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Stocks and Bonds. Their Classifications
Stocks and bonds represent two very different securities. Stocks are equity in a corporation while bonds are debt. Capital Markets are simply markets where securities are bought and sold.
Stocks allow you to own a portion of a public corporation. Initially, they are sold by the original owners of a company to gain additional funds to help the company grow. The owners basically sell control of the company to the stockholders.
Types of Stocks
Corporations issue two types of stock, depending on their cash needs. They are common stocks and preferred stocks. Common stocks are the most common. The value of these stocks depends on how they are traded at any given time. The amount paid depends on corporate earnings.
Preferred stocks are really a mixture of stocks and bonds. Their value rises and falls along with the common stock. Preferred stock is also represents ownership in a corporation with some important differences from common stock. Preferred stockholders are guaranteed dividend payments whereas common stockholders are paid dividends based on quarterly decisions of the board of directors. Although some boards of directors pay regular quarterly dividends, they are no guarantee that they will continue in the future; there is no obligation to pay dividends to common stockholders.
Unlike stocks which represent firm ownership, bonds are long-term securities representing debt. Debts are obligations to repay borrowed money. Debt repayments can be broken down into two parts. The principal is the amount borrowed and must be repaid in conformity to the terms of the bond. Interest is the amount paid over the principal and is usually expressed as a percentage to be repaid in compliance with the terms of the debt.
Bonds are usually resold before they mature, or reach the end of the loan period. This is how bonds rise and fall in value. Since bonds return a fixed interest payment, they tend to look more attractive when the economy and stocks market decline. When the stock market is doing well, investors are less interested in purchasing bonds, and their value drops.
Bonds pay off in two ways. First is the income received through the interest payments. Second, is the payment you get if you resell the bond.
Stocks and bonds are the most common securities traded in Capital Markets. Whereas they both represent sources of capital to a firm, they are fundamentally different; stocks are ownership and bonds are debt. Which to use is a question of how the corporation wishes to raise capital and is a financing decision of a firm’s managers.
Answer the following questions.
1. Do stocks and bonds represent two very different securities?
2. What is the main difference between stocks and bonds?
3. Where are stocks and bonds bought and sold?
4. What types of stocks are mentioned in the text?
5. How do bonds pay off?
6. What does the value of common stocks depend on?
7. What is the principal distinction between common stocks and preferred stocks?
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