- Before we talk about securities markets themselves,
let's talk about the two basic types of securities,
stocks and bonds.
To illustrate the difference between the two, consider this.
From outer space, you're watching through a telescope,
a transaction between an individual and a company.
You see the individual give the company money.
You see the company give the individual a piece of paper.
Did the company sell a stock or a bond?
Well from space, that transaction looks the same,
exchanging money for a piece of paper.
Although the issuance of stocks and bonds
looks the same from a distance,
they represent fundamentally different transactions.
A stock is evidence that a stockholder
is an owner of a portion or a share of a corporation.
If you own a share of stock,
you're an owner in that corporation.
The stockholder receives the stock
typically in exchange for paying cash
to the previous owner of the share.
A bond on the other hand
is evidence that the bondholder is owed money
by the company that issued the bond.
In essence, a bond is an IOU.
The bondholder receives the bond,
typically in exchange for paying cash
to the previous owner of the bond.
A share of stock is evidence of ownership.
A bond is evidence of a loan.
Bonds are often called debt.
Stocks are often called equity.
Let's look at the difference between pure debt
and pure equity.
We are going to look at the two extremes,
just pure debt and pure equity
to highlight the differences between the two.
For example, do annual payments have to be made?
Well, with pure debt, interest payments are mandatory.
Whether the company does well
or the company does poorly, interest on debt has to be paid.
On the other hand, with equity, with stock,
do payments have to be made?
Those payments are called dividends.
They don't have to be made.
I can pay a dividend or not.
With debt, interest payments have to be made.
With dividends, the payments are optional.
Now, what about the amount of the payment?
Typically, with pure debt,
the amount of the interest payment is fixed.
The person who invested in those bonds
can expect a regular, fixed interest payment on those bonds.
On the other hand, with pure equity,
the dividend amount is not fixed.
It can go up, it can go down.
Does the initial investment have to be repaid?
Well, with debt, a loan,
the amount does have to be repaid in the future.
There are maturity dates associated with debt,
and a specified amount has to be repaid.
With equity on the other hand, there is no requirement
that any investment amounts be repaid.
One more difference between stocks and bonds
is the order of priority in the case of bankruptcy.
Who first gets to extract any assets that might remain?
Well, debt holders collect first,
and equity holders get what, if anything, is left over.