In our capital markets overview video, we talked about equity and debt markets. Let's now dive in a little deeper to learn which securities are commonly traded in these markets.
First, how is "equity investment" defined?
"Equity" means ownership, so if you were asked, "how much equity do you have in your home?"
what you're really being asked is, "how much of your home do you actually own?"
or "how much have you paid into it?"
So in the equity market, securities that we own are traded.
Common securities generally include stocks, mutual funds, and exchange traded funds or (ETFs). Let's look at stocks first.
If a company is looking to raise funds to expand, they can either:
- Acquire a loan from a bank or from issuing debt, like bonds. Or –
- Issue equities, like stocks, to investors. By issuing stocks, they can raise funds – but they also give up partial ownership of their company.
This means if an investor owns company stock, then they also own a part of the company
By investing in stocks, investors can potentially make money two ways:
First, through stock price appreciation, which is also called "capital gains."
Let's look at an investor named Angela as an example.
If Angela buys 100 shares of a stock at $40 and then sells all 100 shares at $50, then she has made a gross profit of $1,000.
And second, dividends.
These are regular, fixed payments that the company or stock issuer pays to investors.
Just how much is determined by the number of shares that the investor holds, and it can be paid out every quarter.
Using the same example we just went over, if Angela's 100 shares of stock has a 50-cent dividend paid annually for every share, they she will receive $50 as income for the year.
Dividends on common stock are usually paid out on a quarterly basis, and in this example, Angela will receive $12 dollars and 50 cents every quarter.
Another term to know is "dividend yield."
This takes the annual dividend and divides it by the current price of the stock.
For example, if a stock is trading at $40 per share with a 50-cent dividend, then the annual dividend yield would be 1.25 per cent or 50 cents per $40.
Stocks can be classified in different ways. Here are a few…
- Common shares (or common stock) can give investors dividends and the right to vote on company matters, such as voting to elect a company's board of directors.
Preferred shares or (preference shares) typically don't come with voting privileges, however preferred shareholders do have preferential claim to a company's earnings and preferred shares will typically have higher dividends than common shares.
If a company is late on its payments, it must pay dividends to preferred shareholders before common shareholders can receive their payments.
Additionally, if a company is going through insolvency, where all their assets must be sold and creditors paid, preferred shareholders will be paid before common shareholders.
Finally, common stock typically has a greater tendency to change price (compared to preferred shares) and is more widely traded than preferred shares.
- Common stock may be classified into class shares which may offer different voting rights or dividend entitlements as determined by a company's charter.
For example, Class A stock can be structured similarly to preferred shares.
Class B stock may give investors voting rights, but there could be certain conditions imposed on dividends.
For example, Class B investors might only receive dividends after Class A investors receive their dividends.
- Stocks can also be categorized according to the profile of the company.
Small-cap stocks, for example, indicate that the shares are coming from a company of smaller size with a value of approximately $300 million to $2 billion, as opposed to large-cap stocks, which come from companies that have large market capitalization over $10 billion.
There are other types of labels placed on stocks such as value stocks, growth stocks, income stocks, penny stocks and blue chip stocks.
We'll explore these types in greater detail in future lessons.
As far as risk goes, investors can potentially lose their entire investment with stocks.
There is no guarantee of profits, and any profitability depends on the company's performance.
This is why it's always a smart idea to research before making an investment decision.
Another type of security traded in the Equity Market are mutual funds.
A mutual fund is a basket or group of different stocks.
A large number of investors individually contribute to the fund, and the number of units that they own depends on how much money they invest.
Mutual funds can be appealing to new investors or those looking for a more hands-off approach because they don't typically require a lot of involvement on the part of the investor.
Mutual funds are overseen by professional fund managers who use the money from investors to invest across a variety of securities using strategies deemed appropriate by the fund manager.
Mutual funds are generally built with an overall objective or goal in mind.
Some can be built with an overall goal of safety, for example, whereas others might have goals that focus on dividends or growth.
This key information can be found within a document for each mutual fund called the Mutual Fund Prospectus.
Mutual funds might expose investors to a variety of industries and sectors, some of which that might not always be available if investing into individual stocks.
You may have heard of a term called "diversification."
This term essentially means not putting all your eggs into one basket.
Mutual funds provide an option for investors to invest into multiple investments and spread their investment risk more broadly.
