CLASS 2 - Main Trading Instruments in the Stock Market: What Are They and How Do They Work?

 

CLASS 2 - Main Trading Instruments in the Stock Market: What Are They and How Do They Work?

In the stock market, people buy and sell financial instruments — essentially, pieces of economic value. This isn't a completely “free” market in the wild sense. Instead, it’s governed by clear regulations designed to protect investors and ensure fair play.

In Italy, this oversight is managed by CONSOB (the National Commission for Companies and the Stock Exchange), which enforces rules and ensures transparency in market operations.

Only approved and standardized instruments can be traded. That means every contract or financial product must follow specific legal formats. The most important of these instruments are financial contracts that define the relationship between buyers and sellers.

The Most Common Instrument: Stocks

The best-known financial instrument is undoubtedly the stock (also called a share).
A stock represents a small ownership stake in a company. When you buy a stock, it’s like buying a tiny piece of that business.

Example: Imagine a cake (the company) cut into 1,000 slices. If you buy 10 slices, you own 1% of the cake. That’s how stocks work: you become a shareholder, a co-owner of the business.

How Stocks Are Issued and Transformed

Companies can adjust the number of stocks on the market in several ways:

• Stock split: The company increases the number of shares by dividing existing ones (e.g., 1 becomes 2). This makes shares more affordable without changing the overall value.

• Reverse split: The opposite of a stock split. Several shares are combined into one (e.g., 10 become 1), often to increase the stock price.

• Buyback: The company buys back its own shares from the market, reducing the number in circulation. This can increase the value of remaining shares.

Different Types of Shares

There are several classes of shares:

• Common shares (ordinary shares): The most widespread type. They offer voting rights and access to dividends.

• Preferred shares: Usually don’t offer voting rights but may provide more stable dividend payments.

• Savings shares: Often provide higher dividends but no voting power.

Most investors deal with common shares, which provide ownership, potential profits, and voting rights.

Rights and Responsibilities of Shareholders

Owning shares comes with several important rights:

• The right to receive dividends (a share of the company’s profits).

• The right to receive a portion of the company’s value if it is liquidated (after debts are paid).

• The right to vote in shareholders’ meetings where important decisions are made.

Shareholders are not personally liable for company debts — the risk is limited to the money they invested.

How Much Power Do You Have as a Shareholder? It Depends on How Many Shares You Own

A shareholder’s voting power and influence depend on the number of shares owned.
The more shares you hold, the greater your influence in corporate decisions.

This creates a common situation in many companies: a single majority shareholder often holds more decision-making power than hundreds of small shareholders combined.

How Corporate Governance Works: Shareholder Meetings and Power Structure

One of the most important reasons to call a shareholders' meeting is to elect the Board of Directors, the group responsible for overseeing the company's management and strategic decisions. This board can be replaced at any time if it loses the confidence of the majority of shareholders.

Board of Directors and Executive Roles

Once appointed, the Board of Directors — usually made up of senior figures — holds collective responsibility for the company’s operations and financial obligations. Among its first tasks is to appoint:

• A Chairperson, who acts as the official representative of the board in both internal and public affairs.

• A Chief Executive Officer (CEO), who is entrusted with the day-to-day management of the company.

The CEO works under the supervision and with the approval of the board. While the CEO leads the business strategy and makes executive decisions, the board retains full responsibility for the overall direction of the company.

To run the organization efficiently, the CEO may appoint a General Manager and other senior executives to oversee departments such as finance, operations, and human resources. The goal of this leadership structure is to increase revenue, improve productivity, and grow the company’s overall value.

In many cases, members of the board are also active shareholders, meaning they own shares in the company and have a vested interest in its success.

Internal Oversight: The Supervisory Body

Besides voting on leadership roles, shareholders also elect a supervisory committee (often known as an internal audit or statutory board). This group ensures that the company is managed in a transparent and lawful manner.

Importantly, it also plays a key role in protecting the rights of employees, by overseeing that management acts with integrity and within the rules. This creates a system of checks and balances at the top of the organization.

Preferred and Savings Shares: What Makes Them Special?

In addition to common shares, two other types of stock exist, each with unique characteristics:

Preferred Shares

These offer priority access to dividends and to any remaining assets if the company is liquidated. However, preferred shareholders typically don’t have voting rights in standard company decisions — they only vote on extraordinary matters.

Savings Shares

Savings shares are a specific class of stock that grants priority in dividend distribution. When a company generates profits and decides to distribute them, holders of savings shares are paid first. Only after these dividends are paid—and if any profit remains—are the common and preferred shareholders compensated.

However, savings shares typically do not come with voting rights, meaning holders cannot participate in regular shareholder meetings or corporate governance decisions. These shares are designed for investors who seek stable, recurring income rather than influence over company decisions.

