There’s lot of specialist language in the financial markets: indices, IPOs, forex, bonds and annuities, for example. Here, we bust some of the jargon. Stay with it – it’s easier than you might think.
Typically, annuities are used for financing retirement. You save up a pension ‘pot’ and receive an income, usually paid monthly, in return. That is the annuity. Sometimes this annuity amount is fixed. Or the sum may fluctuate with inflation so your income keeps pace with prices.
Annuity rates are heavily dependent on longevity prospects. The longer the insurance company thinks you will stay alive the less they will be willing to give you each month or year. Annuities are often controversial because their rates have dipped over the years as interest rates have fallen (the two are closely linked).
If you have built up a £100,000 pension pot and you are offered an annuity at 3.5% you will be paid £3,500 a year.
They’re a form of debt. Some bonds are called gilts and are backed by the UK government. They’re ultra-safe – hence ‘gilt-edged’. There are corporate bonds too. This is debt issued by companies for cash-raising purposes.
Many bonds will have a fixed return in exchange for your investment. The interest on a bond is often called a ‘coupon’. Bonds are often traded direct on the stock exchange.
Bonds are not completely risk-free. Most come with a risk rating, from AAA (highest quality) to D – unable to pay back debt. Bonds are often thought safer than shares though traditionally their long-term returns are also lower.
Their use as a financial instrument goes back to 4,500 BC, from copper to wool to conch shells. Nowadays commodities are increasingly about gold, oil and coffee, to name just three. Generally commodities are raw materials.
Prices for commodities are often internationally standardised. The oil price is a good example, making them easier to trade quickly across different jurisdictions. Prices for commodities are often closely linked to economic cycles.
It’s often tricky to predict the other risks of commodity prices in advance. Commodity price risk might be country regime change, potentially affecting supply chain risk or labour production. Or climate risk, such as extreme temperatures, flooding and disease.
A sum of money paid out of company profits. The dividend amount is decided by the company directors and is called the yield. For example, if a share trades at 100p and the dividend annual yield is 3% then the dividend is worth 3p.
If re-invested the dividend will generally boost the long-term performance of your investment. Bear in mind a high dividend isn’t always a good idea. A high dividend might mean a company is concerned about future growth or profits.
Mature, older companies often offer lower dividends but with an expectation from the buyer that the dividend may be reliable and offer (possibly) higher returns than bond rates.
Often used with the noun ‘markets’ – or foreign exchange markets in plain English. The forex market is where currencies are traded. The forex market will give you a clear idea of what you will get if you swop your home currency, say sterling, for another currency.
If you cast your eye down any currency running board you will see currency ‘pairs’. The EUR/USD rate will tell you, for example, how many dollars one euro is worth.
There’s also the world of forex derivatives (super-successful investor Warren Buffett described them as ‘weapons of mass destruction’). Derivatives are a financial product built around an underlying asset. Profit or loss depends on a currency change rate at a future date. They’re often used in risk management purposes, such as ‘hedging’.