We'll cover diversification in more detail in the portfolio management course.
Like stocks, mutual funds do come with risk, so it's important that investors research a mutual fund before they put any money towards it.
One last note about mutual funds: Canadians can only purchase mutual funds that are issued in Canada, not the United States or other countries.
Mutual funds can be managed a couple ways. The first is as a mutual fund corporation. In this model, a board of directors is responsible for managing the fund.
The second is more commonly used: a mutual fund trust. In this model, appointed trustees manage the funds.
Mutual funds can be structured two different ways. They can either be closed-end or open-end.
Closed-end means that a mutual fund is capped: The fund has a fixed number of shares and a fixed number of investors.
Open-end, on the other hand, means there is no cap. More shares are added to the mutual fund, which allows more investors the ability to contribute.
Most mutual funds are structured this way.
What's another type of security that can be traded in the Equity Market? Let's move on now to Exchange Traded Funds, or ETFs for short.
Like mutual funds, ETFs pool together the money of many individual investors who have similar investment goals.
And the money is used by a fund manager to buy a variety of investments, which are then combined in one pot.
So what's the difference?
The main difference between ETFs and mutual funds is the way that investors buy or sell units of the fund.
The “exchange-traded” part of the name means ETF units are bought and sold through a broker on a stock exchange (like the Toronto Stock Exchange, for example) the same way that stocks are.
Mutual funds, on the other hand, are bought and sold through a mutual fund dealer.
Both ETFs and mutual funds can be a relatively low-cost way to diversify a portfolio, but there are costs that investors should be aware of.
One expense is the Management Expense Ratio (or "MER" for short) and this is the cost associated with operating the mutual fund.
As with any security, ETFs come with risk so it's important to research before purchasing.
Hopefully you are recognizing a trend here: no matter what you are investing in – stocks, ETFs, mutual funds, etcetera –
spending some time researching what you'd like to put your money into is a critical step that all investors should practice before investing.
Let's switch gears now and look at common securities traded in the Debt market.
Think of debt investments as loans from the investor to the borrower, for a set period of time.
At the end of the loan period, investors get their initial investment back, plus interest.
The borrower can be a company, a municipality, the provincial government, the federal government, or even a foreign entity.
A common type of debt securities are bonds.
There are a number of features, risks, and rewards associated with bonds.
Bonds are generally considered as having a relatively lower risk profile compared to equities, and they can provide stable and predictable income.
Bonds are also highly liquid, so if an investor wants to sell their bond, they would immediately receive funds in return.
On the other hand, bonds are subject to a number of risks, like interest rate and inflation, which could affect investment returns.
Before buying bonds, investors should research items, like the credit rating of the company or group that's issuing the bond.
A credit rating is established by a third-party agency to assess how good the company is as paying back their loans.
Let's look at a simple example of how a bond works. Bonds are generally issued in denominations of 1000.
In this example, Angela is going to purchase $5,000 of a brand new three-year bond directly from the issuer.
This bond pays an interest rate of 5 per cent, per year.
This rate is called the "coupon rate."
The bond will pay the interest to Angela twice per year, so every six months.
In this example, $125 is paid to Angela every six months.
When three years have passed, Angela should get back her original $5,000 loan from the borrower.
Other things to know about bonds are that their prices can fluctuate up or down and they can be sold before the end of the term.
Also, if all other factors remain the same, the price of a bond can go up if interest rates rise, and they can go down if rates are lowered.
This is because if rates go up, investors can purchase securities that pay a higher interest rate
– meaning that bonds that were already issued with lower rates will not be as attractive due to their lower price.
We will explore debt securities in more detail in a future course on fixed income investments.
A Guaranteed Investment Certificate – or GIC – is another type of debt market security.
GICs are issued by Canadian banks and trust companies.
To purchase, investors are generally required to make a minimum contribution at a fixed rate of interest for a fixed period of time.
Investors must also typically hold onto their GIC until the end of that period of time.
If something were to negatively affect a GIC issuer where they were to become insolvent, the investor could rest easy
– their investment would be covered by the Canada Deposit Insurance Corporation – up to $100,000.
That's an overview of investments that are commonly traded in the equity and debt markets.
As with all securities, it is wise to research and evaluate investment choices based on your risk tolerance and investment goal before you buy.
There will be additional courses that will go into these investments with greater detail in the future, so please come back and check for updates.
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