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[T423]The Econometrics Of Financial Markets

by David, Dav

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.

David Opoku BA Hons. in Accounting and Finance. (Currently specialising in Financial Advising). E-mail:

"There is definitely a connection between what's going on in the US and what goes on in the UK," said Graham Beale, Nationwide Building Society chief executive, "and it really comes down to market confidence, and we are talking about global market confidence because clearly, with the massive disruption in the US, banks have stopped lending to one another. And we need that fluidity back in the market."

Normally, the debts which institutions own (i.e. the money which people owe them) count as assets. Each Pound / Dollar of debt is basically seen as being worth a number of pence / cents, depending on how likely that debt is to be repaid. Today, however, no-one knows how much a lot of that debt is worth, so companies can't sell it. They also can't use it as collateral - and that makes it hard to borrow money from other companies.

This is one reason it's difficult for banks and other financial institutions to provide credit, whether it's a mortgage or a debt consolidation loan, to individuals. For people in debt, this is bad news. Debt consolidation isn't the only debt solution, but it's one which could help many borrowers get their finances in order once more.

So the authorities are trying to resolve the situation. In the US, there's the proposed $700 billion 'bailout'. In the UK, there's the Bank of England's (BoE's) Special Liquidity Scheme.

Quoted on CNN, Treasury Secretary Henry Paulson said the $700 billion bailout was necessary "in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy".

As for the BoE Special Liquidity Scheme, the BoE website says: 'Under the Scheme, banks can, for a period, swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks. By tackling decisively the overhang of assets in this way, the Scheme aims to improve the liquidity position of the banking system and increase confidence in financial markets'.

The details are very different, but the basic idea is the same - to remove some of the debt which banks and other financial institutions are carrying, 'unfreezing' the financial markets and allowing consumers greater access to the credit they need for everything from buying a house to consolidating their debts.

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David has sinced written about articles on various topics from Debts Loans, Watches Reviews and Bodybuilding Supplements. I hold a BA Hons. degree in Accounting and Finance. I am currently specialising in Financial Advising.. David's top article generates over 90500 views. to your Favourites.

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