Capital loss, liquidity risk, credit risk, loss of purchasing power and interest rate risk are some of the hazards investors face when putting their money into investment accounts. Investors are often faced with the balancing act of risks vs. returns, but knowing the basic features of each investment account can help you choose which type is best for you.
Secured investment accounts or securities are real or virtual documents that represent any of the following trade-able assets: ownership of publicly-traded shares of a stock corporation, a creditor relationship with a large corporation or government body regarding a fixed-interest loan, or ownership rights to stock options or derivatives.
A bond is a debt security, which is similar to a promissory note. When you buy bonds, you are lending money to a government, municipality, federal agency, corporation or other entity known as an issuer. The issuer is obliged to pay interest to the buyer periodically during the term of the bond, and to repay the principal when it matures. Bond maturities can range anywhere from a couple of years up to 50 years.
Stocks are equity securities, which allow you to own shares of a corporation. Stock ownership is measured by the number of shares a person owns. The two main types of stocks are common and preferred stocks. Common stock normally allows the owner to vote at shareholders' meetings and to earn dividends. Preferred stockholders do not have voting rights, but they have priority over common stockholders when it comes to claims on assets and earnings.
Derivatives are financial contracts between two or more parties involving the sale or acquisition of underlying assets such as stocks, bonds, commodities, interest rates, currencies and market indexes. The sale or acquisition of the underlying asset, including the value of the derivative, depends on the performance of one or more underlying assets at future points in time. These underlying assets can be owned by either party to the agreement. The performance of underlying assets can be based on prices, interest rates, indexes, exchange rates, or in the event of a default.
Professional money managers often pool money collected from several investors to invest in securities such as stocks, money market instruments, bonds and similar assets into a single fund. Money managers attempt to produce capital gains and income for the fund's investors. Mutual funds allow small investors access to professionally managed packages of equities, bonds and other securities that would otherwise be difficult to invest in separately without a large amount of capital.
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