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Chapter 8: Problem 42

What is a bond? Describe the difference between a stock and a bond.

Short Answer

Expert verified
A bond is a debt instrument where you lend money to the issuer in return for periodic interest payments and the repayment of principal at maturity. A stock represents equity ownership in a company with the potential to share in the company's profits and vote on company matters. The main difference lies in what you own (debt vs. equity) and the expectancy of returns (fixed returns vs. variable returns).

Step by step solution

01

Define a Bond

A bond is a debt instrument that companies issue to raise capital. When a student buys a bond, they are effectively lending money to the issuer (usually a corporation or government entity). In return, the issuer promises to pay back the initial amount (the 'principal') after a set period (the 'maturity date'), along with 'interest' payments at scheduled intervals.
02

Define a Stock

A stock, on the other hand, represents ownership in a corporation. If a student owns stock in a company, they own a piece of that company and may be eligible for a portion of the company's profits (dividends). Additionally, as a shareholder, they may be allowed to vote on important company matters.
03

Describe the Differences

Comparing both, the fundamental difference between stocks and bonds lies in their ownership structure and risk/reward profile. With bonds, one lends money and receives guaranteed return unless the issuer defaults. With stocks, one becomes a part-owner and the returns depend on how well the company performs. Stocks generally carry higher risk but also offer higher potential returns relative to bonds.

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