Question

Briefly explain in no more than 300 words the following diagram which depicts the linkage between the corporation and investors in security markets. As part of your explanation, outline what are some of the types of securities which are traded in the market.

Answer 1

Link between corporation and investors

The above graph shows that the investment increases as the interest rate increases.

Securities are those investments which are traded in the market. Examples of such securities can be stocks and bonds.

There are three types of securities that can be traded in the market:

• Equity:

Equity are shares of company. The shares can be purchased through broker. The market for shares of the company are the secondary market. The method that is adopted by the company is IPO which is the initial public offering but this is considered to be an expensive option for the company. The company usually sells them in bulk quantities. the price of the share usually increases when they are sold in the stock market.

• Debt:

These are loans called bonds. There are rating companies who evaluate the bonds of the companies and rate them how it will be repaid. The borrowers have to pay a higher interest rates if their rating goes down below AAA. There are bonds called junk bonds which have higher risk, but still the investors buy them for their high interest rates. The bonds issued by the company are called as corporate bonds.

• Derivatives:

These are stocks, bonds or other assets. They provide higher returns to the traders. These are generally of two types namely call option and put option.

Call option is the one which allows you to buy the stock at certain price, when the price goes up, it can be purchased at a lower price by negotiating.

A put option on the other hand gives the right to sell the stock. If the stock price is lower, then we can buy the stock and sell it at higher price and make profit.

There are many other derivatives like this which includes forward contracts for commodities. Collateralized debt obligations where securities are divided based on their risks.