Discover what various financial terms mean, from Commodities to Derivatives.
Commodities
The term commodities – items that may be freely bought and sold – typically refers to products such as coffee, cocoa and soya beans ('soft' commodities) or gold, aluminium and crude oil ('hard' commodities). Oil prices soared recently, reaching a record $147 a barrel in July 2008 because of high demand from the fast-expanding economies of China and India. However, they fell sharply in the latter part of 2008 to around $60 a barrel as the world headed into recession.
Commodities typically are bought and sold in futures markets where producers combine with manufacturers and speculators to – in theory – create a smoothly functioning market.
Credit
From the Latin credere ('to trust'), credit is the provision of, typically, a loan to be repaid (with interest) at a later date. Any movement of financial capital normally depends on credit, which in turn is dependent on the reputation or creditworthiness of the institution holding the loan.
The 'credit crunch' of 2007/08 arose when banks became reluctant to lend to each other because of a lack of trust. Banks didn't know how safe other banks were amid fears that quite a few were infected with bad loans originating from the US sub-prime crisis.
Deflation
This describes a situation in which prices are falling – the opposite of inflation. If prices keep falling, people postpone spending in anticipation of cheaper prices. When consumers no longer spend, businesses cannot sell their goods, make profits or pay off their debts, leading them to cut production and employees. A downward spiral then takes hold.
Once deflation sets in, it can be incredibly hard to shake off, as Japan discovered in its 'lost decade' of the 1990s.
Derivatives
These financial instruments refer to a broad class of securities, or investments, whose prices are derived from the prices of other assets (bonds, currencies, shares) or goods (metals, energy sources, agricultural products), hence their name.
Some derivatives are so complex that even senior investment bank executives admit to not understanding them. In 2002, Warren Buffett, America's most successful investor, described them as 'financial weapons of mass destruction'. Because they're so difficult to grasp, they're hard to value and can create what Buffett called a 'daisy chain' of risk as the troubles of one company infect another.
