthen against your original currency.
You can actively trade currencies using various forex brokers e.g. http://www.xe.com
Most forex traders generally trade in the mainstream floating exchange rate currencies e.g. Yen/Euro, Euro/USD, USD/Sterling etc. As these currencies are relatively stable, a lot of FX transactions are heavily leveraged to amplify the small changes.
The FX market is highly liquid with trillions of dollars being moved around the world on a daily basis. Due to the liquidity, there is no requirement for central market makers in FX, so trades are directly between 2 parties. The biggest players in the market are the investment banks with intra-bank bid-ask spreads on currency exchange rates having a razor sharp margin. Unfortunately, these rates are not available to retail investors. Most retail investors will exchange real money at foreign currency exchanges such as travelex. The bid-ask spreads on these exchanges are often very high.
You can actively trade currencies using various forex brokers e.g. http://www.xe.com
Most forex traders generally trade in the mainstream floating exchange rate currencies e.g. Yen/Euro, Euro/USD, USD/Sterling etc. As these currencies are relatively stable, a lot of FX transactions are heavily leveraged to amplify the small changes.
The FX market is highly liquid with trillions of dollars being moved around the world on a daily basis. Due to the liquidity, there is no requirement for central market makers in FX, so trades are directly between 2 parties. The biggest players in the market are the investment banks with intra-bank bid-ask spreads on currency exchange rates having a razor sharp margin. Unfortunately, these rates are not available to retail investors. Most retail investors will exchange real money at foreign currency exchanges such as travelex. The bid-ask spreads on these exchanges are often very high.
Monday, 12 October 2009
Venture Capital
Anybody whose watched dragon's den should be familiar with the concept of venture capitalism. It essentially means that rich people take a punt in your startup company by pumping in cash in return for equity. Since investing in startup companies is high risk and the government wants to encourage startups by providing them with a means of obtaining cash, the UK government encourages venture capitalists by offering tax reliefs on venture capital trusts. Currently, you don't have to pay income tax on the dividends from your investment or capital gains tax when you dispose of your investment.
With the tax relief, you'd imagine that venture capitalism is a great idea. However, you need to bear in mind the failure rate of startup companies and also the length of time that it typically takes for a startup company to turn a profit. Most startup companies attract venture capital in rounds, with milestones set to conclude a round and go on to the next round of attracting captial. Dragon's den is example of the seed round (1st round of financing). At this stage, it's usually the inventor/entrepreneur presenting a viable business case and attracting no more than £3m of capital in return for 30-40% of the company.
With the tax relief, you'd imagine that venture capitalism is a great idea. However, you need to bear in mind the failure rate of startup companies and also the length of time that it typically takes for a startup company to turn a profit. Most startup companies attract venture capital in rounds, with milestones set to conclude a round and go on to the next round of attracting captial. Dragon's den is example of the seed round (1st round of financing). At this stage, it's usually the inventor/entrepreneur presenting a viable business case and attracting no more than £3m of capital in return for 30-40% of the company.
Wednesday, 7 October 2009
Derivatives
Once upon a time, people just used to buy houses or shares in companies i.e. they were dealing with the real world. However, to reduce risk financial services companies started to create more exotic types of transactions called derivatives which are derived from the base financial instruments.
An example of a derivative is a futures contract. This is an agreement whereby the purchaser agrees to buy stock (a share in a company) at a future date. This is often used to purchase bonds which pay an income during the holding period in the full knowledge that you have a guaranteed selling price and can therefore calculate it's yield.
Trading on margin via contracts for differences (CFDs) is another example of a derivative. Here you can go long (make money if price goes up) or short (make money if price goes down) on a stock. If the price moves in the opposite direction to that which you expected e.g. you bought stock long at £1 with a leverage of 10:1 i.e. you only put 10p down and the stock price went down to 90p, then you'd lose your entire stake. The leveraged aspect of contract for differences magnifies your gains and your losses. Traders often use CFDs for hedging e.g. they go long at 10:1 and short at 9:1 on the same or related stocks, thereby being able to play with more money than they've personally got but also reducing their exposure.
An example of a derivative is a futures contract. This is an agreement whereby the purchaser agrees to buy stock (a share in a company) at a future date. This is often used to purchase bonds which pay an income during the holding period in the full knowledge that you have a guaranteed selling price and can therefore calculate it's yield.
Trading on margin via contracts for differences (CFDs) is another example of a derivative. Here you can go long (make money if price goes up) or short (make money if price goes down) on a stock. If the price moves in the opposite direction to that which you expected e.g. you bought stock long at £1 with a leverage of 10:1 i.e. you only put 10p down and the stock price went down to 90p, then you'd lose your entire stake. The leveraged aspect of contract for differences magnifies your gains and your losses. Traders often use CFDs for hedging e.g. they go long at 10:1 and short at 9:1 on the same or related stocks, thereby being able to play with more money than they've personally got but also reducing their exposure.
Wednesday, 30 September 2009
Fixed Rate Bonds
Fixed Rate or Fixed Term bonds are debt lent to banks by investors. A bank (or building society) makes it's money from the difference in the interest rate offered to savers and the rate charged to borrowers. In order to have a guaranteed amount of capital over a particular period of time, the bank offers bonds, to de-risk a run on the bank and to improve the amount of capital that they can offer to investors.
A fixed rate bond offers an interest rate which the financial institution believes will be the mid-rate over the period of the bond. The bank takes the risk, therefore, that a lower rate will prevail and the investor takes the risk that a higher rate will prevail and they would have been better off putting their cash in to instant access or notice savings accounts. Normally, the longer the term of the bond, the lower the interest rate that will be offered. Bonds form an attractive investment for those who want a guaranteed income.
Fixed rate bonds are offered by all banks and building societies with varying lengths of terms, interest rates and terms and conditions attached.
A fixed rate bond offers an interest rate which the financial institution believes will be the mid-rate over the period of the bond. The bank takes the risk, therefore, that a lower rate will prevail and the investor takes the risk that a higher rate will prevail and they would have been better off putting their cash in to instant access or notice savings accounts. Normally, the longer the term of the bond, the lower the interest rate that will be offered. Bonds form an attractive investment for those who want a guaranteed income.
Fixed rate bonds are offered by all banks and building societies with varying lengths of terms, interest rates and terms and conditions attached.
Monday, 28 September 2009
Gilts - Treasury bonds
Gilts is the name given to Treasury bonds. The name alludes to a gold-edged investment on account of it's relatively low risk. Most annuities are compelled to invest in gilts, as they provide such a reliable return.
