Fixed-income or debt securities promise either a fixed stream of income or a stream of income that is determined according to a specified formula. For example, a corporate bond typically would promise that the bondholder will receive a fixed amount of interest each year. Other so-called floating-rate bonds promise payments that depend on current interest rates.
Unlike debt securities, common stock, or equity, in a firm represents an ownership share in the corporation. Equityholders are not promised any particular payment. They receive any dividends the firm may pay and have prorated ownership in the real assets of the firm. If the firm is successful, the value of equity will increase; if not, it will decrease. The performance of equity investments, therefore, is tied directly to the success of the firm and its real assets. For this reason, equity investments tend to be riskier than investments in debt securities.
Finally, derivative securities such as options and futures contracts provide payoffs that are determined by the prices of other assets such as bond or stock prices. Derivative securities are so named because their values derive from the prices of other assets. Derivatives have become an integral part of the investment environment. One use of derivatives, perhaps the primary use, is to hedge risks or transfer them to other parties.
Investors also might invest directly in some real assets. For example, dozens of commodities are traded on exchanges such as the New York Mercantile Exchange or the Chicago Board of trade. You can buy or sell corn, wheat, natural gas, gold, silver, and so on. Commodity and derivative markets allow firms to adjust their exposure to various business risks.
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