It’s worth noting that today only a small number of companies issue savings shares, and this type of stock is becoming increasingly rare. In some cases, savings or preferred shares may be converted into ordinary shares, based on company policy or the owner's decision—granting full voting rights and participation.

Types of Stocks: Value, Growth, and Bet Stocks

Stocks can also be categorized based on the nature and strategy of the issuing company. Here are three widely recognized types:

Value Stocks

These are shares of companies with strong financial fundamentals and consistent profitability. They typically pay regular dividends and are often chosen by investors looking for stability and steady returns. Value stocks represent mature businesses with a proven track record.

Growth Stocks

Growth stocks belong to companies that are also financially healthy, but they choose to reinvest all profits instead of distributing dividends. Their goal is maximum long-term expansion. Because of their potential for rapid growth, these stocks often come with higher price tags. Investors buy growth stocks in the hope of capital appreciation, rather than immediate income.

Bet Stocks

“Bet stocks” refer to shares from startups or companies facing temporary financial difficulties. These stocks are typically seen as high-risk, high-reward investments. Their value can fluctuate dramatically, and while they offer the possibility of large gains, they also carry a significant chance of loss. As the name implies, they are closer to a speculation than a safe investment.

By Price: Blue Chips vs. Penny Stocks

Another useful distinction comes from the stock price:

• Blue Chip stocks are issued by large, well-established companies with a solid reputation and high market capitalization. These stocks typically trade at a high price per share, often $100 or more, and are known for their stability, consistent dividend payouts, and relatively low volatility. They’re often considered safe investments for long-term portfolios.

  On the other side of the spectrum, Penny Stocks are shares of very small or struggling companies that trade for less than $1 per share. They are highly speculative, with low liquidity and extreme price volatility. If a stock remains underpriced or inactive for too long (typically around 90 days), it can be delisted from major exchanges and moved to the Over-The-Counter (OTC) market, where trading is less regulated and riskier.

  Companies can also be delisted not only due to low share prices, but also because of insufficient trading volume. When a stock no longer attracts investor interest and remains stagnant, it risks being removed from the main exchange listings.

  ETFs – Exchange-Traded Funds: Investing Made Easy

  ETFs (Exchange-Traded Funds) are investment funds structured as publicly traded companies. They hold a basket of selected assets—such as stocks, bonds, or commodities—and divide the total value into shares that can be bought and sold on the stock market, just like regular stocks.

  Although technically a type of mutual fund, ETFs differ because they are traded throughout the day, and often pay dividends to shareholders. They provide a convenient way to diversify, offering exposure to entire markets, sectors, or strategies with a single transaction.

  The performance of an ETF depends on the overall performance of the assets it holds. For example, one of the most well-known ETFs is QQQ (or QQQQ), which tracks the NASDAQ-100, a tech-heavy index of major U.S. companies.

  Two Types of ETFs: Index and Actively Managed

  There are two main types of ETFs:

  • Index ETFs: These are passively managed and simply track the performance of a chosen market index (e.g., NASDAQ, S&P 500). They automatically mirror the movements of that index without human selection.

  • Actively Managed ETFs: These are run by portfolio managers who handpick the assets based on their strategy and market outlook. The composition of the ETF may change over time with the goal of maximizing returns.

  REITs – Real Estate Investment Trusts: Property Investing on the Stock Market

  REITs (Real Estate Investment Trusts) are publicly traded companies that invest in real estate assets. By buying shares of a REIT, investors gain exposure to rental income, property appreciation, and real estate operations without directly owning physical buildings.

  REITs are legally required to distribute a significant portion of their profits to shareholders, usually through regular dividend payments. This makes them especially attractive to those seeking passive income with a focus on the real estate sector.

  They offer a practical and liquid alternative to traditional property investment, allowing people to invest in commercial, residential, or mixed-use developments with just a few clicks.

  Bonds: Credit and Debt Securities Explained

  In the financial world, bonds represent a completely different instrument from stocks. While buying stocks makes you a part-owner of a company, buying a bond means you are lending money to that company (or a public institution). In this case, the investor becomes a creditor, and the issuer of the bond becomes a debtor, committing to repay the borrowed capital by a specific date, along with an agreed-upon interest rate.

  Not Ownership, but Lending

  Bonds are debt securities, not ownership shares. When you purchase a bond, you're not acquiring part of the company but providing external financing. In return, the company promises to pay back your investment, plus a return in the form of interest — either fixed or variable — which is defined before the contract starts.

  Interest can be paid through regular coupon payments (electronic today), or it can be paid in full at maturity.

  Bond Markets and Main Categories

  Bonds are traded on the bond market, which includes both corporate bonds (issued by companies) and government bonds (issued by public institutions).

