Products and Their Risks
Equity Securities
Common stock represents residual ownership in a corporation, carrying voting rights and the potential for dividends and capital appreciation, but standing last in the liquidation priority behind creditors and preferred holders. Preferred stock pays a fixed dividend and behaves much like a fixed-income security, so its price is sensitive to interest rate changes; cumulative preferred requires that skipped dividends accumulate and be paid before any common dividend. Related equity instruments include rights, which are short-term and let existing shareholders subscribe below market, and warrants, which are long-term with an exercise price initially above market. American Depositary Receipts (ADRs) let U.S. investors hold foreign shares in dollar terms, introducing currency risk.
Debt Securities and Yields
A bond's price moves inversely with market interest rates, and longer maturities and lower coupons produce greater price sensitivity (duration). Yield measures rank predictably: at a discount, coupon rate is below current yield, which is below yield to maturity; at a premium the ordering reverses. Corporate bonds carry credit risk assessed through ratings, while U.S. Treasuries are backed by the federal government and are exempt from state and local tax. Municipal bonds provide federal-tax-exempt interest, compared on a taxable-equivalent basis, and are issued as general obligation bonds backed by taxing power or revenue bonds backed by project income.
Options and Strategies
Options give the buyer the right, and the seller the obligation, to trade the underlying at a fixed strike. Long calls have limited loss (the premium) and unlimited gain potential; long puts profit as the stock falls, with maximum gain of strike minus premium. Uncovered call writing carries unlimited risk. Strategies include covered calls for income, protective puts for downside insurance, debit and credit spreads to define risk and reward, and straddles to trade volatility. Breakeven, maximum gain, and maximum loss follow directly from the strike prices and net premium, and all listed options are issued and guaranteed by the Options Clearing Corporation.
Packaged Products
Investment companies under the Investment Company Act of 1940 include open-end funds (mutual funds), which continuously issue and redeem shares at net asset value; closed-end funds, which trade at market prices; and unit investment trusts, which hold a fixed portfolio to a termination date. Exchange-traded funds trade intraday like stocks. Variable annuities invest in separate account subaccounts, shifting investment risk to the contract owner, while fixed annuities expose holders to inflation risk. Direct participation programs and many REITs pass income and, for DPPs, losses through to investors, and hedge funds are typically sold as illiquid private placements to accredited investors.
Investment Risks
Systematic (market) risk affects nearly all securities and cannot be diversified away, whereas unsystematic risk is company-specific and can be reduced through diversification. Interest rate risk is greatest for long-term, low-coupon bonds, while reinvestment risk affects investors who must redeploy coupons or called principal at lower rates. Credit or default risk is measured by issuer ratings, and mortgage-backed securities add prepayment risk when falling rates prompt refinancing. Matching a product's risk profile to a customer's objectives is central to suitability.
Last updated: July 2026