A gilt is effectively a loan to a government. As the UK hasn't defaulted on it's debts (all be it, they had to get a loan from the International Monetary Fund in the 70s), so it is a good investment. The price of a gilt generally goes up if interest rates are low and goes down if they're high.
A gilt is usually advertised as '£value nominal of interest Treasury Stock maturity date',
where value is the nominal value of sold debt, interest is the percentage interest you could expect per year if you paid the nominal value and maturity date is the date on which the government will pay back the nominal value. For example '£1000 nominal of 3pc Treasury Stock 2012' would pay back £1000 on 1 January 2012 and will pay £30 per year from when you buy that debt until the maturity date. The nominal value isn't necessarily the amount you pay. You may pay more or less. The yield is the interest returned per year divided by the amount you paid (rather than the nominal value). For example, if you paid £900 for £1000 nominal of 3pc Treasury Stock 2012, the interest rate would be 3% but the yield would be 30/900=3.3%.
You can buy gilts from the government's debt management office.
Alternatively, you can buy gilts via a stockbroker or at the post office.
Thursday, 24 September 2009
Corporate bonds
Whilst shares, unit trusts & investment trusts are a share of the ownership of 1 or more companies, a corporate bond involves the lending of your money to a company for a fixed time length and for a fixed interest rate. At the end of the period covered by the bond, your capital will be returned. The amount of capital returned can vary, however, as the price of a corporate bond does change dependent on market demand.
An advantage of buying a corporate bond over buying equity in a company, is that you will be 1st in the line of creditors to be paid if a company fails. However, you still should anticipate the risk of default by the company, and higher interest rates generally indicate a higher risk of default. In general FTSE 100 companies will be at less risk and therefore pay less interest.
Buying individual corporate bonds is possible via most stockbrokers. However, it's easier to buy a fund rather than an individual bond. For example, the Jupiter corporate bond fund is investing ~90% in corporate bonds, 6% in gilts (treasury bonds) and the rest in cash. Hargreaves Lansdowne (http://www.h-l.co.uk) is one stockbroker currently allowing you to buy this fund. In terms of risk, corporate bonds are generally less risky than equities and more risky than cash & gilts. Typically, people who are approaching retirement and seek a steady income will sell some of their equity funds and buy corporate bond funds to reduce their risk.
Wednesday, 23 September 2009
Pensions
A Pension isn't exactly an investment vehicle in itself but is a wrapper for a variety of other investments. A typical pension fund will be invested in unit/investment trusts , cash, bonds & gilts (treasury bonds). Usually, if you have a company pension, you will be given a limited choice as to how you'd like your pension fund to be invested. Typically, you're given the choice of high, medium and low risk with the high risk choice being more heavily invested in unit/investment trusts and low risk heavily leans to cash & gilts. Sometimes, they'll allow the more experienced investor to choose their own investments but there's usually a limited number of investments available and the buy/sell costs tend to be higher than on the open market.
You may want to think about investing in a pension if 1 of these 2 is true:-
1. You're unlikely to accumulate more than £50k - the issue here is that if you have no savings at all, then you'll get the basic state pension plus a top up in pension credits worth the equivalent of a £50k pension pot.
2. You are a basic rate taxpayer - if so, the government will pay back any tax on your pension contributions. However, when you retire you'll be taxed on your annuity (insurance bought using your pension fund) at the basic rate. There's an argument that you're only deferring tax, and the other disadvantages of pensions may negate the advantages.
The main disadvantage of pension funds is that your investments are out of your reach until your designated retirement age. Up until April 2010, the earliest you were allowed to retire was 50, and from that date it will be 55 unless your existing pension contract already specifies an earlier retirement date. The government has historically, and probably will continue to change the options on investing for a pension, tax advantages associated with pension contributions, minimum retirement dates, rules on how long you can hold off taking an annuity and rules on what you can do with your pension fund.
When a pension contributer's retirement age is reached, he/she will either have to buy an annuity or delay the annuity for a set period of time defined by the pension fund trustee or can opt to have an income drawdown.
An annuity is effectively an insurance policy that a pension fund holder can take it. If say, you have £100k in your pension fund, then an annuity provider may promise to pay you 6% per year for the rest of your life, say, if you buy an annuity with your pension fund. The actuary who works for the annuity company works out the percentage payable by looking at the typical lifespan expected for somebody like yourself (Factors taken in to account are gender, age and lifestyle) and the current price of gilts (treasury bonds) which the annuity provider legally has to invest in a substantial proportion in, as it's deemed low risk. If you die earlier then the annuity company profits from you and if you die later then it loses and has to pay out using the funds of those who died earlier. There are different types of annuities available and the percentage payable varies. Typical factors which again alter the payout rates are:-
1. If you want the annuity to be payable just to yourself or to you and dependents on your death.
2. If you want the annuity to escalate by RPI or a fixed rate.
An income drawdown allows you to take an income from the fund rather than having to buy an annuity. Currently, you can take an income of anywhere from £0 to 120% of what a typical annuity would have paid you. You can only take income drawdown, however, until you're 75 when you currently have to buy an annuity.
Whether to buy an annuity or opt for income drawdown is a difficult choice. Currently annuities aren't paying a lot mainly because the price of gilts is high and the yield on the gilt, consequently low. However, if you were to opt for an income drawdown, perhaps gilts could become even more expensive and/or typical lifespans could extend and you'd be offered less, or you could die, in which case a substantial portion of the remaining capital will be absorbed by the pension fund.
Sometimes, the fact that your savings are in a pension fund rather than unit trusts or cash is a good thing. For example, if you are made redundant, it's only your liquid capital which is taken in to account, so you could have a substantial pension fund but no cash or unit/investment trusts and still be given high benefit payouts.
http://www.pensionsadvisoryservice.org.uk has some up to date information about pensions and annuities. They are a voluntary organisation that receive a grant from the department of work and pensions (DWP). Although, their advice is nominally independent, it should be borne in mind that they may be heavily influenced by the financial services industry so you should always do other research before forming a complete opinion.
http://www.thepensionservice.gov.uk is a site run by the department of work and pensions itself. It doesn't provide so much information about pensions and annuities but it does have some useful calculators for calculating the age at which you'll retire and the amount of basic state pension that you could currently expect based on your contributions. As there's been a lot of changes recently (e.g. women can't retire until 65 but both men and women only have to pay a minimum amount of national insurance for 30 years rather than 44 to qualify).
Tuesday, 22 September 2009
Investment Trusts
Investment trusts have the same aim as unit trusts i.e. to buy in bulk, shares in multiple companies. The difference is in the structure.
A unit trust can only take capital from investors to buy shares and the fund price is directly derived from the value of the share portfolio which the fund has bought.
