Modern bond and stock markets trace their history to a common origin when organized securities trading in the United States began in 1792. Both bonds and stocks were traded on a single market in New York City. Later the markets became specialized, with stock trading evolving into the New York Stock Exchange. Bond trading developed differently and became largely an “over-the-counter” market.
Stocks are ownership securities. This means shares traded on the stock market represent ownership in the issuing corporation. A particular stock may or may not provide income through dividends. Bonds, by contrast, are debt securities. The issuing organization uses bonds to borrow money. Bonds pay a fixed annual sum called the coupon rate. They must be redeemed (paid back) when they reach their maturity date.
Because stocks represent ownership in the issuing entity, all stock issuers are corporations. The bond market is more complex. Local and state governments sell bonds (commonly referred to as municipal bonds) as do the U.S. Treasury Department and foreign governments. The corporate bond market is important as well, with industrial, transportation, utility, financial and conglomerate companies being the largest bond issuers.
The majority of shares traded are bought and sold through centralized stock exchanges like the New York Stock Exchange. When an investor places an order with a broker, the order is executed on a stock exchange, although online trading has streamlined the transaction process. Much of the stock market volume isn’t actually generated on the trading floor as it once was. The bond market isn’t built around centralized exchanges. Instead, bond brokers find buyers and sellers through a worldwide network of other brokers.
Prices of bonds and stocks behave in distinct and even opposite ways. For example, stocks tend to go up if a company does well. When profits fall during an economic downturn, share prices on the stock market tend to fall. By contrast, bond prices frequently go up when economic news is bad. Interest rates often drop in hard economic times. This makes existing bond yields more attractive, especially to nervous investors looking for a safe place to put money they want to take out of the stock market. Demand for bonds goes up, driving up prices at the very time stocks are falling.
Individual investors tend to focus on bond or stock markets largely based on their investment goals. A person who is primarily interested in current income with limited risk will generally look to bonds as an investment vehicle. The investor who seeks equity growth is far more likely to put most of his money into stocks, using bonds mainly to diversify his portfolio and so reduce overall risk.