Thursday, 22 May 2008

Investor and Borrower

The world is divided among 2 entities: An Investor - those who have that extra bit of money, and a borrower - those who need money. Sometimes they interact directly - like you and your friend. Sometimes, they interact via a governing/regulatory agency like a bank or an exchange. This has just led us to a new concept: Market Types.
We can either have an Exchange traded/regulated market or an Over The Counter(OTC) market.

So, whenever you need money you go to your friend and ask for it. He may or may not lend you. If he does, he can lend you interest free(almost always) or on an interest(he is not your friend). Lets redraw this picture. You need money and you go to a bank - you are a borrower. You have some spare cash, and you have no idea what to do with it. You then decide to put that money in a Bank Fixed Deposit. You just became an investor.

There are a number of ways to borrow or lend money. Borrowers can generate money for themselves by issuing a Bond, or a Stock.

Whenever a Bond is issued the borrower expects investors to lend money. The borrower has an obligation to return the money with an interest. This is one of the safest mode of investment, but doesn't give you a high return on investment. The rate of interest hovers around 6-10%. Government issued bonds are also very popular as it is very safe.

Whenever Stocks are issued by a company, it expectes the investors to buy stocks and become its part. As you are a part of the company you either gain or lose on a daily basis depending upon its performance. If you own the largest number of shares then you become the owner of the company!!! It becomes answerable to you. There is no limit of how much can you gain or lose in this type of investment.

Bonds are safer because it get paid first, and then the remaining amount is distributed to stock holders. If the company loses money till it becomes insolvent, it will pay you first with interest.

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