An investment trust is itself a publicly listed company (plc) with all of the benefits that a company has including the borrowing of capital. The investment trust's fund price is effectively the share price of the company which owns the share portfolio. The fund price is, therefore, more loosely related to the price of the shares in the share portfolio and can be magnified by using borrowed capital to buy more shares to enhance the investment trusts' fund price.
There are a couple of more exotic investment trust structures:-
A split capital investment trust will issue different classes of shares to investors and the investor can choose which class of shares he wants to invest. The different classes of shares could pay out capital growth and dividends, or just dividends, or just capital etc.
A real estate investment trust is an investment trust which invests in property rather than company shares.
A unit trust can only take capital from investors to buy shares and the fund price is directly derived from the value of the share portfolio which the fund has bought.
An investment trust is itself a publicly listed company (plc) with all of the benefits that a company has including the borrowing of capital. The investment trust's fund price is effectively the share price of the company which owns the share portfolio. The fund price is, therefore, more loosely related to the price of the shares in the share portfolio and can be magnified by using borrowed capital to buy more shares to enhance the investment trusts' fund price.
There are a couple of more exotic investment trust structures:-
A split capital investment trust will issue different classes of shares to investors and the investor can choose which class of shares he wants to invest. The different classes of shares could pay out capital growth and dividends, or just dividends, or just capital etc.
A real estate investment trust is an investment trust which invests in property rather than company shares.
Monday, 21 September 2009
Unit Trusts
Unit Trusts are also known as funds. The basic premise is that the unit trust buys shares in various companies and then sells shares (units) of the fund to investors. The advantage of funds, as compared to buying sells directly in the companies yourself, is that the fund manager can buy the shares more cheaply as he buying in bulk and pass some of this benefit on to the individual investors.
Unit Trusts can be actively or passively managed.
An actively managed fund is one where the fund manager evaluates the performance of individual companies from time to time and may drop them from the fund or may buy shares in other companies.
A passively managed fund is usually linked to one of the main stock market indices e.g. FTSE 250. The constituent companies within the FTSE 250 are only changed every 3 months or so. At this time, the passively managed fund will sell shares in those companies who are no longer in the FTSE 250 (i.e. are no longer one of the top 250 companies trading on the main stock market that have the largest market capitalisation) and buy shares in those companies who have been promoted in to the FTSE 250.
Passively managed funds tend to have cheaper buy/sell costs than actively managed funds. Active fund managers like to highlight when they've done better than the main indices or choose statistics which put them in a good light e.g. they can vary their performance figures to highlight that they've beaten the indices in the last 6 months, last year, last 3 years, last 5 years or since the fund started. Often they'll have done better with 1 of these statistics, rarely is it true that they've done better with all of these ranges. For this reason, in my opinion, passively managed funds are better in the long run, whilst if you're a short term investor you may wish to choose an active fund whose manager is currently running a bit of luck.
Actively managed Unit Trusts often target particular sectors or countries or bands of countries e.g. New Star Technology, Gartmore China Opportunites, JPM Europe etc. Popular targets include income (as opposed to growth), small companies, emerging markets etc.
A fund that is targetting growth typically has the suffix ACC added to it, whereas a fund which targets income will usually have the suffix INC added to it. Growth funds will buy extra shares with any dividends paid by companies that they invest in, whereas Income funds will pay out, usually twice yearly, all of the share of dividends which have occurred during the period. Unless you need the income, it's best to re-invest the income in shares yourself, in any case.
A lot of unit trusts have a bid and an offer price. The bid price is what you'll receive when you sell the units and the offer price is what you have to pay to buy the units. The difference between the bid and offer prices is known as the spread. The spread can vary but effectively represents the commission that the market maker (company which buys shares from sellers and sells shares to buyers) makes on each trade.
You can create portfolios to hold all of your fund information on sites such as http://www.iii.co.uk/, http://www.trustnet.com/.
You can find up to date news about the financial industry and it's effect on the stock market on sites such as http://advfn.com/, http://cityam.com/, http://uk.finance.yahoo.com/.
You can find more general news on sites such as http://www.fool.co.uk/, http://ft.com/, http://moneyweek.com/, http://cnnmoney.com/, http://www.investorschronicle.co.uk/ .
Unit Trusts can be actively or passively managed.
An actively managed fund is one where the fund manager evaluates the performance of individual companies from time to time and may drop them from the fund or may buy shares in other companies.
A passively managed fund is usually linked to one of the main stock market indices e.g. FTSE 250. The constituent companies within the FTSE 250 are only changed every 3 months or so. At this time, the passively managed fund will sell shares in those companies who are no longer in the FTSE 250 (i.e. are no longer one of the top 250 companies trading on the main stock market that have the largest market capitalisation) and buy shares in those companies who have been promoted in to the FTSE 250.
Passively managed funds tend to have cheaper buy/sell costs than actively managed funds. Active fund managers like to highlight when they've done better than the main indices or choose statistics which put them in a good light e.g. they can vary their performance figures to highlight that they've beaten the indices in the last 6 months, last year, last 3 years, last 5 years or since the fund started. Often they'll have done better with 1 of these statistics, rarely is it true that they've done better with all of these ranges. For this reason, in my opinion, passively managed funds are better in the long run, whilst if you're a short term investor you may wish to choose an active fund whose manager is currently running a bit of luck.
Actively managed Unit Trusts often target particular sectors or countries or bands of countries e.g. New Star Technology, Gartmore China Opportunites, JPM Europe etc. Popular targets include income (as opposed to growth), small companies, emerging markets etc.
A fund that is targetting growth typically has the suffix ACC added to it, whereas a fund which targets income will usually have the suffix INC added to it. Growth funds will buy extra shares with any dividends paid by companies that they invest in, whereas Income funds will pay out, usually twice yearly, all of the share of dividends which have occurred during the period. Unless you need the income, it's best to re-invest the income in shares yourself, in any case.
A lot of unit trusts have a bid and an offer price. The bid price is what you'll receive when you sell the units and the offer price is what you have to pay to buy the units. The difference between the bid and offer prices is known as the spread. The spread can vary but effectively represents the commission that the market maker (company which buys shares from sellers and sells shares to buyers) makes on each trade.
You can create portfolios to hold all of your fund information on sites such as http://www.iii.co.uk/, http://www.trustnet.com/.
You can find up to date news about the financial industry and it's effect on the stock market on sites such as http://advfn.com/, http://cityam.com/, http://uk.finance.yahoo.com/.
You can find more general news on sites such as http://www.fool.co.uk/, http://ft.com/, http://moneyweek.com/, http://cnnmoney.com/, http://www.investorschronicle.co.uk/ .
