Capital Market
The capital market is divided into the stock market and the bond market. The stock market deals with company stocks, options, convertibles, rights and warrants. The bond market deals with bonds issued by the government and companies.
Stock Market
Companies could raise cash by issuing shares to the public investors. This allows the public to a chance to own part of the company and participate in the growth of the business.
When you become a stockholder, the profits of the company will be distributed back to the owners of the company. This is called dividend. Many retirees choose to buy stocks of companies with a tradition of distributing high dividends. These retirees depend on the dividend as a source of income.
Not every company will distribute high dividend. Companies experiencing growth will usually need the profits to be reinvested back into the company to finance its projects. Though the stockholders do not get the dividend income, but the stocks could rise in value, thus providing the holder with a potential for huge capital gain.
The rise and fall of the market price of stocks, options, convertibles, rights and warrants all stem from the performance of the underlying company these financial instruments are associated with. Therefore, it is important for you to research into the companies and the industries these companies operate in before you buy the financial instruments associated with these companies.
Stock is a volatile investment. It is best to hold the stock for long term. This will minimise the risk of short term fluctuations. The rate of return on stocks is high and not many investment can match the performance of stock.
Businesses do fail or become obsolete. Therefore, it is advisable not to put all your eggs into one basket. Spread out your investment into different stocks. You avoid losing all your investment if one company fails.
To minimise the risk, you should research into the companies and industries, invest for the long term and diversify your portfolio.
Learn more about successful stock investing.
Bond Market
Companies could also raise cash to finance their operations by issuing bonds. When you buy a bond, you are loaning money to the bond issuer.
All bonds have a par value (or face value) and maturity date. Upon maturity, the issuer is obliged to repurchase the bond from the bondholder at par value. The par value is fixed upon issue.
An interest free bond with a par value of $100 could be issued for $80 with a maturity date of 6 years. You could buy this bond today for $80, and wait 6 years for the issuer to buy back the bond from you at $100. The difference of $20 represents the interest the issuer is giving to you for loaning your money to them.
Some bonds can provide you with a fixed income known as interest. The interest rate is called coupon rate and is expressed as a percentage of the par value. The coupon rate is fixed upon issue.
A company issues a bond with a face value of $100 with a maturity date of 8 years and coupon rate of 4%. This bond currently sells for $100. You could buy this bond today for $100 and receive a 4% interest every year until maturity when the issuer buys back the bond from you at $100. The 4% or $4 interest is the income from loaning your money to the bond issuer.
Bonds can be traded from one person to another just like stocks. The market price of bonds (not the par value) moves in the opposite direction of the market interest rate (not the coupon rate).
Because the par value and coupon rate is fixed, therefore the returns you get from bonds is also fixed. Hence, there is very low risk in your investment. Historically, the rate of return on bonds is lower than stocks.