10 Basic Financial Terms Every One Should Know

Understanding financial terms is vital for fully appreciating India's growing financial system.  Because current economic conditions are rapidly changing and new financial instruments are being developed, it is critical for the general public to be familiar with basic financial terms.

1. Inflation: Inflation refers to the rate at which the prices of goods and services increase over time, leading to decreased purchasing power of money. It is classified as demand-pull (the result of increased demand), cost-push (the result of increased production cost), and built-in (wage-price spiral). Inflation levels are measured in terms of consumer prices (CPI) and wholesale prices (WPI). The higher the inflation, the lower the return on savings, investments, and interest rates. Central banks use simple monetary policy tools, such as repo rates and cash reserve requirements, to control inflation in order to stabilise the economy.
2. Liquidity: Liquidity can be defined as an asset's ability to convert into cash with preservation of its value. Cash and stocks that can be sold rapidly are examples of liquid assets. Conversely, less liquid assets, such as real estate, require a longer time frame to sell. Liquidity becomes crucial in times of emergencies when flexibility and financial need come into play.
3. Marginal Cost of the Fund-Based Lending Rate (MCLR): MCLR, which was initiated in April 2016 to ensure the bank-to-client communication about lending rates, may be seen as the minimum interest rate that a financial institution will assign to loans. Since various banks put forth their own MCLR rates, it is advisable to do rate comparisons before applying for a loan according to one's purpose, as these rates keep varying over time.
4. Credit Information Bureau of India Limited (CIBIL) Score: As a result of inadequate financial inclusion in India, many people do not understand the significance of the CIBIL score. A CIBIL score is a three-digit number ranging from 300 to 900 that indicates the borrower's creditworthiness and repayment ability and is, therefore, of utmost importance in obtaining loans and credit cards. A CIBIL score is dependent upon a variety of factors such as repayment history, outstanding debts, credit mix, and loan term. However, a score of 700 and above gives you an edge in loan approval. In addition, a good credit score can provide the leverage to allow borrowers to negotiate for more favorable terms and perhaps even a higher credit limit with additional perks such as a premium credit card.
5. Equity: Stock market equity is a holding of part of a firm through purchasing its shares. The shareholders are allowed to claim the earnings and assets of the company. Common shares provide voting rights, which help the shareholders approve or disapprove the activities of the company. They provide more returns in terms of dividends and capital appreciation but are riskier because the payment of dividends is not ensured. Preferred shares provide fixed dividend payments and seniority over common shares in the event of a firm winding-up.
6. Bonds: A bond can thus be viewed as a debt to a corporation or the government. It will pay regular interest and then repay the principle after a certain period of time. Bonds are comparatively safer than equities in general, thus they provide smaller returns. The most frequent forms of bonds are government bonds, business bonds, and municipal bonds.
7. Leverage: When borrowed money are used to raise the likelihood of a return on investment, this is known as leverage in the financial world. This allows a business or individual to manage bigger assets with less money. Although leverage increases the chance of profit, it also increases the danger of loss. Businesses, commerce, and real estate all often utilise it. As an example, you may spend ₹1 lakh and borrow ₹4 lakh at a 10% interest rate to buy a ₹5 lakh house. An increase in the property's value to ₹6 lakh results in a ₹1lakh profit (20% return on entire investment). Your actual gain is ₹60,000 as you have already paid ₹40,000 in interest, which is equivalent to a 60% return on your ₹1 lakh equity.
8. Mutual Funds: Mutual funds are investment vehicles that collect funds from a variety of participants to build a diverse portfolio of assets such as stocks, bonds, and other securities, which are then professionally managed by Fund Managers. Furthermore, mutual funds are distinguished by low trading costs and the benefit of broad diversification, making them accessible to even modest investors. Mutual funds are divided into three categories: equities, debt, and balanced funds, each with a particular risk appetite and financial aim.
9. Sovereign Gold Bonds: In November 2015, the Government of India introduced these bonds as an excellent alternative to investing in shiny yellow metals. They are created in grams of gold and issued by the Reserve Bank of India, with a minimum investment of 1 gram and a maximum limit of 4 kg for individuals and HUFs, while for trusts, it is restricted to 20 kg. The investors will get a fixed interest of 2.5% per annum, payable on a semi-annual basis, and the benefit of price appreciation. These bonds are issued for a period of 8 years, and the investor can exit from the 5th year and thereafter. Since sovereign in nature, these SGBs are free from theft, storage, and purity issues and entail tax advantages and eligibility as collateral for loans.
10. Exchange trade Funds (ETF): ETFs are investment funds that combine the diversification of mutual funds with the ease of stock trading. They are collections of securities like stocks, bonds, or commodities, often tracking an index such as the S&P 500 or Nifty 50. Unlike mutual funds, ETFs trade on stock exchanges, allowing investors to buy and sell them throughout the day at market prices.

Conclusion

Everyone should be financially literate since it enables them to manage their money wisely and make educated financial decisions. Understanding the fundamentals of finance can help you make an efficient budget, save money, and spend it sensibly, which will guarantee that you won't experience needless financial stress. You can also build a retirement plan, invest wisely, and accumulate wealth over time. As a result, basic financial literacy is important, and you can establish a solid basis for financial freedom by consistently mastering financial terms.

This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.