Friday, 18 September 2009
Stocks & Shares
Stocks & Shares or Equities all refer to the same thing, the buying of shares in the ownership of a company.
This is a very high risk strategy, as individual companies can go bust, in which case you'll lose your entire investment, but conversely you can also make much better returns than the market if you choose a company well. The way to reduce your risk is to buy shares in lots of different companies but if you do this, unless you're committing a lot of money to shares, it would be cheaper to buy funds (unit trusts or investment trusts) as they can reduce the purchase and sale costs due to buying in bulk volume.
People who do buy individual stocks tend to either look for growth (companies where they expect the company to grow rapidly and the stock price to reflect this) or income (companies that have a tendency to pay out a substantial proportion of their profits to shareholders in what's known as dividends).
Companies which usually grow rapidly are small and medium sized companies with growth tailing off the larger a company becomes. The stock market for small to medium sized companies is called the Alternative Investment Market (AIM). However, as most brokers (companies that help you buy and sell shares) just focus on the FTSE, a lot of small to medium sized enterprises (SMES) will list themselves on that market themselves.
People who invest in individual shares tend to do a lot of research in to the strength and potential growth of the company by examining the company's balance sheets (accounts) which will be available on the company's website, if it's a public company (a company listed on the stock market - AIM or FTSE). It's quite difficult to read all of the balance sheets of all of the companies who you may want to invest in, so there are sites which help.
Yahoo Finance http://uk.finance.yahoo.com/ is one of the best sites if you're interested in investing in stocks and shares or funds. What it will detail for an individual company includes:-
Open(ing price) - this is the stock price when the market opened today
Bid (price) - this is the price that you can currently sell your stock back to the market at.
Ask (price) - this is the current price that you can buy stock in a company from the market
1y Target Est(imate) - this is the estimate from a group of analysts as to what the market price will be in a year's time. Take this with a pinch of salt. Analysts are often paid by companies to give them favourable prices/forecasts.
Day's range - minimum and maximum price during the day. Generally, of interest only to day traders (people who buy and sell stock within a single day) rather than buy and hold investors (people who buy stock and hold on to it for months/years).
52w(ee)k range - minimum and maximum price over rolling year period. Generally of interest to buy and hold investors.
Volume - the number of shares traded during the day. By comparing with the Average Volume, day traders can tell if a company's hot or not at the moment.
Avg Volume - the average number of shares traded per day.
Market Cap(italisation) - this is the number of shares * current share price. This tells you how much the market currently values the company and can be used to compare with the revenue/profit/net assets. You can then decide if the market's undervaluing or overvaluing the company.
P(rice)/E(arnings) ratio - This is simple measure of how the market's currently valuing the company. The Price is the current stock market price for this company, and the earnings is the last year's profits which were distributed to shareholders. Typically, fast growing companies will have a high P/E ratio, as the market expects earnings to grow rapidly and as the earnings refers to the previous year's earning, it's current earnings will be much higher. Investors looking for growth will typically look for company's which they believe will increase earnings rapidly and whose P/E ratio is lower than what would be expected.
E(arnings) P(er) S(hare): This is a division of the company's last year's profits distributed to shareholders by the number of shares that have been sold in that company. This tells you how much you would have earned per share had you held the shares last year. This is of interest to income investors i.e. people who want a good rate of income (analogous to interest) from their investment. Typically large organisations e.g. banks/oil companies will have relatively little potential for growth so will distribute a greater proportion of their profits to shareholders than SMEs who will instead invest the money to grow the company.
Div(idend) & Yield: The Yield is analagous to the interest rate and is given as a percentage of the earnings/market cap.
There are also analyst's forecasts (which should be taken with a pinch of salt). The next year's revenue is of interest if you don't want to read the current year's revenue listed in the company's accounts. This tells you how much the company earned in sales. For mature organisations you can divide the profits by the revenue and compare with similar organisations. Companies that differentiate from the norm could highlight a need for further investigation. The expected net debts are also of interest. A company could have substantial revenues and large profits but if it's net debts are very large, there could be trouble ahead if the rate of interest charged on the debt goes up, for example e.g. Lehman brothers.
In the old days, brokers and individual investors spent a large amount of time poring through company's facts and figures to try to determine which companies were the best to invest in.
In my honest opinion, this is quite pointless nowadays, if it wasn't back then. A company's price on the market does not correlate with it's underlying value in the short and medium term, and since investors in company's shares include pension funds, unit & investment trusts, derivatives and a lot of people who don't bother doing any research at all, it seems to me at least to be more speculation than investment nowadays.
This is a very high risk strategy, as individual companies can go bust, in which case you'll lose your entire investment, but conversely you can also make much better returns than the market if you choose a company well. The way to reduce your risk is to buy shares in lots of different companies but if you do this, unless you're committing a lot of money to shares, it would be cheaper to buy funds (unit trusts or investment trusts) as they can reduce the purchase and sale costs due to buying in bulk volume.
People who do buy individual stocks tend to either look for growth (companies where they expect the company to grow rapidly and the stock price to reflect this) or income (companies that have a tendency to pay out a substantial proportion of their profits to shareholders in what's known as dividends).
Companies which usually grow rapidly are small and medium sized companies with growth tailing off the larger a company becomes. The stock market for small to medium sized companies is called the Alternative Investment Market (AIM). However, as most brokers (companies that help you buy and sell shares) just focus on the FTSE, a lot of small to medium sized enterprises (SMES) will list themselves on that market themselves.
People who invest in individual shares tend to do a lot of research in to the strength and potential growth of the company by examining the company's balance sheets (accounts) which will be available on the company's website, if it's a public company (a company listed on the stock market - AIM or FTSE). It's quite difficult to read all of the balance sheets of all of the companies who you may want to invest in, so there are sites which help.
Yahoo Finance http://uk.finance.yahoo.com/ is one of the best sites if you're interested in investing in stocks and shares or funds. What it will detail for an individual company includes:-
Open(ing price) - this is the stock price when the market opened today
Bid (price) - this is the price that you can currently sell your stock back to the market at.
Ask (price) - this is the current price that you can buy stock in a company from the market
1y Target Est(imate) - this is the estimate from a group of analysts as to what the market price will be in a year's time. Take this with a pinch of salt. Analysts are often paid by companies to give them favourable prices/forecasts.
Day's range - minimum and maximum price during the day. Generally, of interest only to day traders (people who buy and sell stock within a single day) rather than buy and hold investors (people who buy stock and hold on to it for months/years).
52w(ee)k range - minimum and maximum price over rolling year period. Generally of interest to buy and hold investors.
