What are shares?
Shares also known as equities are a type of financial security that represents ownership interest in a company.
Why do people buy shares?
Investors buy shares for various reasons; such as
i) Capital appreciation, which occurs when a share rises in price;
ii) Dividend income, which come when the company distributes some of its profits to shareholders
Why do companies issue shares?
Companies issue shares to get money for various needs, which may include:
i) Introducing new products;
ii) Expanding into new markets;
ii) Improving business infrastructure or building new ones;
iv) And many other reasons that may improve the profitability of the company.
What kinds of shares are there?
There are two main kinds of shares:
These are the most common class of shares representing the shareholder’s proportional ownership interest in a company. These shares do not have preferential rights, as is the case with preference shares.
These are shares of a company that entitle the holder to a fixed dividend amount to be paid by the company. This dividend must be paid before the company can issue any dividends to its ordinary shareholders. Also, if the company is dissolved, the owners of preference shares are paid first before the ordinary shareholders. However, preference shareholders have no voting rights over the affairs of the company, as do the ordinary shareholders.
What are the benefits and risks of investing in shares?
Shares offer investors the greatest growth potential in the form of capital appreciation over medium to long term, while investors may get dividends during the period of investing. Investors willing to keep their monies invested in shares for a long time are generally rewarded with strong, positive returns. But shares are subject to bi-directional price movement. Therefore investing in shares does not offer any guarantee whatsoever that the company’s shares will grow and do well, so there is possibility of losing money in shares too.
If a company is in financial difficulties for instance or files for bankruptcy, ordinary shareholders are the last in order to be paid from the proceeds of the sold assets. The company’s creditors will be paid first, then holders of preference shares and lastly the ordinary shareholders. But, more importantly share prices perform depending on the future prospects of a company. If you as an investor have to sell shares on a day when the price is below the price you paid for the shares, you will lose money on the transaction.
Share price movements in the market can be discomforting to some investors but exciting to others. A share’s price can be affected by internal factors in the company, such as a defective product, or by events the company beyond the control of the company, such as changes in weather or market events. The risks inherent for holding shares can be offset in part by investing in a number of different shares or investing in other kinds of assets that are not shares, such as bonds.
What are bonds?
A bond is a debt security in which an investor lends money to a company or government which borrows the funds for a defined period of time and set interest rate. A bond is used by companies, municipalities or local government authorities, governments to raise money and finance a variety of economic projects and activities.
When you buy a bond, you are lending money to the issuer, which may be a government, municipality/local authority, or a company. In return, the issuer promises to pay you a specified rate of interest periodically during the life of the bond and to repay the principal or face value or par value of the bond, when it matures. During the life of the bond, the price will change just like share price based on market and other conditions relating to the issuer. Some listed bonds also trade on a daily basis during their lifetime.
Why do people buy bonds?
While bonds traditionally earn lower returns than shares due to their relatively lower risk, they offer great investment opportunity that can meet different investors’ needs. The most common reasons why investors buy bonds are:
1. Consistent Income -
Unlike dividend income from investing in shares which is paid only when the company is doing well financially and at the discretion of the management, coupon (or interest) payments are consistently distributed at regular intervals, usually every six months, although there are some bonds which pay interest once on maturity. Individuals seeking this periodic and consistent income might find bonds a better alternative investment than the dividend payments some stocks offer.
2. Stability -
If bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing. It is prudent to invest in an instrument that matches your objectives for making such an investment, for instance, if you need to receive almost guaranteed cash during the investment, then bonds will be an ideal investment.
Why are bonds issued?
Companies, governments and municipalities issue bonds to raise money for various needs, which may include:
i) Financing debt
ii) Funding expansion of business operations
ii) Funding capital investments in schools, highways, hospitals, and other projects
What are the risks of investing in bonds?
As with any investment, investing in bonds carries some risks. These include:
1. Credit risk:
Credit risk is the main risk faced by the investor when investing in bonds. Since a bond is a loan to an organisation and its performance depends on the organisation’s financial capacity to pay it back, some organizations that issue bonds occasionally default on their obligations. The issuer may fail to make timely interest or principal payments and hence default on its obligations.
2. Interest rate risk:
Interest rates and Bond prices are inversely related. This means if interest rates increase, the price of the bond will fall. The interest rate on a bond is set at the time it is issued. Generally, the coupon rate will reflect the interest rate levels at the time of issuance. However, if interest rates increase, investors will be unwilling to buy the bonds in the secondary market that were issued at lower rates. Therefore; interest rate changes can affect a bond’s value.
3. Inflation risk:
Inflation is a general upward movement in price levels. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. Inflation-linked bonds reduce this risk since these payments are adjusted based on inflation rate; hence, offering investors a protection against inflation.
4. Liquidity risk:
This refers to the risk that it may be difficult for investors to sell their bonds whenever they wish to do so, potentially preventing them from buying or selling when they want.
What types of bonds are there?
There are three main types of bonds:
1. Government bonds:are issued by the Ministry of Finance through the Central Bank on behalf of the Government of Lesotho. They are normally regarded as risk free instruments, making them a safe and popular for investment;
2. Corporate bonds: are debt securities issued by private and public corporations;
3. Municipal bonds: are debt securities issued by municipals and other local government authorities to fund their projects. For investors interested in these bonds, it is important to understand the extent of government support to the municipal issuing these bonds.