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Stocks Versus Bonds

Aug 17, 2007
The main difference between a stock and a bond is that stock gives you part ownership in a company whereas bonds are loans made by an investor. Rather than benefiting from company profits the way that stock holders do, bond holders receive a fixed rate of return - a percentage of the bond's original offering price. The return is called the 'coupon rate'. Bonds have a maturity date at which time the principal amount is returned. This makes bonds a more reliable investment, but they provide less potential reward.

1. Risk vs Reward

Although bonds typically have less risk than their stock counterparts, that doesn't mean they can't flop - bonds can still end up giving you no money at all. Companies with higher credit worthiness are more likely to be safe investments but their coupon rate will be lower than companies with lower credit ratings. Credit ratings are provided by firms such as Standard and Poor and Moody's Investor Service. Credit ratings range from a high AAA to a low D.

2. Governmnet Bonds

US government bonds are considered to be the safest type of bonds. Blue chip corporations (those with established performance records that span over many decades) are also very safe bond investments. Smaller corporations have a greater risk of defaulting on their bonds, but bond-holders are preferential creditors and will get compensated before stock holders in the event that the business goes bankrupt.

3. Selling Your Bond

Bonds can be bought and sold on the open market. Their value fluctuates according to the level of interest rates in the general economy. For example, if you hold a $1000 bond that pays 5% per year in interest you can sell the bond at higher than face value as long as interest rates are below 5%. If they rise above 5%, your bond can still be sold but usually at less than face value. This is because investors are able to get a higher interest rate than what your bond pays so in order to offset the difference your bond has to be sold at a lower cost.

4. OTC Markets

The vast majority of bonds can be traded over the counter through banks. Some corporate bonds are also listed on stock exchanges and may be bought through stock brokers. New issues of bonds are usually sold in $5000 increments while bonds bought and sold after the initial issues are quoted in increments of $100. A bond that is listed at 96 is selling for $96 per $100 face value. For this reason, unless you are ready to make a big investment, you should probably stick to stocks.
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