Difference between stocks and bonds

The Indian market is floodedwith sales of stocks and bonds. Shares and bonds are two important toolsof investment that form the portfolio of any investor at any given point oftime. Stocks and bonds are financial instruments for investors to obtain areturn and for companies to raise capital. In simple terms, stocks offer anownership stake in the company and bonds are similar to loans made to thecompany.

A bond is a form of loan orIOU (I owe you). The holder of the bond is the lender (creditor), the issuer ofthe bond is the borrower (debtor), and the coupon is the interest. Bondsprovide the borrower with external funds to finance long-term investments, or,in the case of government bonds, to finance current expenditure.

Bond is an instrument ofindebtedness of the bond issuer to the holders. It is a debt security, underwhich the issuer owes the holders a debt and, depending on the terms of thebond, is obliged to pay them interest (the coupon) and/or to repay theprincipal at a later date, termed the maturity. Interest is usually payable atfixed intervals (semiannual, annual, sometimes monthly). Very often the bond isnegotiable, i.e. the ownership of the instrument can be transferred in thesecondary market.

Companies usually dividetheir capital into small parts of equal value. This smallest part is known as ashare. Companies usually issue shares in the public to raise capital. Peoplewho buy or are allotted shares are called shareholders.

Stocks of a company areoffered at the time of an IPO (initial public offering) or later as equityshares. The company offers investors an ownership stake by selling stocks. Investmentin equity shares is rather riskier compared to investments made in bonds. Thevalue of stocks corresponds to the value of the company and therefore, stockprice fluctuates depending upon how the market values the company.

In contrast, bonds are loansoffered at a fixed interest rate. When a company believes that it can raisecapital cheaper by borrowing money from banks, institutional investors orindividuals, they may choose to offer interest-paying corporate bonds. Withbonds, an investor is promised a fixed return. While bonds are relatively “safer”than stocks because of lower volatility, it should be noted that there isalways a chance that company will be unable to repay bondholders. In thatsense, bonds are not “risk-free”.

However, when a company declaresbankruptcy, stockholders are the first to bear losses. Creditors (includingbond-holders) are next.

Stocksvs bonds

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