  Here are the main types of bonds:

  • Plain vanilla bonds: standard bonds with fixed or variable coupons and repayment at maturity.

  • Convertible bonds: can be converted into company shares under certain conditions.

  • Foreign currency bonds: issued in a currency different from the investor’s own — they carry currency risk.

  • Bonds with warrants: come with a right (warrant) to buy additional securities (usually shares) at a fixed price.

  • Indexed bonds: the yield is linked to an index (e.g., inflation or Euribor).

  • Zero-coupon bonds: don’t pay periodic interest; they’re bought at a discount and repaid at face value.

  • Drop-lock bonds: variable-rate bonds that "lock in" a fixed rate if market rates fall below a set level.

  Government Bonds: Public Debt Instruments

  When a bond is issued by a government or public authority, it’s known as a government bond. These are widely used to fund public spending and are a common choice for conservative investors.

  Examples include:

  • In the U.S.:

    • Treasuries (U.S. government debt)

    • T-Bonds (long-term)

    • T-Bills (short-term)

  • In Italy:

    • BOT – short-term Treasury bills

    • BTP – long-term government bonds

    • CCT, CTZ, BTE, CTR, CTO, CTE – various formats with different terms and returns

  Some bonds were historically issued in ECU, the European Currency Unit, before the euro was introduced.

Derivatives: What They Are and How They Work

Among the most complex and advanced financial instruments are derivatives. These are financial contracts whose value is based on the price of another asset, known as the underlying. This underlying asset can be almost anything: stocks, bonds, currencies, indices, ETFs, interest rates, and more.

Derivatives are traded on specific markets — such as the derivatives market — and involve two counterparties who agree on future conditions for buying or selling the underlying asset.

Main Types of Derivatives

The most common derivative instruments traded on the market include:

• Financial Futures

• Options

• Warrants

• Covered Warrants

• Swaps

Let’s focus in particular on financial futures, widely used by traders and institutional investors.

Financial Futures: Contracts on the Future

A financial future is a standardized contract that obligates both parties to exchange a certain amount of a financial asset (stocks, indices, bonds, etc.) at a specific future date and at a predetermined price.

Because these contracts are standardized, futures can be easily traded on regulated markets before expiration and are interchangeable between investors.

One of the key features of futures is the ability to exit the position before maturity by entering an opposite contract (i.e., if you bought, you sell; if you sold, you buy). This cancels the obligation and avoids the physical or financial delivery of the underlying asset.

What Are Futures Used For?

Futures can serve two main purposes:

• Speculation: trying to profit from expected price movements in the market

• Hedging: protecting against price changes in a real asset that will be bought or sold in the future

Those who buy a future typically expect the price of the underlying to rise.
Those who sell a future usually expect the price to fall.

If the goal is purely speculative, the position should be closed before expiration.
If the goal is risk management, such as locking in a future purchase price, the contract may be held until maturity and used for the original transaction.

Guarantees and Market Safety

Because futures involve significant financial commitments, there's a Clearing and Guarantee House (often referred to as a Clearing House) that acts as an intermediary. It ensures that both parties meet their contractual obligations.

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 A Practical Example of a Financial Future

Let’s say you’re a baker, and you know you’ll need wheat in three months to make your bread.
Today, wheat costs €100 per quintal, but you’re afraid the price might go up to €120.

The solution?
You use a futures contract to lock in today’s price of €100 for delivery in three months.

What happens?

• Today (contract agreement):
  You sign a futures contract with a counterparty (a farmer or an investor), agreeing to buy 100 quintals of wheat at €100 per quintal in 3 months.

• In 3 months:

  • If wheat costs €120, you save €20 per quintal – you’re protected!

  • If wheat drops to €90, you still must pay €100, as per your contract – you missed out on saving, but that was the agreed price.

What if you’re an investor?

Now imagine you don’t actually need wheat, but you believe the price will rise.
You buy a futures contract at €100 and then sell it before expiration when the market price is €120.

You profit €20 per quintal, without ever touching the wheat.

The takeaway?

• If you produce or buy real goods, futures help protect against price risks.

• If you're an investor, futures are tools to speculate on future market movements — with potential for high profits… but also high risks.

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Currency Futures: What They Are and How They Work

Currency futures are derivative contracts very similar to financial futures, but with one key difference:

Instead of being based on stocks, bonds, or indices, these contracts involve the exchange of one currency for another.

What is a Currency Future?

A currency future is an agreement between two parties to exchange a specific amount of one currency for another at a predetermined future date, and at an exchange rate fixed on the day the contract is made.

These contracts are typically used either to hedge against currency risk or to speculate on exchange rate movements.

