Stocks and Bonds are financial instruments available to an investor to invest his money in a particular type of business. Once a start-up business manages to attain a sustainable and a substantial size in the market, it looks at securing funds for further expansion of the business by means of issuing either of these two instrumentsâ€¦i.e. Stocks or Bonds.
Both Stocks and Bonds are issued or purchases with different intents. A stock gives share in the ownership of the business. As an owner a stock holder enjoys certain privileges that are available to an owner like voting authority/rights in business impacting decisions. Predominantly, a stock holder enjoys a share in profits of the business as well. These profits are distributed in the form of dividends.
In a manner similar to issuing stocks a company or business might decide to raise funds by the means of issuing Bonds. An owner of a bond becomes the lender to the company, which the company or business borrows to expand the business further. The borrower promises to pay back the principle amount as well as the accrued interests on the principle amount. Thus a purchaser of a bonds is one who buys a little bit of the debt of the company.
But a bond holder enjoys certain privileges over a stock holder in the following ways:
In the event a company or business gets liquidated and fails to remain afloat, a Bond holder gets priority in the repayment of debt, dependent upon the set and agreed terms and conditions. In such a case, the stock holder has the last claims on the remaining or residual assets.
A business may choose to declare dividends in case it makes profits in any particular fiscal, it may choose not to do so as well despite making profits. But a business or a company is obligated to make periodic interest payments to bond holders as per agreements. Thus, the investor is assured in getting fixed returns on his investment.
However, a voting right only exists with the stock holder. Bond holders do not enjoy voting rights.
At any given point in time a Bond holder has an option to convert his Bonds into stocks of the company if he chooses to do so. This conversion of Bonds to Stocks takes place at certain pre-determined ratios of stocks to bonds. This predominantly happens when a company or business turns profitable and the value of the Stocks of that particular company rises. The investor then, reaps immediate capital gains by converting his Bonds to Stocks. Along with Capital gains the Bond holder also gets right to vote.
Once made public, the shareholders can trade their stocks in the market place, at prices determined by the market. These prices generally indicate the worth of the company through the investor’s point of view.
Bonds too can be traded publicly similar to stocks, though deciding the price at which to sell a bond can be slightly tricky. Multiple factors, like the fluctuation in the interest rate, company’s credit rating etc. can be certain factors.
While Stocks are issued by Corporations, Bonds can be issued either by a corporation or a government entity.
Stocks, as an investment tool is considered to be riskier than bonds for primarily two reasons. One being the fact that the payout on the stock is greatly dependent on the company’s profitability, whereas a bond assures a fixed return within a stipulated time frame. The second critical factor being that if a company underperforms then there remains a chance that the value of its stock could be completely eroded with no chance of recovery. In a similar scenario a bond holder, as a creditor retains the right to get back the amount invested in the business.