 Personal Finance PowerPoint Presentation. Bond Market versus Stock Market. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia Bond Market versus Stock Market. What's the difference which you can find online? Take a look at the references, resources, continue your research from there. This by Chisoba Mora, updated February 22, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping those in mind, comparing and contrasting now the bond market and the stock market. It's time to invest your money. So how exactly are you going to allocate that money? As we've seen in prior presentations, we often want to keep in mind that allocation method, that diversification, and the two key components or two of the major components we might want to be allocating between are equities or the stocks and the bonds fixed income. So after all, a well-diversified portfolio strategy is recommended before you start to buy assets such as stocks and bonds. Now notice you're going to hear this all the time every time you think about investments, allocation of your assets, diversification, and it's a good idea to be diversified, especially of course on the long run, keeping into consideration your total investment goals, your time horizon, and your risk tolerance levels. But even though we hear it all the time, it's kind of difficult to do in practice because oftentimes when we see stocks doing quite well, if the market's going quite well, then we feel like the bonds aren't really giving us that return, and we tend to want to then move to the stocks. And when the economy goes down, we start to feel like, oh well, the stocks are getting killed over here. I want to move my money straight into the checking account possibly, or into a savings account, CDs, or into bonds. So it's really important to kind of drill in our mind that this diversification goal, time horizon, and reiterate them because they're hard to do in practice. So indeed, stocks and bonds are two of the most traded types of assets, each available for sale on several different platforms or through a variety of markets or brokers, and there are important primary differences between stocks and bonds. The bond market, the bond market is where investors go to trade, buy and sell debt securities, prominently bonds, which may be issued by corporations or governments. So on the bond side of things, we're often thinking about first possibly the government bonds because those are the great measuring tools to be comparing to because they have a very low default risk related to them because the government bonds should be able to pay back their debts given the fact that they can tax and they can basically print money. So then you can use them as a baseline to compare other bonds. You can think of bonds as in essence for you loaning money to the issuer of the bond, the government or the corporation and they in return giving you the promise to pay back the bond at the end, that being the maturity and generally some kind of interest, interest being similar to say rent, if you were to say rent someone an apartment for example, you would expect the apartment back at the end of the rental period and rent for the use of the apartment. Interest is basically the rent for the use of the money. So the bond market is also known as debt or credit market. Securities sold on the bond market are all various forms of debt. By buying a bond, credit or debt security, you are lending money for a set period and charging interest the same way a bank does to its debtors. So the bond market provides investors with a steady, albeit nominal source of regular income. So the idea of the bond or what's good about the bond is typically you're going to have your income preset for the standard types of bonds because you've agreed to a set interest rate. However, that interest rate usually doesn't have a return that would be as potentially high as investing in stocks, but you also don't typically have the potential of it really going down a lot below the principle, for example, because of the setup of the bonds where on the stocks you have more risk of that. So in some cases, such as treasury bonds issued by the federal government, investors receive biannual interest payments. So when you basically rent out property, you often get paid on a monthly basis. When you do the bonds, a typical kind of payout would be on a bi-yearly basis, meaning every six months. Many investors choose to hold bonds in their portfolios as a way to save retirement for their children's education or other long-term needs. Investors have a wide range of research and analysis tools to get more information on bonds. Investopedia is one source breaking down the basics of the market and the different types of securities available. Other sources include Yahoo Finance Bond Center and Morningstar, so you can check them out to kind of look at ratings, for example. They provide up-to-date news analysis and research. Investors can also get more specific details about bond offerings through their brokerage accounts. So where bonds are traded, the bond market does not have a centralized location to trade, meaning bonds mainly sell over the counter, OTC. As such, individual investors do not typically participate in the bond market. Those who do include large institutional investors like pension funds, foundations and endowments, as well as investment banks, hedge funds and asset management firms. Individual investors, when we're thinking about the individual side of things, who wish to invest in bonds may do so through a bond fund managed by an asset manager. So oftentimes, we're going to be using the bonds and possibly not buying the bonds on an individual bond-by-bond basis, but possibly using some kind of asset manager, possibly using tools such as mutual funds, ETS. Many brokers now allow individual investors direct assets to corporate bond issues, treasuries, munis and CDs. New securities are put up for sale on the primary market, and any subsequent trading takes place on the secondary market. So this concept of primary market and secondary market can sound confusing, but the primary market just means with regards to bonds, buying the bonds directly from the issuer of the bonds, be that the government or the corporation typically. When you're thinking about