I always believe its easier to understand through examples. Too many financial terms out there, but here are the basics:
Risk Averse - When you get all excited about bonds and shares and commodities, and you want to jump in and invest, but you dont.
Counterparty - Almost everyone whom you need to deal with.
Credit Risk - Risk that your friend will never return the Rs 100 that he owes you.
Market Risk - Risk that tomato will go upto Rs 30 a kilo suddenly due to some bad news on TV.
Counterparty Default - When your husband cheats on you.
Asset - Your house/ bike/ car
Depreciation - When your house looks "dull" compared to the new flat down the road.
Liability - The rent/ installments that you pay for your house/ bike/ car
Mortgage - When you proudly say its MY house, when the legal title is with the bank.
Capital - Your salary
Reserve - Fixed Deposit with your bank
Reserve Liquidity - Savings Deposit with your bank
IOU - Recurring Deposit with your bank
Accrued Interest - Interest from FD/ RD/ SB
Position - Current value of your house.
Unrealised profit - When your land cost shoots up and you are happy to have bought a house earlier.
Unrealised loss - When the laptop price slumps and you curse yourself for having bought a laptop last week.
Mark-to-Market - When you walk past a TV shop and see how much your TV costs currently.
Notional - Amount of bank loan that you always worry about, but never get to pay.
Know Your Client (KYC) - When you research all possible relatives and friends to see if the potential bridegroom is a "good boy" for your girl.
Guarantee - When you certify that the next door boy is "very good" when a potential father-in-law comes to check on him.
Collateral - The gold that a bride wears, that could go into a pawn shop when times go sour
Random Access
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Sunday, October 05, 2008
Friday, October 03, 2008
My 2 cents on all things Finance - Part 2
The tough get tougher when the trough gets deeper.
Passing out of school brought about a whole new change for me, new country, new friends, new passions, new distractions, new way of life. It was all too overwhelming, and it took me a good two years to realise its just as challenging as my beloved Chennai. Money started disappearing faster than it has, all my life. Expenses became the norm of life. I spent everyday, my "own" money. Its enormous risk spending money that you did not earn. And one fine day, it all disappeared. I had to borrow, for the first time in my life. It pains, worse than the worst sin you had ever committed. Debt came into my dictionary. Debt was bad, debt pains, debt is horrible. Stay away from debt. And so I fought for the next 4 years to repay my debts.
It was almost a natural progression that my gentle curious interest in money and piggy bank savings should lead me to work in a Financial Services firm. I did learn a lot on how to work; and learnt a bit on how they make money work for them. Margin became more than a pencil line on a white sheet of paper. I was surprised how much people risked, and for a few shares which they dont even get to see! Financial statements of companies made a lot more sense, although still meant little.
A switch to an insurance firm gave me an all too simple view of insurance. People paid for something which could never happen. People paid for a perceived risk, and some smart companies calling themselves insurance gave assurance that in case something bad happened, they would cover their families. And millions believed in this concept. And the fun part of it was that I did learn that insurance companies themselves insured!
Moving on to an investment bank, it felt weird. Is the world really this simple and foolish? People think banks are the safest places to put their money in, but banks invariably take the most risks! They give loans to people, they invest in companies, they trade like crazy. They borrow money from government/banks/people at a lower rate, lend to banks/corporates/people at a higher rate and pay people with the margin.
