There are a lot of similarities and differences between common stock and bonds. The similarities are in terms of purpose of issue and the regulation of the securities. The differences are in terms of place of buying and selling, issuing organizations, maturity, cash flow timings, risk profiles, seniority during liquidity, and voting rights.
Both bonds and common stocks are types of capital market securities that are issued to raise capital to fulfil the capital needs of organizations. Organizations issue these securities in capital markets as per their financing needs. Also, these securities are regulated by the same regulator in most countries, the body which regulates capital markets.
The difference between bonds and stocks in terms of place of trading is that there are proper organized stock exchanges where stocks are bought and sold. On the other hand, bonds are traded in an over the counter market, i.e. there is no physical place where the trading of bonds take place.
Also, common stock is issued generally by companies whereas bonds can be issued by governments, companies, municipalities etc. Each of these organizations issue different types of bonds, suited to their capital requirements.
While common stock is perpetual in nature, bonds have a fixed maturity, which can range from one year to up to thirty years. So far thirty year bonds are the longest maturity bonds that have been issued anywhere in the world.
Further, cash flows for stocks is through dividends, while for bonds it is through periodic interest payments and also the principal amount at the time of maturity. Bonds have senior claim to cash flows at the time of liquidity, i.e. when a company defaults, its assets will be used to first pay bondholders and then stock holders.
Stock holders get ownership in the company and have voting rights proportionate to their holding in the company, while there are no such rights for bondholders. So, overall the risk profile of bonds is considered much lower as compared to stocks, resulting in stocks attracting an equity premium when they are valued.
Investment returns can vary from one type of security to other in terms of both quantity and source of return.
Returns for bonds are due to two sources, interest payment called coupons, and price changes due to yield change. Coupons are periodic payments from the issuer to the bondholders. This coupon is fixed at the time of issue of the bond, as a percentage of the face value of the bond. Further, when bonds are traded from the time of issue till the maturity, the yield on the bonds change. As a result the price of the bonds also fluctuate (Boundless).
If the yield on the bond is more than the coupon, the bond trades at a discount to the face value and vice versa. So an investor who does not hold the bond till maturity, will derive return from the change in price while the bond is being traded.
Returns for common stock can be from two sources, capital gains and from dividend gains. Capital gains occur when the price of the stock moves upwards as compared to the buying price of the stock. Most investors invest in common equity in search of capital gains (Boundless).
Another source of return in common stock is through dividends. Although it is not a legal requirement for companies to pay out dividends and a lot of large companies do not pay dividends, this can be a major source of return for a lot of investors. Further, the stock price changes also depend on the dividend yield of companies, thus affecting capital gains as well (Boundless).
Preferred stock returns are from dividend payments, which are generally fixed and accumulating. While companies may not pay dividend to common equity holders, dividend payments for preferred stock is guaranteed and if not paid in a particular year, it gets accumulated and added to the next year’s payments (Boundless).
References
Boundless. (2015). Comparing Common Stock, Preferred Stock, and Debt. Boundless Finance. Retrieved from https://www.boundless.com/finance/textbooks/boundless-finance-textbook/stock-valuation-7/rules-and-rights-of-common-and-preferred-stock-72/comparing-common-stock-preferred-stock-and-debt-328-3880/.