Key Features of Currency Futures:

• ✅ Standardized contracts with the same terms for everyone

• ✅ Traded on regulated markets (not over-the-counter)

• ✅ Frequently used by large institutions, import/export businesses, banks, and professional investors

Practical Example: A Company Importing from the U.S.

Imagine you’re the CFO of an Italian company that needs to pay $100,000 to an American supplier in three months.

The Problem:

Today, the EUR/USD exchange rate is 1.10 → You would need approximately €90,910 to buy those dollars.

But you’re worried that the dollar might strengthen in the next 3 months (e.g., the exchange rate drops to 1.00), meaning you’d have to pay €100,000 instead of €90,910.

The Solution: Use a Currency Future

To protect against this risk, you enter a currency future today that locks in the exchange rate at 1.10.

This means that in three months, you’re committed to buying $100,000 at the agreed-upon rate of 1.10, regardless of where the actual market rate is at that time.

What Happens in Three Months?

• If the exchange rate is 1.00 → You would have had to pay €100,000,
  but thanks to the future, you only pay €90,910 → ✅ You saved money.

• If the rate is 1.20 → You could’ve paid just €83,333,
  but you’re locked into €90,910 → ❌ You missed out on savings.

But this is not a loss—you accepted a fixed rate for protection, not speculation.

What if You’re a Speculator?

Now imagine you’re a trader who believes the dollar will strengthen against the euro.

You buy a dollar future today at 1.10, and a month later the rate falls to 1.05.
You sell the future and profit from the difference—without ever holding physical dollars.
The entire gain is financial, based on market movement.

Summary Table

Feature	Currency Future
Underlying	Two currencies
Purpose	Hedging or speculation
Market	Regulated (e.g., CME – Chicago Mercantile Exchange)
Exchange Rate	Fixed at the time of contract agreement
Maturity	Predefined (e.g., monthly or quarterly contracts)
Use Case	Companies locking in exchange rates for future transactions

What Are Warrants?

A warrant is a financial instrument that gives the holder the right (but not the obligation) to buy or sell a specific financial asset—usually a stock—at a fixed price, known as the strike price, before a predetermined expiration date. To get this right, you pay a small initial amount called the premium.

There are two types of warrants:

• A Call Warrant gives you the right to buy the asset at the fixed price.

• A Put Warrant gives you the right to sell the asset at the fixed price.

 How Does a Warrant Work?

Let’s look at a Call Warrant example.
Suppose you buy a call warrant on "CompanyX" stock with a strike price of €10, an expiration in 3 months, and a premium of €1.

Here are two possible outcomes:

1. If after 3 months the stock price is €15, you have the right to buy it at €10. This gives you a gain of €5, but since you paid €1 for the warrant, your net profit is €4 per share. The warrant is said to be In The Money (ITM).

2. If after 3 months the stock price is €10 or lower, you would not exercise the warrant, because buying at €10 when the market is at or below that level gives no advantage. You simply lose the €1 premium. If the stock is exactly €10, the warrant is At The Money (ATM); if the price is lower than €10, it is Out of The Money (OTM).

Now consider a Put Warrant example.
You buy a put warrant on "CompanyY" stock with a strike price of €20, an expiration in 3 months, and a premium of €1.

Two possible outcomes:

1. If the stock price drops to €15, you can sell it at €20 thanks to your warrant. That gives a gain of €5, minus the €1 premium → your net profit is €4. The warrant is ITM.

2. If the stock price rises to €22, you would not exercise the right to sell at €20. You just lose the €1 premium. The warrant is OTM.

How Are Warrants Different from Options?

Although warrants and options are similar, warrants have some limitations. For example, you cannot sell a warrant short, meaning you must own it in order to sell it. This restricts flexibility and prevents many advanced trading strategies that are possible with options. As a result, options have become more popular and widely used, while warrants are less common today.

 Quick Recap:

Type	Gives the right to...	When it’s profitable	When it’s ITM
Call Warrant	Buy at a fixed price	If the market price rises	Market price > strike price
Put Warrant	Sell at a fixed price	If the market price drops	Market price < strike price

 

 What Is a Swap?

A swap is a financial contract between two parties where they agree to exchange cash flows over a fixed period of time.

• It’s a type of derivative, meaning its value is based on something else (like interest rates or currencies).

• It is a custom agreement, usually made privately (over-the-counter, or OTC).

• It helps companies or banks manage risks, like interest rate changes or currency fluctuations.

Why Use a Swap?

Companies use swaps to protect themselves from unpredictable changes in the financial markets:

•  Interest rates can go up or down.

• Exchange rates between currencies can change.

Instead of being exposed to those risks, they use swaps to lock in certainty.

How Does a Swap Work?

