Bonds vs. Stocks The difference between a bond and a stock.
Bonds vs. Stocks
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- So we now know that there are two ways that a company can
- raise capital.
- It can do it by borrowing money, which is debt.
- Or by selling shares of itself, or essentially
- allowing other people to become partial owners of it,
- and that is equity.
- And these directly translate into securities, that you're
- probably familiar with, but maybe you didn't have a more
- exact idea of what they are.
- You know what equity securities are, and just so
- you know, what is a security?
- A security is essentially something that can be bought
- and sold that has some type of claim on something, or some
- type of economic value.
- So a security in the equity world is a stock.
- And a security in the debt world is a bond.
- Let me explain it.
- So let me just draw the balance sheet for the
- fictional company.
- It was pointed out to me that socks.com actually is not a
- fictional company.
- That someone is indeed selling socks online.
- Which, by the way, I think is a great idea.
- So let's see, I have my assets right here.
- These are the assets of the company.
- But that's not what we're worried about right now.
- And let me draw the equity of the company.
- This is maybe shares that they sold.
- So let's say that they have-- that there
- are 10 million shares.
- And then we have the debt, the debt of the company, or the
- There are other liabilities other than debt, per se, but
- that's all we'll worry about right now.
- This is the debt.
- I'll do it in brown.
- We have the debt.
- And maybe the assets-- let me just think of a good round
- number-- the assets are $10 million in assets.
- And let's say our debt is $6 million.
- And then what's left over for the equity-- and the way you
- have to view it is OK, if I have $10 million and I owe
- people $6 million, what's left for the owners of the company?
- Well, the owners of the company will
- have $4 million left.
- And it will be split amongst the owners of the company.
- And there's 10 million individual shares.
- So every person who has one of those stock certificates will
- own one ten-millionth of this $4 million, or essentially,
- $0.40 a share, or something.
- So anyway, this is-- and I think you're familiar with
- this already-- this is essentially stock.
- When we say 10 million shares, that's 10
- million shares of stock.
- I could just draw 10 million stock certificates.
- And, I guess, whatever the ticker symbol is.
- And there could be 10 million of those.
- Now debt is interesting.
- There's a lot of ways you can raise debt, and actually
- there's a lot of ways you could raise equity, it
- actually doesn't have to be with selling.
- Well, for the most part you are selling stock.
- You could maybe think of some other way, and we'll talk
- about other forms of equity, preferred
- stock and all of that.
- But in the simplest level, you're really
- always selling stock.
- Debt's a little different.
- Debt could be just in the form of a bank loan.
- So this could be a bank loan, where you literally go to the
- bank and say hey, I need $6 million, and they say OK, here
- you go, and we'll give it to you for this interest. And you
- have to pay back the money, above and beyond the interest,
- over this time schedule.
- So it's not too different than maybe a mortgage.
- Or they might say OK, you pay the interest for five years,
- and at the end of the five years you also have to pay the
- principal amount.
- So you have to pay the whole $6 million.
- Or you maybe have to come up with a new loan or
- something like that.
- So that would just be a bank loan.
- There's other things that are revolving lines of credit,
- which is kind of like a company's credit card to some
- degree, that it doesn't have to use it.
- But if it does, that's kind of debt the company takes on.
- But kind of the one that people always talk about, I
- guess in the same phrase, is bonds.
- So bonds are-- essentially you are borrowing from the public
- markets again.
- You are borrowing from a bunch of people.
- So what you do is you have, let's say, the $6 million.
- And it could be divided into-- you could divide this into
- 6,000 bond certificates.
- So this could be 6,000 bond certificates-- let me see, and
- six million divided by 6,000, that's a thousand, right?
- So it's going to be 6,000 times $1,000 bond
- And let's visualize what a bond
- certificate could look like.
- So that could be a bond certificate.
- And its face value, and sometimes they'll call it the
- par value, or the stated value.
- It'll say-- let's call it bond from Company XYZ.
- And it's face value is $1,000.
- So it's essentially-- this is an IOU from Company XYZ.
- If I were to hold one of these, if I had one of these
- sitting on my desk right now, that tells me that Company XYZ
- is going to pay me $1,000 at some future date.
