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Shares vs other financial instruments

For many investors, stock trading is considered the supreme discipline of investing. Beyond that, however, there are several other popular assets that can be invested in through their broker. These include bonds, cryptocurrencies, CFDs, and futures.

With shares, you become a co-owner of a company

Shares are fractions of the share capital of a stock corporation. They certify shareholders' ownership shares in the company. Investors become co-owners by purchasing the securities and together they form the stock corporation. The value of the company is calculated by adding up the values of all its shares. Shareholders participate in the success of the stock corporation because, on the one hand, they can receive an annual share of the profits in the form of dividends. On the other hand, they hope that with the success of the company, the price of the shares will also increase so that they can sell their shares at a profit in the future. With shares, you invest in companies.

If a corporation wants to expand, it can go public. Listed shares have various advantages for investors: Through the regulated stock exchange, shares are free and tradable for everyone. Investors can also sell their shares very fast through the stock market. The price of the share is based on the supply-and-demand principle and is calculated by the stockbroker - today this is done by computer.

Shares are divided into preferred and common stock. Ordinary shares give a shareholder the right to vote at general meetings. Holders of preferred shares, on the other hand, have no voting rights. On the other hand, they receive a higher dividend. Most stock corporations in Germany issue common stock. Preferred shares are often used by traditional family-owned companies such as Henkel, VW, BMW, and Sixt to increase their equity without having to give shareholders a vote.

With bonds, you lend capital to the issuer

Shares differ from bonds, where the investor lends his money to the company (issuer) against payment of interest for a fixed period. If an investor purchases a bond from a company, he is its creditor. Shareholders, on the other hand, are co-owners. If a bond is newly issued, the investor subscribes to the bond by granting the issuer a loan for the amount of the bond's par value. Investors receive a fixed interest rate and the nominal value of the bond back at maturity. Since the nominal interest rate remains the same throughout the investment period, these bonds are referred to as fixed-income securities. However, there are also floating-rate bonds. The interest payment can be made either as a total sum at maturity or annually.

Bonds can be categorized according to the type of issuer, for example, public-sector bonds. Government bonds are among the most common securities of this type. Almost every state can act as an issuer. The Federal Republic of Germany, for example, issues federal bonds. In addition, federal states, cities, and municipalities can issue bonds. The second group includes bank bonds. These are fixed-or floating-rate securities issued by banks, savings banks, and other financial institutions to finance their lending business. The third group includes what are probably the best-known interest-bearing securities: corporate bonds. They are also known as "corporates" or "corporate bonds".

Since bonds are legally debt instruments, the following usually applies to securities: the weaker the credit rating of the issuer, the higher the interest rate. This is known as the risk premium. The more risk investors take, the more they want to be compensated for it and the higher the interest rate. This is because if the issuer becomes insolvent, there is a risk of losing the capital invested. For this reason, the rating, i.e., the assessment of creditworthiness, has an impact on the terms and conditions of the bonds to be issued. The creditworthiness of companies is assessed by rating agencies such as Moody's, Standard & Poor's, and Fitch. The rating helps investors assess the respective risk of the bond.

Trading with digital currencies (cryptos)

Trading digital currencies, also known as "cryptos", is always compared to stock trading - often unfairly. Cryptocurrencies are usually very volatile compared to the stock market. Unlike stocks, they have no intrinsic or tangible value. With a stock, investors are actually investing in the company. With cryptocurrency, one invests in the technology or digital currency. However, there are also similarities: Basically, with stocks and with cryptos, the price is determined by demand. Moreover, both assets can be valued based on the idea behind them. The stock is based on the business of the company behind it. Digital currencies are based on the idea of trading a currency in a decentralized manner via blockchain technology, which ultimately eliminates the need for banks to process payments. Cryptos can be traded via crypto exchanges, special marketplaces, banks or your broker.

Participate disproportionately in price movements with CFDs.

Unlike stocks and bonds, contracts for difference (CFDs) are traded over the counter. In legal terms, investors enter into an agreement with the CFD provider (broker). The broker sets the prices, determines the terms and conditions, and offers the corresponding trading opportunities and the associated online platforms. Contracts for difference allow investors to profit disproportionately from price movements of underlying assets such as indices, stocks, currencies, and commodities. As the name suggests, it is all about the difference in the price of the underlying asset between the investor's entry and exit points. With long CFDs, investors bet on rising markets, and with short CFDs on falling markets. For example, a leverage of 10 means that the value of the long CFD increases by 10 percent if the underlying asset moves up by one percent. However, the leverage works in both directions: If the investor's market expectation is not fulfilled, correspondingly losses occur. If, for example, the share falls by one percent with a leverage of 10, this means a loss of 10 percent for a long CFD.

Investors deposit a security deposit, the so-called margin, on their trading account. This is, except for a leverage of 1, lower than the cost of the underlying. This allows CFD investors to trade large sums with comparatively little capital. This is the reason for the leverage. CFD brokers also ensure that all positions are closed automatically before the trading account slips into the red. In the case of very high leverage of 100 and more and extreme price movements, it was nevertheless possible in the past for margin calls to be made, whereby investors had to compensate for the loss subsequently. However, the margin call has been abolished in Germany. Today, CFD traders cannot lose more than they use in CFD trading. In addition, leverage of only 5 to 30 - depending on the underlying asset - is now possible.

Diversify the portfolio with futures

Futures are forward contracts and, like CFDs, belong to the group of derivatives whose value is derived from underlying assets such as shares, indices, commodities or currencies. Unlike CFDs, futures are traded on an exchange. More precisely: on the futures exchange. In simple terms, the settlement of these transactions takes place in the future. The counterpart to this is the cash exchange, through which the transaction takes place immediately, such as in stock trading. In the case of futures, the buyer and seller agree to deliver the agreed quantity of an underlying asset at a specific location at a price and time determined in advance. Both parties must accept the forward contract on these terms. The price of the forward contract at the time of contract performance is not relevant. Both parties can release themselves from their obligations by reselling the forward contract. In technical jargon, this is referred to as closing out the position.

In practice, the latter means that a buyer of an oil future, for example, does not actually receive delivery of the oil. The prerequisite for this is that he sells the future before maturity. Background: Traders, capital investors, and speculators want to avoid the physical delivery of the underlying. In this case, cash settlement, i.e., payment of the underlying in foreign currency, is used. Investors usually buy futures "on margin." That is, they do not pay the full value of the futures contract but only make a down payment, which is called margin.

Actually, futures served and still serve as hedging transactions for companies that want to secure prices for the future. Today, however, they are often used for speculation. Futures are also an interesting financial product for private investors. For example, investors can add futures on commodities such as oil or industrial metals to their portfolio and thus diversify. To trade futures, you need a broker that offers these trading opportunities. Futures are traded on strictly regulated and supervised exchanges such as Eurex. In practice, brokers prevent retail investors from having to make an unwanted delivery or purchase commitment. Therefore, investors are notified at an early stage to close out positions. The corresponding contracts are usually blocked one to two weeks before the delivery date. If the investor does not close out the position himself in time, the "forced liquidation" is carried out by the broker. This is equivalent to closing out the position at the expiration date. The investor's account is settled according to the last price before the expiration date, i.e., debited with losses or compensated with profits.

Here is an overview of the different investment alternatives:

  • Investments have very different risk-reward profiles
  • For defensive investors, bonds are usually an investment alternative
  • For optimistic investors, equities and leveraged products are a suitable alternative
  • With CFDs and futures, investors can participate disproportionately in price movements