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The Contribution of the Euro-dollar Market to the Modern Financial World

The Contribution of the Euro-dollar Market to the Modern Financial World

The Euro-dollar market* had caused many changes to the modern financial world in which, the open competitive effect of the international money market caused the liberalization by almost all industrialized countries of domestic money and banking markets. The market acted as a fully international mechanism for attracting deposits and offering loans, over a broad range of maturities and at highly competitive rates. The first important development of Euro-dollar business came after the Second World War, when Soviet bloc holders of dollar balances wanted to keep them in a form not subject to control by the US authorities. They kept them with London banks. However, the development of the market as a large-scale international structure really dates from 1957. It was given its impetus then by a rise in UK Bank rate to 7% and the imposition of restrictions on sterling credits to finance trade between non-sterling countries. At that time, banks in the US were limited (by Regulation Q) as to the amount of interest they might pay on deposits. Banks outside the US were able to offer a higher rate for dollar deposits, and yet, by operating on finer margins, to offer competitive terms for dollar loans. Many banks were well placed to take advantage of this situation. This was because of their wide overseas connections, long experience of international business and variety of outlets for making international loans. The first substantial development of the market took place in London, and London conducted much of the largest share of the business, which contributed considerable invisible earnings to the UK balance of payments.

The role of sterling has been a central point to the development of the Euro-dollar market. To the sense that, the control of sterling has not only been a central preoccupation of British governments, but largely determined Britain’s strategy towards the international financial market. Since 1958, governments have found themselves in a “dilemma” by the pressures of which the international use of sterling had placed on the British economy where “depleted” reserves of the entire sterling area constituted the most significant constraint on achieving economic growth. The management of sterling was the heart of governing Britain until conditions allowed the convertibility of the currency in the late 1950s. The central point that, throughout the postwar period, the British government sought agreements that enabled US dollars to flow to Britain whilst restricting the convertibility of sterling in domestic and foreign hands, (the Washington Loan Agreement, the Marshall Plan, and military assistance programmes encouraged a flow of dollars to Britain).

The UK government placed particular emphasis on exports to the dollar area (dollar-earning exports), with sterling area exports deemed next in importance. As early as the 1950s, Conservative governments, set about reasserting the international status of sterling and the importance of the City of London as the world’s premier financial centre. In 1953, commodity markets and exchanges for raw materials were re-opened in London. March 1954 saw the long awaited return of London Gold Market (open to all non-residents of the sterling area). Changes were made in currency regulations in 1955, which allowed the partial convertability of the pound for non-sterling area residents and non-dollar area residents. This was followed finally by the full convertability of sterling in December 1958, and by the Bank of England’s decision in 1962 to provide cheap foreign exchange cover and allow non-residents to hold dollar balances with the Bank of England (thus signalling the beginning of the Euro-dollar market). Dollars could now be deposited with the Bank of England in an external account, thereby escaping US exchange regulations and earning a higher rate of interest than obtainable in the US. The aim here was well calculated. London’s position as the main financial centre would be re-established and the City would quickly become the world’s leading Euro-dollar market.

However, the real significance of the Euro-dollar market lay in the fact that it originally drew its funds from non-bank suppliers and ultimately lent them to non-bank users, in which the established market was not dependent upon the existence on the USA remaining in deficit. As, the market soon become an integrated international money market providing its own specialised service which had shown considerable powers of survival. Merchant banks simply turned to the expatriate dollars, and used them in the way they have used sterling, operating freely on a global scale in the financing of international trade and the arrangement of longer term loans. American and other foreign banks wanting to take advantage of the paucity of financial controls in the UK soon joined this new market that was dominated by the merchant banks. Hence, between 1967-1978 the representation of foreign banks in London grew from 113 to 395. As, for the City’s banks, the establishment of sterling convertability in 1958 “was arguably the most important event of this century”, for it heralded the rise of the London Euro-dollar market. The table below shows how dramatic the Euro-dollar market had indeed become. A total of 91 international Euro-currency issues totalling the equivalent of ,884m took place in 1967. The firms shown below are ranked in order of the aggregate amount of issues for which they acted either as managers or as co-managers. Apart from those listed, there were 45 firms active in such management .

Euro-dollar Bond League

Firm – Total Dollar Equivalents (000)- Number of Issues:

Banque de Paris et des Pays-Bas – 490,000 – 21

Banca Commerciale Italiana – 445,000 – 19

S.G. Warburg & Co – 385,700 – 21

Deutsche Bank A.G. – 367,500 – 17

Kuhn, Loeb & Co – 295,000 – 15

White Weld &Co – 285,200 – 14

Lazard Freres & Co – 265,000 – 14

N.M. Rothschild & Sons – 260,000 – 11

Morgan & Cie International S.A. – 260,000 – 8

Lehman Brothers – 250,000 – 9

Banca Nazionale del Lavoro – 194,000 – 9

First Boston Corporation – 168,000 – 8

Banque Nationale de Paris – 152,500 – 6

Societe Generale de Banque – 135,000 – 7

Amsterdam-Rotterdam Bank N.V. – 135,000 – 6

Credit Commercial de France – 131,200 – 7

Kredietbank – 130,200 – 9

Smith, Barney & Co Inc. – 130,000 – 8

Societe Generale – 125,000 – 5

Credit Lyonnais – 122,200 – 5

(Source: The Times, the Euro-dollar bond league 29 December 1967)

The City of London proved to be a highly successful international commercial banking and financial centre, despite growing fears of competition from other centres. It presented strength, derived largely from the generalised “trust” with which the world views the City. The survival and revival of London as an international financial centre after the disruptions of the Second World War and the weakness of sterling as an international reserve currency had been largely based upon the development of the Euro-currency markets. In specific the growth of new or “parallel” markets alongside the old “classic” discount market, which with the relative decline of sterling as an international currency, had become a domestic concern. These new markets had revitalised the foreign exchange markets in response to the emergence of barriers of various kinds between ultimate borrowers and lenders. On the one hand, the domestic parallel money market in sterling evolved out of responses which were intended to evade the credit restrictions which successive British governments had attempted to impose during the 1960s through their participation in the old discount market. On the other hand, the decline of sterling and the difficulties associated with the US governments’ restrictions on the use of the dollar as an international currency gave rise to new markets in Euro-dollars and other Euro-currencies. New money markets where money is lent and borrowed between banks, companies and other organisations without the control of the monetary authorities (governments and central banks). It was a measure of the City’s autonomy that such developments took place.

The development of the Euro-dollar Market can be described by using a Marxist analysis of capitalism, in particular, the workings of the capitalist economy and its political and social implications. In specific, to the theory of the state in advanced capitalism, and on the basis of the materialist conception of history and Marx’s general theory of capitalist production. As any attempt to develop a theory of the state, must deal with a Marx’s works on the state. In the sense that, capitalism is analysed predominantly as “civil society”, as a more or less self-contained sphere in which all citizens, including capitalists and workers, confront each other as competing individuals on the market. Using this conception, the state occupies another sphere standing outside civil society, which purports to represent universality or the community between people, but is constantly undermined by the antagonistic individualism of its basis, namely civil society.

Karl Marx claimed that, “the abstraction of the state as such belongs only to modern times. The abstraction of the political state is a modern product” . The Euro-dollar market inherently being a new phenomenon proved some uncertainty to the British Labour government during the mid-1960s, which had to approach the new market through an analysis of the world in which the Labour Party sought to govern. Such an analysis posed a variety of questions. Firstly, why particular institutions and processes posed such a set of problems for the individual Labour governments? Secondly, why particular issues come to preoccupy political debate in one period only for it to dwindle in importance in the next? Finally, why particular patterns of political and social cleavage prove so tenacious? With such questions, and a new market developing, the British Labour Government had to respond with a set agenda in order to control specified targets including the sequence of booms and slumps, the differing strengths of the national economy, the rise and significance of multinational corporations, the role of international financial agencies, and the changing role of the government in economic and social life. Such a task seems a formidable one, but one that was not considered impossible. As what holds the analysis together is the recognition that the world during the 1960s was capitalist to the sense that Marx used the term. The law of value still operated throughout the major economic and social processes. Due to this reason, the preceding outline of Marx’s analysis remains relevant, as it provides the means by which the true nature of the British government’s dilemmas can be explained and understood.

