ECON 111c, Project 1 – Investment Assets Chart
Source: Investment Assets Chart handout
Tags: investment assets, stocks, bonds, mutual funds, money market, corporate bonds, junk bonds, municipal bonds, treasury bonds, ECON 111c, intro microeconomics, University of Texas at Austin
Difficulty: Introductory
Prerequisites: Basic understanding of what a financial market is and familiarity with the idea of risk vs. return.
This topic sits at the heart of introductory microeconomics: understanding the different vehicles available for investing money. Before you can analyse markets, you need to know what is actually traded in them. This material covers equities (stocks), pooled investment vehicles (mutual funds, money market funds), and fixed-income securities (bonds of various kinds). If you can distinguish these instruments and articulate their trade-offs, you have the vocabulary for every portfolio and market-structure question that follows in the course.
Investment assets fall into three broad families: equity (ownership stakes in companies), pooled funds (professionally managed baskets of securities), and debt (loans you make to companies or governments in exchange for interest). Each comes with a different mix of risk, return, liquidity, and tax treatment. Choosing among them is fundamentally about matching your goals and risk tolerance to the right instrument.
Common stock
A security representing an ownership share in a corporation. Common stockholders are last in line for assets if the company liquidates, but they benefit most when the company grows.
Think of it as: you own a small slice of the whole company, with all the upside and all the risk that comes with it.
Preferred stock
A class of ownership in a corporation that carries a higher claim on assets and earnings than common stock, typically paying a fixed dividend.
In simple terms, this means you get paid before common shareholders and receive a steady dividend, but you usually give up voting rights and some growth potential.
Mutual fund
A professionally managed pool of money collected from many investors, used to buy a diversified portfolio of securities.
Think of it as: hiring a money manager to pick investments on your behalf. Your returns depend heavily on that manager's skill and judgement.
Money market mutual fund
A type of mutual fund that invests in short-term, low-risk debt securities such as US Treasury bills and commercial paper.
In simple terms, this means a very safe, very liquid place to park cash, though the returns are modest and fees can eat into them.
Corporate bond
A debt instrument issued by a corporation to raise capital. The company borrows money from bondholders and promises to repay principal plus interest.
Think of it as: lending money to a company. Some corporate bonds can convert into stock (convertible bonds), which is a nice upside, but they can be harder to sell than government bonds.
Junk bond (high-yield bond)
A bond rated below investment grade, issued by companies that carry a higher risk of default. The higher interest rate compensates for that risk.
In simple terms, this means the company is riskier, so it has to pay you more to borrow your money. High reward, high chance of losing your investment.
Municipal bond
A debt security issued by a state, city, or local government entity to finance public projects such as roads, schools, or infrastructure.
Think of it as: lending money to your local government. The major draw is that interest income is often exempt from federal (and sometimes state) income tax, but you face interest-rate risk.
US Treasury notes and bonds
Debt securities issued by the US federal government, sold at a discount to face value. Investors receive the full face amount at maturity.
In simple terms, this means lending money to the US government, the safest borrower there is. You can buy directly from the Treasury, but because the risk is so low, the yield is low too.
Common stock gives you ownership, voting rights, and the highest long-run return potential, but you are last in line if the company fails.
Preferred stock sits between bonds and common stock. You get a fixed dividend (like a bond) plus some potential for price appreciation (like a stock).
Preferred shareholders have a higher claim on assets and earnings than common shareholders, but typically cannot vote.
In a liquidation scenario, the order of payment is: bondholders first, then preferred shareholders, then common shareholders.
A mutual fund pools money from many investors and hires a professional manager to invest it across a diversified portfolio.
The key advantage is diversification: your money is spread across many securities, reducing the impact of any single one performing badly.
The key disadvantage is dependency: your return depends heavily on the manager's skill and judgement. A poor manager can underperform a simple index.
Mutual funds charge management fees, which reduce your net return.
These invest in very short-term, very safe debt: Treasury bills, certificates of deposit, commercial paper.
The main advantage is liquidity: you can get your money out quickly, and the value stays very stable.
The main disadvantage is cost: expense ratios can eat into what are already modest returns.
Often used as a parking spot for cash you may need soon rather than a long-term growth vehicle.
Issued by companies to raise capital for operations, expansion, or refinancing.
You lend money to the corporation; in return, you receive periodic interest payments and get your principal back at maturity.
Some corporate bonds are convertible, meaning they can be exchanged for shares of the company's stock. This gives bondholders equity upside while still collecting interest.
A downside is lower liquidity compared to government bonds: corporate bonds can be harder to sell on the secondary market.
Issued by companies with lower credit ratings, often those trying to raise capital quickly.
The yield is higher to compensate investors for the elevated default risk.
Can boost overall portfolio returns, but a default means you may lose part or all of your investment.
The trade-off is stark: higher income now in exchange for a real chance the issuer cannot repay.