In a swap contract, the two parties agree to exchange money based on different conditions.

There are two main types of swaps:

Interest Rate Swap (IRS)

This is when two parties exchange interest payments on a notional amount (they don’t exchange the capital itself).

• One pays fixed interest

• The other pays floating interest (based on a reference like Euribor or LIBOR)

Simple Example – Interest Rate Swap:

	Company A	Company B
Original Loan	Floating Rate (Euribor + 1%)	Fixed Rate (3%)
Problem	Wants a fixed cost	Wants to benefit from lower floating rates
Solution	They agree to an IRS contract

They exchange only the interest payments:

• A pays 3% fixed to B

• B pays Euribor + 1% to A

This way:

• A virtually turns its loan into a fixed-rate loan

• B gets a floating rate

Why Do It?

To stabilize costs. If interest rates rise, floating rates become expensive. So Company A protects itself by “swapping” for a fixed rate.

Currency Swap (CS)

This is when two parties in different countries swap currencies and interest payments.

Instead of exchanging money every time with a bank (and facing currency fluctuations), they agree to lend each other their own currency, and pay interest on it.

Example – Currency Swap:

Day 1 – Start of Swap
- Italian company gives €10,000 to a US company
- US company gives $11,000 to the Italian company

Over 3 years:

• Italian company pays interest in dollars to the US firm

• US company pays interest in euros to the Italian firm

At the end:

• They return the original amounts (€10,000 and $11,000)

Why Use a Currency Swap?

Because:

• Each company has better access to its own currency

• They want to avoid exchange rate risks

• They can lock in a fixed exchange rate from the start

Swap vs Forward Contract

Swaps are often confused with forward contracts, but they are different:

Feature	Swap	Forward
Type	Derivative	Derivative
Custom-made?	Yes	Yes
Where traded?	OTC (private market)	OTC or exchange
Duration	Long term, multiple cash flows	Short/medium term, single cash flow
Purpose	Manage interest/currency risk over time	Agree to future buy/sell at a fixed price

Full Recap

Type of Swap	What’s Exchanged	Goal	Who Uses It
Interest Rate Swap (IRS)	Fixed interest ↔ Floating interest	Manage interest rate risk	Companies, banks
Currency Swap (CS)	Currency + interest payments	Manage exchange rate risk	Multinationals, governments

 Key Takeaways

• Swaps are private financial contracts (OTC) between two parties.

• They involve exchanging money, usually to manage risk.

• Interest rate swaps exchange only interest payments (not capital).

• Currency swaps exchange capital and interest in different currencies.

• These tools are used mainly by large institutions, not retail investors.

• They are not traded on public exchanges, unlike futures or standard options.

What Are Options?   

Options are financial contracts, part of the category of derivatives. This means their value depends on another financial asset, called the underlying.

When you buy an option, you pay a premium (an upfront cost) to get the right, but not the obligation, to buy or sell the underlying asset at a specific price (called the strike price) before a certain date (called the expiration date).

Options are traded on regulated markets like the CBOE (Chicago Board Options Exchange), BOX, and PHLX.

Types of Options

Type	Right Given
Call	Right to buy the underlying asset
Put	Right to sell the underlying asset

These contracts are highly flexible: they can be bought, sold, and even short-sold (you can sell an option without owning it, aiming to buy it back cheaper). This allows traders to build both speculative and protective strategies.

Most Common: Stock Options

Stock Options are options where the underlying asset is a stock. They are the most widely used type of option for several reasons:

• High liquidity in the stock market (especially in the U.S.)

• Strong participation from traders and institutions

• Speculative potential through leverage: you can control large amounts of stock with a small premium

• Ease of trading (you can quickly enter and exit positions)

Other Types of Options

Underlying Asset	Option Type
Stocks	Stock Options
ETFs	Options on ETFs
Indices (e.g. S&P)	Index Options
Bonds	Bond Options
Currencies	Currency Options
Interest Rates	Interest Rate Options
Futures	Options on Futures
Forwards	Options on Forwards

When the underlying is itself a derivative (like a future or a forward), these are known as derivatives of derivatives.

How Options Are Used

Although options can be exercised (you use your right to buy/sell the asset), in most cases traders don’t exercise them. Instead, they buy and sell the options themselves to profit from price changes.

Use Case	Description
Speculation	Betting on future price movements
Hedging	Protecting a portfolio from risks
Exercise	Actually buying/selling the asset

In practice, speculation is by far the most common use.

How Are Options Valued?
To calculate the fair value of an option, we consider:

• Current price of the underlying asset

• The strike price

• Time remaining until expiration

• Volatility of the asset

• Interest rates

• Expected dividends (for stock options)

The most widely used model for valuation is the Black-Scholes Model.

