The difference between stocks and bonds is that stocks are shares in the ownership of a business, while bonds are a form of debt that the issuing entity promises to repay at some point in the future. A balance between the two types of funding must be achieved to ensure a proper capital structure for a business. More specifically, here are the key differences between stocks and bonds:
- Priority of repayment. In the event of the liquidation of a business, the holders of its stock have the last claim on any residual cash, whereas the holders of its bonds have a considerably higher priority, depending on the terms of the bonds. This means that stocks are a riskier investment than bonds.
- Periodic payments. A company has the option to reward its shareholders with dividends, whereas it is usually obligated to make periodic interest payments to its bond holders for very specific amounts. Some bond agreements allow their issuers to delay or cancel interest payments, but this is not a common feature. A delayed payment or cancellation feature reduces the amount that investors will be willing to pay for a bond.
- Voting rights. The holders of stock can vote on certain company issues, such as the election of directors. Bond holders have no voting rights.
There are also variations on the stock and bond concept that share features of both. In particular, some bonds have conversion features that allow bondholders to convert their bonds into company stock at certain predetermined ratios of stocks to bonds. This option is useful when the price of a company's stock rises, allowing bondholders to achieve an immediate capital gain. Converting to stock also gives a former bond holder the right to vote on certain company issues.
Both stocks and bonds may be traded on a public exchange. This is a common occurrence for larger publicly-held companies, and much more rare for smaller entities that do not want to go through the inordinate expense of going public.