Issued by state, city, or local government entities to fund public projects (roads, schools, water systems).
The headline advantage is a federal tax exemption on interest income. Depending on your state, state and local taxes may also be exempt.
The main risk is interest-rate risk: if rates rise, the market value of your existing bond falls.
Generally considered safer than corporate bonds but riskier than US Treasuries.
Issued by the federal government; considered the safest fixed-income investment available.
Sold at a discount to face value. At maturity, you receive the full face amount.
You can purchase directly from the US Treasury (via TreasuryDirect), cutting out broker fees.
The trade-off is yield: because the risk is essentially zero, the return is lower than corporate or municipal bonds.
No complex formulas in this unit, but keep these relationships in mind:
Risk and return move together: higher potential return = higher risk of loss.
Liquidity and return tend to move inversely: the easier it is to sell, the lower the yield (Treasury bills vs. corporate bonds).
Tax treatment can change the effective return: a municipal bond yielding 3% tax-free may beat a corporate bond yielding 4% before tax, depending on your bracket.
When you hear that a company "issued bonds" to fund a new factory, that is a corporate bond offering. When your city raises money for a new bridge, it issues municipal bonds. Your employer's retirement plan likely holds a mix of mutual funds, and the cash-sweep option in most brokerage accounts is a money market fund.
Understanding these distinctions matters because every financial decision you make, from opening a retirement account to evaluating a company's balance sheet, involves knowing which instruments are in play and what trade-offs they carry.
Students often think preferred stock is "better" than common stock because of the word "preferred." It is not better overall; it is safer (fixed dividends, higher claim in liquidation) but offers less growth potential and usually no voting rights.
Students frequently confuse bonds with stocks. A bond is a loan you make to an issuer. A stock is an ownership stake. Bondholders are creditors; stockholders are owners.
"Junk bond" sounds worthless, but these bonds are actively traded and widely held. The name refers to credit quality, not to value. Many institutional portfolios include them deliberately for the higher yield.
Municipal bonds are not risk-free. They are exempt from certain taxes, but they still carry interest-rate risk and, in rare cases, default risk.
⚠️ Know the hierarchy of claims in liquidation: bondholders > preferred shareholders > common shareholders. This is a classic exam question.
⚠️ Be able to distinguish equity instruments (common stock, preferred stock) from debt instruments (all bond types). If the question says "ownership," think stock. If it says "lending" or "fixed interest," think bond.
⚠️ Understand the risk-return trade-off across all asset types. Expect a question asking you to rank assets from safest to riskiest, or from lowest yield to highest yield.
⚠️ Municipal bond tax advantages are frequently tested. Know that federal tax exemption is the main draw.
⚠️ The difference between a mutual fund and a money market mutual fund is a common mix-up on exams. One is broad and diversified; the other is narrow, short-term, and very safe.
True or false: Preferred stockholders typically have voting rights in corporate elections.
Answer: False. Preferred stockholders usually give up voting rights in exchange for fixed dividends and a higher claim on assets.
Fill in the blank: A bond rated below investment grade is commonly called a ______ bond.
Answer: Junk bond (or high-yield bond).
True or false: Municipal bond interest is generally exempt from federal income tax.
Answer: True.
Fill in the blank: The main advantage of a money market mutual fund is ______.
Answer: Liquidity (the ability to access your money quickly with minimal risk of loss).
True or false: Common stockholders are paid before bondholders if a company goes bankrupt.
Answer: False. Bondholders are paid first, then preferred stockholders, then common stockholders.
Q: An investor wants steady income with less risk than common stock but more growth potential than a bond. Which asset class best fits?
A: Preferred stock. It pays fixed dividends (income) and has a higher claim than common stock (lower risk), while still offering some potential for price appreciation.
Q: Why might an investor accept a lower yield on a municipal bond compared to a corporate bond of similar maturity?
A: Because municipal bond interest is typically exempt from federal income tax. The after-tax return on the municipal bond may actually be higher, depending on the investor's tax bracket.
Q: What is the primary risk of investing in junk bonds?
A: Default risk. The issuing company has a lower credit rating, which means there is a meaningfully higher chance it will fail to make interest payments or repay principal.
Q: Explain one advantage and one disadvantage of investing through a mutual fund rather than buying individual stocks.
A: Advantage: diversification, because your money is spread across many securities, reducing the impact of any single stock's poor performance. Disadvantage: you are dependent on the fund manager's skill, and you pay management fees regardless of performance.
Q: A friend says US Treasury bonds are "sold at a discount." What does that mean?
A: You buy the bond for less than its face value. When the bond matures, you receive the full face value. The difference between what you paid and what you receive is your return.
This material connects directly to supply and demand: the price of any security is set by how many people want to buy it versus how many want to sell. It also ties into the concept of opportunity cost, since choosing one investment means forgoing the returns of another. Later in the course, when you study market structures and firm behaviour, understanding how companies raise capital (equity vs. debt) will be essential context.
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