Aka Securities. These are objects which promise payment to whoever holds the object. They include: stocks/ equities (which represent ownership in various businesses/ funds), bonds (loans), derivatives (whose value is determined based on the value of other instruments).
Creating securities
Investment bankers help raise capital for various businesses by creating bonds and stocks. They get big fees for it.
Underwriting
They often take the responsibility of selling such securities by purchasing it from the business and holding on to them - usually until they can sell it.
Fiduciary duty
When securities are created, investment bankers have a duty towards the investor who may buy it to inform them fully and clearly about the risks involved in the security.
Yet, they collect fees from the businesses which want to create the security; a large fraction of which is distributed as bonus to the individuals working on these deals. So, investment bankers may often neglect this duty.
Bonds
These are documents in which borrowers acknowledge that they owe money to the holder of the document (lender), with the terms of repayment. The lender usually gets some return on investment, which may vary with the company’s performance. Hence, bonds are often traded: other people can buy the loan.
Often, bonds yield periodic interests, the size of which corresponds to the risk in the bond.
Bonds may be short-term or long-term.
Sovereign Gold Bond
- Let a government borrow your gold (rather money equal to k grams) for n years and pay you interest. After the term (or slightly earlier), you will be able to redeem money corresponding to the quantity of gold lent.
- India 2022
- 2.50% annually payable half-yearly, guaranteed by the Government of India and no expenses or other charges.
- no storage hassles like physical gold, no capital gain tax on redemption, traded on exchanges, can be used as collateral for loans, and no GST and making charges unlike in physical gold.
Mortgage backed securities
Individuals get mortgages from certain businesses - loans with their homes as collateral. These lenders then bunch together such loans and sell ownership of these loans to others who then may split it up and sell shares of these loans on the stock market.
Insurance/ betting against
Aka Credit default swap, hedging. When there is a large lending, the lender (or someone else!) may acquire insurance to cover credit-defaults. The insurers may inturn provide the guarantee by relying on an insurance they themselves bought, and so on. So, there can possibly be a chain of insurers, and the risk can be pushed to the bottom of the chain. If these bankruptcy insurances are not public knowledge, it is possible that the insurer may be taking a risk it cannot handle in case of a huge financial depression.
In the sub-prime mortgage crisis of 2006, companies like Magnetor profited by encouraging the creation of and demand for more risky financial instruments, and betting that they will fail/ go down in value (shorting)! Here, hedging became baiting!