Stocks vs Bonds

Stocks vs Bonds

Bonds vs Stocks

- Two ways for a company to raise capital: debt (borrowing money) and equities (shares). Both of these are translate to financial securities: tradable financial assets.

- Securities in the equity world are stocks whereas security in the debt world are bonds.

- In order to increase equity, the main way to raise equity is to sell stock but for debt there are multiple source to whom a company could owe debt.

Stock market

- Stock market is a place where people buy/sell shares of publicly listed companies. It offers a platform for exchange of shares.

- Examples of Stock Exchanges are NASDAQ, London Stock Exchange and the New York Stock Exchange

What it means to buy company’s stock:

- Companies decide to sell shares (units of equity ownership) on the stock markets (the place where shares are bought) in order to gain access to funds and capital from investors as a way to expand their business

- When you put in money to buy shares into a company you’re essentially becoming a partial owner of the company. Hence positive and negative growth of a company impacts you as a shareholder. If the company grows, you receive dividends (money given to shareholders)

- A company often decides how many shares to put on the stock market.

Example:

- Suppose a company’s assets (any item of value owned by a company) equates to $500m

- However it has liabilities (anything that your company owes – sacrificing its economic benefit) equating to £480m.

- Therefore the owners keep the £20m: this is referred to as the equity (assets – liabilities = equities).

- Suppose this company has 2 million shares. Since we have £20 million in equity, we therefore get each share to be worth £10.

- So we can get the equation share price = equity/number of available shares.

- A key term that will be useful is market cap: it’s the market value of shares (it differs from what the company says it is).

Bonds

- However, one of the main sources of debt is to the general public i.e. bonds. Bonds are investments from the general public into the company.

- Bonds are essentially loans where the general public acts as the bank.

Example:

- Suppose a company has £4 million debt divided into 1000 certificates. Each bond certificate is worth $4000 dollars (its face value).

- Therefore what this is saying is that the company owes each of the owners £4000 for each certificate they own. The public infact don’t have to pay £4000, they could, for instance, only pay £3000.

- However, the nature of these bonds means that not only will the company grow benefitting the business/firm but the general public will receive profit.

HOWEVER THERE ARE INFACT ZERO COUPON BONDS – BONDS WITH 0 interest. It may seem counter-intuitive, however, these bonds are often sold at extremely low prices so the consumer can get money without worrying about market failure etc. However an obvious disadvantage, is that whilst normal bonds provide interest allowing for a continuous flow of income, the zero coupon bonds don’t so its only good in the long run but receives higher income.

- In simple terms, the difference between the two bonds above are that zero coupon bonds are generally more risky and you only receive your money ‘after maturity (an agreed date)’. Whereas with normal ones, you receive generally less money compared to if you chose a zero coupon bond and this smaller sum of money is also split into interest periods..

Summary of differences between bonds and stocks

Bonds

1. Issues of debt

2. Guaranteed return

3. Lower risk, lower reward

4. Returns in the form of interest

Stocks

1. Issues of a stake of ownership in a company

2. Not guaranteed return; dependent on how company does

3. Higher risk, higher reward

4. Returns in the form of interest