Companies and corporations need capital to fund start up and day to day operations, as well as finance new and ongoing projects. Rather than apply for traditional bank loans, these businesses can opt to get funding by issuing stocks or bonds. The corporations or companies will therefore exchange stock or bonds for money. This article highlights the differences between these two types of capital sources for corporations and companies.
A stock represents a claim on the assets and liabilities of a company. Once an investor buys stock from a company, he or she practically owns part of the company. Therefore, the investor will enjoy profits or suffer losses depending on how well the company performs. The value of the stock is determined by the company’s performance and value. The investor can choose to hold onto the stock or sell it off if it’s publicly traded in the stock markets. If the issuing company does well and records profits, stockholders can get a share of these in the form of dividends. How much each stockholder gets is determined by the number of stocks they hold.
A bond is a debt. Once an investor buys a bond, the issuing company or institution – such as a government – is obliged to pay back the loan amount plus interest. The bond usually has a fixed value and predetermined maturity date. The interest rate can be fixed or variable and is also paid to the bond holder at predetermined periods, for example every six months until the bond matures.
|Represents ownership and claim to the issuing company’s assets||Is a debt the issuing company owes the bondholder|
|Stockholder gets profit in the form of dividends||Bondholder gets profit in the form of interest|
|High risk||Relatively low risk|
|Various forms of participation e.g. voting allowed depending on type of stock held||No participation in issuing company’s activities|
Let’s take a look at how they differ in terms of investment type, returns, risk involved, and investor participation.
- Stocks represent ownership of the issuing company or corporation. The stockholder owns a certain percentage of the company. For example, if a company issues 2000 shares and one investor buys 300, he or she owns 15% of the company. Bonds on the other hand represent debt. If an investor buys a bond worth $100,000 the issuing company owes him the same amount plus interest when the bond matures.
- The returns earned from stock are called dividends. If the issuing company makes profits, it can decide to share them among shareholders. The dividend each shareholder receives depends on the number of shares he or she has. If, however, the issuing company makes a loss, no dividends are paid out. Bondholders on the other hand earn returns in the form of interest. This is calculated as a fixed or fluctuating rate. It’s payable at predetermined intervals ranging from six months to years. Once the bond matures, the issuing company or government is obliged to refund the bond amount to the investor.
- Stocks are considered riskier investments. They are usually based on speculation that a company will perform well. If the company makes profits, the stockholder gets to share in them. However, if losses are incurred, the investor could see their stock value plummet. Bonds on the other hand involve lower risk. The bondholder is assured of a steady return in the form of interest whether the issuing company makes a profit or loss. However, in case of profit, the interest received won’t increase, therefore limiting the amount the investor can get in form of returns.
- Since stocks represent ownership, some stockholders are allowed to participate in some company activities such as voting. Bondholders on the other hand cannot participate in the issuing company’s activities.
Here’s a YouTube video that provides more information regarding stocks and bonds.