Volume - the number of shares traded during the day. By comparing with the Average Volume, day traders can tell if a company's hot or not at the moment.
Avg Volume - the average number of shares traded per day.
Market Cap(italisation) - this is the number of shares * current share price. This tells you how much the market currently values the company and can be used to compare with the revenue/profit/net assets. You can then decide if the market's undervaluing or overvaluing the company.
P(rice)/E(arnings) ratio - This is simple measure of how the market's currently valuing the company. The Price is the current stock market price for this company, and the earnings is the last year's profits which were distributed to shareholders. Typically, fast growing companies will have a high P/E ratio, as the market expects earnings to grow rapidly and as the earnings refers to the previous year's earning, it's current earnings will be much higher. Investors looking for growth will typically look for company's which they believe will increase earnings rapidly and whose P/E ratio is lower than what would be expected.
E(arnings) P(er) S(hare): This is a division of the company's last year's profits distributed to shareholders by the number of shares that have been sold in that company. This tells you how much you would have earned per share had you held the shares last year. This is of interest to income investors i.e. people who want a good rate of income (analogous to interest) from their investment. Typically large organisations e.g. banks/oil companies will have relatively little potential for growth so will distribute a greater proportion of their profits to shareholders than SMEs who will instead invest the money to grow the company.
Div(idend) & Yield: The Yield is analagous to the interest rate and is given as a percentage of the earnings/market cap.
There are also analyst's forecasts (which should be taken with a pinch of salt). The next year's revenue is of interest if you don't want to read the current year's revenue listed in the company's accounts. This tells you how much the company earned in sales. For mature organisations you can divide the profits by the revenue and compare with similar organisations. Companies that differentiate from the norm could highlight a need for further investigation. The expected net debts are also of interest. A company could have substantial revenues and large profits but if it's net debts are very large, there could be trouble ahead if the rate of interest charged on the debt goes up, for example e.g. Lehman brothers.
In the old days, brokers and individual investors spent a large amount of time poring through company's facts and figures to try to determine which companies were the best to invest in.
In my honest opinion, this is quite pointless nowadays, if it wasn't back then. A company's price on the market does not correlate with it's underlying value in the short and medium term, and since investors in company's shares include pension funds, unit & investment trusts, derivatives and a lot of people who don't bother doing any research at all, it seems to me at least to be more speculation than investment nowadays.
Thursday, 17 September 2009
Investments
The 2nd part of investment is how to make a sufficiently higher rate of return on your money than sticking it under the bed - in the climate between October 2008 and July 2009, this may well have been one of the best investment ideas.
So, to start off where can you put your money:-
1. Cash
2. Stocks (Shares of companies)
3. Unit Trusts
4. Investment Trusts
5. Pensions
6. Corporate Bonds i.e. lending money to companies
7. Treasury Bonds (gilts) i.e. lending money to a government
8. Fixed Term Bonds i.e. lending money to banks
9. Derivatives (category which encompasses a broad range of investments derived from investing directly in a company).
10. Venture capital i.e investing in startup companies
11. Foreign Exchange
12. Property
Each of these investments has different levels of risks and historical rates of returns. I'll start today by looking at cash, which is where the majority of people's money goes to.
There are many sites out there which will tell you the best place to locate your cash saving. http://www.moneysupermarket.com/savings/ is one site which I use. With savings, you need to not only look at what the current rate of return will be but also read the small print to check that the interest rate isn't just a taster rate i.e. a rate that will only be offered for a few months. Most experts say that you should keep enough cash in available savings accounts to last you for 6 months of unemployment, so if you don't have this level of savings already, I wouldn't recommend examining other investment opportunities until you've done this, otherwise you may find yourself unemployed with no savings and having to finance your lifestyle on benefits and debt (which is a very expensive option). Some accounts are very complex to operate. For example, I opened a savings account once and they sent me about 6 different pin numbers for 2 linked accounts - a current account (which I didn't want) and a savings account (which I did) and with a direct debit automatically opened to move money from the current account to the savings account. The interest rate was impressive but the website was so difficult to use that I never managed to work out how to deposit money in to the current account, the direct debit kicked in and I found myself in the situation where A&L where demanding I pay £60 to close my account, even though I'd never actually used it. They climbed down in the end, but these are the kinds of pitfalls that you might encounter.
Not all of the best interest rates appear on 1 comparison website, so you should read the sunday newspapers and keep an eye out on rates advertised in the bank branches for other opportunities to grow your cash savings. For current accounts, again you can look at comparison websites but most current accounts don't pay much in the way of interest so keep as little as possible in there. I generally maintain about a week's worth of money in my current account. What you really want to go for with a current account is the range of services which go with it. e.g.
1. How much will you pay if you go in to overdraft
2. What is the size of the free overdraft limit on offer
3. Do they offer a linked credit card or savings account
4. How long does it take for electronic payments to be transferred from/to the account
5. How much will you pay in transaction charges when abroad
6. If you're a young person what additional offers do they do e.g. movie tickets, money back etc. Be careful that these offers aren't being funded by higher charges, however.
So, to start off where can you put your money:-
1. Cash
2. Stocks (Shares of companies)
3. Unit Trusts
4. Investment Trusts
5. Pensions
6. Corporate Bonds i.e. lending money to companies
7. Treasury Bonds (gilts) i.e. lending money to a government
8. Fixed Term Bonds i.e. lending money to banks
9. Derivatives (category which encompasses a broad range of investments derived from investing directly in a company).
10. Venture capital i.e investing in startup companies
11. Foreign Exchange
12. Property
Each of these investments has different levels of risks and historical rates of returns. I'll start today by looking at cash, which is where the majority of people's money goes to.
There are many sites out there which will tell you the best place to locate your cash saving. http://www.moneysupermarket.com/savings/ is one site which I use. With savings, you need to not only look at what the current rate of return will be but also read the small print to check that the interest rate isn't just a taster rate i.e. a rate that will only be offered for a few months. Most experts say that you should keep enough cash in available savings accounts to last you for 6 months of unemployment, so if you don't have this level of savings already, I wouldn't recommend examining other investment opportunities until you've done this, otherwise you may find yourself unemployed with no savings and having to finance your lifestyle on benefits and debt (which is a very expensive option). Some accounts are very complex to operate. For example, I opened a savings account once and they sent me about 6 different pin numbers for 2 linked accounts - a current account (which I didn't want) and a savings account (which I did) and with a direct debit automatically opened to move money from the current account to the savings account. The interest rate was impressive but the website was so difficult to use that I never managed to work out how to deposit money in to the current account, the direct debit kicked in and I found myself in the situation where A&L where demanding I pay £60 to close my account, even though I'd never actually used it. They climbed down in the end, but these are the kinds of pitfalls that you might encounter.
