Last updated on October 21st, 2024 at 10:18 am
I remember the first time I tried to invest in stocks. I was so excited to start investing, but I was overwhelmed by all the options available. I didn’t know what a stock was or how to buy one. Stocks are one of the many financial products available out there. Fundamentally, financial products are any financial asset that can be purchased or sold.
Stocks
Stock, or equity, represents a portion of ownership in a company. When you buy stock, you purchase a piece of that company. This ownership comes with various benefits and rights, such as the ability to vote on company matters and receive dividends if the company profits.
Types of Stocks
Common Stock: These financial instruments are the most common types of stocks. Common stockholders might have voting rights and can receive dividends.
Preferred Stock: Preferred stockholders are prioritised over common stockholders when receiving dividends and assets in case of liquidation. However, they often have limited or no voting rights.
Blue-Chip Stocks: These are stocks of well-established, large, and financially sound companies with a history of consistent dividends and stable growth. Examples include Apple, Microsoft, and Johnson & Johnson.
Growth Stocks: These are companies’ stocks expected to experience rapid growth in earnings and revenue.
Value Stocks: These are stocks of companies that are undervalued relative to their intrinsic worth. They often have low P/E ratios and may be overlooked by the market.
Income Stocks: These are stocks of companies that pay regular dividends.
Cyclical Stocks: These are stocks of companies whose performance is closely tied to the overall economy. Their prices tend to fluctuate with economic cycles.
Defensive Stocks: These are stocks of companies that are relatively resistant to economic downturns.
Derivatives
Derivatives are financial instruments whose values are derived from underlying assets, such as stocks, bonds, commodities, or currencies. They are often used to hedge risk, speculate on price movements, or increase leverage.
Types of Derivatives
Futures Contracts: These are agreements to buy or sell a specific asset at predetermined prices on future dates. They are often used for hedging and speculation.
Options: These are contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price within a certain timeframe. There are two main types of options:
- Call options: Give holders the right to buy the underlying assets.
- Put options: Give holders the right to sell the underlying assets.
Swaps: These are agreements to exchange one asset for another. They are often used to manage risk or improve financial efficiency.
Forwards: These are similar to futures contracts but are customised agreements between two parties. They are often used in over-the-counter markets.
Credit Default Swaps (CDS): These are insurance contracts that protect the buyer against the default of a debt instrument.
Bonds
Bonds are debt instruments governments, corporations, or other entities issued to raise capital. When buying a bond, we are fundamentally lending money to the issuer. In return, the issuer promises to pay us periodic interest payments and repay the principal at maturity.
Types of Bonds
Government Bonds: These bonds are issued by governments, such as the Reserve Bank of India or U.S. Treasury. They are generally considered to be relatively safe investments.
Treasury Bills: Short-term government bonds that mature in less than a year.
Treasury Notes: Government bonds that mature in 1 to 10 years.
Treasury Bonds: Government bonds that mature in more than 10 years.
Corporate Bonds: These bonds are issued by corporations to raise capital for various purposes. They can be classified based on their credit quality:
- Investment-grade bonds: Bonds issued by companies with a relatively low risk of default.
- High-yield bonds (junk bonds): Bonds issued by companies with a higher risk of default.
Municipal Bonds: These bonds are issued by state and local governments to finance public projects. They often offer tax advantages.
Convertible Bonds: These bonds can be converted into common stock of the issuing company under certain conditions.
Zero-Coupon Bonds: These bonds do not pay periodic interest but are sold at a discount to their face value. The return comes from the difference between the purchase price and the face value.
Investment Funds
Investment funds are pooled investments managed by professional fund managers. They allow individuals to invest in a diversified portfolio of securities, such as stocks, bonds, and other assets.
Types of Investment Funds
Mutual Funds: These are actively managed funds that invest in a variety of securities. They can be classified based on their investment strategy, such as:
- Index funds: Track market indexes such as the Nifty 150 or Nifty smallcap 250.
- Growth funds: Invest in stocks of companies that are expected to experience rapid growth.
- Value funds: Invest in stocks of companies that are undervalued relative to their intrinsic worth.
- Income funds: Invest in securities that generate income, such as bonds and dividend-paying stocks.
Exchange-Traded Funds (ETFs): These are funds that trade on stock exchanges like individual stocks. They are passively managed and often track a specific index. ETFs offer several advantages, including lower costs and intraday trading.
Hedge Funds: These are privately managed funds that use a variety of investment strategies, including leverage, short-selling, and derivatives. They are typically available only to accredited investors.
Real Estate Investment Trusts (REITs): These are companies that invest in real estate properties. They offer investors the opportunity to invest in real estate without owning individual properties.
Commodity Funds: These funds invest in commodities, such as oil, gold, and agricultural products. They can be used to hedge against inflation or to speculate on commodity price movements.
Wrapping Up
It's important to understand the risks and benefits of financial products before using them in your investment strategy. This is why we recommend an investment products overview before investing for yourself or others. If you wish to become a finance professional, you can enrol in Imarticus Learning’s Certified Investment Banking Operations Program.
This is one of the top investment banking courses out there and will teach you everything you need to know about the different financial products offered in investment banking.
Frequently Asked Questions
What is the difference between stocks and derivatives?
Stocks represent ownership in a company, while derivatives are financial products whose value is derived from an underlying asset. Stocks offer potential for higher returns but are also riskier. Derivatives can be used to hedge risk, speculate on price movements, or increase leverage.
What are bonds and why are they used?
Bonds represent a loan to a company or government. Bonds are used as they generally provide a more stable income stream compared to other financial products.
What is the role of investment funds in a diversified portfolio?
Investment funds allow individuals to invest in a diversified portfolio of securities, reducing risk and providing exposure to different asset classes.
How do you choose the right types of financial instruments for your needs?
Consider your investment goals, risk tolerance, and time horizon. Consult with a financial advisor to get personalised advice.
