Chapter One The Debt Merry GoRound The Debt

Chapter One The Debt Merry -Go-Round

The Debt Merry-go-round Lenders Intermediaries Markets Borrowers _______________________ Individuals Companies Banks Insurance companies Pension funds Mutual funds Interbank Stock exchange Money market Individuals Companies Central government Bond market Municipalities Foreign exchange Public corporations

Financial Markets The markets are all about the raising of capital and the matching of those who want capital (borrowers) with those who have it (lenders) Banks take deposits from those who have money to save and bundle it up in various ways so that it can be lent to those who wish to borrow More complex transactions than a simple bank deposit require markets in which borrowers and their agents can meet lenders and their agents, and existing commitments to borrow or lend can be sold on to other people. Stock exchanges are a good example

Financial Markets (cont. ) Lenders Individuals Companies Borrowers Individuals Companies Governments Municipalities and similar bodies Public corporations

Securities The first time the money is lent and changes hands and the first time the security is issued, is the primary market. All the buying and selling that takes place thereafter we call the secondary market A major characteristic of the markets is that these securities are typically freely bought and sold. This makes life easier for the lender and helps the borrower to raise the money more easily

Raising capital Bank loans Bonds Equity If it’s the first time the company has done this, we call it a ‘new issue’ If the company already has shareholders, it may approach them with the opportunity to buy more shares in the company, called a rights issue The reward for the shareholders by way of income is the dividend

Size of Global Financial Assets GDP/Assets World (in $ trillion) Percentage Share of the World Asia Latin America 2001 2009 GDP Bank Deposits 31. 0 79. 0 57. 8 92. 9 10. 4 8. 5 13. 6 10. 7 6. 1 2. 0 6. 9 2. 8 2. 7 0. 6 5. 6 1. 8 Equities Bonds Total 29. 0 42. 0 150. 0 47. 1 92. 0 232. 2 4. 5 3. 0 6. 2 11. 5 4. 3 8. 3 1. 4 1. 7 1. 8 4. 7 2. 5 3. 1 0. 3 0. 7 0. 6 2. 1 1. 0 1. 5 Source: Credit Suisse (2010) Global Wealth Report Emerging Europe

The World’s Financial Assets, By Market 2009(%) __________________________ United States 25 Eurozone 32 Japan 14 United Kingdom 7 China 6 Other 16 —— 100 ___________________________ Source: Credit Suisse (2010) Global Wealth Report

Gearing The danger of gearing comes when too much money is borrowed, especially if boom times are followed (as they usually are) by recession The firm may be unable to pay the interest out of its reduced profits, quite apart from the problem of repaying the principal sum itself Stock market analysts, therefore, look at firms’ balance sheets and look at the ratio of long-term debt to equity

Gearing (cont. ) Original equity + Rights issues + Retained profit = Shareholders’ funds