To Marx, the executive of the modern state is portrayed as “a committee for managing the common affairs of the whole bourgeoisie”. However, there is a problem, which must confront any contemporary theory of Marxism, namely the relation between appearance and reality. The state appears as independent from the sphere of market exchange, but in reality it is a different matter. The Euro-dollar is an example of such a case, in essence a phenomenon of the 1960s, an international money market where commercial banks undertook wholesale transactions involving foreign currencies. It had been a growing market, which has often involved conflicts with the state. As governments change, the market had been growing at a rapid pace, which had proved to be difficult to regulate. It seems that the Euro-dollar market was one of the initiating processes, which led to what is known today as globalization. To the sense that, the market had caused many changes to the modern financial world which, evolved on a global scale. The open competitive effect of the international money market had caused the liberalization by almost all industrialized countries of domestic money and banking markets. Where, successful participants in the money market of today, have a far more sophisticated understanding of financial risk, and the tools to manage them. As the changes in the markets have required many banking institutions to change in the way of financial regulation.

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However, when examining the Euro-dollar market, one has to turn to the 1960s which witnessed the focus of the changing relationship between the national state and the global financial markets, where the policies of Keynesian sought to bring “economic forces” under control. The idea was that the state should assume responsibility for the economy, intervening where the market fails to stimulate economic growth. In times of a recession, the state should stimulate demand through deficit financing (such as, state expenditure based on credit). The state was thus charged with creating demand through an increase of the money supply. Keynesian raised these means to the principle of capitalist reproduction. Governments used these methods in a form of expansionary policies. Keynesianism depended upon the use of money for expansive industrial development and the management of “sound” finance.

One major question arose, throughout the paper: what are the risks and problems of the Euro-dollar market, and is the growth of this market a “welcome tonic or a slow poison” to the international financial system (with particular emphasis to the United Kingdom)?

There was no doubt that the growth of the Euro-dollar market had contributed spectacularly to the easing of the world liquidity problem. In less than a decade, the market grew from nothing to ,000 million compared with an increase in official world reserves of only ,000 million from 1951 to 1965. However, the growth of this market merely “put-off” the evil day when the reserve currency countries, and in particular the United States, had to adjust their payment situations to the facts of life. On the technical level the growth in the Euro-dollar market exposed the world in general and Britain in particular to every similar dangers to those experienced in the early thirties. Of its nature it was a market notable for its lack of regulation and control. No one country could exercise control over it. Euro-dollar deposits were no longer used solely for trade finance, and hence were not self-cancelling. Although individual banks observed limits to the amount of dollars they were to lend to individual “names”, countries or areas, deposits passed through many hands before they had reached the final user. It was almost impossible to tell the extent to which any country or individuals were committed to repaying Euro-dollars. If a serious breakdown occurred anywhere in the system, the strain would be transmitted to the centre. Britain’s involvement in this market was so extensive with £2,773 million liabilities and £2,487 million credits, by 1968, that a breakdown would inevitably throw doubt on Sterling .

The risks and problems associated with the Euro-dollar market made themselves felt at three levels: the individual bank, the individual country, and at the level of the international financial system as a whole. For an individual bank the main risk was the possibility that a borrower may not repay his Euro-dollar loan. The borrower for any number of purposes – over which because of their unsecured nature, the lending bank had very little control, may use Euro-dollar funds. For an individual country, the problems created by the Euro-dollar market were two-fold: Firstly, the danger that the domestic banks involved in the market may over-extend themselves and thereby place demands on the official foreign exchange reserve. Secondly, the fact that the existence of the Euro-dollar market had provided another channel through which short-term capital can flow internationally and, hence, had tended to increase the volume of short-term capital moving into or out of any particular country”.

There were difficulties in establishing a mechanism that could bring about the necessary degree of international control over the Euro-dollar market. The most important was the fact that there was no single institution, either national or international, that could control the market, and act as an international lender of last resort in the same way that a national central bank can in the case of a national money market. There seemed to be a system of informal understanding among the central banks, developing probably as part of their co-operation in fighting exchange crisis, under which substantial volumes of US dollars could be mobilised quickly to meet any serious destabilising forces in the Euro-dollar market. In circumstances where the needs of the Euro-dollar market did conflict with other policy objectives, however, it was doubtful the national central banks would give priority to the Euro-dollar market. This was the basic weakness. As, in order to avoid this situation, the US dollar funds needed to stabilise the Euro-dollar market would have had to be made available on a more formal basis – such as by means of pre-arranged swap and stand by arrangements between the national central banks and the BIS. In this situation the BIS would be free to call on these swap funds in accordance with the needs of the Euro-dollar market. In addition, to meet these requirements during a period of crisis the volume of US funds at the disposal of the BIS would have had to be substantial. Undoubtedly, the major portion of these swap funds had to originate from the Federal Reserve System.

Generally, however as far as the international financial system was concerned, one heard nothing but good of the Euro-dollar market and of its rapid expansion. Whitehall had generally welcomed it as a means of financing the UK’s overseas mandate (investments) without putting undue strain on sterling. The City of London virtually created the market and had made a good deal of business out of it. The Chancellor of the Exchequer stated way back on the 8th December 1960, of using US dollars to improve the UK balance of payments, and to improve the UK dollar indebtedness. Throughout the end of the 1960s, it was apparent that the Euro-dollar market not only financed the UK economy, but assisted in the UK’s balance of payment’s problems. The British government foresaw the Euro-dollar Market as a way for advancing its own interests and concerns. The role of the public authorities and the nationalised industries proved to be very crucial to the UK government. These industries became a way for the UK government to raise foreign currency on a medium and long-term basis in order to finance its repayments of shorter-term debt and to improve the UK reserves. Both the Inland Revenue and the Treasury agreed on one thing that, something had to be done to “helping local authorities to obtain access to the Euro-dollar market” . To the sense that, both parties considered it desirable to include a provision in the Finance Bill of 1970 to the effect that “the interest on securities issued by a local authority in the currency of a country outside the scheduled territories shall be payable in full without deduction of tax at source, and be exempt from income tax where the beneficial owner of the securities is not resident in the UK”. This was the combined view of the Treasury and the Inland Revenue as a “means of removing an impediment to foreign currency borrowing by UK authorities in the Eurobond market” . The reason for this was that, “it was in the public interest for nationalised industries and large local authorities to borrow on the Euro-dollar market” .

Controls in the UK had been designed to protect the reserves by restricting access to the market by UK residents and restricting of “switching” out of sterling by banks in the UK. UK residents who were able to show a need were allowed to maintain foreign currency deposits (which earned Euro-dollar rates) with UK banks. These deposits soon accrued dramatically. Also control was permitting UK residents (especially the local authorities) to borrow foreign currencies in this market, or overseas where this allowed beneficial transactions to take place without recourse to the reserves (e.g. for foreign investment). Banks in the UK were allowed to maintain an excess of foreign currency claims over liabilities (i.e. to switch out of sterling) only to the extent necessary for them to maintain working balances.

This would accommodate a significant and useful benefit to the UK balance of payments. The idea was considered to be of such importance that large steps were taken to encourage UK borrowers to “tap” into the foreign currency sources of finance. The UK government passed powerful legislation through parliament, which involved serious sensitive issues such as tax measures encouraging foreign currency borrowing (i.e. tax allowances, tax evasion, and payment of gross interest), and double taxation agreements.