After a good five years in the financial services sector, I realised the entire financial system relies on one main thing. TRUST. If you lend money or borrow money, there should be trust between the parties. Worse still if you deposit the money in your favorite bank, which uses this money to buy shares, and sells shares that it does not own, and enters into repurchase agreements to fill the missing shares, securitises these shares with another bank to get more cash, and uses this cash to buy some government bonds, and gives this bonds to another bank to borrow more money and uses this money to give loans to a start up company hoping for a return on capital and to you as a house loan hoping you will pay the monthly interest, mitigates the risk of not getting back the money by getting another bank to act as a guarantee, gets whatever shares the company currently owns, sells those shares in the secondary market at a higher rate. And this example is just the tip of the iceberg. So, where is YOUR money? Its extremely complex in today's world, and nobody really knows where is your money. And my gut feel is that your simple deposit with your bank will lead that money to tie virtually every bank out there in some kind of transaction! So, if you want your money back, you are giving virtually every bank a run for their money :)
But, you say, the government is there to regulate. The bank does continuously calculate its balance sheet and tries to maintain a balance between its future cashflows, and keeps a percentage of the money it owes people as reserves, to please the regulators. But again, nothing is 100%. For you, the money you keep in the bank is safe. For the bank, the money it keeps is a loss! So, they went to a resort in Switzerland and came up with Basel 1 and Basel 2 to convince the government to let them trade as much money as possible, leaving their coffers as dry as possible.
Now, what if the key word goes missing. If TRUST is not there, between the bank and customer, or bank and bank, the whole financial system goes topsy turvy. Nobody wants to cheat, and no cheat can exist in the system for long. But then, what if you cant pay your house loan of Rs 10000 per month? Nothing happens. What if a million such people cannot repay. One housing loan company might go bust. What is one housing loan company goes bust? Nothing much maybe. What if 10 such companies go bust? The bank that fund these companies is screwed. As in the example above, that means almost every bank!
The survival of the fittest kicks in. Since risk is like a time bomb being passed across from one institution to another, the one that has the highest risk when the alarm bells ring bursts. The rest are tested for their survival. If someone does not have cash at that point of time, its time to say goodbye. ML and Lehmann found this out recently. The cash rich companies and banks see this as an opportunity to buy whatever they can. Consolidation results. The big and bounty survive. The small and fragile break. Its just the nature of the financial system.
Rumours test the keyword TRUST. A 4-pager "The boy who broke the bank" by Ruskin Bond is a highly recommended read for starters. Anything and everything in the fragile environment is a bank-breaker. A current example is of ICICI, second largest lender in India, whose shares dropped 14% in a day based on rumours that it does not have enough cash.
So, what can you do about it?
1. Have trust with people and institutions that you deal with financially.
2. Dont put all eggs in the same basket. Diversify your portfolios.
3. Bank is just another person. There is nothing which is 100% safe.
4. Dont go with the flow. Dont buy a house because every other colleague buys one.
5. Watch out for market signs. You should be very careful if you see every housewife buying and selling shares without knowing what it is!
6. Dont think you are too smart. A billion others out there are not idiots.
7. Start small, grow in chunks. You can dream big, but dont risk big.
8. Knowledge is power. Dont do anything without knowing what you are doing.
9. Patience is a virtue. For an individual, investment is good; trading is not.
10. It all boils down to fundamentals. Dont go by perceived value when the times are bad.
Random Access
The search has just begun !!!
Passing out of school brought about a whole new change for me, new country, new friends, new passions, new distractions, new way of life. It was all too overwhelming, and it took me a good two years to realise its just as challenging as my beloved Chennai. Money started disappearing faster than it has, all my life. Expenses became the norm of life. I spent everyday, my "own" money. Its enormous risk spending money that you did not earn. And one fine day, it all disappeared. I had to borrow, for the first time in my life. It pains, worse than the worst sin you had ever committed. Debt came into my dictionary. Debt was bad, debt pains, debt is horrible. Stay away from debt. And so I fought for the next 4 years to repay my debts.
It was almost a natural progression that my gentle curious interest in money and piggy bank savings should lead me to work in a Financial Services firm. I did learn a lot on how to work; and learnt a bit on how they make money work for them. Margin became more than a pencil line on a white sheet of paper. I was surprised how much people risked, and for a few shares which they dont even get to see! Financial statements of companies made a lot more sense, although still meant little.