The Black-Scholes Model – Explained Simply

The Black-Scholes Model, introduced in 1973 by Fischer Black and Myron Scholes, provides a formula to calculate the theoretical value of a European option (an option that can be exercised only at expiration).

It considers five variables:

Variable	Meaning
S	Current price of the underlying asset
K	Strike price
T	Time to expiration (in years)
r	Risk-free interest rate
σ	Volatility of the underlying asset

Black-Scholes Formula (for a call option):

C = S × N(d₁) – K × e^(–rT) × N(d₂)

Where:

• C = Price of the call option

• N(d₁) and N(d₂) = Values from a standard normal distribution

• e^(–rT) = Discount factor for present value

Key Insights from the Model:

The more time until expiration, the more volatile the asset, and the higher the stock price compared to the strike, the more valuable the option.

The Black-Scholes Model is not perfect, but it is a standard used globally in trading, risk management, and option pricing.

Summary

• Options are contracts that give you a right (not an obligation) to buy (Call) or sell (Put) an asset.

• You pay a premium to acquire this right.

• The most common are Stock Options, but there are also options on indices, currencies, futures, and more.

• Options are mainly used for speculation, not exercise.

• The Black-Scholes Model is the most trusted tool for calculating the theoretical value of an option using price, volatility, interest rate, and time.

Introduction to Mutual Funds

let's understand another investment tool accessible even to everyday savers: Mutual Funds, also known as UCITS (Undertakings for Collective Investment in Transferable Securities).

These are financial vehicles that allow collective investment of savings, meaning that money from multiple investors is pooled together and invested as a single portfolio.

What Are Mutual Funds?

A mutual fund is essentially a basket of financial assets (such as stocks or bonds), selected from the capital markets.
The fund collects money from many investors who delegate the management of their savings to a professional company.

This company manages the money collectively, investing it in financial instruments according to the fund’s strategy.

How Do They Work?

1. Savers invest their money in the fund.

2. The fund pools this money and invests it in various assets.

3. The fund is managed by a professional management company, called an AMC (Asset Management Company), in Italian: SGR – Società di Gestione del Risparmio.

4. The total fund is divided into units (or shares), and each investor owns a number of these units.

A unit is a small portion of the fund. Its value changes over time based on the performance of the investments.

Who Manages the Fund?

• Asset Management Companies (SGRs) are typically joint-stock companies with capital over €1 million, often part of banking or insurance groups.

• The fund and the company are legally separate entities, meaning the fund's assets are protected even if the company has financial issues.

• By law, SGRs must operate with:

  • Diligence

  • Integrity

  • Transparency

  • Minimized conflicts of interest

Investors' Rights

• All fund participants have the same rights.

• Profits and losses are distributed in proportion to the number of units held.

• The fund does not guarantee a fixed return, unless it is a specific type of guaranteed fund.

• The value of the units can rise or fall based on the performance of the fund’s assets.

Summary Table

Element	Description
What it is	A pool of money from multiple investors managed collectively
Managed by	Asset Management Companies (SGRs)
Invested in	A diversified portfolio (stocks, bonds, etc.)
What the investor gets	Units of the fund (whose value fluctuates)
Returns	Not guaranteed; depend on market performance
Investor rights	Equal for all; based on the number of units held

What Are Mutual Funds and Who Are They For?

Mutual funds are financial instruments managed by professionals (fund managers) that allow even small investors to access financial markets easily and with guidance.

When properly advised, even people with little experience can choose investments that match their risk/return profile.

Easier Access with Accumulation Plans

Thanks to Systematic Investment Plans (SIPs) — known in Italian as PAC (Piano di Accumulo del Capitale) — mutual funds have become accessible even to those who don’t have large savings up front.

Investors can make small monthly payments and gradually enter the markets, reducing the risk of bad timing on lump-sum investments.

Types of Funds Based on Investment Objective

Depending on the expected return, risk level, and financial goals, an investor can choose from various types of mutual funds:

Type of Fund	Main Features
Balanced Fund	Mix of stocks and bonds (moderate risk and return)
Bond Fund	Invests in debt securities, lower risk
Equity Fund	Invests in stocks, higher potential return but riskier
Money Market Fund	Very low risk and return, highly liquid
Flexible Fund	Fund manager freely adjusts allocation based on the market

Legal Registration Required

Every mutual fund must be officially registered in the financial intermediaries registry maintained by the financial market regulator (in Italy, Consob).
This ensures control, transparency, and investor protection.

Profit Distribution: Two Options

Funds can manage the profits (capital gains) in two different ways:

1. Income-Distributing Funds

• Profits are distributed to investors through coupons (monthly, semi-annual, or annual).