However, certain issues arose which showed the sensitivity of the situation of whether the UK government were favouring business interests, when pursuing its policies, and whether HM government would relieve these industries of the loss should-ever there be a change in the exchange rates (in a form of a Government Exchange Guarantee). The argument being that the government could not allow a nationalised industry to default and by encouraging the nationalised industries to borrow for the sole purpose of easing the balance of payments, the interest rates would be more than counter-balanced by the increased production that would be made possible. Given successful management of demand, such production would either find its way into exports or into the satisfaction of needs, which would otherwise be placed into imports. This meant that external sources of capital financed a large part of the UK’s portfolio and direct investment abroad, and UK borrowers were allowed under exchange control to raise foreign currency loans to finance domestic investment. This was implemented by providing an “off-shore” regulation-free environment devised to trade financial assets denominated in foreign currencies.

One situation concerned the Ford Motor Company in the USA. The company had entered into a contract to purchase for dollars, the sterling required to enable the company to undertake their offer to buy 45% shareholdings in the Ford Motor Company of the UK, which they did not already own. The UK Government on the 13th December 1960, received 0 million for value for this offer . Secondly, it was a market that even interested the IBRD. On 18th August 1960 Mr Miller of the IBRD’s Paris Office wrote to the UK Treasury, to discuss with the Bank of England, the question of whether the International bank could follow the example that was apparent, with many other institutions investing dollars in the UK at short term, and to place these into what was identified as the “Euro-Dollar Market”. At the end, the IBRD eventually dropped the idea of placing certain liquid dollar assets in London, because of the unfavourable attitude of the US Treasury. Although the IBRD decided not to process this further, it nevertheless resembled the importance and relevance of the Euro-dollar market, and of the City of London itself .

In 1968, the progress in reducing the UK balance of payments deficit was much slower than the UK Government had either anticipated or desired. As, the third quarter figures of 1968 experienced an unprecedented net inflow of nearly £200m on long-term capital account and a further reduction in the current account deficit. On the combined current and long-term capital accounts there was an identified surplus of around £105m: the best quarterly result since the fourth quarter of 1966, and following deficits of about £310m and £170m in the first and second quarters. Official long-term capital transactions benefited in the third quarter. There was a very large net inward movement of private long-term capital amounting to around £175m . However in 1969, there was a considerable turnaround between the first and second halves of the year, when the current and long-term capital deficit fell from £427m to £31m. Apart from the substantial progress in cutting the trade deficit, a significant part of the improvement resulted from changes on the capital account. The outflow on official capital (in the capital account) inevitably rose. Bond issues overseas by UK public corporations provided a counterbalance to the increase. Tighter credit in the UK tended to check outward movements and encouraged inward movements of long and short-term capital. As investment of this kind involved no call on the UK reserves, in the standard form of the balance of payments, the investment was recorded as a debit, but the Euro-dollars which financed it were recorded not as a credit, but as a monetary inflow. In general, it seemed that there had been an encouraging start towards the UK achieving its immediate objective for 1969-70, and that the outlook for achieving a larger continuing surplus thereafter was good .

However even though it is easy to view these events by their own logic, in order to understand their real significance, they must be set in the context of the negotiations which took place between Britain and Europe in the mid-1950s. In the summer and autumn of 1955, Britain was invited to discussions on closer European economic integration by the six nations, which eventually signed the Treaties of Rome in March 1957. After a flurry of activity in Whitehall, the Cabinet Office circulated the Trend Report, which pointed out to four decisive considerations against membership . Firstly, the Cabinet Office and the Treasury had concluded that membership would weaken the UK’s economic and consequently its political relationship with the Commonwealth and the colonies. Secondly, it was judged that the UK’s economic and political interests were worldwide and that a European common market would be contrary to the approach of freer trade and payments. Thirdly, it was thought that participation would gradually lead to political federation, which was unacceptable to Britain. Finally, the Cabinet Office concluded that membership would be detrimental to the British economy since it would involve the removal of protection for British industry against European competition. When placed alongside the earlier considerations relating to sterling, the Trend Report convinced the Eden government that Britain should withdraw from the Messina Talks. Instead of negotiating with the Six, Thornecroft at the Board of Trade convinced the Cabinet to launch an alternative non-discriminatory scheme aiming to “disunite” the Six away from the idea of the common market. This scheme, labelled Plan G, later developed into Britain’s free trade proposals, which became the basis of the European Free Trade Area (EFTA) established after the Stockholm Conference in 1959 . Whilst, Plan G proposed a free trade area designed to eliminate industrial tariffs, it carried no further implications regarding wider economic integration. Within a free trade area, Britain could retain its traditional trading structure, and as Board of Trade concluded, this would be entirely different from a European discriminatory bloc in which Britain came under domination of Germany.

The successful conclusion of the Treaty of Rome in March 1957, came as a major surprise to the British state. It was fundamental to British thinking that the Six would not go ahead without the participation of the UK. In a frank memorandum titled “What went wrong?”, the Treasury surveyed the scene in July 1959, and concluded that the government had made a number of serious errors . Britain had misunderstood the US position, not realising that the US State department would always back the Community given its political and defence implications. It had made a number of tactical errors, in trying to divide the Six, in believing that the UK would be allowed to join at any stage once the Community was formed and in failing to establish a “negotiating machinery” to match that of the French. Finally the British government had continued to pursue the half-hearted 17 nation EFTA strategy when it was clear that neither the French nor the Germans were attracted to the idea, which in any case the Treasury concluded “does not bear examination for five minutes”. The next 14 years would be spent struggling with the legacy of the British state’s failed attempt to prevent the creation of the Community.

A further examination must make reference to the form of Britain’s postwar integration into international trade and money markets. Although a number of events began to weaken Britain’s position in the global political economy (Suez and the relentless process of decolonisation), access to privileged markets had enabled the economy to reconstruct and prosper in the early 1950s. Moreover, the British governments could utilise the international prestige of sterling and the City of London to counter, (at least in theory), the effects of balance of payments deficits. Once it became clear that, de Gaulle would not sanction UK entry to the Community, Britain was caught in a bind and was forced to pin its economic hopes on the revival of the City of London.

In the 19th century, it was the competitiveness of “British industry” which led to the international use of sterling. However, by the late 1950s, the lack of competitiveness of Britain’s industrial base (particularly “via” Europe) now meant that the international use of sterling could quickly turn from an asset to a liability. As sterling was made convertible, short-term capital inflows and outflows increased in volatility. In these circumstances, the Bank of England found it increasingly difficult to defend the exchange rate – where the slightest “rumour” could lead to a massive speculation against the pound, destabilising the domestic economy. Although these pressures were seen to exist even as early as 1956 (when sterling was only partially convertible) over the first two days of Britain’s invasion of Egypt there was a massive outflow of million – (they became more acute over the next 20 years). From the early 1960s, the “British economy” was dominated by a pattern which saw rising levels of imports, falling exports, and when the balance of payments surplus diminished the introduction of high interest rates to attract short-term capital (hot money) to London.

On entering office in 1964, Wilson found that convertibility and the establishment of the Euro-dollar markets had produced a situation whereby financial markets could validate or disapprove of policy measures within hours. In many ways, the story of the Wilson’s government is one of speculative action against the pound followed by international rescue operations to shore up the sterling exchange rate. Deflationary measures pursued throughout 1965, and 1966 failed to stem the tide of speculation, forcing the government to devalue in November 1967 and to negotiate a ,5 billion standby credit from the IMF. Wilson agreed with the Bank of England and the Treasury that devaluation was a strategy to be avoided unless the Labour Government was willing to destroy confidence in sterling and the City as the premier financial centre.

