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Stocks and Bonds

How do stocks and bonds differ? What are the key differences between them with respect to ownership rights, claims on income and assets, maturity, risks, and tax treatment? Why might an organization choose one versus the other as a long-term financing instrument?

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Good questions! Let's take a closer look at each question.

RESPONSE:

1. How do stocks and bonds differ? What are the key differences between them with respect to ownership rights claims on income and assets, maturity, risks, and tax treatment?

Ownership rights: Whereas stocks give investors part ownership of a company, bonds are loans made by investors to corporations or governments.

Claims on income and assets: Unlike stockholders, bondholders do not share in a company's assets and income (profits). Rather than benefiting from company profits the way that stockholders do, bondholders receive a fixed rate of return - a percentage of the bond's original offering price. The return is called the 'coupon rate'.

Maturity date: Bonds have a maturity date at which time the principal amount is returned. Bonds can be issued for any period of time - some take up to 30 years to matury. For stocks, the investors decides when the sell. http://www.free-uk-shares.co.uk/difference-between-stocks-bonds.html

Risks: Both options have their risks as well. With stocks, although theoretically there may be no ceiling, there is a bottom. Stocks can drop in value and become worthless. With bonds, there is interest rate, inflation and credit risk. Credit risk is the risk that the bond issuer will be unable to make its payments on time or at all, effectively defaulting on the bonds. http://www.russell.com/us/Education_Center/Learn/Stocks_and_Bonds.asp So, bonds always carry the risk that the principal amount may not be paid back. Companies with higher credit worthiness are more likely to be safe investments but their coupon rate will be lower than companies with lower credit ratings. Credit ratings are provided ...

Solution Summary

This solution discuses the differences between stocks and bonds with respect to ownership rights, claims on income and assets, maturity, risks, and tax treatment. It also explores reasons why an organization might choose one versus the other as a long-term financing instrument.

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