Welcome to the world of advanced securities! Beyond basic stocks and bonds, there are hybrid and derivative securities that combine features or derive value from other assets.
Think of them as the "combination meals" and "gift cards" of the securities world!
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What do you think a "hybrid" security might combine?
Hybrid securities blend characteristics of both debt and equity. The most common example is a convertible bond.
A convertible bond starts as a regular bond paying interest, but gives you the option to convert it into company stock later.
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When might you want to convert a bond into stock?
Derivative securities are different - they don't represent direct ownership or lending. Instead, their value "derives" from underlying assets like stocks, bonds, or commodities.
Think of derivatives as contracts based on something else's performance.
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Can you think of any everyday contracts that depend on something else's value?
Stock options are popular derivatives. A call option gives you the right (but not obligation) to buy a stock at a specific price within a certain time period.
If the stock price rises above your option price, you can profit without owning the actual stock!
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Why might someone buy an option instead of the stock itself?
Futures contracts are another derivative type. They're agreements to buy or sell something at a predetermined price on a future date.
Farmers often use futures to lock in crop prices months before harvest, reducing their risk from price swings.
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How do futures help both buyers and sellers manage risk?