• Part or all of the profits are credited directly to the investor’s bank account.

2. Accumulation Funds

• Profits are retained inside the fund, increasing the value of each share.

• The investor only receives the gains when selling their shares.

Closed-End vs Open-End Funds

Closed-End Funds

• Limited access: Often restricted to a specific category of investors.

• Share redemption is allowed only on specific dates.

• The number of shares is fixed and usually high in value.

• Often involves higher risk investments.

Open-End Funds

• Available to everyone.

• The number of shares can change daily, depending on new subscriptions or redemptions.

• It is the most common type of mutual fund, offering flexibility and ease of access.

Final Distinction: SIP (PAC) vs Lump-Sum (PIC)

Type	Name	Features
SIP (Systematic Investment Plan / PAC)	Invest through periodic contributions (e.g. €100/month).	Lowers market timing risk. Suitable for long-term, gradual investing.
Lump-Sum Investment / PIC	Invest the full amount at once (e.g. €10,000 upfront).	Higher potential return if market timing is good. More capital needed immediately.

Mutual funds are extremely useful tools that allow people to invest with small amounts of money, taking advantage of professional management.

They are regulated, diversified, and accessible, and let investors choose according to their risk profile, goals, and financial resources.

What Is an Index Fund?

An Index Fund is a type of mutual fund that does not try to beat the market, but simply copies it.

What does “copy the market” mean?

It means the fund is built to replicate the performance of a specific market index — which is a list of companies (stocks or bonds) representing a segment of the market.

Instead of trying to pick winning stocks, the fund buys all the securities in the index, in the same proportions, to match its performance.

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Real Example – S&P 500 Index Fund

Imagine an Index Fund that tracks the S&P 500, an index representing the 500 largest companies in the U.S. (such as Apple, Microsoft, Amazon).

The Index Fund will buy those same 500 companies (or a very similar selection), in the same proportions.

For example:

• If Apple makes up 6% of the S&P 500, the fund will invest 6% of its assets in Apple.

• If Microsoft is 5%, it will do the same.

So, if the S&P 500 gains 10% in a year, the fund will gain around 10% as well (minus small management fees).

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Index Funds vs. Actively Managed Mutual Funds

Feature	Active Fund	Index Fund (Passive)
Goal	Beat the market	Match the market
Management Style	Active: fund managers pick stocks	Passive: fund replicates index
Management Fees	High (0.8%–2% per year)	Low (0.05%–0.3% per year)
Transparency	Medium: strategy not always clear	High: follows a public index
Trading Activity	Frequent (managers make moves)	Minimal (only when index changes)
Risk of Human Error	High	Low

Why Index Funds Are Great for Beginner Investors

Index Funds are popular with people who:

• Do not have technical investing skills

• Want low fees

• Prefer automatic, hands-off investing

• Have a long-term investment goal

Practical Comparison

Imagine two investors, Giulia and Marco, each investing €10,000 for 10 years.

Investor	Type of Fund	Average Return	Annual Fees	Capital After 10 Years
Giulia	Active Fund (managed)	6%	1.5%	~€16,200
Marco	S&P 500 Index Fund	6%	0.2%	~€17,800

Even with the same gross return, Marco ends up with more money because his fees are much lower.

How Does an Index Get Copied?

There are two methods:

1. Full (physical) replication:
   The fund buys all the securities in the index, in the same proportions.

2. Optimized replication:
   The fund buys only a selection of the index's securities that together imitate the index closely, reducing transaction costs.

Is it managed by an institution?

Yes — although Index Funds are “passive,” they are still managed by a professional fund management company.

• These companies can be large firms like Vanguard, BlackRock (iShares), or local banks and brokers.

• The individual investor does not manage the stocks directly.

• The manager’s role is to track the index accurately, keep costs low, and rebalance the portfolio when the index changes.

Therefore, a normal person can invest in an Index Fund easily, but they do not manage it themselves. They invest through:

• A bank

• An online broker/platform

• A financial advisor

Summary

• Index Funds replicate the performance of a market index (like the S&P 500).

• They are cheaper, simpler, and more transparent than active mutual funds.

• Ideal for long-term, low-maintenance investing.

• Managed by professionals, but accessible to anyone.

Hedge Funds: What They Are and How They Differ from Mutual Funds and Index Funds

After understanding what traditional mutual funds and Index Funds are, it’s useful to learn about another category of investment funds: Hedge Funds.

Hedge Funds are similar in structure to mutual funds because they pool capital from multiple investors to invest collectively, but they differ significantly in their management strategy and the range of tools and techniques available to managers.

Main differences between Hedge Funds and traditional mutual funds:

1. Entry restrictions:

   • Hedge Funds are generally reserved for institutional investors, qualified investors, or wealthy individuals.