So relatively, the development of the Euro-dollar market coincided with the recoveries of the capitalist economies and the growing pressure of the US economy. The shortage of dollars gradually changed into dollar saturation. This market took over aspects of a developed domestic credit system, which was operating globally and independently from the central banks. Speculative capital assumed the function of national and international institutions, financing budget and balance of payments deficits. Such “money” existed as a claim on central bank money in national states on unregulated financial markets. The global role of the City foresaw the result as the dominance of financial over industrial capital. To the sense that although Britain was a low-wage and low-productivity country, it was a centre of global finance (due to the contribution of the Euro-dollar market). However, this did not mean that British industry had been undermined as a consequence of financial interests and policies favouring the concerns of financial markets, although the global role of the City “has had” a detrimental effect on British industrial development. Rather, the development of London as the centre for the global circulation of capital expressed the organisation of “British” capital at the most developed level of global capitalist relations. However, this development of the dominance of financial capital over productive capital must be treated with caution, since it was high interest rates that attracted money capital to London and the fact that the UK is one of the main countries attracting productive investment (particularly from US-based multinationals).

So what can we learn from the British experience? The British case illustrates that there is nothing simple about the choice between government and the market: both are flawed mechanisms in terms of maximising efficiency and both require a deeply rooted underlying consent about their manner of operation and acceptance of their distributional outcomes. Lever later acknowledged in 1974/75 that, “modern governments, overestimated their ability to shape and manage the complex drives of a mature economy. They wrongly assumed that they understood all the reasons for its shortcomings and so, not surprisingly, were all too ready to lay hands on superficial remedies for overcoming them. And all this without any attempt to understand the economies of an increasingly interdependent world” .

It remains to be said that that the nation-state provides the domestic political underpinning for the stability of global capitalist relations. Therefore in order to maintain the position of a nation state’s integration into the “world market” nation states are under constant pressure to make more efficient use of available resources. Failure to achieve this will result in a loss of reserves, precipitated by balance of payments difficulties, and inflationary pressure, provoking global exchange instability and financial crisis.

ENDNOTE

* Here are two very similar definitions of the term Euro-dollars:

Robert Gilpin, (The Political Economy of International Relations, Princetown University Press, 1987, p. 314-315), states that: The Euro-dollar market received its name from American dollars on deposit in European (especially in London) banks yet remaining outside the domestic monetary system, and the stringent control of national monetary authorities.

Enzig and Quinn (The Euro-dollar System: practice and theory of international interest rates, MacMillan Press, 6th edition, 1977, p. 1) state that: the Euro-dollar system is a term used to describe the market in dollar deposits and credits which exists outside the United States of America.

FCO 59/212: Economie Affairs (External), International Monetary Matters, Euro-dollar Market, (1/11/1967-8 /5/1968) (Foreign Office – Economic Relations Department), File Number: UE 4/44

Marx Karl, Contribution to the Critique of Hegel’s Philosophy of Law, in Marx/Engels 1975, vol: 3, p32.

E. Wayne Clendenning, Euro-dollars: The problem of control, The Banker, April 1968

PRO file FCO 59/212: Economie Affairs (External), International Monetary Matters, Euro-dollar Market (Jan 1967- December 1967)

PRO File IR/40/17474: Memo from J.G. Littler to Mr. Andren on foreign currency Borrowing by local authorities, 31 March 1969.

PRO File IR/40/17474: Confidential letter, from Mr. J.G. Littler to Mr. Andren titled foreign currency borrowing by local authorities, 14 March 1969.

PRO File IR/40/17474: Confidential letter from G.B.N. Hartog to Mr Elliston, titled Finance Bill: Eurobond issues by local authorities, 31 March 1969.

T 308/11: Use of “Windfall” Dollars To (A) Improve UK Balance of Payments Position (B) Reduce UK Dollar Indebtedness, (December 1960)

T 236/6260: IBRD- Placing of Dollars Funds in London, 18th August 1960

PRO File T 230/1056: UK submission to working party No. 3 of OECD Economic Policy Committee 1969 (28/01/69 – 11/11/69). File Number: 2EAS 549/188/02

PRO File T 230/1056: UK submission to working party No. 3 of OECD Economic Policy Committee 1969 (28/01/69 – 11/11/69). File Number: 2EAS 549/188/02

Burgess S and Edwards G, The Six plus One, International Affairs, no: 64, 1988, p407.

Camps M, Britain and the European Community 1955-63, Oxford University Press, Oxford, 1964.

PRO file T234/720, Memorandum titled, What went Wrong? Was prepared by the Treasury, July 1959

Harold Lever, The cabinets of 1964-70 had highly gifted individuals. Why then was so little achieved?, The Listener, 22 November 1984, p24-25.

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Learning money management skills is fundamental to a financially secure life. If you don’t learn how to manage your money and allocate it properly, you will likely have a hard time planning and succeeding at many of your goals. Some people learn these skills from their parents while growing up. Others struggle through their adult years until they have the opportunity to learn the information. http://www.ixgw.com/ Best Financial Advice – Financial Planning | www.IXGW.com
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Learning how to save money is an important money management skill. Even if you only save a small amount each month, such as , you are ahead of the game. Put it in a money market or savings account so that it can garner interest. You should always have savings in place, whether it’s for retirement, an emergency fund, or saving for a home.
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To manage money effectively, avoid debt whenever possible. In particular, avoid “bad debt.” This refers to debt that accrues interest or is used to purchase a disposable item. Credit card debt is typically an example of bad debt. “Good debt” is the type that builds wealth over time, such as the cost of a home or education that can lead to a better job. It’s acceptable to take on “good debt” as long as you can afford the payments.

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Creating passive income is essential for reaching financial freedom.  Fortunately, there are many types of passive income we can choose to invest in. Listed in this article are sources of Passive Income we can use to supplement our current earnings.

Bonds

Bonds are bank or government loans which have been cut down to smaller chunks. For example a loan for £100,000 can be split up into 100, £1000 bonds. Each bond is then sold to a stake holder, who then receives an income from the interest rate of the loan. This form of passive income is quite low risk compared to stocks. Bonds give a constant return at the interest yield you invested at. The main problem with bonds is that the income is fixed, whereas stocks have the ability to increase in value and may also provide a dividend pay-out.

Mutual fund/ unit trusts

Mutual funds or unit trust (UK) are professionally managed portfolios. Each mutual fund company may invest in different stocks and commodities.  Bear in mind that mutual funds usually come with huge fees, for example you may have to pay an initial charge of 3-5% and there may even be annual performance fees attached. You can try to save yourself money by purchasing stocks in the mutual fund directly from the mutual fund company rather than from the stock market, through your stock broker. Vanguard is a good example of a mutual fund company.  Some of these companies invest in index stocks (which mimic the trend of the stock market) or a large variety of other commodities or companies. The main benefit to this form of investing is leverage. Vast quantities of money (often billions) are pooled together from multitude of investors which can bring huge returns but adversely this can equal huge losses.

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The main drawback with mutual funds is the fact you’re paying someone to risk your money for you whereas you can invest in the stock market yourself. Mutual funds can be a very lucrative form of passive income but yet are you willing to let someone else risk your money for you?

Royalties

Royalties can be generated from Books, music and movies.  After you have published your thought, knowledge or talent in any of these formats, you will continue to get receive a cut from every single book, song or film sold. For example J.k Rowling will still be rolling in Harry Potter royalty money for the rest of her life. With the introduction of iTunes and ebooks it has become very accessible to generate an income from royalties.

Cash and Fixed Deposits

Cash and Fixed Deposits also generate passive income, since inflation rates are almost guaranteed to be higher than the savings rates, resulting in negative real returns for cash deposits. The only time when you would invest in cash is when all other asset classes are overvalued and waiting for an opportunity to enter the market.

