Chapter 1, Problem 1PS

Summary Introduction

To determine:

The difference between fixed-income security and equity

Introduction:

Investment − investing your money in some securities with an objective of earning something in future.

Security markets - There are mediums (security markets) through which investors could deploy their surplus funds in the instruments of investment. Equity and fixed income securities are two broad types of securities.

Answer to Problem 1PS

Equity generally is a low priority claim while the debt security or the fixed-income security is a high priority claim.

Explanation of Solution

There are two broad categories of securities − fixed-income securities and equity.

Equity generally involves long term investment which is growth oriented but is risky as the investor does not have any assurance of return. The investment value varies depending on the performance of the business. In a corporation, equity represents an ownership share. It is a low priority claim. The life of equity is generally indefinite.

Fixed-income securities are also known as debt securities. These generally involve short term investments. These investments are income oriented investments and these are steady as the investor gets a steady rate of return when the business generates profits. Debt does not represent any ownership interest. This has a higher priority claim. Its life is limited. There is a specified cash flow which happens over a certain specified period of time after which the claim ends.

While equity symbolizes ownership interests, debts are more financial, investment earnings. Debt involves less risk when compared to equity. The potential returns are less in debt securities when compared to the equity investments. Lot of research and follow-up is necessary for success with equity investments when compared to investments in debt securities.