Investing in cash/fixed interest securities involves lending money to the government, banks and/or corporate organisations. In return for the loan the borrower generally pays a set rate of interest for the agreed loan period. Typically, the higher the credit quality of the borrower the lower the interest rate they will be willing to pay for a loan. Also, the lender usually requires a higher rate of interest for longer loan terms. Short-term loans, up to say three months, are commonly referred to as ‘cash’, while longer-term loans are termed ‘fixed interest securities’. Once the term of the loan has expired the borrower is theoretically required to return the money, although in practice the loan is often renewed at an up-to-date interest rate for a further term. The interest income received by borrowers from lending money is generally quite stable and regular.
Loans that have not yet matured can often be bought or sold, with their market value influenced by a number of factors, including the ongoing credit quality of the borrower and the current level of interest rates relative to the rates prevailing at the time that the loan commenced.
Despite a somewhat bewildering array of investments that exist, most are comprised of one or more of the three asset classes outlined above. From these building blocks are constructed the seemingly never ending and often complex array of financial products that confront investors. There are now many ‘financially engineered’ structures which alter risk/return tradeoffs over different time periods or which cut and splice the income and capital parts of different investments with one another. To add further complication, there are also securities such as derivatives that allow investors to lock into set prices to purchase or sell investments, commodities, currencies and interest rates at future points in time.
Some investments are an amalgamation of many underlying investments. These can include investment companies and managed funds (such as the Third Link Growth Fund), which pool the money of many individual investors to then invest in a ‘portfolio’ of underlying investments held in one or more of the above three asset classes.