- And that future date is at maturity.
- So it's going to pay $1,000 at maturity.
- And you say oh, well, Sal, that's all good, but what
- about the interest in between?
- And there's two ways to think about this.
- Maybe they're going to pay me $1000 in the future, but I
- only had to give them $500, right?
- So, if you think about it, there's automatically interest
- accruing in that.
- If I gave them $500 and then five years later they pay me
- $1000, they are essentially paying interest, right?
- They're paying me more back than I gave to them.
- And in future videos we'll actually do the math of how to
- figure out that type of interest.
- In that situation, where they're not kind of paying me
- interest as they go, this would be viewed as a zero
- coupon bond.
- And I know I'm throwing out a lot of terminology, but it'll
- all make sense to you to in a second.
- So zero coupon essentially means they're not paying
- interest until they pay off the whole loan.
- And then they might kind of-- the interest will be implicit
- in the whole value amount.
- And I kind of jumped the gun a little bit.
- But coupon is essentially a regular payment on the bond
- that the company makes, in this case XYZ will make, that
- is essentially-- you can almost view it as a kind of
- But if you really had to figure out the interest that
- you're getting on the bond, you'd actually have to
- figure-- and I'll do maybe a whole playlist on bond
- mathematics-- you would have to figure out-- It's based on
- the coupon, what you gave them, and then what they're
- going to pay you, and when they're going to do it.
- So it's a little bit more complicated than just saying,
- oh, look at that, they're giving a 6% coupon, which
- essentially means twice a year they're going to give me 3% of
- the value of my bond.
- So just as the big picture, both of
- these things are traded.
- This is a stock, it's traded on exchange.
- You're probably familiar that.
- If you go to Yahoo!
- Finance, you type in the ticker symbol and you get the
- price for that day.
- Bonds are also traded.
- Unfortunately, it's not as easy to get a quote on a bond.
- Usually you have to have a Bloomberg
- terminal of some type.
- You can't get it on Yahoo!
- Finance, and I think that's by design, by bond traders
- because they probably don't like the transparency there.
- But it is just like a stock.
- It is a security.
- It is traded.
- There is a price.
- But then there's a very fundamental difference in what
- the holder of the bond is doing.
- In a bond, you essentially-- if I'm holding a $1,000 bond,
- that means that I've lent some amount of
- money to the company.
- And it'll be in this part of it.
- And as long as a company doesn't go bankrupt, they'll
- pay me some interest and pay me my money back.
- When I own a stock in the company, I own a share of the
- equity, as opposed to a share of the debt, which is the case
- with the bond.
- When I own a share of the equity, the company's not
- promising to pay back anything.
- It's just saying look, you are a part owner of this company,
- and anything that any of the owners get, you'll get.
- So if this company becomes worth a lot.
- If we start dividending out things to the shareholders,
- then you'll get that.
- If the company gets sold by someone and pays x dollars per
- share for it, you'll get that money.
- And if the company goes bankrupt,
- you'll also go bankrupt.
- So that actually leads to an interesting question, if the
- company goes bankrupt-- actually, let's do the
- example right now.
- Let's say the company goes bankrupt.
- And I'll do a more in-depth example of this.
- The question is, let's say the company goes bankrupt.
- And people decide that it's not operational anymore, that
- it just can't do business.
- Because there's actually two types of bankruptcy.
- There's one where you say, oh, the business is good, and just
- can't pay off it's debts.
- So we have to somehow restructure this side of it.
- And then the other type of bankruptcy is liquidation,
- where they say, you know what?
- This business doesn't even make sense
- to operate any more.
- Let's just sell off all of the assets.
- So the question that I'll leave you with in this video
- is, what happens in a situation where you enter
- People want to liquidate the assets.
- And let's say when you liquidate the assets, there's
- only $8 million of assets.
- So, the question is, who do you think is going to eat that
- $2 million.
- Is it going to be the debtholders, or the
- Who is going to lose their money first, or you can almost
- say, who is more senior when it comes to actually getting
- their money back?
- And I'll leave you with that, maybe to the next video, or a
- future video that I'll do on bankruptcy.
- See you in the next video.
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