   • For example, the minimum investment used to be around 1 million euros but has since been lowered to approximately 500,000 euros.

   • Additionally, there is often a maximum number of investors allowed (e.g., in Italy, about 200 per fund).
     This makes Hedge Funds largely inaccessible to the average investor, unlike mutual funds or Index Funds, which anyone can subscribe to.

2. Exit restrictions:

   • Hedge Funds use specific management techniques that require the capital to remain stable for certain periods.

   • Therefore, they often impose lock-up periods where investors cannot withdraw their money for one year or more.

   • Also, Hedge Funds typically value their shares only monthly, resulting in less liquidity compared to mutual funds or Index Funds, which usually allow daily redemption.

3. Investment strategies:
   Hedge Funds are characterized by greater freedom in choosing instruments and strategies. Common techniques include:

   • Leverage: investing amounts larger than the actual capital available by using debt or derivatives, which can amplify both gains and losses.

   • Arbitrage: simultaneously buying and selling related securities to profit from price differences.

   • Short selling: selling securities that the fund does not own, betting that their price will fall, so they can be repurchased later at a lower price to realize a profit. This can also be used as a hedge against market declines.

Why are Hedge Funds different from Index Funds?

• Objective: while Index Funds aim to simply replicate the performance of a market index (passive management with low costs), Hedge Funds seek to outperform the market using active, often complex and risky strategies.

• Accessibility: Hedge Funds are for sophisticated investors with high capital, whereas Index Funds are suitable for everyone, including small investors.

• Liquidity: Hedge Funds may lock up capital for extended periods, whereas Index Funds tend to be much more liquid.

Summary

Hedge Funds are exclusive, complex, and riskier investment funds that use advanced strategies to try to achieve higher returns than traditional or indexed funds. They are managed by professionals but require high minimum investments and often impose capital lock-up periods, making them suitable only for experienced or institutional investors.

What is a Fund of Funds?

A Fund of Funds (FoF) is a type of mutual fund that doesn’t invest directly in stocks or bonds, but instead invests in other mutual funds.

How does it work?

Imagine you want to invest, but you’re not sure which assets to choose, or you don’t want to take too much risk by investing in just one fund.

• The fund manager of a Fund of Funds is a financial expert or team who selects a mix of different mutual funds to include in the fund’s portfolio.

• They usually choose around 25–30 different funds, which helps diversify the risk. So, if one fund performs poorly, others may perform well and balance things out.

• These selected funds can be of many types: equity funds, bond funds, real estate funds, and even hedge funds (which are normally hard to access for small investors).

Real-life example

Let’s say you invest in a Fund of Funds. Here’s how it might be structured:

• 30% in a US equity fund,

• 20% in a European bond fund,

• 15% in a real estate fund,

• 10% in a hedge fund,

• 25% in various other funds.

You only see one investment in your account, but under the surface, your money is spread across all these different funds.

What does the fund manager do?

• They analyze and select other funds based on performance, risk, costs, and market conditions.

• They decide how much to allocate to each fund to balance growth potential with risk.

• They monitor performance regularly and can reallocate funds if needed, to adapt to market changes.

What do you see as an investor?

When you invest in a Fund of Funds, you just see one product in your portfolio. Its value goes up or down depending on how the underlying funds are performing.

Other fund types: SICAV and Real Estate Funds

• SICAV (Investment Company with Variable Capital)
  A SICAV is like a mutual fund, but with one key difference: when you invest in a SICAV, you become a shareholder of the company that directly manages the money.

  • Example: if you invest in a SICAV that focuses on tech stocks, you are a shareholder of the SICAV company, and its value depends on those tech stock investments.

• Real Estate Funds
  These funds invest in property assets like offices, shopping centers, or residential buildings.

  • Open-ended real estate funds: you can buy or sell shares at almost any time.

  • Closed-end real estate funds: only allow entry and exit at certain times, with a fixed number of shares.

  • Example: a closed-end real estate fund might purchase a shopping mall and distribute rental income to investors.

How is a fund evaluated?

A fund is measured against a benchmark, which is a market index (like the S&P 500 or FTSE MIB) representing the market the fund is investing in.

• If the fund outperforms the benchmark, it means the fund has done better than the market.

• If it underperforms, it means it has done worse.

Why choose mutual funds?

• Because they let you invest with small amounts of money and rely on professionals.

• Because they help you diversify your portfolio, lowering your risk.

• Because they are suitable for long-term goals, like retirement or saving for a house.

Today, mutual funds are very important for society:

They are often the only accessible tools for small investors to build additional retirement savings (like pension funds or severance pay investments) or healthcare savings (like medical support funds), especially when public systems aren’t enough.

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