Part two of WealthTrack’s series, “The New Retirement Reality” focuses on how to boost retirement income and guarantee a stream of ;income for life with Kiplinger’s retirement guru,
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Critical Examination Of The Financial Market Efficiency

Critical Examination Of The Financial Market Efficiency

Introduction

Any mechanism organized for trading financial assets or liabilities is termed financial market. It is a market in which financial assets and liabilities are traded (Richard & Bill, 2006). Financial assets in this context include all forms of securities ranging from common stocks to derivatives. Efficiency as it is commonly used can be seen as” the ability to achieve desired result without wasted efforts or energy” (Encarta dictionary, 2009). In other words, it has to do with how resources are productively utilized, the extent to which something is done well. Efficiency of financial market can thus be said to encompass how financial assets and liabilities are productively exchanged and funds effectively invested in Financial Market Instruments. However, exchange of securities for funds cannot be done except with a price willingly accepted by both parties while the price is determined mostly by the value and extent of information available to investors in the market. This paper however discusses the efficiency of financial markets exploring theories and assumptions and explaining in details, all terminologies (majorly price and information) relating to financial market efficiency.

Literature Review

Extensive findings have been conducted on the efficiency of financial market. This has led to the development of different theories such as; determination of values of securities, effect of information on share prices, dividend policies to mention a few.

Definition of Financial Market

Financial market, according to Olowe, 1997, is a mechanism by which surplus and deficit units of an economy can be brought together through the buying and selling of financial claims. He further asserts that the primary function of financial markets is to enable funds to be effectively allocated from the surplus units in the economy to the deficit units for productive investments. Richard and Bill, 2006, view financial market as any mechanism for trading financial assets and securities. They further explain that frequently, there is no physical market place; transactions are being conducted via telephone or computer. It is any market in which financial assets and liabilities are traded and a mechanism through which corporate financial managers have access to a wide range of sources of finance and instruments. Capital markets however function in two important ways:

Primary markets – providing new capital for business and other activities, usually in the form of share issues to new or existing shareholders or loans. It provides the focal points for lenders and borrowers to meet. Primarily, new finance is raised in this market.
Secondary markets – trading existing securities, thus enabling existing investors to dispose their holdings at will. An active secondary market is a necessary condition for and effective primary markets, as no investor will want to stick to an investment that cannot be realized when desired.

The Institute of Chartered Accountants of Nigeria describes financial market as the facilities and institutions provided by financial system for the creations, custody and distribution of financial assets and liabilities. The market according to the institute, has two major segments; the money and capital markets.

Money market creates opportunity for raising or investing short term funds. The tenor of which ranges from overnight to about one or two years. The financial instruments exchange in this market includes treasury bills, bill of exchange, treasury certificates, commercial papers etc. Capital market on the other hand are mechanisms, institutions and structures where medium term and long term funds are pooled and made available to businesses, government and individuals. It is in the capital markets that instruments which are already outstanding are transferred.

Financial Market Instruments

These are securities or financial assets traded in the financial markets and as mentioned earlier, financial markets has two major segments – money and capital market, the instruments traded in the money market are as follows:

Treasury Securities – these are short term obligations of the federal government to the bearer a fixed sum of money after a specified number of days from the date of issue. Treasury securities are of two types depending on their face values and maturities. While treasury bills usually have a low fixed return and matures in about 91 day of issue, treasury certificate share similar features with it but has a longer maturity period and a higher fixed return.
Certificate of Deposits (CDS) – these are receipts from banks for deposit of funds for a specified period of time at a specified interest rate. CDS is an interbank instrument and serve as a means for channelling commercial banks’ cash surpluses to merchant banks who are main issuers of this type of instrument. When the bank promises to pay the principal and interest at maturity, usually within 3 – 36 months, it is called negotiable certificate of deposits. However, when CDS have features of a time deposit receipt and are normally held till maturity, they are termed non-negotiable certificates of deposits. Non negotiable certificates of deposits also have maturity ranging from 3 to 36 months.
Commercial Paper – this is a short term unsecured promissory note issued by a company at a discount to an interested investor for cash for a specific maturity period. The investors in commercial papers are usually credit worthy individual or institutional investors. It usually has a maturity ranging from 30 to 270 days. Commercial paper can however be categorised into dealer papers and directly placed papers. Dealer papers are commercial paper placed with investor through a dealer which may be a bank while directly placed papers are commercial notes placed directly with investors by company issuing the papers which will require the issuing company to maintain an outfit with trained personnel who have a good knowledge of financial market and have good contacts in the markets. In any case, commercial papers are invested in by investors who can borrow in the loans market without security or even with a negative pledge. Commercial papers are traded only in the primary markets.
Bankers Acceptances – also known as bill of exchange are drafts accepted by the drawee bank specifying that a certain amount will be paid after a specified period of time. The acceptance is done by writing the word “accepted” across the face of the draft together with authorised signature. Once this is done, the bill can then be discounted by the payee at a discount rate. It is used for financing international trade through letters of credit. It is also used for financing of commodities trade especially with respect to bonded warehouses and the credit created through bankers acceptance are self liquidating short term credits. The maturity ranges from 90 – 180 days or sometimes 30 – 270 days.
Bank Deposits – this is a placement of fund by investors/depositors with bank at an agreed rate of interest. Bank deposits are divided into call deposits/savings account deposit and fixed deposit. Call deposits are made with no specified maturity period and can be terminated by any both parties by given notice to the other party based on the agreed notice period, fixed deposits are deposit of funds with a bank for a fixed period of time at a specified rate of interest which could be fixed or floating. The maturity of deposits can vary from a few days to number of years. The deposit may or may not be certified with a deposit receipt or certificate.
Derivatives – these are means of gaining or losing from hedging or speculating against movements in currencies and interest rates. They are financial instrument whose value derives from underlying assets, they are securities that allows an investor to gain exposure to the performance of an underlying securities without physically owing it. Profitable though, there may be hidden risk in the derivatives market. Financial experts term it “financial weapon of mass destruction” and is described just like hell which may be easy to enter and almost impossible to exit. Examples of derivatives are; forward contract, future contract and options.

Capital Market Instruments

Debt Instruments – these are long term loans raised by a company or government for which interest is paid and at a fixed rate. A debt instrument has a nominal value which is the debt owed by the issuer of the instrument and interest is paid at a stated coupon rate on this amount. In most cases, debt instrument are redeemable.
Preference Shares – this is also a major source of long term financing to a company. The holders are preferred to ordinary shareholders in terms of dividend payment. Preference shares could be cumulative when they have right to the unpaid dividend of previous periods, carried forward to another periods until it eventually paid up in which case the arrears must be paid before ordinary share dividends are paid. Just like debt instruments, preference shares may also be redeemable.
Ordinary Shares – the holders of these shares are owners of the company. They have nominal values and the memorandum and article of association of a company specifies the number of authorised ordinary shares a company can issue. The ordinary shareholders have residual claims in the company i.e. they are paid dividend only after other fixed obligations have been met.
Convertible Securities – these are hybrid securities that share both the features of a fixed income security and ordinary shares. They are securities (usually fixed interest) that are convertible into ordinary shares of the company at the option of the holder in the future.

Having explained the concept of financial market and its component, we need to examine whether its efficient or not. Before this can be done, efficiency, as it has different connotation in different environments needs to be clarified in the light of financial market.

Efficiency

The word efficiency is part of everyone’s vocabulary. To most, it means the ability to achieve a desired result without or with minimum wasted energy or effort. To Encarta dictionary, 2009, it is the ability to do something well or achieves a desired result without wasted energy or effort, i.e. to degree to which something is done well or without wasted energy or effort. Generally speaking, it is a means of increasing the well being of a particular situation given an amount of productive resources and existing state of technical knowledge in an economy, eliminating wasted effort and allowing for more production from available resources therefore achieving the desired result by avoiding wastage and also preventing the avoidance of wastage from causing any harm. (David N.H, 2005).

However, to different professions it means different things, “the economists talk about allocative efficiency – the extent to which resources are allocated to the most productive uses this satisfying society’s need to the maximum. The engineers talk about technical efficiency – the extent to which a mechanism performs to maximum capability. The sociologists and political scientists talk about social efficiency – the extent to which a mechanism conforms to accepted social and political values.” (Richard & Bill, 2006).

