Understanding Stocks and Bonds

If the purpose of your online visit is understanding stocks and bonds, this article will be an interesting read. Here I shall provide an easy to follow explanation, which will help you in understanding how stocks and bonds work.
WealthHow Staff
Two of the most important financial instruments that companies use to raise capital for their projects are stocks and bonds. One of the best ways of investing money is to buy stocks and bonds of companies with a promising future. If you are clueless about what are stocks or bonds and how do they differ as investment vehicles, this WealthHow article will be an eye opener.

Understanding Stocks

A stock is a quantum of ownership or equity of a public listed company, which you can buy, through the stock market. When private companies grow to a point, where they need to raise substantial capital for their future operations, they decide to 'go public' and sell a big share of the company, in the form of stocks, through an Initial Public Offering (IPO), (Read the what is an IPO process) through a stock market.

Whoever buys the stock of a company, becomes a 'shareholder' or a partial owner of the company. The company may or may not offer dividends (profit shares) to the shareholders in direct proportion to the number of stocks owned by them. There are two types of stocks sold by the company, which includes 'Preferred Stock' and 'Common Stock'.

A shareholder with preferred stock, is given higher preference when distributing dividends but he has no voting rights on the company decisions. Preferred stocks may be converted into common stock. Common stock holders are given secondary preference while distributing dividends but they may have voting rights on important decisions made by the company. Once sold by the company, stocks are traded in the secondary market, provided by the stock exchange. According to the company performance, the stock price may rise or fall. You may buy any stock on offer in a stock market, through a brokerage firm with a license to trade. The key to making money in stocks is to 'Buy Cheap & Sell Dear.'

Understanding Bonds

Now that you know what stocks are, let us see what are bonds as investment instruments. A bond is a debt instrument used by public listed companies to raise capital for their projects. Just like there is a stock market, there are bond markets to facilitate their buying and selling. When you buy a bond, you loan a fixed amount of money to the company which issues it. A bond is a debt certificate with a coupon (interest) value, which is paid after the maturity date of the bond, along with principal. Just like stocks, bonds are traded in a secondary market.

You can gain a profit by buying bonds at a lower price and selling them at a higher price. Once the maturity date of the bond is reached, whoever is the holder of the bond, at that moment, is paid the principal value of the bond, along with promised interest. Even the US government issues bonds in the form of treasury bonds and bills to raise money for its spending. These treasury bonds also come with a fixed maturity period and coupon value and they make for some of the safest investment options in USA.

Difference Between Stocks & Bonds

Unlike a stock, the purchase of a company bond does not give the bond owner, a quantum of ownership in the company. It is merely a loan extended to the company, which it is obligated to return to the holder after maturity. Bond payments after maturity are given higher preference over paying dividends to shareholders by all public listed companies.

Another difference between stocks and bonds is the validity period. As long as a shareholder retains his stock, he can gain dividends from the company till it stays operational. On the other hand, once a bond reaches maturity and the payment is made by the company, there can be no further business between the bondholder and the issuing entity.

If you want your wealth to grow, investing in stocks and bonds is one of the best ways to let it do so. Though these investments are fraught with a high degree of risk, a smart investing strategy can help you overcome the risk and make decent profits. Researching the balance sheets and performance potential of the company whose stock or bond you are buying, is the key to making profits through investment in such securities. For an insight into understanding how to pick the best stocks, a recommended reading is 'Intelligent Investor' by Benjamin Graham. Hope this article has left no doubt in your mind about what are stocks and bonds.