Not all of the best interest rates appear on 1 comparison website, so you should read the sunday newspapers and keep an eye out on rates advertised in the bank branches for other opportunities to grow your cash savings. For current accounts, again you can look at comparison websites but most current accounts don't pay much in the way of interest so keep as little as possible in there. I generally maintain about a week's worth of money in my current account. What you really want to go for with a current account is the range of services which go with it. e.g.
1. How much will you pay if you go in to overdraft
2. What is the size of the free overdraft limit on offer
3. Do they offer a linked credit card or savings account
4. How long does it take for electronic payments to be transferred from/to the account
5. How much will you pay in transaction charges when abroad
6. If you're a young person what additional offers do they do e.g. movie tickets, money back etc. Be careful that these offers aren't being funded by higher charges, however.
Wednesday, 16 September 2009
How to become rich
Unfortunately, the only easy way of getting rich quickly is to buy a lottery ticket, do some online gaming or taking a punt at spreadbetting or "investing" in penny shares. The chances of any of these routes making you richer are very slim but there's always a chance.
I've worked in online gaming for 5 years and I've certainly done well out of it :) A houseedge on a game can vary anywhere from -1% (when promoting a new game on a new channel) to +20%. Online gaming companies also make significant money from interest on deposits.
The most reliable way to become rich is to spend less than you make, and invest the surplus income in assets with a high rate of return over a prolonged period. So, there are 2 things to work out - firstly how to find a job/business opportunity that makes you the most money, and secondly how to find an investment which pays a high rate of return.
To find a job/business opportunity which pays good money, it comes down to that old favourite "supply and demand". Let's take a few examples of jobs which are at extremes of how much money you can make.
1. Footballer. In the old days, footballers got paid very little, turning out to play for their local team. What's turned this around is a massive increase in demand. With football being attractive to a large number of people, it's a relatively easy way for advertisers to get their message to a large number of people. For this reason, commercial TV pays football clubs large amounts of cash to allow them to televise football matches. In turn, the tv companies use the audience figures to attract advertisers. For the same reason that football's attractive, it's become of interest to various parts of marketing who've focussed on the sport, driving up revenue so that it's no longer the preserve of relatively poor people but has wealthy individuals paying for seats and merchandise. This would have made football clubs rather than footballers rich but for the fact that it's also attractive to some rich people to own a football club and there are only so many football clubs to buy, meaning that some rich folk are willing to run clubs at a loss so long as they can continue to bask in the related media attention. There are very few top class footballers, and the clubs with all of the money have to vie for this small pool of talent. That's why top premiership footballers are earning millions, league 1 players £50,000 and league 2 players on average wages.
2. Doctors and Lawyers. Both jobs pay well not only because of the relative complexity of their jobs but also because of the large reduction in the supply pool which occurs because of the methods of recruitment. Both of these professions require a candidate to have top grade exam results and then to go through years of training. In the case of barristers, the only way to get in to the profession is to obtain pupillage i.e. to work for free for another barrister for a number of years. In this way, the supply pool consists predominantly of highly intelligent children of other rich people.
3. Chief Executive Officer/Managing Director. The pay involved in this role is determined by the value of the company and the industry that they work in. The main reason why these guys get paid so much is that they've survived all of the politics to get to the position that they inhabit. Although, they get paid the most, they also have a very high rate of attrition which again requires a huge salary in order to attract other candidates to take on the role.
4. Hollywood Actor. Again, in the old days actors and actresses were relatively poorly paid and it wasn't a profession that held any respect - "Don't put your daughter on the stage, Mrs Worthington". What's made the top actors so wealthy was film and video. Hollywood's a business and, if a new actor becomes a box office hit in his first movie, then he's a more reliable hire to a film company than an unknown. Hence all of the film companies will clamour to hire the star for a new film, pushing up his pay demands, whilst prior to him getting his first film he was likely waiting on tables for minimum wage. The entertainment business is quite unusual in that there's a large supply of candidates, but the supply pool for hits is limited due to companies self-limiting the pool to known successes.
5. Refuse collector. This is a role that can be done by anybody and doesn't require any great communication skills and little training. Unsurprisingly, the pay is very small.
6. Tube driver. This is an unusual role in that it's not highly skilled, and hence attracts a large pool of candidates, but pays far above the average wage. The reason for this is that the job is controlled by the unions who have the ability to threaten the employers with strike action to ensure an above average rate of return for their members. As the London tube serves millions of commuters each day, and it's not possible to train up replacement tube drivers due to the uniqueness of that network, there is too much risk to an employer in allowing prolonged strikes to go ahead.
I've worked in online gaming for 5 years and I've certainly done well out of it :) A houseedge on a game can vary anywhere from -1% (when promoting a new game on a new channel) to +20%. Online gaming companies also make significant money from interest on deposits.
The most reliable way to become rich is to spend less than you make, and invest the surplus income in assets with a high rate of return over a prolonged period. So, there are 2 things to work out - firstly how to find a job/business opportunity that makes you the most money, and secondly how to find an investment which pays a high rate of return.
To find a job/business opportunity which pays good money, it comes down to that old favourite "supply and demand". Let's take a few examples of jobs which are at extremes of how much money you can make.
1. Footballer. In the old days, footballers got paid very little, turning out to play for their local team. What's turned this around is a massive increase in demand. With football being attractive to a large number of people, it's a relatively easy way for advertisers to get their message to a large number of people. For this reason, commercial TV pays football clubs large amounts of cash to allow them to televise football matches. In turn, the tv companies use the audience figures to attract advertisers. For the same reason that football's attractive, it's become of interest to various parts of marketing who've focussed on the sport, driving up revenue so that it's no longer the preserve of relatively poor people but has wealthy individuals paying for seats and merchandise. This would have made football clubs rather than footballers rich but for the fact that it's also attractive to some rich people to own a football club and there are only so many football clubs to buy, meaning that some rich folk are willing to run clubs at a loss so long as they can continue to bask in the related media attention. There are very few top class footballers, and the clubs with all of the money have to vie for this small pool of talent. That's why top premiership footballers are earning millions, league 1 players £50,000 and league 2 players on average wages.
2. Doctors and Lawyers. Both jobs pay well not only because of the relative complexity of their jobs but also because of the large reduction in the supply pool which occurs because of the methods of recruitment. Both of these professions require a candidate to have top grade exam results and then to go through years of training. In the case of barristers, the only way to get in to the profession is to obtain pupillage i.e. to work for free for another barrister for a number of years. In this way, the supply pool consists predominantly of highly intelligent children of other rich people.