A switch to an insurance firm gave me an all too simple view of insurance. People paid for something which could never happen. People paid for a perceived risk, and some smart companies calling themselves insurance gave assurance that in case something bad happened, they would cover their families. And millions believed in this concept. And the fun part of it was that I did learn that insurance companies themselves insured!
Moving on to an investment bank, it felt weird. Is the world really this simple and foolish? People think banks are the safest places to put their money in, but banks invariably take the most risks! They give loans to people, they invest in companies, they trade like crazy. They borrow money from government/banks/people at a lower rate, lend to banks/corporates/people at a higher rate and pay people with the margin.
After a good five years in the financial services sector, I realised the entire financial system relies on one main thing. TRUST. If you lend money or borrow money, there should be trust between the parties. Worse still if you deposit the money in your favorite bank, which uses this money to buy shares, and sells shares that it does not own, and enters into repurchase agreements to fill the missing shares, securitises these shares with another bank to get more cash, and uses this cash to buy some government bonds, and gives this bonds to another bank to borrow more money and uses this money to give loans to a start up company hoping for a return on capital and to you as a house loan hoping you will pay the monthly interest, mitigates the risk of not getting back the money by getting another bank to act as a guarantee, gets whatever shares the company currently owns, sells those shares in the secondary market at a higher rate. And this example is just the tip of the iceberg. So, where is YOUR money? Its extremely complex in today's world, and nobody really knows where is your money. And my gut feel is that your simple deposit with your bank will lead that money to tie virtually every bank out there in some kind of transaction! So, if you want your money back, you are giving virtually every bank a run for their money :)
But, you say, the government is there to regulate. The bank does continuously calculate its balance sheet and tries to maintain a balance between its future cashflows, and keeps a percentage of the money it owes people as reserves, to please the regulators. But again, nothing is 100%. For you, the money you keep in the bank is safe. For the bank, the money it keeps is a loss! So, they went to a resort in Switzerland and came up with Basel 1 and Basel 2 to convince the government to let them trade as much money as possible, leaving their coffers as dry as possible.
Now, what if the key word goes missing. If TRUST is not there, between the bank and customer, or bank and bank, the whole financial system goes topsy turvy. Nobody wants to cheat, and no cheat can exist in the system for long. But then, what if you cant pay your house loan of Rs 10000 per month? Nothing happens. What if a million such people cannot repay. One housing loan company might go bust. What is one housing loan company goes bust? Nothing much maybe. What if 10 such companies go bust? The bank that fund these companies is screwed. As in the example above, that means almost every bank!
The survival of the fittest kicks in. Since risk is like a time bomb being passed across from one institution to another, the one that has the highest risk when the alarm bells ring bursts. The rest are tested for their survival. If someone does not have cash at that point of time, its time to say goodbye. ML and Lehmann found this out recently. The cash rich companies and banks see this as an opportunity to buy whatever they can. Consolidation results. The big and bounty survive. The small and fragile break. Its just the nature of the financial system.
Rumours test the keyword TRUST. A 4-pager "The boy who broke the bank" by Ruskin Bond is a highly recommended read for starters. Anything and everything in the fragile environment is a bank-breaker. A current example is of ICICI, second largest lender in India, whose shares dropped 14% in a day based on rumours that it does not have enough cash.
So, what can you do about it?
1. Have trust with people and institutions that you deal with financially.
2. Dont put all eggs in the same basket. Diversify your portfolios.
3. Bank is just another person. There is nothing which is 100% safe.
4. Dont go with the flow. Dont buy a house because every other colleague buys one.
5. Watch out for market signs. You should be very careful if you see every housewife buying and selling shares without knowing what it is!
6. Dont think you are too smart. A billion others out there are not idiots.
7. Start small, grow in chunks. You can dream big, but dont risk big.
8. Knowledge is power. Dont do anything without knowing what you are doing.
9. Patience is a virtue. For an individual, investment is good; trading is not.
10. It all boils down to fundamentals. Dont go by perceived value when the times are bad.
Random Access
The search has just begun !!!
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