Lesson 1 of 7 · 11 min
Equity versus debt, why companies issue shares, and equity in global markets
Equity is a residual ownership claim with no promised payments, which is why it carries more risk than debt, has historically earned more, and gives companies flexible capital to grow.
In short
- Debt is a liability with contractual interest and principal; equity is not a liability and promises nothing. Shareholders hold the residual claim on assets after all liabilities are paid.
- Equity investors seek total return (price appreciation plus dividends); bond investors holding to maturity seek interest income.
- Companies issue equity in the primary market to raise capital and gain liquidity, which also gives them a 'currency' for acquisitions and stock-option pay.
- Capital is mostly used for long-lived assets, expansion, R&D, new products or regions and acquisitions; sometimes it is raised just to stay a going concern (regulatory capital, debt covenants).
- Over more than a century, equities earned clearly higher real returns than government bonds and bills, which roughly kept pace with inflation; the higher return compensates for higher risk and volatility.
- The ratio of equity market capitalisation to GDP is a rough gauge of whether a market looks under- or overvalued relative to its own history.
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