3. Chief Executive Officer/Managing Director. The pay involved in this role is determined by the value of the company and the industry that they work in. The main reason why these guys get paid so much is that they've survived all of the politics to get to the position that they inhabit. Although, they get paid the most, they also have a very high rate of attrition which again requires a huge salary in order to attract other candidates to take on the role.
4. Hollywood Actor. Again, in the old days actors and actresses were relatively poorly paid and it wasn't a profession that held any respect - "Don't put your daughter on the stage, Mrs Worthington". What's made the top actors so wealthy was film and video. Hollywood's a business and, if a new actor becomes a box office hit in his first movie, then he's a more reliable hire to a film company than an unknown. Hence all of the film companies will clamour to hire the star for a new film, pushing up his pay demands, whilst prior to him getting his first film he was likely waiting on tables for minimum wage. The entertainment business is quite unusual in that there's a large supply of candidates, but the supply pool for hits is limited due to companies self-limiting the pool to known successes.
5. Refuse collector. This is a role that can be done by anybody and doesn't require any great communication skills and little training. Unsurprisingly, the pay is very small.
6. Tube driver. This is an unusual role in that it's not highly skilled, and hence attracts a large pool of candidates, but pays far above the average wage. The reason for this is that the job is controlled by the unions who have the ability to threaten the employers with strike action to ensure an above average rate of return for their members. As the London tube serves millions of commuters each day, and it's not possible to train up replacement tube drivers due to the uniqueness of that network, there is too much risk to an employer in allowing prolonged strikes to go ahead.
Tuesday, 15 September 2009
Lehman brothers - 1 year on
It seems like a good idea to start this blog as it's the 1st anniversary of the collapse of Lehman brothers. A lot of people are now aware of the reasons behind their collapse but it's probably worth re-iterating some of it.
Lehman brother's was an investment bank. Investment banks make their money in a variety of ways, the main ways being:-
1. Raising capital (capital's a posh word for money). The main way's that an investment bank raises money for it's clients (which are mainly companies) is to sell shares in that company or to sell the client company's debt to other companies and people. An investment bank makes money by taking a cut of the money that it's raised for a client.
2. Trading (buying and selling) in securities. Securities is an all encompassing word, which covers company shares, a company's debt, credit notes i.e. ious that a company may issue and any derivative (i.e. complex and opaque) of these. An investment bank makes money by taking a cut of any trade - this is known as market making, or by trading in securities itself, in the same way as a private individual may buy and sell shares, for example.
3. Advisory. Investment banks provide advice to companies and rich folk about which investments, they believe will make the most money.
4. Investment management. This is actively managing investments for companies, rich people and pension funds (who own rich and poor people's money).
Given all of the relatively lucrative ways of making money highlighted above, why did it all go horribly wrong for Lehman's. Well the short answer is that they got greedy.
The general US and UK economy grows by 3% on average per year. This means that if you invested in every person and company in the UK, say, you could expect to make a 3% return on your investment each year.
If an investment bank were to offer you a 3% return on your money, you might feel ok about this as bank rates are pretty low at the moment, but when they've been higher, you'd likely not be rushing to put your money in.
Luckily, for investment banks, they can get better returns by not investing in non-productive
people and faiing companies. So they can boost the returns to 5-7%, say. Now, for most people this would be a nice return but for rich people, they like to make more money than this. As there are a few investment banks around, they therefore have to convince companies and rich people that they can get higher rates of return than this. The manner in which investment banks chose to inflate their returns was by trading on margin/leveraging their assets.
What does trading on margin/leveraging their assets mean? Well an analogy is - if you buy your house for £150k without a mortgage, then you're not trading on margin/leveraging your assets, since you're merely transferring £150k in cash in to £150k in property. However, if you buy your house by putting down a £15k deposit, then you're leveraging your assets by 10 times. i.e. you originally only had £15k in cash, but now you've got £150k in property. A lot of people do this and, for most people it works out well. However, you've likely heard of negative equity. Negative equity happens when you buy a £150k house with £15k and the price drops below £135k. i.e. assets (in this case property) have dropped by more than the capital (cash) that you put in. When this happens, your bank usually starts to get a bit nervous and if your mortage is up for renewal whilst you're still in negative equity then you could get problems getting another offer.
So going back to why Lehman's went bust. To attract business away from other investment banks, they needed to offer attractive rates of return and the only way to do this was by leveraging the assets. In their case, rather than putting their money in to property, a lot of their money went in to reinsurance paperwork based on mortages lent to poor US people, many of whom had no chance of ever paying back the mortage (these mortgages are known as subprime, because most sensible people wouldn't have lent to such folk). Lehman's originally did the sensible thing of just selling on these substandard products to their clients but when the property market in the US turned south, they realised they had a major problem on their hands. The magnified returns which their clients had previously enjoyed would turn in to magnified losses, and there wouldn't be many people happy with Lehmans. So, what they tried to do is to prop up the market by buying the dodgy paperwork themselves. Their problem was that independent commentators had cottoned on to who was most exposed to the subprime market and had started to highlight this in various financial articles. There then ensued a run on the value of Lehman's brothers on the stock market, which highlighted the problem to the financial authorities.
Lehman brother's finally collapsed because, just as normal people have to pay their mortgage every month, Lehman had to pay for the leveraged debt that they'd taken on when buying the dodgy subprime paperwork. As most of their money was tied up in this and they were making losses rather than profits, the only way of paying the monthly fees to their lenders was by selling some of their assets. However, as they were leveraged so highly (44*assets at one stage), the debt which was owed was more than their entire assets so they were heading for bankruptcy. Their one hope would have been if somebody had come along and bought them. Although, you'd think you'd have to be mad to buy a company that was heading for bankruptcy, the thing is that Lehman brother's amongst the public was still well known and a buyer could hide all of the problems that Lehman's had suffered until the market turned around again and they'd have a bigger slice of the investment banking market. Many of the potential buyers were also owed the money which Lehman's couldn't pay, as well, so it may have been better to buy them rather than lose the money they were owed when Lehman's went bankrupt. Another reason why Lehman's figured that they'd got bought out was that they were too big to fail i.e. their losses were so huge that allowing them to fail would have an unacceptable ripple effect on the entire financial system. The US government, however, decided not to bail out Lehman's with taxpayers money. Commentator's say that this was because they'd already bailed out other institutions and wanted to draw a line. This left Barclay's capital as the one potential knight in shining armour. The problem there was that under UK law, BarCap would have to hold a shareholder's meeting to approve the deal and this couldn't be arranged before the financial markets opened. As soon as the financial market's opened, there was sure to be a further run on Lehman's share price. The lower Lehman's share price went, the lower it's financial rating becomes and this has a knock on effect of making the cost of it's debts higher, making it less attractive for any potential buyer. The UK government was also reticent to allow BarCap to step in, when it may have later needed to have been bailed out itself.
