Basics of the stocks market
A stock or share is a financial instrument that symbolizes possession in a corporation and represents an equivalent claim on its assets and earnings. Ownership of shares suggests that the shareholder owns a piece of the company equal to the number of shares held by them with comparison to the total outstanding shares of that respective company.
There are two types of stocks, namely common and preferred. The main difference between the two models is that common shares have voting rights that permit the average shareholder to voice their opinions and concerns in corporate meetings while preferred shares generally do not. Preferred shares get their name since they have preference over common shares in a company to receive dividends and assets, especially if the company is facing bankruptcy.
Once shares are listed on a stock exchange and trading begins, the price of these shares will fluctuate as investors keep reassessing their inherent value.
The stock market is made up of exchanges like the NYSE and the Nasdaq. Stocks are listed on these exchanges and bring traders together in a market for transactions. The exchange tracks the supply and demand and mainly the price of each stock. When people refer to the stock market being up or down, they’re generally referring to one of the major indexes.
The stock market offers an interesting example of the laws of supply and demand at work. For every stock transaction, there should be a buyer and a seller. Because of the unchallengeable laws of supply and demand, if there are more buyers for a specific stock than there are sellers of it, the stock price will trend up. On the other hand, if there are more sellers than buyers, the price will lower down.
When you buy a share on the stock market, you are most likely not buying it from the company directly but from some other trader. Similarly, when you sell shares it is to some other investor.
A market index can represents the market as a whole or a specific sector of the market, like technology or retail companies. Most commonly known indexes are S&P 500, Nasdaq and the Dow Jones.
Investors use these indexes to standardize the performance of their own portfolios and to inform trading decisions. You can also invest in an entire index through exchange-traded funds (ETFs), which focus on a specific subdivision of the market.
Undoubtedly investing in the stock market carries risk, but when taken a disciplined approach, it can be one of the most efficient ways to grow net worth of an individual. Generally, the value of a person’s home is responsible for most of their net worth, the very wealthy are known to have a big chunk of their capital invested in stocks.
The words “bull” and “bear” are introduced to the stock market to indicate gains and losses. The bear has been picked as a symbol of fear since it means stock prices are falling. Conversely, a bull market means stock prices are on the increase which is the ideal outcome for traders to maximize their returns. It is said that it’s a bull market since March 2009 making it the longest positive run in history.
Bull markets follow bear markets which can then return back to a bull market and this pattern continues signalling the start of larger economic configurations. In other words, a bull market means investors are confident, which in return indicates economic growth. Conversely in a bear market investors are pulling back or looking to sell off, indicating the economy may not be doing so well.
While it is impossible to avoid bear market conditions the risk that comes from an undiversified portfolio can definitely be avoided. To eliminate company-specific risk, investors differentiate by combining numerous types of stocks together. This balances out the unavoidable losses and eliminates the risk that one company’s downfall will risk your entire portfolio.
Although, it is important to keep in mind that building a diversified portfolio of individual stocks takes a lot of time, patience and research. The substitute to this are the aforementioned ETFs or specific index funds. These reflect a variety of investments, so diversification is automatically achieved.
Everything you need to know about bonds
As a means to make extra income to improve standard of living, people invest in various things using various means as investment which include stock market, bond purchase and issuing. Let me quickly introduce you to “BOND” as an investment tool in this century.
Bonds as an investment tool has been around for thousands of years, dating back to as far as 2400BC. The first ever government “bond” was issued by the Bank of England in 1693 to raise money to fund a war against France. The first U.S. Treasury bonds, which were initially called “Liberty Bonds,” were issued to fund World War I. In 1917, the First Liberty Loan Act authorized the issue of $5 billion worth of bonds at 3.5 percent interest three weeks after the United States declared war on Germany.
Base on this brief History, what is ‘BOND’? Bond is a contract between two parties. Companies or governments issue bonds because they need to borrow large amounts of money. They issue bonds to business market and investors buy them (thereby giving the people who issued the bond money) and payback at a future date to the investors who bought the ‘bonds’. Also, a bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental).
A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer. Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.
Base on this, I can boldly say a bond is a sure means of investment although there are several varieties of bonds available today. Bonds usually can be purchased from a bond broker through full service or discount brokerage channels, similar to the way stocks are purchased from a stockbroker. But there are some basic information you need to have at your fingertips about bonds before going into investing in the security:
Risk of Bonds: It will definitely be inappropriate to invest in a security like bonds without proper grasping of the risk associated with it. Bonds like all other securities has its own risk and challenges. These are;
Credit/Default Risk: Credit or default risk is the risk that interest and principal payments due on the obligation will not be made as required.
Prepayment Risk: Prepayment risk is the risk that a given bond issue will be paid off earlier than expected, normally through a call provision. This can be bad news for investors, because the company only has an incentive to repay the obligation early when interest rates have declined substantially. Instead of continuing to hold a high-interest investment, investors are left to reinvest funds in a lower interest rate environment.
Interest Rate Risk: Interest rate risk is the risk that interest rates will change significantly from what the investor expected. If interest rates significantly decline, the investor faces the possibility of prepayment. If interest rates increase, the investor will be stuck with an instrument yielding below market rates. The greater the time to maturity, the greater the interest rate risk an investor bears, because it is harder to predict market developments farther out into the future.
Bond Yields: Bond yields are all measures of return. Yield to maturity is the measurement most often used, but it is important to understand several other yield measurements that are used in certain situations.
Yield to Maturity (YTM): As said above, yield to maturity (YTM) is the most commonly cited yield measurement. It measures what the return on a bond is if it is held to maturity and all coupons are reinvested at the YTM rate.