Financial Market Efficiency

To investment guru or financial expert, efficiency is somewhat more precise, it relates to pricing and information efficiency, the efficiency of substituting funds for financial market instruments. It has to do with how fast and convenient asset can be transformed into cash and vice versa, how prices of securities are determined and how risks inherent in such securities are managed. This can however be summarized from the roles the financial market are expected to perform in the economy which, according to Olowe, 2007, are classified into three (3);

Allocational efficiency – the role of financial market to optimally allocate scarce savings to productive investments in a way that benefits everyone.
Operational efficiency – to server as intermediary who provides the service of channelling funds from savers to investors at minimum costs that provides them with fair return for their services.
Pricing efficiency – the role in determining the values at which securities will be exchanged, where market prices are used as signals for capital allocation. The prices are set by the forces of demand and supply. Fama, 1976 (in Olowe, 1997) sees pricing efficiency as efficiency in the processing of information.

Based on the fore going, we can conclude that pricing and information are the two major determinant of efficient financial market. Thus we can define financial market efficiency as a market where security prices quickly and fully reflect all available information. A market in which any device intended to outperform the market will be rendered useless. Therefore in an efficient financial market, the same rate of return for a given level of risk should be realised by all investors.

Pricing of securities

Pricingas a Major Determinant of Financial Market Efficiency – pricing of security can however be discussed in relation to Risk and return. Risk, which is created by wide range of factors as general economic condition, economic factors peculiar to securities, competition, technological development, investor preferences, and all other sorts of circumstances, is defined, according to Van horne, 1986, as the variability of possible returns on investments. Olowe, 1997, also sees risk as the probability of the deviation of the return expected from holding a security from the actual return from the holding of such securities. With the introduction of risk, an investor will be indifferent as to which security to invest in when there are availability of investment having similar returns. The conceptual framework for examining the relationship between risk and return as they affect security pricing is discussed under the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Model (APM).

1. Capital Asset Pricing Model (CAPM)

This model was developed by Sharpe (1964), Linter (1965) and Mossin (1966). It shows the relationship between expected return of security and its unavoidable risk. It provides framework for the valuation of securities and can be used to find an entity’s cost of equity.

CAPM are however developed on the following assumption;

CAPM is a one period model and assumes that investors are risk averse.
Investors are rice takers and have homogenous expectation about securities.
There exist a risk-free security such that investors may borrow or lend unlimited amounts at the risk fee rate.
All securities are marketable and perfectly divisible. More so, their quantities are fixed.
Information is freely available to all investors.
There are negligible restrictions on investment and no investor is large enough to affect the market price of stock.

The foregoing assumptions summarily assume that there exist a perfect market and that the financial market is efficient. Therefore, given the assumptions, we will price every asset that falls on security market line while the security market line equation is given as;

E(R1) = RF + [E(RM) - RF]β1

Where β1 = COV(R1RM)

σ2m

E(R1) = expected return on security

RF = risk – free rate

E(RM) = expected rate on market portfolio

β1 = beta of security i

COV(R1RM)= covariance of return on security i with the returns on a market portfolio.

σ2m = variance of returns on the market portfolio

Illustration; if the expected return on security is 24% and its beta is 1.8. show whether the security is under or over valued if the risk – free rate is 13% and return on market portfolio is 18%.

Solution;

E(R1) = RF + [E(RM) - RF]β1

= 0.13 + [0.18 – 0.13]1.8

0.22 i.e. 22%.

We conclude that it is undervalued as the expected return is 2% less than the predicted. i.e. 24% > 22%.

Characteristics of CAPM

For the fact that not all risk of security return is of concern to risk averse investor, asset must be priced so that its risk adjusted required rate of return falls exactly on the security market line. Thus the only risk which investors will pay a premium to avoid is market risk hence the division of  total risk of any individual security into systematic and unsystematic risk. Whereby systematic risk is general and affects the entire market and unsystematic is peculiar to factors that are unique to a particular entity. Efficient diversification, however, reduces the total risk of the portfolio to the point where only systematic risk remains.
Risk portfolio as measured by beta is the weighted average of the betas of individual securities in the portfolio. The proportion of portfolio funds represents the weights allocated to individual securities in the portfolio and it is mathematically denoted as;

n

βP = ∑ wi βi

i=1

where βp = beta of portfolio p

βi = beta of security

Wi = proportion of security in portfolio p

Conclusively. CAPM has been derived based on some simplifying assumptions, most of which do not conform to reality. For this reason, it has been criticised on the ground that it assumes the market portfolio to consist all assets – stocks, bonds, properties and human capital. In real life situation, empirical tests of CAPM tend to use proxies such as stock market indices as a measure of market portfolio.

The Arbitrage Pricing Model

This was suggested by Rose (1976) because of the dissatisfaction with the CAPM on both theoretical and empirical grounds. It is a multi-factor model (multiple beta model) as opposed to CAPM which is a single factor model. A security’s actual return in a factor generating mode is given as;

n

Ri = E(Ri) + ∑ bijFj + ej

J=1

This can be restated as Ri = E(Ri) + bi1F1+bi2F2 + ………. + binFn + ei

Ri = actual return on security

E(Ri) = expected return on security i

Fj = the (uncertain) value of factor j

bij = sensitivity to factor j

ei = the error term. It is also the security-specific return.

Similar to the CAPM, we diversify the unsystematic risk away but in addition, we arrive at the market equilibrium as individuals eliminate arbitrage profits across multiple factors. The model does not specifically indicate what the factors are or the economic or behavioural importance of the factors. However market return as in the case of CAPM might be one of the factors.  The APM, thus, suggests that there is a linear relationship between security return and some factors. In equilibrium, according to this model, expected return on security i E(Ri) will be given by:

E(Ri) = Rf +ƛ1 bi1 + ƛ2 bi2 + ……..+ ƛn bn

Where Rf = risk – free rate

ƛn = risk premium for the types of risk associated with particular factors. Its equation can be rewritten as: ƛn = En – Rf

where En is the expected return of a portfolio which has unit response to other factors.

Illustration

The return of stock company is related to two factors as follows.

E(Ri) = Rf +0.7ƛ1 + 1.6 ƛ2 + 1.3 ƛ3

Where 0.7,1.6 and 1.3 are sensitivity coefficients associated with each factor. If the risk – free rate is 12%, ƛ1 is 7%, ƛ2 is 4% and ƛ3 is 6%. Calculate the expected return on the company’s stock.

Solution;

E(Ri) = 0.12 + 0.7(0.07) + 1.6(0.04)+1.3(0.06)

= 0.311 i.e. 31.1%

In conclusion the APM is seen as superior to CAPM as CAPM allows a risk averse investor to focus more attention on systematic risk in pricing securities and diversify away the unsystematic risk. Under the APM on the other hand, individuals arbitrage across multiple factors so that when arbitrage opportunities cease to exist, the market is in equilibrium. However, there is yet to be agreement factors in the APM and whether it is testable. Thus CAPM can still be used in security pricing.

Information on Securities

Information can be classified as historical, current or forecast. Only current or historical information is certain in its effect on price. The more information that is available the better the situation meaning that informed decisions are more likely to be correct. Security prices are characterized with random and unpredictable movements. The movement of security prices may be interpreted to imply that investors in the market take a quick cognizance of all the information relating to security prices and the prices quickly adjust to such information. Thus the efficiency of the security prices depends on the speed of price adjustment to any available information. The more the speed of adjustment the more efficient the prices. Market efficiency as regards the availability of information is however reflectec in Efficient Market Hypothesis (EMH) in three basic forms;

Weak form
Semi – strong form and;
3. Strong form.
1. Weak form of EMH states that the current share prices fully reflect all information contained in the past price movements which makes it impossible for an investor to predict future security prices by analysing historical prices and achieve a better result than the stock market itself. Therefore for a market to be efficient at this form, significant correlation should not exist between securities prices aver time. More so, if an investor’s trading strategy could not beat the market based on the information available to him, we conclude that the market is efficient at weak form. Olowe, 1997 puts that Nigerian capital market is efficient at weak form.
2. Semi – strong form of efficiency is concerned with whether securities fully reflect all publicly available information. This implies that an investor will not be able to outperform the market by analysing the existing company – related or other relevant information available. This form implies that the share prices reflects an event or information very quickly, and therefore, it is not possible for an investor to beat the market using this information.
3. Strong form of efficiency is concerned the fact that securities prices reflect all published and unpublished public and private information. This implies that people with private or inside information will be able to outperform the market at this form.

