Posted: Apr 01, 2019
When an individual is investing, you buy something that you expect it will grow in value and then provide profits. There are three categories of financial investments that most people concentrate on including bonds, stocks, and cash equivalents. When companies want to raise capital, they can issue or offer bonds and stocks for the public sale.
Stocks and bonds
When an individual invest in stocks, they tend to buy ownership shares in the company also known as the equity shares. What you get back or return on investment will depend on the failure of success of the company. Bonds refer to debt investment representing a loan one makes to an institution in exchange for interest payment at a specific term plus repayment of the principal when the bond is due. The best financial investment is the bond. The reason for investing in bonds is because stocks normally pay investor's dividends, and there is no guarantee (Brady, 2012). However, bonds tend to pay interest, and an individual is sure to get the money back unless the company goes bankrupt. Also in case of a bankruptcy, bonds tend to offer more safety than stocks.
The prices of stocks tend to go down and up because of profitability or lack of profits of the company’s stocks. When the company makes a lot of profits, the person who owns the company’s stocks will be sure to get a lot of money (Brady, 2012). However, if the company loses money, then you will expect to lose money on your investment. If the company goes bankrupt, the stockholders are always the last in line to get their money and thus, often lose their entire investment.
However, the case of bonds tends to be different from that of stocks. As the bondholder, an individual normally get an interest payment at special intervals irrespective of whether the company is doing well or not provided it does not go bankrupt. Any piece of negative or positive news from the company can affect the price of a company’s stock. However, in the case of bonds, provided the company does not file for bankruptcy, the bondholder will get their interest and also the principal payment (Petch,2015). The negative aspect of investing in bonds is that even if the company makes a lot of profits, the bondholder will not earn any additional interest apart from the original amount. In the case of a bankruptcy, the bondholder is usually the first in line to get the money left or money generated by the sale of company’s assets. In the case of stocks, the stockholder is usually the last in line to get money, and they may never even get that money (Maeda, 2009). Hence, it is more advantageous to invest in bonds than in stocks. During bankruptcy, it is, after all, the bondholders and any other creditors get paid that the stockholders will get their money back.
As a financial manager of an investment company, I would consider it better to invest in bonds rather than on stocks. Bonds are better than stocks because they provide a guarantee of return to the investor while stocks do not provide a guarantee to return (Maeda, 2009). The possibility of return in stocks is high and so is the possibility of losing money. Bonds represent debt and investing in debt tends to be safer than investing in equity (stocks). It is because the debt holders have a high priority over the shareholders, and when the company goes bankrupt the debt holders will be ahead of shareholders in getting paid.
Default risk refers to the event in which individuals or companies will be unable of making the required payment on debt obligations (Badilia & Gliagias 2013). I would measure the default risk of the bonds through credit rating. Rating agencies such as Standard & Poor’s Corporation and Moody's normally provide the credit ratings. When using the credit ratings, those bonds seen as less likely to default had higher ratings and accompanied by lower yields. Bonds with higher likelihood of default had lower ratings and accompanied by higher yields. Thus, in measuring default risk, the high-yield bonds have a lot of default risk.
Bonds are either short-term or long-term depending on how much time is remaining before they mature. The long-term bonds normally have a higher duration than the short-term bonds; as a result, long-term bonds normally have high-interest rate than the short-term bonds (Fabozzi, 2001). The longer the time to maturity is equal to the larger the potential for price fluctuation and the shorter the time to maturity results to the lower the price fluctuation. I would consider investing in short-term bonds because the US Federal Reserve policy affects the short-term yields. On the other hand, the market forced tends to affect the performance of long-term bonds. Because the investor sentiments tend to change rapidly than Fed policy, it leads to more intense price fluctuations for the long-term bonds. Taking the short-term bond is a good investment option because I do not intend to take the risk with my money.
Badilia, R & Gliagias, N (2013). Understanding credit risk for corporate bonds
Brady, J (2012). Income investing in bonds, stocks, and money markets McGraw-Hill Professional
Fabozzi, F (2001). Bond portfolio management John Wiley & Son
Maeda, M (2009). The complete guide to investing in bonds and bonds funds Atlantic publishing company
Petch, K (2015). Is investing in bonds safer than the stock investing?
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