Finance: Savings, Borrowing, and Investment - Essay Example

? Savings, Borrowing and Investment Table of Contents Table of Contents 2 Introduction 4 Savings 4 Definition 4 Explanation 4 Principles of savings 4Example 5 Evaluation 6 Borrowing 6 Definition 6 Explanation 6 Principles of Borrowing 7 Example 7 Evaluation 8 Investment 8 Definition 8 Explanation 8 Principles of Investment 8 Example 9 Evaluation 10 References 11 Introduction The project deals with outlining the principles related to savings, borrowing and investment which should be considered and followed by “True Love Endures” to continue its operations and achieve success in the industry. Savings Definition Savings is the amount of the disposable income which is not spent on the consumption or use of consumer goods. It is either accumulated or directly invested in payment of home mortgage, in capital equipment etc. It can also be invested indirectly by purchasing the securities. Explanation It is the amount which is left after meeting up all the personal expenses. In case of those individuals who are financially stable, they have an amount of money left after spending for personal expenses. Thus their savings is positive. For those individuals who generally depend on taking credits and loans to meet up all the needs and requirements, their savings figure is negative. Savings can be turned into increased income for an individual by the investment of the saved amount of money. Principles of savings Every individual should save a certain amount of their money for the uncertain tough times in future. There are various ways of utilizing the savings to have an increased income. Compounding is the most attractive among them. The method of investing the savings and getting the interest, calculated on the basis of compounding technique, is highly profitable. However the savings should be utilized in such a manner that it gives high return but involves minimum amount of risk. AER Annual equivalent rate is the amount of interest which is calculated based on the assumption that the payment of interest is combined with the actual or original balance and then the next interest payment is again based on the higher account balance. This actually means that the interest is getting compounded many times in a year depending on the number of interest payments made. In United Kingdom, the interest that is received from the investment in the savings account is calculated in the method of AER. It is calculated as: AER= (1+ r/n) ? -1 Where, n= number of times r= gross interest rate Example Interest on fixed deposits Fixed deposit is considered to be a risk free mode of investing the savings. Fixed deposit actually refers to a savings account or the certificate of deposit which continues to pay a fixed amount of interest until the completion of the maturity date. The amount invested in the fixed deposit cannot be withdrawn by the investor prior to the completion of the maturity period. They can only be withdrawn with an advanced notice. Benefits The fixed deposits of the reputed banks and other financial institutions are regulated or controlled by the banking regulators of that respective country where the bank originates. This makes the investment very secure (Swart, 2004). The fixed deposits help the investors to earn a fixed amount of income as interest for the entire tenure, which gets compounded after every quarter. Thus the investors who prefer having an income on the regular basis should choose for investing in the fixed deposits. This mode of investment of the savings saves the tax of the investors and provides them with high return. This type of investment is preferred by the investors who wish to obtain a fixed amount of interest for a particular period of time with minimum or no risk involvement. Government bonds The government bond is a debt security which is issued by the government for supporting the government spending, very commonly used in the domestic currency of a particular country. Let us take an example: the federal government bonds in United States include Treasury bond, savings bond etc. Before making an investment in the government bonds, an investor needs to thoroughly assess the minor risks which may be associated with the country related to the country risk, political risk, interest rate risk etc. Benefits The investors are given a certain predetermined rate of interest over the total life of the government bond. There are tax advantages on investing in the government bonds. The profit on these bonds is mostly tax free. The main benefit of the investment in government bonds is the safety associated with it. Unless a situation arises when the country is in a severe economic downturn condition, the investor will not lose his money. This mode of investment is preferred by those investors who want to make risk free investments with no chance of losing the money at all (Larimore, Lindauer and LeBoeuf, 2006). It is one of the most effective procedures of utilization of the savings of an individual. Evaluation Fixed deposit is the most risk free mode of investment and the best way of utilization of the savings of any individual. It will fetch fixed amount of income as interest for an individual for a certain period of time till the completion of the maturity period. An individual can also utilize some portion of his savings by investing in government bonds. It is a safe mode of investment and allows an investor to enjoy tax advantage by making such investment. Borrowing Definition Borrowing is the act of acquiring money temporarily with the intension of repaying the amount of money borrowed. Explanation Borrowing money gives an investor the instant gratification by letting him purchase something that is too expensive and not affordable by him immediately, like a house or a car. The borrower borrows the money from any lender for a particular period of time and pays a certain amount of interest along with the principal money while repaying the borrowed amount. Principles of Borrowing The borrowing should be made to that extent which can be repayable by the borrower within a certain period of time. The borrower should also make a proper repayment plan for the repayment of the borrowed amount. A borrower must always take into consideration the true cost of borrowings which depends on how much amount is borrowed, for how much time the money has been borrowed and the interest rate on such borrowings. A loan or borrowing with low interest rate is not always advantageous. A long term loan with low interest rate may end up having higher costs as compared to a short term loan having higher rate of interest. APR It is the annual rate charged for borrowing which is expressed in a single percentage number representing the actual cost of funds (annual) over the term of the loan. This includes any kind of additional cost which is associated with a transaction. Example Bank Loans A bank loan can be said to be a monetary loan obtained from the commercial lender. The loan should have a specific purpose (for ex- car loan, home loan, personal loan etc.) and a predetermined duration. It also has an interest rate (fixed or adjustable). Benefits: The borrower is guaranteed with the money up to a certain time period until it exceeds the time period mentioned in the loan conditions (Business Hotline Publication, 2005). The rate of interest may be fixed