Stocks and bonds are the heart of securities markets around the world. Shares of stock represent equity interest in a corporation; while bonds are debt securities that corporations and governments use to borrow money. Most other securities are “derivatives,” whose value depends on another (underlying) security or item of value (for example, stock options and warrants, futures contracts for stocks and commodities, and currency trading contracts). Mutual funds usually invest in stocks, bonds or short-term (money market) bonds. Investors choose stocks as investments to grow their portfolios, and sometimes for income. Bonds are attractive as income-producing investments.
Shares of stock represent ownership (equity) in a company. Nearly all shares are either common or preferred stock. Stockholders assume most of the financial risk of investing in a corporation. If the company does well, the value of their shares will grow, but if the company fails, they are the last to be paid after creditors and bondholders. Bonds are “debt securities” issued by corporations to borrow money. Governments also issue bonds for the same reason. Bonds pay fixed interest (called a coupon rate) and are redeemed for their par (face) value at maturity, which can be anywhere from a few weeks to 30 years or more.
Common stock gives the owner voting rights at stockholder meetings and may pay dividends. A common stock that does not pay dividends may still be a good investment if the company is putting the money into expansion for the future. The common stock of major corporations is traded on stock markets like the New York Stock Exchange and NASDAQ. Smaller firms’ stock may be held privately or traded through brokers in the “over-the-counter” (OTC) securities markets.
Preferred stocks are a hybrid of common stocks and bonds. They are ownership shares but normally don’t have voting rights. Preferred stocks and their dividends must be paid off before any funds go to holders of common sock. Most preferred stocks have substantial guaranteed dividends and are popular with investors seeking income, rather than equity growth.
Companies may choose to raise capital for expansion or to meet expenses by issuing bonds to borrow money instead of selling equity shares. The income investors get from bonds is fixed, and when bonds are traded on the OTC market or on exchanges, their price varies depending on prevailing interest rates, market conditions and the credit risk investors think the company represents. Corporate long-term bonds may have maturities up to 30 years. They are usually issued with face values of $1,000 or $5,000, which is the amount the company must pay at maturity to redeem the bond.
Like corporations, federal, state and local governments issue bonds to pay for projects or cover expenses. Federal Treasury bonds (often called Treasury notes if they are middle-term 1- to 10-year maturity) are considered the safest bonds and are exempt from state and local taxes. State and local bonds (collectively called municipal bonds or “munis”) are similar, except the income from most is exempt from federal taxes. Government bonds are issued with face values from $1,000 to as much as $100,000.
Both corporations and governments issue short-term bonds with maturities of under 1 year and usually less than 6 months. These bonds are structured like other bonds, but trade on what is called the “money market.” They are large-denomination bonds and not generally sold and traded by individuals but by large institutional investors. Corporate “commercial paper,” as these bonds are called, Treasury issued “T-Bills” and short-term municipal bonds are the securities bought and sold by money market funds. Investors with money market accounts receive the interest, minus the fund’s fees, along with the tax breaks if the bonds are government-issued. Although these bonds pay fixed rates, they are so short-term that the makeup of a money market fund portfolio is always changing, so money market rates are variable.
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