Conclusively, Olowe, 2007 asserts that the following assumption are sufficient for an efficient market;

No transaction cost of trading in securities.
Information is freely available to all market participants.
All investors have the same time horizon
All investors have homogenous expectation especially as to the implication of current information for the current price and distribution of future prices of each security.

The general assumption underlying an efficient market therefore implies that prices of securities in the market must reflect sufficiently enough information to allow investors make informed decisions about investment in such markets.

References.

David N. H., (2005), Public Finance and Contemporary Application of Theory to Policy, 8th edition, U.S.A Library of Congresss.

ICAN Study Pack on Strategic Financial Management. VI publishing, Lagos, 2006

Linus E. A. and  Kalu I.U.,  “State Government Finances and Real Asset Investments: The Nigerian Experience,” African Journal of Accounting, Economics, Finance and Banking Research Vol. 4. No. 4. 2009.

Microsoft Encarta, Encarta Dictionary, Microsoft corporation, 2009.

Olowe, R.A (1997). Financial management: concepts, analysis and capital investments. Brierly Jones Nig. Ltd., Lagos, 1997

Pandey, I.M. (2004). Financial Management, 8th edition. Vikas Publishing, New Delhi, 2004.

Richard k & Bill N, (2006) corporate finance and investment decisions and strategies, 5th edition. Pearson education ltd. London.

Van Horne, J.C. (1968), Financial management and policy, 7th edition. Englewood cliffs N.J.: Prentice Hall.

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The Stock Market: the Second Biggest Financial Scam of the Twentieth Century Part 2 of 2

The Stock Market: the Second Biggest Financial Scam of the Twentieth Century Part 2 of 2

In steps the Stock Market, promising higher returns than stodgy old bonds, and money market accounts; hence, the stock market became the destination of choice for retirement savings and Wall Street responded by increasing the offerings to retail consumers through Mutual Funds. Before the year 2000 it was not uncommon to hear that the S&P returned 16% over the previous 10 years. Looking at the returns of one of the best known indexed mutual funds, the Vanguard 500, returns since its 1976 inception are 11.75%, impressive until you look at the 1 year return, -2.41%, the 5 year return, 11.89% and the 10 year return 5.06%. These are average returns not real returns. As an example let?s look at the growth of 1 dollar in the mythical High Fly Fund. High Fly posts a 50% gain in one year and your dollar grows to .50. The next year it posts a 25% loss, now your investment is worth .125. The average return for High Fly reported by the mutual company is 12.5%, but that is not your actual return. Your actual return or compound annual growth rate (CAGR) is in the neighborhood of 6% per year worse if you factor in inflation.

Is 6% acceptable given the risk that investors take on by investing in the stock market? David F. Swenson, CIO of the Yale Endowment explains investor risk in his book, Unconventional Success, when he states: ?Because equity owners get paid after corporations satisfy all other claimants, equity ownership represents a residual interest. As such stockholders occupy a riskier position than, say, corporate lenders who enjoy a superior position in a company?s capital structure.? He goes on to say ?the 5.0 percentage point difference between stock and bond returns represents the historical risk premium, defined as the return to equity holders for accepting risk above the level inherent in bond investments.? Mr. Swenson?s comments and calculations of the risk premium were based on a compound annual return of 10.4% in the stock market compared with 5% bond yields. 10.4%-5% equals a risk premium of 5.4%. Unfortunately I have yet to find a calculation of CAGR (compound annual growth rate) that matches Mr. Swenson?s. I found many examples of average returns that match the 10.4% average growth rate but not the CAGR. The reason that this is important is that all other savings vehicles are quoted by the CAGR. Your savings accounts, bonds and money market account are all quoted by the CAGR or its equivalent, the annual percentage yield (APY). In order to determine where to allocate your funds, you must compare apples to apples not apples to oranges. As you might guess the CAGR for the stock market is lower.

A quick look at the CAGR calculator for the stock market on moneychimp.com shows the average return from January 1, 1975 to December 31, 2007 to be 9.71%. You only realized that return if you were invested in the market the entire time. What if you began investing in 1980? The numbers look about the same. If you started in 1985 your returns look a little better. By 1990 the CAGR drops to 8.21%. If you started in 1995 your CAGR jumps to 9.32%. If you began investing in 2000 your CAGR drops to minus 0.06%! If you eliminate the results of the past 7 years from the S&P performance and track performance from January 1, 1975 to December 31, 1999 the CAGR was 13.03%. When the stock market is good it is great, when it is bad, it is pretty darn miserable. For the record, there has been only one 9 year period from January 1, 1950 to December 31, 2007 in which the average return for the S&P was 16.14% and the CAGR was 15.32%: the period from January 1, 1990 thru December 31, 1999.

It should be clear from these numbers that your returns are dependent not only on how long you are invested in the markets but when you started investing. In fact the stodgy old bond investor has outperformed the stock investor over the past 7 years.

The 1990?s investor will have a very different view of market performance than the 2000?s investor.

Mr. Swenson?s book is a must read for anyone investing in mutual funds, he makes a compelling case, explaining why actively managed mutual funds are generally a money losing proposition for investors and why a balanced portfolio based on six solid asset classes constitutes the winning combination for investors.

How can I call the stock market the second biggest financial scam of the twentieth century if I am quoting numbers that are on the face of it pretty good? For four reasons:

1) because the true CAGR going back to 1950 is much lower 7.47%. It will take the average American worker 25 years and one month saving ,000 per year to accumulate one million dollars in wealth as long as the market achieves CAGR of 9.71% and in 29 years 2 months if forced to accept the longer term returns of the market. These numbers leave very little margin for error for the average American worker. Retirement projections for the most part are based on returns that have existed at only one point in the stock market?s history since 1950;

2) because the same laws that facilitate the transfer of individual investor money into the stock market also mandate its withdrawal at a specific time which is tantamount to what all financial pundits have called a money losing strategy, Market Timing. In other words the laws governing tax-deferred savings mandate that withdrawals begin at age 70 and a half at the latest forcing retirees to time the market to determine their exit;

3) the time horizon for capturing meaningful gains from the market is long indeed, at least 30 years. To quote Mr. Swenson, ?Returns of bonds and cash may exceed returns of stocks for years on end. For example from the market peak in October 1929, it took stock investors fully twenty-one years and three months to match returns generated by bond investors.?

Charles Farrell, an adviser with Denver?s Northstar Investment Advisors, used data from Morningstar?s Ibbotson and Associates to analyze 52 rolling 30-year periods, starting with 1926 to 1955 and ending with 1977 to 2006 ?But here?s what?s interesting: The Majority of your wealth would almost always have come in the last 10 years. Mr. Farrell calculates that, on average, you would have notched 8% of your final wealth after the first decade and 32% after the second. In other words, 68% of the total sum accumulated was amassed in the last 10 years.? (Wall Street Journal, Jonathan Clements November 21, 2007);

4) because current marketing strategies by financial pundits, gurus and Wall Street treat stock market investing as a money in, money out proposition obscuring the true risks of investing and the true time horizon needed to accumulate wealth. In other words, the money needed for retirement must be invested for an extended period of time, roughly 30 years. It cannot be borrowed against. It cannot be used to buy a home, car, pay for college or a child?s wedding.

It can only be used for retirement 30 years hence. Any other needs must be paid for from an additional source other than retirement savings. Most people lack the financial education to understand this and blindly chase market returns hoping for a big score.

