What is short-selling?

Think of short-selling like a deal with your local greengrocer. Assume apples cost 50p each but their price changes depending on factors such as harvests, deliveries and weather.

Peter, always keen to make a fast buck, believes that the price will soon fall and wants to cash in on his prediction. He persuades Paul, his local apple dealer, to lend him ten apples, which he does for a small fee, on the promise that his ten apples will be returned the next day.

Peter then takes his apples down to the local fruit market and sells all ten for what he believes to be a heady price of 50p each. Just as Peter had predicted, based on his belief that there had been a bumper crop because of good weather, the next day the price of apples falls to 25p as a big delivery from the local farm floods the market. A cash-rich Peter decides to take advantage of the low price and buys ten apples at the new lower price so he can return what he borrowed to Paul.

Despite many sellers at the fruit market cursing the lower prices, Peter makes off with a handsome profit of £2.50, minus the small fee he paid to Paul. However, Peter did get lucky: had the delivery not arrived, the price of apples would have gone up and he would have been forced to buy back the ten apples he owed Paul at a higher price, losing money

What is Libor

Pretend you are a bank. You want to borrow some money from a friend, but seeing as they are a bank too, they are going to want to charge you interest. Before you go to haggle with them about the loan, you do a quick sum to figure out what rate you should pay. Let’s say 15 of your friends (all banks too) are doing exactly the same. The average of all the interest rates you expect to pay gives you an indication of what it would cost to borrow money that day - the Libor rate.

When figuring out exactly how much you should expect to pay, you must look at yourself carefully. Do you pay your bills on time? Are you earning regular money? If the answer is yes, then your friend will probably charge a competititve rate of interest - if he has enough cash to lend you.

But if you are struggling to pay debts and are having trouble securing a regular income, your friend will want to charge you a higher rate of interest. After all, they have to make sure that the return on the loan is attractive enough to cover the chance that you may not actually repay it.

You must remember, too, that your friend will be taking into account not only what they know but also what everyone thinks of you. After all, they, not you, will decide how much you pay.

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