This section introduces some basic concepts, which will be looked at in greater detail in subsequent issues.
Borrowing and lending
When we borrow
something, we are given permission to use it for a period of time and we usually have to pay for this, for example, if we are hiring
a car
, we are, in fact, borrowing it and we pay
to do so.
We can also borrow money. Borrowed money is called a loan
or credit
. The price we pay to borrow it is interest
. The actual amount that we borrow is the principal or capital amount
.
It's easy to understand why many people want to borrow
money. Very few of us have enough money to pay cash for something as expensive as a house or a car, so we borrow money and agree to pay back the amount, plus interest, over time. If we can live without something, though, it is better to wait until we have the money to pay for it in cash.
But why would anyone lend
us money? To make it worth their while, lenders must earn something for the service that they provide and for the risk that they take. The interest
that they get from the borrower is their reward or "return". Interest is usually written as a percentage of the principal amount over a period of time. For example, for a R10 000 loan, you may have to pay 24 percent interest a year
or R200 a month
in addition to the amount that you have borrowed.
Never borrow money if you are not sure that you can afford the repayments.
Credit
Credit
is borrowed
money. When we buy something "on credit", whether it is a fridge or a car, we are using it before we have paid for it. When we borrow
money, we are spending money before we have earned
it.
Interest rates
Interest is either money we earn when we deposit money at the bank, or it is the price that we pay for credit. The interest percentage that we earn or pay per year is called the interest rate
. For example, we may borrow R50 000 at an interest rate of 20 percent a year to buy a car. In simple terms, the cost of borrowing that money for the first year of the loan is 20 percent of R50 000, which is R10 000 (R833 a month).
However, interest rates are sometimes a bit more complex, depending on whether all the interest is calculated at the beginning
of the period of the loan, or you pay interest on the balance
of the debt after every monthly repayment. Ask your bank to explain to you exactly how the interest on your loan will be calculated.
Goods and services
The things we buy are either goods
or services
. Items such as food, furniture and clothes are goods, while medical care, banking and education are services.
Supply and demand
Producers supply
goods and services to meet customers' demand
. For example, if a lot of people buy apples, producers will produce a lot of apples. If there is a strong demand
for apples but a limited supply
, the price will rise
. As producers supply more apples to meet demand, the price will fall again.
When people are buying all the apples they can afford, and producers are selling all the apples they can produce at a profit, we say that demand and supply are in equilibrium
(or balance) and the price of apples is stable.
Intermediary
In the financial world, an intermediary is someone who facilitates business between the consumer (the client) and the supplier of the service (a bank or an insurance company or the JSE Securities Exchange, for example). Intermediaries include insurance brokers, bank officials and stockbrokers.
Returns
A return
is basically income. Investors must make a return on their money or they may as well keep it under a mattress and not invest it. The money that investors invest in businesses is called capital
, or equity
. Investors expect a return on their equity. If a business cannot provide the expected return on equity (ROE)
to the investors who have put money into it, then the investors will take their money out of the business and the business will have to find new investors or close down. Banks, just like other businesses, must attract investors by ensuring an adequate return on their money.
Inflation
Inflation is the overall, ongoing rise in prices
. Prices are always rising and falling as supply and demand change, but a price increase on a single product is not inflation. Inflation is usually given as the percentage increase in overall prices over a year. This reflects the reduction in the purchasing power of your money
. If you divide 72 by the inflation rate (say 10%), you get the number of years it will take before your money buys only half of what it buys today!
Risk and reward
The more risk
an investor takes, the bigger the reward
he or she expects. If there is a high risk that investors will lose part or all their capital, they will expect a higher return on equity to compensate for that risk.