Understanding Bonds and Stocks

This document provides an overview of bonds and stocks, including their features, trading methods, and how to calculate annual return rates. It explains the concept of bonds, their features such as face value, coupon, and maturity, and how they are traded. It also discusses stocks, their features such as dividends and voting rights, and the process of trading stocks. Additionally, it provides a formula for calculating annual return rates and includes examples for better understanding. References are also provided for further reading.

Running Head: Investing
INVESTING
Student Name
Institution Affiliation
Instructor’s Name
Date

Investing
a) What are bonds? What are their features and how are they traded?
A bond is a formal contract where the borrower is obliged to repay borrowed amount of money
with interests (coupon) at fixed intervals over a period of time. The interest rate maybe fixed or
floating. In this contract, the principal amount is repaid upon maturity.
Features of bonds
Face/par value- The face value in bond contract refers to the principal amount that the
bondholder will be paid or receive upon maturity. This value is the given amount rather than the
value of the bond.
Coupon- This refers to the interest that the bond yields. It is normally paid by the borrower at
fixed or floating rates over a fixed period of time. The yield is normally expressed in terms of
percentage and is determined by the prevailing factors such as prevailing interest rate, inflation
and probability of not being paid.
Maturity-This refers to the date when the principal amount of the bond becomes due and must be
repaid in full to the bondholders. It is normally influenced by the issuer. Maturity influences
yields in that the longer the maturity the higher the yields and vice-versa.
Issuer- This refers to the company or government that issues the bond. The issuer is the borrower
and is obliged to repay back the maturity in addition to periodical interest paid to bondholders.
How bonds are traded
The bond issuer issues bond to the broker who buys and resell them to investors. Investors who
then want to trade in bonds would then be required go through a broker, who acts as an agent of
the issuer. The bonds are issued at par value.

Investing
b) What are stocks? What are their features and how are they traded
Stocks are units of ownership in a company. Therefore when one buys a stock, he/she has an
ownership equivalent to the proportion of one’s stocks. Stocks do not have fixed returns.
However, shareholders are entitled to dividends whenever the company makes profit. They are
usually issued by companies in order to raise additional capital.
Features of stocks
They earn dividends whenever the company makes profit. Ordinary shareholders are paid
dividends after all company obligations have been settled such of repayment of debentures.
Ordinary shareholders have voting rights. They can vote in an annual general meeting on matters
concerning the company.
They are free transferable. Stocks can freely change ownership from one person to the other
unlike debentures.
The rate of dividends vary depending on the company’s performance. For instance, if the
company makes supernormal profits, higher rates of dividends will be paid unlike when the
company has underperformed.
In the event of winding up or liquidation, shareholders are paid last after all the other obligations
have been settled.
How stocks are traded
Stocks are traded through brokers who are members of stocks or securities exchange. The
prospective buyer registers with the broker upon which an account for him/her is opened. The
investor would use the account to buy and sell shares of different companies through the broker.

Investing
c) How do you calculate an annual return rate
Annual return rate is calculated by applying the formula:
Return rate percentage= (Income + gain)/ Original value
Where Gain= Ending value – Original value
d)
Return rate percentage= (Income + gain)/ Original value
Suppose Original price is $100 and the market price =$120 and the company pays no
dividends
Gain=120-100=$20
Income=0
Return rate %=Gain/Original value
=20/100
=0.2
=20%
e)
Return rate percentage= (Income + gain)/ Original value
Suppose Original price is $100 and the market price =$120 and the company pays
dividends of $40 per share
Gain=120-100=$20
Income=$40
Return rate %= (Income + Gain)/Original value
= (40+20)/100

Investing
=60/100
=0.6
=60%

Investing
References
Burton G. Malkiel, A Random Walk Down Wall Street, 10th ed. (New York: W. W.
Norton & Company, Inc., 2007).
Charles P. Kindleberger, A Financial History of Western Europe (London: George Allen
& Unwin, Ltd., 1984).
Financial Industry Regulatory Authority (FINRA), http://apps.finra.org/ (accessed May
20, 2009)
John Sabelhaus, Michael Bogdan, and Daniel Schrass, “Equity and Bond Ownership in
America, (2008),” Investment Company Institute and Securities Industry and Financial
Markets Association, http://www.ici.org/pdf/rpt_08_equity_owners.pdf (accessed on
May 20, 2009)