When you work, you are supplying something of value which could be your time, talent or products. In exchange for your efforts, your employer or customers are willing to pay you money.
When you invest, you are actually making your money work for you; it’s as if you found a job for your money. The person or entity with which you place your investment pays for the use of your money.
There are myriad ways to invest money, but many persons fail to take advantage of them because they are intimidated by the complexities of investing. When it comes to investments, there are terminologies and procedures that you must learn just like any subject that is taught in school.
Once you grasp the basics of investing, then you will become more confident in the process. In order to make a properly informed investment decision you need to:
1. Understand how the investment can increase your initial principal or supply an income;
2. Understand the risks inherent in the investment;
3. Understand how the investment can help you to attain your goals.
With these elements in mind, let’s now look at how you can invest by lending money.
Short-term financing
The saying ‘money makes the world go round’ is indeed true. Just like individuals, businesses and governments need to have enough money to pay bills, purchase important items, and carry out long-term development plans. Very often, the incoming cash flow is insufficient to meet the needs of these entities, and they are forced to look to outside sources for money.
When corporations or governments have to borrow money to carry out their short-term requirements, such as working capital support or buying inventory, they can go to the money market to access financing. With the assistance of intermediaries called brokers, these entities can create debt investment instruments and offer them to investors in exchange for their money.
When you invest your money by buying a money market instrument, you will earn a certain amount of income over a specified period in interest payments, as outlined in the agreement. In addition, the instrument will indicate a date when you should get back your initial sum. The period when your investment matures, or becomes due for repayment, is usually within twelve months.
Types of money market instruments
There are several types of money market instruments in which you can invest. Private institutions such as large corporations offer commercial paper for sale through broker institutions which liaise with investors. Certificates of deposit are issued directly to the public by commercial banks and other deposit-taking institutions.
Governments can issue Treasury Bills (T-Bills), which are auctioned at discounted prices to investors who submitted bids. Instead of getting regular interest payments, investors will receive the full principal amount that was purchased. The difference between the sum that was actually lent to the government and the repayment amount is the investors’ profit.
A popular money market option in Jamaica is called a repurchase agreement, which is created when an investor who owns a government security temporarily sells it for cash, and agrees to buy it back inclusive of interest in the future. Many investment institutions issue these contracts, also called repos, by repackaging government debt for resale to their clients.
Long-term money lending
When corporations and governments wish to borrow from investors for periods in excess of one year, they can create medium- to long-term debt instruments called bonds. In bond terminology, the face or par value is the amount of money that will be repaid when the bond matures, and the coupon is the amount of interest that will be paid at regular intervals.
Most of the bonds available in Jamaica are issued by the government. A debenture is one type of bond that offers fixed interest rates with quarterly interest payment schedules. The government can also raise money in foreign currencies by issuing Eurobonds or global bonds outside of Jamaica, in a foreign currency such as United States or Euro dollars.
Some bonds offer fixed coupon rates which provide a percentage return based on the face value of the bond. For example, if a bond has a 10 per cent coupon rate and the face value is $100,000 JMD, then the interest payments for the year would be $10,000 JMD. Variable rate or floating rate bonds offer coupons that are tied to a certain market interest rate or price, such as the six-month T-Bill rate.
Apart from the interest payments, investors can earn by reselling bond instruments on the secondary market. The market prices for bonds may fluctuate based on demand and supply, changes in interest rates or general economic conditions. Therefore, buying a bond and reselling it at a higher price will yield a profit.
We have looked at how lending money can allow you to increase your initial investment amount and earn an income. Next week, we will look at the risks of this investment option and how it can help you to achieve your financial goals.
Copyright © 2011 Cherryl Hanson Simpson. No reproduction without written consent.
Originally published in The Daily Observer, September 29, 2011
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Cherryl is a financial consultant and coach, founder of Financially S.M.A.R.T. Services. See more of her work at www.entrepreneursinjamaica.com and www.financiallysmartonline.com. Contact Cherryl