Difference between Bonds and Stocks
If you are at all interested in making some type of investment in the finance market, it is essential to know the differences between bonds and stocks. This will allow you to make the proper decision with regard to making a sound investment. Let's take a look the key aspects of both.
Definition
Investing in bonds is essentially the process of loaning money to a specific organization that you wish. This may be a company or a government or some type of business organization. In return for your investment, you will receive a receipt and a promise of interest that typically comes in the form of a bond.
In addition to being a certificate of interest, bonds are also traded freely in the open market. Their value may actually fluctuate depending on the prevailing interest rates. What this means is that the value of your investment is directly affected by the interest rate.
Stocks actually represent shares of a specific company. What they actually signify is that you are in essence a part owner of the company or a shareholder. Your stake in the particular company is determined by how many shares you own.
Arrangement
Bonds may represent loans made by investors to companies and other organizations. These organizations typically sell off shares as a means to raise capital without having to give up control of the company. What bonds represent in essence is an IOU or a promise to repay at a later date.
It is important to keep in mind that bondholders do not actually share in the profits of a company. Instead, they get a return on their investment that is pegged at a predetermined rate. This is typically referred to as the "coupon rate", and is basically a percentage of the original price of the bond.
The purchase of a stock on the other hand essentially signifies partly buying into a corporation. What this means is that the value of stock will reflect the financial upturns and downturns of the company. People who invest in stocks generally expect a high rate of return.
Risks And Returns
What stocks have going for them is an unlimited potential to appreciate. There is basically no limit to how valuable stocks can become. Bonds on the other hand are subject to an upper limit, particularly in cases wherein they are held to maturity. And while bonds can be sold at good prices before they reach maturity, the potential for appreciation does not come close to what stocks may have to offer.
Both stocks and bonds entail certain risks as well, with stocks having the disadvantage of a possibility of dropping in value and becoming worthless. Bonds on the other hand carry the risk of interest rates, inflation and credit risk. If a company fails, a bond holder would be paid back before any other creditor.
Similarities and Differences
Bonds
- Essentially the process of loaning money to a specific organization
- Traded freely in the open market
Stocks
- Represent shares of a specific company
- Signify that you are in essence a part owner of the company or a shareholder
