Q3. How do stocks and bonds differ i... [FREE SOLUTION]

Chapter 17: Q3. (page 368)

How do stocks and bonds differ in terms of the future payments that they are expected to make? Which type of investment (stocks or bonds) is considered to be more risky? Given what you know, which investment (stocks or bonds) do you think commonly goes by the nickname 鈥渇ixed income鈥�?

Short Answer

Expert verified

The future payment of the stocks and bonds depends on the organization's financial health, but the difference is that the bond payment is prioritized.

The investment in stocks is considered to be riskier.

The investment in bonds goes by the nickname 鈥渇ixed income鈥�.

Step by step solution

Step 1. Stocks and Bonds payment

If the organization that has issued bonds and stocks is about to shut down in the future, the legal aspects ensure that the bond payments are made by selling the assets. And if anything is left, the stock payments are made. If the organization is doing well, the profit left after the bond payments is distributed among the stockholders.

Step 2. Risky investment

As seen above, the bond payments are prioritized over the stock payments; one can conclude that the stock investment is riskier. If the organization runs into bankruptcy, the stockholders will lose all the invested money.

Step 3. Fixed-income investment

A bond is a debt contract subject to timely payments, unlike the stock investment, which is buying shares in the organization and earning a dividend when the organization makes the profit. Hence, the investment bonds can get fixed income but not the investment in stocks.