the secondary market, now you have the bonds already issued and you're selling from one investor, say, to another investor, not buying them directly from the issuer. So the market where investors buy and sell securities they already own. So these fixed income securities range from bonds to bills to notes. By providing these securities to the bond market, issuers can get the funding they need to project for projects or other expenses needed. So who participates in the bond market? The three main groups involved in the bond market include the issuer. These are the entities that develop, register and sell instruments on the bond market, whether they're corporations or different levels of government. So typically the issuer, they're the ones that need the money, they're the one we're in essence loaning to if we are investing corporations and governments typically. For example, the U.S. Treasury issues, Treasury bonds, which are long term securities that provide biannual interest payments for investors and mature after 10 years, investing in certain securities of the bond market such as U.S. Treasury securities is said to be less risky than investing in stock markets, which are prone to greater volatility. So obviously, again, that government bonds are typically the baseline that we can compare to due to the less risk because you don't have the default risk as prevalent there because they can print money and tax to service debt. Underwriters usually evaluate risks in the financial world. In the bond market, an underwriter buys securities from the issuer and resells them for a profit. Participants, these entities buy and sell bonds in other related securities. By buying bonds, the participant issues a loan for the length of the security and receives interest in return. Once it matures, the face value of the bond is paid back to the participant. So bond ratings. Bonds are normally given an investment grade by a bond rating agency like Standard and Poor's and Moody's. These ratings expressed through a letter grade tell investors how much risk a bond has of defaulting. So they're not perfect, but these rating agencies can help us to determine the risk levels of the bonds, helping us to determine prices, helping us compare and contrast different types of investment opportunities of a similar nature. A bond with an AAA or A rating is high quality while an A or BBB rated bond is medium risk. Bonds with a BB rating or lower are considered to be high risk. So the stock market. The stock market is a place where investors go to trade equity securities such as common stock and derivatives including options and features. So typically when we think about the stock market, we're usually kind of thinking primarily the common stock is the baseline investing tool that most individual investors would be thinking about having an equity investment in the company. Meaning you actually if you actually own the stocks, you typically have a voting capacity and you're basically it's thought to have the claim to basically the assets minus the liabilities or in essence the equity of the company. Stocks are traded on stock exchanges. So typically when we're buying stocks as an individual investor, we're not buying private stocks, we're buying public stocks typically, which are typically larger stocks, larger stocks that want to have that outside investment from a larger pool to get more capital. So they can basically grow and therefore participate on exchanges, exchanges then requiring some more transparency and formalization and standardization on how these corporations represent or present their financial statements so that investors can do comparing and contrasting more easily between different types of investments and have a more transparent option for their investments, giving a higher level of trust to investors opening up markets beneficial both to the investors as well to the companies that can generate capital that way. So buying equity securities or stocks means you are buying a very small ownership stake in a company. So you can think of that similar as like a voting right that we have in a Democratic Republic, for example, in a Democratic Republic, we don't basically vote on every decision like whether to go to war or something like that. We vote instead for people to represent us who then you know kind of make the decisions similar things with the stocks. We have a kind of voting capacity. We can vote for things. For example, the board of directors, the board of directors should be repping representing us by trying to make money by hiring management that will be capable of making decisions in order to generate revenue for the stockholders. So while bondholders lend money with interest equity holders purchase small stakes in the companies on behalf of the company performs well and the value of the shares purchase will increase. So as a stockholder, we can get paid back in a couple of different ways. We're not just going to get fixed interest payments. We might get dividend payments, but the dividend payments are going to be dependent upon whether the company through management we can vote for the board of directors and stuff but they still once voted for half the decision making power to well that whether or not they give out dividends or not, which would be basically given back some of the earnings of the company or whether they don't give dividends or decrease the dividends and put the money back into the company. And if they do that, hopefully we we benefit from them adding value to the company increasing the stock price of the company, which we can then sell. So the primary function of the stock market is to bring buyers and sellers together into a fair regulated and controlled environment where they can exercise their trades. This gives those involved in the confidence that trading is done with transparency and that pricing is fair and honest. So the exchanges help us to basically do that. And that's one of the reasons that the United States, for example, exchanges typically can garner a lot of capital investment due to the fact that there's a pretty high level of security related to them. If you can generate the trust, then you can often generate you know the capital related. So this regulation not only helps investors but also the