Know Your Dough

Stocks and Bonds: What are they, and how do they work?

The world of investing can be pretty confusing, and there are so many things that you can invest in that it is not any wonder people don’t know where to start. Today, I am going to discuss the two most common types of investments: stocks and bonds.

Stocks
When you buy a stock, you are buying a piece of a company. Companies issue stock when they need to raise money. Think about the show “Shark Tank” – business owners are in need of money in order to grow and improve their business, and they come to the “sharks” asking for money for a percentage of their company. When you buy company stock, you are essentially a “shark,” except the percentage of the company that you own is so small that you don’t have a miniscule amount of say in how the company is run.

The price of stocks rise and fall based on how much people are willing to buy or sell them for. When the price of a stock increases, that means that people are placing a higher value on the company, and the opposite is true when the price decreases. It is also easy to think about the movement of stock prices like supply and demand. When the demand for the stock goes up (and more people are buying) the price also goes up. When the demand for the stock goes down (and more people are selling) the price goes down.

Bonds
Companies issue bonds for the same reason they issue stocks – in order to raise money. The difference is that bonds are a form of debt financing where the company is the borrower, and you are the lender.

When the bonds are issued, the company sells them to you for face value at the coupon rate – the fixed interest rate that the company will pay over the life of the bond. In the olden days, your bond certificate would come with little coupons (hence, the coupon rate) that you would mail in annually (or more frequently, depending), and the company would send you back the interest earned. With the power of modern technology and tracking, coupons are no longer necessary.

Let’s imagine that you buy a bond directly from the company at a face value of $1,000 with a coupon rate of 5% over a 10 year period. You would receive $50 every year for 10 years. At the end of the 10 year period, you would receive your final interest payment plus the return of your initial investment.

This is just the tip of the iceberg when it comes to financial instruments, even stocks and bonds themselves. If you have any questions that delve deeper into stocks and bonds, please reach out to me at allison@iomechallenge.org.

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