thereby making it easy in forecasting the interest payments. The bank loan is one of the most secured sources for borrowing money. Overdraft The overdraft is another type of borrowing facility that is linked to a bank’s current account. The overdrafts are designed in such a manner that they can manage the short term needs of borrowing. Benefits The overdraft is a flexible mode of borrowing money. It is easy and very quick to arrange. Evaluation The purpose of borrowing money varies. There may be a requirement of a short term borrowing by an individual for his/ her business purpose. In such a case he/she can borrow by means of overdraft financing. On the other hand when there is a need for a high amount of money or long term borrowing by an individual, he/she can apply for bank loan. The sources of borrowing also depend on the interest rates associated with it. Any individual preferring low interest rates can opt for taking the loan for a longer period of time with lower interest rates. On the other hand another individual can take the same amount of loan for a shorter span of time and repay the loan along with higher interest rates. Investment Definition In finance, Investment means putting the money into something and expecting to make some profit from it in future. Most of the investments include certain amount of risk for the investors. Explanation As mentioned earlier, investment is the procedure of committing the money into something with the expectation of receiving a certain additional amount of money in future. There are various methods of making investments. This includes investing in stocks, commodities market, foreign currencies etc. Principles of Investment The savings of an individual are utilized for increasing the income by investing the amount in something which can give a higher return on such investments. The investors use various investment plans as effective means of utilizing the savings and growing more money which might be required in the future. The diversification in the investment portfolio is an important strategy of utilizing the portfolio. But the implementation of such diversification should be made carefully as diversification does not mean only adding investments to the portfolio. It has to be an effective diversification portfolio where the risk associated with any particular investment is minimized to some extent by the other investments in the portfolio. Example Stock market investment It is the investment that is made in the equity shares of any company. This type of investment gives the owner or the investor of the shares the right to receive a certain portion of the company’s profit and also take part in making the company’s decisions (Hafer and Hein, 2007). The stock market investment is the most risky investment and gives the highest return (Rosen, 2008). It outperforms all the other types of investment strategies (Fontanills and Gentile, 2002). When the earnings of the company are high, the stock prices also increase leading to higher profitability of the investors. If the company originates from the growing market, the investment in its equity is very profitable and will provide a good return on the investment. The companies whose names are listed in the stock exchange generally enjoy the facility to cover a wide range of services and industries. However, this mode of investment involves high risk. In case of any economic downturn, the stocks of the company will be at risk in spite of the strong management team or high brand value of the company. Benefits The investment in stock market provides various benefits like easier liquidity, high flexibility of the invested amount, high rate of return and a regulatory framework for safeguarding the rights of the stock holders. Investment in stock gives the right to the holder to be one of the owners of the company and gain a certain amount of the company’s profits known as the dividend. The stock holder can also take part in making company’s decisions. The buying and selling of shares also involve capital gain. Thus the total return to an investor is the dividend amount plus the capital gain. Commodities Investment Commodities refer to the raw materials included in the commodity market like energy, food, metals etc., which form an important part of our regular life. The investment in these types of commodities is known as commodities investment. Benefits There are many benefits of investing in the commodity market. One of the main benefits of making investments in the commodities market is that this type of investment protects an investor from the period of inflation or various other uncertain economic conditions. When the economy of any country is in a declining state, the government starts printing more money for increasing the amount of investment in the commodities. It is very advantageous for any company to invest in the commodities market as it forms an important part in the diversified portfolio of the investment. Foreign currency investment The foreign currency investment involves making investment in the currencies of other countries. Foreign currency investment helps an investor in diversifying its investment. This type of investment helps an investor to hedge his position against any fluctuation in currency but without moving the invested money offshore (Wasendorf, 1998). Benefits Foreign currency investment has many benefits over other forms of investments. It helps in hedging the position of an investor. It helps the investors to enjoy the profits from the short term as well as the long term investment opportunities. Evaluation Stock market investment gives the maximum return on an investment. But this type of investment is highly risky and volatile. In case of economic downturn of any country the investors, who have made investment in the shares of any company originating in that country, suffer from huge losses. Thus the investors should make their investment portfolio in such a manner that when one investment fails to give sufficient amount of return, the other investments in the portfolio can offset the loss. Investment in commodities market forms an important part of the diversified portfolio. For example, when the stock market is declining then making investment in gold can be very advantageous (Fabozzi, Fuss and Kaiser, 2008). Foreign currency investment can also be an important part in the investment portfolio of an investor as it helps in hedging the position of the investor against a situation of currency fluctuation. References Business Hotline Publication, 2005. Overdrafts and bank loans. [pdf] Available at: [Accessed 5 June 2013]. Fabozzi, F. J., Fuss, R. and Kaiser, D. G., 2008. The Handbook of Commodity Investing. New Jersey: John Wiley & Sons. Fontanills, G. A. and Gentile, T., 2002. The Stock Market Course. New Jersey: John Wiley & Sons. Hafer, R. W., Hein, S. E., 2007. The Stock Market. Connecticut: Greenwood Publishing Group. Larimore, T., Lindauer, M. and LeBoeuf, M., 2006. The Bogleheads' Guide to Investing. New Jersey: John Wiley & Sons. Rosen, K. D., 2008. Investing in Income Properties: The Big Six Formula for Achieving Wealth in Real Estate. New Jersey: John Wiley & Sons. Swart, N., 2004. Personal Financial Management. Cape Town: Juta and Company Ltd. Wasendorf, R. R., 1998. Foreign Currency Trading: From the Fundamentals to the Fine Points. New York: McGraw Hill. Read More