corporations whose securities are being traded. So obviously the company wants access to the capitals and we as investors want to be able to trust the system so that we're feel comfortable investing in them. So the economy thrives when the stock market maintains its robustness and overall health. So just like the bond market, there are two components to the stock market. The primary market is reserved for first run equities, initial public offerings, those of the IPOs will be issued on the market. So you're basically buying directly from the company as the company issues new stocks. Most of the time we're not buying IPOs when we're investing in the stock market. We're buying from other people that are investors that are reselling the stock. So this market is facilitated by underwriters who set the initial price for securities. Equities are then opened up on the secondary market. So secondary market, similar to as we saw with the bonds, instead of us buying the stocks directly from the issuing company, we're buying them from other investors. So which is where most trading activity happens. That's where we typically are at. So the prominent US stock exchanges in the United States, the prominent stock exchanges include the NASDAQ, a global electronic exchange that lists the securities of smaller capitalization companies from different parts of the world. Although technology and financial stock make up the bulk of the index, it also includes consumer goods and services, healthcare and utilities. This exchange also forms the basis of the US technology sector benchmark index. So indexes are great tools because they're kind of averages to try to get an idea of different components of the market or possibly the market as a whole, basically using kind of averaging techniques and using certain stocks that you think are hopefully this basket of stocks represents a certain component or segment or possibly the entire market. So then we got the New York Stock Exchange. The NYSE is the largest exchange in the world based on the total market cap of its listed securities. Most of the oldest and largest publicly traded companies are listed on the New York Stock Exchange. The New York Stock Exchange has gone through a series of mergers and was most recently purchased by the Intercontinental Exchange, the ICE in 2013. 30 of the largest companies in the New York Stock Exchange make up the Dow Jones Industrial Average, the DJIA, which is one of the oldest and most watched indexes in the world. So again, this is a type of index that's trying to give us, you know, a measure of a component basically of the market. These indexes can be quite useful. American, although they have their limitations, they're kind of like averages, you know, they have their uses, they're not perfect. American Stock Exchange, the AMEX, which was acquired by the New York Stock Exchange, Aaron X, and became the New York Stock Exchange American in 2017. It was first known for trading and introducing new products and asset classes. The exchange was also the first to introduce an EFT operating electronically. The exchange is home to most small cap stocks. Key differences. One major difference between the bond and stock markets is that the stock market has central places or exchanges where stocks are bought and sold. The other key difference between stock and bond market is the risk involved in investing in each. When it comes to stocks, investors may be exposed to risks such as country or geopolitical risk based on where the company does business or is based. Currency risk, liquidity risk, or even interest rate risk which can affect a company's debt, the cash it has on hand and its bottom line. Bonds, on the other hand, are more susceptible to risks such as inflation and interest risk. When interest rates rise, bond prices tend to fall. If interest rates are high and you need to sell your bond before it matures, you may end up getting less than the purchase price. So we've talked about some of these risk factors in a bit more detail in prior presentations. Obviously, when we think about different types of investments, there's always risk and reward that we have to basically balance out. And the idea of diversification is to get some areas where typically when one component such as stocks is possibly going to be doing well, then maybe the bonds are not going to be at the stocks go down because they have more volatility and are more likely to fluctuate up and down. Possibly then the bonds might be there to kind of hedge us out and not experience those deep dips on the bond side of things. But you can get into more detail on each of those risk factors individually as well. So if you buy a bond from a company that isn't financially sound, you're opening yourself up to credit risk. In a case like this, the bond issuer isn't able to make the interest payments leaving itself open to default. So if you buy bonds that are less secure, like if you buy government bonds, it's less likely or almost not likely at all, hopefully that the bonds are going to have a default risk because that would mean that the U.S. government couldn't service their debt even though they have taxation capacity as well as possibly basically printing money. But a lot of times when we're talking about individual investors, they'll go to the higher grade bonds and they'll go to the U.S. government bonds because those are going to be the bonds that you're trying to use to temper or mitigate the risk of the more volatile stocks. But it kind of depends on your overall investment strategy. So you could go to more risky bonds which might have a higher possible return but they also have more risk involved with them. So stock market or performance can broadly be gauged using indexes such as the S&P 500 or Dow Jones Industrial Average. These indexes are great because they're trying to give us an idea of sections of the market. And also if we use investment tools like ETFs or mutual funds, we can tie them to these indexes and that could possibly cost less in terms of management, could cost for the management of like a mutual fund. We've talked about mutual funds in prior presentation. Similarly, bond indexes like the Barclays Capital Aggregate Bond Index can help investors track the performance of bond portfolios.