Fortunately there is a simple solution, but like most simple solutions this one requires work and financial education. I will introduce this simple solution in part 3 of this series.

Disclaimer: This is a thought-provoking article that draws upon real world examples, articles, books and websites that are readily available to the public. This article is not intended to offer investment advice. Any actions that you take in the market place should be the result of your own financial education and consultation with a licensed professional. Financial calculations were accomplished using the savings goal calculator found at Bankrate.com unless otherwise indicated.

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A bank money marketplace rate is the eye that financial institutions pay in order to account holders of money market money (MMFs)

A bank money marketplace rate is the eye that financial institutions pay in order to account holders of money market money (MMFs)

Banking institutions providing MMFs as expense opportunities pool all of them together as well as give the money in a greater bank money current market rate than has been paid to the traders. The difference in between what banking institutions obtain in interest payments and what’s paid in order to account-holders is exactly what provides these types of institutions with the revenue to pay for capital as well as operating costs, such as financial institution branches, employee salaries, revolutionary technology, and security. These earnings can also be committed to particular (and hopefully smart) expense opportunities. The actual build up within cash marketplace company accounts, as in cost savings and checking company accounts, are safe by the Government Down payment Insurance Corporation (FDIC) for approximately 0,thousand. This federal protection is another advantage to getting short term money deposited during these types of opportunities.

Cash marketplace interest rates can vary, so an understanding of the current interest rates being marketed will be good information to be equipped with, particularly when settling terms with agents. Money market shared money typically purchase extremely fluid opportunities with different maturities, therefore there is cash flow to satisfy buyer demand in order to redeem gives. Money market money is neither insured nor assured by the Federal Down payment Insurance Corporation or any other government company. Money marketplace securities generally have big minimum purchaMoney marketplace is the title given to the arena where the majority of this short-term borrowing happens. It was typically just available to big institutions.se needs, therefore which makes it difficult for most individual traders to buy them. Money marketplace money, however, have substantially lower requirements, which are generally even less than average shared fund minimal requirements. Money market accounts are similar to cost savings accounts, however frequently pay higher curiosity and may carry certain limitations , such as a minimum balance or perhaps a limited number associated with transactions allowed monthly. Money market accounts are accounts that give relatively higher interest rates (in tangible conditions) and need bigger minimal balances to support this ‘high curiosity rate’ service. Money market accounts are at the same time also known as money marketplace demand accounts or even money marketplace down payment company accounts (MMDA). Money marketplace accounts or MMAs usually have a restriction on withdrawals which restrict is way stricter compared to savings account withdrawals limitations. Money market company accounts tend to be essentially turbo-charged cost savings company accounts. You earn approximately exactly the same interest rate, and you can create a limited number of inspections from them. While results for money market company accounts aren’t up to along with cds (Compact disks), it is a trade-off associated with convenience. With Compact disks, your money is preserved with the financial institution for a restricted period of time, with a penalty with regard to early withdrawal. This lowers the lending institution’s danger whenever financing money. With money marketplace company accounts, you have the independence and adaptability in order to pull away cash if you need to, so the bank provides you with much less curiosity accordingly. Money marketplace money generally spend much better interest prices than a conventional savings account will, but you’ll generate less than what you might get in cds.

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Are Money Market account opening may have an impact on my financial future?

Are Money Market account opening may have an impact on my financial future?

Younger consumers who want to plan your financial future, it is important to find ways to invest their savings wisely without running a huge risk of losing their money at all. Although there are many variations, such as contacts and mutual funds and 401k investments, among other things, it is also important to diversify instead of all your eggs in one basket. Working as a money market account, the overall financial strategy is a great feeling but younger customers looking for safe alternatives for at least part of their future savings. In addition to struggling economy, mutual funds and 401k may decide on the basis of the return of an investment account, which beat type are included in mutual funds or 401k. With a money market account, and the total yield is a lot of conservative nature, the money would be protected and even the slightest return to a struggling economy in unexpected ways.

With the global economic crisis that has gripped the financial world since the mid-2000s, many corporate and investment banking institutions have lost a lot of money because of their high-risk speculative investments in bonds and securities of the package. Many banks also failed as a result. Although Money Market Interest rates actually declined during that period, in some cases less than one percent of the $ 10,000 minimum balance, they still do not lose money. Money market accounts are certainly considered to be conservative choice in terms of investment, but to one percentage point a lot better than losing millions. Consumers still have the opportunity to take limited number of transactions in their money market account, and as long as they maintain a minimum balance, will be eligible for low interest yield. Ask for a consumer who has a low interest rate money market savings accounts, and the other, which will take place during the Lehman Brothers account and ask them who is currently better than they are. Guess is, considering that Lehman Brothers, one of the largest investment firms in the U.S., went bankrupt, the answer will come from a person with a lower yield money market option.

Diversity of investment means more consumers today than ever before. Make the smart choice in terms of how your savings will provide long-term results may be difficult, especially for the ever-changing economy. However, the decision to open an account in your investment portfolio should always be able to protect themselves from high-risk, high-yield accounts that they can be volatile and even a hint of bad economic news.

Financial Investment 12 – Term Deposits, Government Bonds,treasury Bills & Money Market Funds

Financial Investment 12 – Term Deposits, Government Bonds,treasury Bills & Money Market Funds

Financial instruments found in the debt market include:

1. Term Deposits

2. Government bonds

3. Treasury Bills (T-Bills)

4. Money Market Funds

5. Corporate Bonds and Debentures

6. Domestic Bond Funds.

In this article, we will only discuss the term deposits, government bonds, treasury bills and money market fund.

1. Term DepositsTerm Deposits are qualifying instruments for tax shelter and will share the following characteristics.

a) Short-Term Deposit: less than 1 year

b) Long-Term Deposit: to 5 years.

Interest Rate: depends on length of deposit and competitive interest rates available in the marketplace.Long-term investments are called Guaranteed Investment Certificates (GICs) and can be purchased for a lesser amount such as 0. They are also called a Certificate of Deposit (CD). Rates may vary as little as 0.10% amongst the deposit takers.Term Deposits may be cashed prior to maturity, but this may incur a penalty. GICs generally cannot be cashed before they mature, although some deposit takers are now more flexible.

2. Government saving bonds

Country residency is required and guaranteed by the country of issuer.

a) Are registered bonds that provide protection against loss, theft or destruction.

b) Are not transferable.

c) Can be purchased for a minimum of 0 to a maximum of 0,000.

d) The interest is taxable and is competitive with GICs.

e)  Mature in 10 to 12 years.

In Canada, Canadian saving bonds are issued as either R bonds or C bonds.

In US, US saving bonds are issued as series EE bonds, Series I BondsThe investment risk for government savings bonds Issued by Canadian government or US government is nil, since the bond is guaranteed by the federal government.

3) Treasury bills (T bill)Treasury bills are a short term money market instrument and issued by the federal government in terms of 30, 60, 91, 182 and 364 days. They are sold by auction.Banks and investment houses buy at wholesale in multiples of million denominations. They then sell these T-Bills to brokers and investment dealers who break down their purchases into ,000 lots.

T bills are sold discount to their face values and also sold on the secondary market and their value fluctuates depending on competitive interest rates at the times of resell.The short-term nature of T-Bills does not cause a large exposure to interest rate risk, but to some extent there is an inflation risk.If a T-Bill is sold before maturity, any gain is taxed as interest.

4. Money market fundsMoney market fund holds T bills and other short term money market contracts. Investors pool the investments through the mutual fund. Units in this fund can be bought and sold daily. Money market funds produce capital gains although their primary function is to generate interest income. Interest is generally paid monthly, while capital gains are paid annually.The benefits of money market funds include

a) Security of principal

b) Liquidity.

c) Eligible for plan registration

I hope this information will help. If you need more information, you can read the complete series of the above subject at my home page:

Kyle J. Norton

http://lifeanddisabitityinsuranceunderwriter.blogspot.com

/http://financialinvesting12.blogspot.com/

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