1 year on, there's talk of green shoots of recovery etc. and the investment banks are hiring once more. All seems rosy. Don't bet on it. The problem remains that the only way that investment banks can attract business is by offering high rates of return. The only way to achieve high rates of return is through leveraging. In the good times, leveraging creates huge profits and huge bonuses for investment bankers. In the bad times, it creates huge losses and inevitable bailout by other financial institutions/taxpayers. The UK&US financial authorities so far have taken no steps to prevent this from happening again out of fear that the investment banks that account, in the case of the UK, for a disproportionate amount of the economy will move their casinos to another country e.g. Singapore.
Lehman brother's was an investment bank. Investment banks make their money in a variety of ways, the main ways being:-
1. Raising capital (capital's a posh word for money). The main way's that an investment bank raises money for it's clients (which are mainly companies) is to sell shares in that company or to sell the client company's debt to other companies and people. An investment bank makes money by taking a cut of the money that it's raised for a client.
2. Trading (buying and selling) in securities. Securities is an all encompassing word, which covers company shares, a company's debt, credit notes i.e. ious that a company may issue and any derivative (i.e. complex and opaque) of these. An investment bank makes money by taking a cut of any trade - this is known as market making, or by trading in securities itself, in the same way as a private individual may buy and sell shares, for example.
3. Advisory. Investment banks provide advice to companies and rich folk about which investments, they believe will make the most money.
4. Investment management. This is actively managing investments for companies, rich people and pension funds (who own rich and poor people's money).
Given all of the relatively lucrative ways of making money highlighted above, why did it all go horribly wrong for Lehman's. Well the short answer is that they got greedy.
The general US and UK economy grows by 3% on average per year. This means that if you invested in every person and company in the UK, say, you could expect to make a 3% return on your investment each year.
If an investment bank were to offer you a 3% return on your money, you might feel ok about this as bank rates are pretty low at the moment, but when they've been higher, you'd likely not be rushing to put your money in.
Luckily, for investment banks, they can get better returns by not investing in non-productive
people and faiing companies. So they can boost the returns to 5-7%, say. Now, for most people this would be a nice return but for rich people, they like to make more money than this. As there are a few investment banks around, they therefore have to convince companies and rich people that they can get higher rates of return than this. The manner in which investment banks chose to inflate their returns was by trading on margin/leveraging their assets.
What does trading on margin/leveraging their assets mean? Well an analogy is - if you buy your house for £150k without a mortgage, then you're not trading on margin/leveraging your assets, since you're merely transferring £150k in cash in to £150k in property. However, if you buy your house by putting down a £15k deposit, then you're leveraging your assets by 10 times. i.e. you originally only had £15k in cash, but now you've got £150k in property. A lot of people do this and, for most people it works out well. However, you've likely heard of negative equity. Negative equity happens when you buy a £150k house with £15k and the price drops below £135k. i.e. assets (in this case property) have dropped by more than the capital (cash) that you put in. When this happens, your bank usually starts to get a bit nervous and if your mortage is up for renewal whilst you're still in negative equity then you could get problems getting another offer.
So going back to why Lehman's went bust. To attract business away from other investment banks, they needed to offer attractive rates of return and the only way to do this was by leveraging the assets. In their case, rather than putting their money in to property, a lot of their money went in to reinsurance paperwork based on mortages lent to poor US people, many of whom had no chance of ever paying back the mortage (these mortgages are known as subprime, because most sensible people wouldn't have lent to such folk). Lehman's originally did the sensible thing of just selling on these substandard products to their clients but when the property market in the US turned south, they realised they had a major problem on their hands. The magnified returns which their clients had previously enjoyed would turn in to magnified losses, and there wouldn't be many people happy with Lehmans. So, what they tried to do is to prop up the market by buying the dodgy paperwork themselves. Their problem was that independent commentators had cottoned on to who was most exposed to the subprime market and had started to highlight this in various financial articles. There then ensued a run on the value of Lehman's brothers on the stock market, which highlighted the problem to the financial authorities.
Lehman brother's finally collapsed because, just as normal people have to pay their mortgage every month, Lehman had to pay for the leveraged debt that they'd taken on when buying the dodgy subprime paperwork. As most of their money was tied up in this and they were making losses rather than profits, the only way of paying the monthly fees to their lenders was by selling some of their assets. However, as they were leveraged so highly (44*assets at one stage), the debt which was owed was more than their entire assets so they were heading for bankruptcy. Their one hope would have been if somebody had come along and bought them. Although, you'd think you'd have to be mad to buy a company that was heading for bankruptcy, the thing is that Lehman brother's amongst the public was still well known and a buyer could hide all of the problems that Lehman's had suffered until the market turned around again and they'd have a bigger slice of the investment banking market. Many of the potential buyers were also owed the money which Lehman's couldn't pay, as well, so it may have been better to buy them rather than lose the money they were owed when Lehman's went bankrupt. Another reason why Lehman's figured that they'd got bought out was that they were too big to fail i.e. their losses were so huge that allowing them to fail would have an unacceptable ripple effect on the entire financial system. The US government, however, decided not to bail out Lehman's with taxpayers money. Commentator's say that this was because they'd already bailed out other institutions and wanted to draw a line. This left Barclay's capital as the one potential knight in shining armour. The problem there was that under UK law, BarCap would have to hold a shareholder's meeting to approve the deal and this couldn't be arranged before the financial markets opened. As soon as the financial market's opened, there was sure to be a further run on Lehman's share price. The lower Lehman's share price went, the lower it's financial rating becomes and this has a knock on effect of making the cost of it's debts higher, making it less attractive for any potential buyer. The UK government was also reticent to allow BarCap to step in, when it may have later needed to have been bailed out itself.
1 year on, there's talk of green shoots of recovery etc. and the investment banks are hiring once more. All seems rosy. Don't bet on it. The problem remains that the only way that investment banks can attract business is by offering high rates of return. The only way to achieve high rates of return is through leveraging. In the good times, leveraging creates huge profits and huge bonuses for investment bankers. In the bad times, it creates huge losses and inevitable bailout by other financial institutions/taxpayers. The UK&US financial authorities so far have taken no steps to prevent this from happening again out of fear that the investment banks that account, in the case of the UK, for a disproportionate amount of the economy will move their casinos to another country e.g. Singapore.
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