Discover what various financial terms mean, from Hedge Funds to Interest Rates.
Hedge funds
The very rich, alongside pension funds and insurance companies, invest in hedge funds, which tend to be very secretive and charge very high fees.
They can deliver exceedingly high returns: in 1992, George Soros and his Quantum fund made hundreds of millions of pounds betting that the pound would be ejected from the European Exchange Rate Mechanism. But hedge funds can go spectacularly wrong: in 1998, Long Term Capital Management Fund had to be rescued because its collapse threatened the international financial system.
The 2008 financial crisis hit the world's hedge funds hard – as many as 30% of the 8,000 hedge funds could disappear. They have been accused of feeding the credit bubble by providing a market for toxic investments arising from sub-prime mortgages.
Inflation, hyperinflation and stagflation
Inflation – rising prices – has been kept largely under control in the US and Britain in the last 20 years. A little inflation – 2-3% – does little harm, but if prices rise too fast, workers will demand big pay rises, which can lead to spiralling inflation. Inflation eats away at the value of wages and savings: if a person earns 10% on their savings but inflation is 10%, they have actually earned nothing.
Hyperinflation, or out-of-control inflation, usually occurs during wars and periods of severe political instability. In October 2008, Zimbabwe had the world's highest inflation rate ever: 231,000,000%.
Stagflation arose in the 1970s when stagnation (a period of little or no economic growth) and inflation occurred simultaneously. Previously these two had never appeared together.
Interest and interest rates
For borrowers, interest is the percentage of the loan that they will have to pay extra in order to have that loan. If they have to pay 10% interest annually on a £5,000 loan, that will come to £500 every year.
The rate of interest on loans in the UK is determined by base rates set by the Bank of England. In November 2008, it slashed interest rates by 1.5% to 3% to soften the blow of recession. Interest rates are the main weapon to regulate economic activity, even though they can be a blunt instrument. They usually take six months to have an effect, but they also have an important psychological value.
