The production and distribution of goods and services are at the centre of our economic activity. A properly functioning market economy ensures that sufficient quantities of both are available.
But have you ever wondered where the capital to fund the flow of goods and services comes from? Or how the money and capital markets work? Or what they’re actually for? Quite simply, we wouldn’t have a prospering economy without these markets and their stock in trade: various types of security.
Types of security (a selection)
Securities are used to raise money and capital in the short, medium and long term.
- Money market securities usually have short maturities and are used to obtain liquidity at short notice. They are generally issued by public institutions, but companies and banks also boost their liquidity by issuing commercial papers or certificates of deposit. Money market instruments are normally discounted securities.
- The public sector, banks and corporations use bonds to borrow (raise) capital. The interest paid out to investors is higher or lower depending on the bond issuer’s creditworthiness, i.e. their credit rating. The lower the borrower’s default risk, the lower – and thus less attractive – the interest rate is for investors. As a rule, a fixed interest rate is agreed over the entire term of the bond. However, there are also special variants on the market, such as bonds with variable interest rates (floaters), rising or falling interest rates (step-up, step-down) and even bonds with no nominal interest rate (zero-coupon bonds or zero bonds). The yield from the latter is “hidden” in the difference between the issue and redemption prices, or between the bond’s purchase and sale prices. Apart from the nominal interest rate, also known as the coupon, the achievable return is an important criterion in investors’ decisions. Interest-rate markets are subject to constant fluctuation. Interest rates rise, interest rates fall, the quality of issuers is sometimes better – and sometimes, alas, worse. Every change influences bond prices, and investors are well advised to be aware of the risks of investing in this asset class.
- Shares represent interests in a company’s equity. Companies that sell their shares operate as stock corporations (German: Aktiengesellschaft [AG]) or partnerships limited by shares (German: Kommanditgesellschaft auf Aktien [KGaA]). While most of our definitions of capital-raising securities are somewhat dry, shares are actually quite exciting phenomena. Often misunderstood as speculative instruments, shares in Germany are more like wallflowers. Germans invest less than 10% of their savings in shares – although even that modest percentage amounts to more than EUR 6 trillion (!). Clearly shares are risky. But very few investors need short-term access to all their assets, all the time.
- Assets require structure. Distributing assets among different types of security is already one way of reducing the risk of losses. And if this asset distribution is undertaken by specialists who take account of the investor’s preferences and objectives, as well as the investor’s risk preferences, this represents a big first step towards a successful long-term investment strategy. But only a first step – because nothing on the securities markets is set in stone. Constantly adapting one’s assets to changes is time-consuming and involves financial expenditure. This is why entire teams of fund managers tackle these challenges on a daily basis, managing their clients’ assets professionally and responsibly within the appropriate legal framework.
- Investment funds invest money very broadly, more or less as a legal requirement – the technical jargon calls this process “diversification”. How does it work? Which securities make it into fund portfolios and why? What do fund managers have to think about? What tools do they have at their disposal? What risks do investors face? The truth, sad to say, is that very few investors in Germany are sufficiently knowledgeable – or even have sufficient interest – to invest their assets wisely, with the aim of achieving good results in the long term.
Curious? Have you just opted for a career in the investment industry? You may do your job well, but do you always know exactly what you’re doing? In our “What non-bankers and career changers need to know about securities” seminar, we give you a solid overview of the securities business. Oh, and we welcome questions and love lively discussions.