Current Yield: Current yield can be used to compare the interest income provided by a bond to the dividend income provided by a stock. This is calculated by dividing the bond’s annual coupon amount by the bond’s current price. Keep in mind that this yield incorporates only the income portion of return, ignoring possible capital gains or losses. As such, this yield is most useful for investors concerned with current income only.
Nominal Yield: The nominal yield on a bond is simply the percentage of interest to be paid on the bond periodically. It is calculated by dividing the annual coupon payment by the par value (face value) of the bond. It is important to note that the nominal yield does not estimate return accurately unless the current bond price is the same as its par value. Therefore, nominal yield is used only for calculating other measures of return.
What makes a bond price go up and down?
Interest rates may be the most significant factor affecting a bond’s value. When interest rates fall, the market price of existing bonds rise because their fixed-interest rates may be more attractive in the market than the rates for new issues. Similarly, when interest rates rise, the market price of existing bonds with lower, fixed-interest rates tend to fall.
Inflation may erode the purchasing power of interest income. Generally, bonds with longer maturities are more sensitive to inflation than bonds with shorter maturities.
Economic conditions may cause bond values — particularly corporate bonds — to fluctuate. An economic change that adversely affects a company’s business may reduce the perceived ability of a company to make interest or principal payments.
How to invest in bonds
Bonds may be traded in the market just like stocks, and you will typically pay a broker a fee if you buy or sell a bond. There is, however, one exception; you may purchase U.S. Treasury securities directly through the Treasury Direct program of the Federal Reserve System, in which case you do not need a broker’s services and incur no fee beyond the bond’s purchase price.
Two other ways to purchase bonds that offer diversification are bond mutual funds and unit investment trusts (UIT). Bond mutual funds sold through a brokerage firm may charge a sales fee, or “load.” No-load funds may be purchased directly from the fund company. You may also purchase a variety of load or no-load funds through most online brokerage firms.
Some funds are sold on discount brokerage sites without a transaction fee, while others are subject to trading fees. Bonds have a clear advantage over other securities. The volatility of bonds (especially short and medium dated bonds) is lower than that of equities (stocks). Bonds are subject to risks such as the interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
The importance of investing strategy
When it comes to investing, the first cause of action should be to evaluate your investment goals, strategy, and decide how long you would be investing for. The next step would be to pick where or what to invest in, whether it be real estate, art, or in the stock market.
It is crucial to understand various aspects and types of ways one can get started with the stock market. There are multiple indexes and options to pay attention to before investing to minimize the risk and maximize your returns.
Which best describes the difference between stocks and bonds?
A bond and a stock are very different from one another when considering their structure, safety, use availability, and price. When you buy bonds, you are most probably seeking the safety of investment and semi-annual income against your registered asset.
What are the stocks characterestics?
Stocks offer the possibility for a price increase on the shares bought, and if the corporation decides to pay dividends, a quarterly income to the shareholders as well.
Stocks or shares symbolize a possession of an interest in a corporation. Every corporation has shares which they issue to the public to raise capital.
The raised capital is then used to reinvest in the company to boost performance and sales as well as future fund projects.
Stocks pay dividends, which are a sharing of the corporation’s profits to its shareholders. Yet, the dividend follows only if the board of directors declares to pay out the dividends. The dividend payments to shareholders do not reflect as an expense on either the financial statements or income tax return of the corporation.
What are the bonds characterestics?
Bonds are certificates for long-term debts which the institution guarantees to pay the principal amount at a fixed interest payment to the bondholders, usually every six months until the maturity of bonds is reached.
Businesses are understood not to issue bonds since they are realistically loans that are secured by a physical asset belonging to the buyer.
It highlights the amount of debt taken to pay the agreed-upon amount from time to time in the future. This means offering them the returns at a pre-agreed upon percentage (rate).
Stocks vs Bonds: the main differences
There are several key differences between stocks and bonds:
- One of them being stocks are issued by corporations, while Government and financial institutions as well as some companies issue bonds.
- Secondly, stocks are instruments that highlight the interest of ownership issued by the company in exchange for funds. Meanwhile, bonds are funds replicating the performance of a benchmark market index.
- While stockholders are partial owners of the company, bonds represent lenders to the firm.
- Stocks reward investors with dividends, and bonds give out a fixed interest payment.
- Stocks provide their holders with the right to decide on performance evaluations of the respective companies (attend board meetings and so on) while bonds are based solely in terms of payment and liquidation.
After considering the above facts, it is imperative to comprehend that stocks represent a much more significant investment risk than bonds since bondholders are prioritized for repayment while stocks fluctuate depending on the performance of the company.
This, in turn, means bondholders have a fixed income when compared with the inconsistent returns of shareholders. Furthermore, the profits of stocks are not guaranteed while it is fixed with bonds.
Finally, stocks trade in a centralized market while bonds are issued over the counter at government/ financial institutions. Bond repayments are tax exempted, while shareholders are subjected to pay a dividend distribution tax in most cases.
To sum up, both stocks and bonds are known forms of financial instruments that are used by customers to invest their funds with the hope of getting higher returns.
Though these opportunities can be used for meeting short-term goals, many successful investors have declared that holding onto them, in the long run, proves to give out more gains.
Bonds issued by the Government are broadly used and also shows the financial stability of the respective country. If the earnings offered are less, it means the country is in an excellent position to pay off its debt.
In this scenario, it does not need to involve many lenders. When creating a portfolio, either or both of these instruments would be comprised to boost the likelihood of yields.
Read also our article about saving money and investing