Understanding Key Differences Between Stocks & Bonds

  • Soumyaa Rawat
  • Nov 10, 2021
  • Financial Analytics
Understanding Key Differences Between Stocks & Bonds title banner

What are Stocks?

 

Also known as equity, a stock represents the ownership of a fraction of a public company that is traded in a stock market. 

 

Referred to as a ‘share’ of a company’s ownership funds, stocks are publicly traded in a stock market that directly makes the owner of these shares entitled to the company’s profits. 

 

Trading of stocks is a renowned practice of earning quick money as the stock market witnesses ups and downs in the prices of different stocks. For all those companies that have completed their IPO offerings, stocks are publicly traded (bought and sold) in the stock markets that run across the world. 

 

Investors keep a close watch on the stock prices of the shares and buy and sell them accordingly. In order to make quick money under a supervised and legal market setting, equity investment alternatives have helped people from all age groups to earn profits and ace the act of trading. 

 

(Must check: Top US IPOs)

 

Let us understand the concept of stocks with the help of an example. Suppose there is farmland of 2 acres owned by an individual. 

 

Now, let us suppose that this farmland is divided into small patches of land among farmers who take their respective lands on lease. Thus, each farmer gets his ‘share’ in the cumulative land stretch owned by another individual. 

 

Now, whenever a farmer thinks that the land has become too expensive to maintain or might fetch him/her a good price, then s/he can sell it. This is similar to what happens in the stock market. 

 

Stocks are bought and sold on a regular basis among a group of investors who find fit to buy their shares or sell them in the U.S. stock market. 

 

Similarly, a group of investors can also hire middlemen, known as brokers in the field of the stock market, who invest money in shares on behalf of their clients. 

 

(Related blog: Stock Market Analysis)

 

 

What is a Bond?

 

On the other hand, bonds are a different concept. Defined as a regular source of income that refers to a loan borrowed by a borrower at a fixed rate of interest. Known as debt instruments, bonds are issued by governments or organizations for borrowing funds from the public at a fixed rate of interest. 

 

Like stocks, bonds also pay off well. However, they have distinct compositions when it comes to their nature of income and the source of profits. 

 

“Purchased by the bond owner or the holder, usually individuals or citizens, these bonds are issued in order to raise money for major purposes like warfare, development, etc. when the issuer is the government or any governmental organization. “

What are Bonds? 

 

That said, bonds are of various types - government bonds, government agency bonds, municipal bonds, and corporate bonds. While the first 3 types refer to bonds initiated by governments, corporate bonds are issued by corporations and private companies that need funding. 

 

In order to make people lend funds through these bonds, a corporation or a government must be able to win their trust. 

 

As stated in the bonds contract, the specifics of the bonds include the maturity date, the rate of interest, and the amount to be returned at the time of maturity. 

 

(Suggested blog: Types of bonds)

 

 

Stocks v/s Bonds 

 

As we have already understood the concepts of stocks and bonds, we will now be understanding what differentiates these 2 concepts. In essence, we will be reading a brief comparison of stocks v/s bonds. 

 

  1. Constitution

 

One of the biggest differences in bonds vs stocks 2020 is that a bond is a debt instrument that lets a borrower borrow money from a lender at a fixed rate of interest. 

 

Whereas in the case of stocks, an equity fund entitles the investor to share a part of the company’s profits. In a bond market, bonds are issued when a bondholder becomes a lender to the issuing authority. 

 

Whereas, in the stock market, investors trading in equity become shareholders who only own a fraction of the company’s public shares. Thus, the nature of a bond is borrowed money while stocks constitute invested money in the shares of a company. 

 

“These entities buy and sell bonds and other related securities. By buying bonds, the participant issues a loan for the length of the security and receives interest in return.”

Differentiating between stocks and bonds 

 

  1. Issuing Authority

 

Another difference when it comes to stocks v/s bonds is the difference between their respective issuing authorities. On one hand, stocks are issued by private corporations that have successfully completed their IPO offerings. 

 

On the other hand, bonds are issued by governments, government organizations, and private companies. Altogether, the issuing authorities only issue bonds in search of funds to help them survive through a period of time. 

 

While both these financial instruments are meant to take place between institutions and individuals, there is still a vast difference between the way they are issued. Also, bonds do not have a central place of exchange. 

 

However, stocks can be exchanged in the stock market that is a central place for such an exchange. 

 

  1. Flexibility of Maturity

 

Another major difference between stocks and bonds is that the maturity date of bonds is not flexible. 

 

One has to abide by the maturity date bond contracts have  and is only liable to get the investment return at the time of the maturity of the bond. However, that is not the case with stocks. 

 

The maturity date of stocks can be determined flexibly by those who own the shares of the company. As soon as an investor wishes to sell off his/her shares further, the maturity date of those shares come to an end immediately. 

 

Simply put, stocks do not have a maturity date whereas bonds do. 

 

(Recommended blog: What are Lupa Stocks?)

 

  1. Investment Returns and Risks

 

The fourth difference between stocks and bonds is that both of these instruments have different investment returns. Bonds have a fixed rate of interest that is added to the principal amount at the time of maturity. 

 

The investment return, also known as face value, is already mentioned in the bonds contract prior to the completion of the maturity date. As opposed to bonds, stocks do not have a definite investment return. 

 

Although there is a high possibility of getting high dividend returns, stocks do not have a fixed rate of interest as compared to bonds. Moreover, bonds are a debt instrument while stocks are equity instruments. 

 

Another aspect worth considering in this segment is that bonds rarely have any risks attached to them. They are secure, do not rely on the volatility of the stock market and are issued at a fixed rate of interest. 

 

However, it is the opposite in the case of stocks. Stocks are traded at higher risks that cannot promise anything. While some investors might enjoy high profits, others might have to face massive losses. 

 

Furthermore, stock market volatility can also severely affect the investment returns of shares. Perhaps one of the biggest areas of difference between these two is the involved risk in their investment. 

 

  1. Voting Rights 

 

The last difference between these two financial instruments is that by trading in stocks, investors are eligible for gaining voting rights of a company. 

 

Since the issuing authority of shares is a private company, it simultaneously extends its voting rights in proportion to the number of shares held by an investor in proportion to the shareholders’s equity. 

 

Unlike stocks, bonds do not come along with voting rights. Bonds are mere debt instruments that promise investment return of principal amount added with the rate of interest. 

 

Despite providing funds to a particular government or organization, holding bonds does not make anybody eligible for having a say in the institution’s operations and decisions.

 

(Also read: Top Virtual Reality Stocks)

 

 

In the End

 

To sum up, stocks are equity instruments that are traded in a central stock market operated by a statutory body. 

 

They represent a fraction of a company’s profits and voting rights and are traded among investors with respect to a particular company’s performance in the stock market. 

 

On the other hand, bonds are debt instruments that are issued by governments or companies in order to collect funds for various purposes - welfare, development, expansion, etc. 

 

(Referred reading: Types of financial risks)

 

All in all, there are various key differences between stocks and bonds that help us separate the two concepts. Despite being financial instruments, bonds and stocks differ from each other on the basis of returns, risks, issuing authority, maturity term, owners, market regulation, and nature of ownership. 

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