Bond Market vs. Stock Market: What’s the Difference?

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by Adedamola Bada · 8 min read
Bond Market vs. Stock Market: What’s the Difference?
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Being available for operating on different kinds of platforms, both stocks and bonds fall under the category of most traded items globally. Check the fundamentals of each asset type and find what makes them different.

The financial market has to do with any marketplace that facilitates the buying and selling of securities, such as the bond and stock market. These markets are indispensable, especially for the capitalist economies, because they provide firms and businesses with adequate resources and liquidity. Financial markets help buyers and sellers to actively carry out transactions with their financial holdings.

Some particular securities are more popular than others in the financial markets which is based on their history and performance. Stocks and bonds happen to fall under the category of most traded items because they can be sold or bought on different platforms. Stocks are also referred to as shares or equity in a publicly-traded firm. Bonds refer to a fixed-income loan a government or private entity receives from an investor.

Overview of Stock Market vs. Bond Market

Whenever the term stock market is mentioned, in most cases, it means one of the top stock market indexes like the S&P 500 or the Dow Jones Industrial Average. This is often the case because it’s burdensome to keep track of all stocks in the market. So, the way out is to use these indexes, which shows the exploits of the stock market, to monitor the entire market.

Bonds refer to the situation when an investor lends money to a corporation or government. An investor receives interest on the loan as long as the money remains with the borrower. Once the period for the loan expires, the principal will be returned to the investor.

Bond Market Explained

The financial market where bonds can be issued and traded by participants is known as the bond market. Bonds are official documents showing the obligation of the issuer to repay a monetary debt owed the holder. They can also be said to be a type of loan which makes governments or big corporations indebted to the general public.

Every bond has what’s called a “date of maturity,” which compels the borrower to repay the principal upon its arrival. Before this date comes, the time in between is known as the bond’s term. The creditors receive payment in the form of interest from their loaned money. The interest comes in periodically and is known as the coupon. This coupon has a rate attached to it, which is determined by the perceived risk and term of the bond.

Investments usually come with a level of risk, and the same applies to bonds. The lender should be aware that the borrower may fail to meet up with coupon payments or the return of the principal. This is known as credit risk. However, in the event of bankruptcy, the bondholders will have it easier than shareholders because, as creditors, they are entitled to be repaid first.

Where are Bonds Traded?

There’s no particular place apportioned for the bond market, which makes bonds an over-the-counter (OTC) transactions. This makes it very difficult for individuals to get involved in the bond market on their own. For an individual to actively invest in bonds, they have to go through a bond fund overseen by an asset manager. Non-individual bond investors include hedge funds, pension fund foundations, asset management firms, investment banks, and lots more.

New securities are advertised on the primary market, while the secondary market is used to further any subsequent trading. Securities are provided on the bond market by issuers to raise funds for their projects.

Bond Ratings

A bond rating is done by a bond rating agency such as Standard & Poor’s and Moody’s. The rating serves as an investment grade and is usually in the form of letters. The letters inform the investor of the risk level of the bond. When a bond has a “AAA” or “A” rating, it means it is of high quality. A bond rated “A”- or “BBB” is considered medium risk. When a bond has a BB rating or lesser, it is said to be high-risk.

How Bonds Affect the Stock Market

Since both the stock and bond markets are after the money of investors, there’s bound to be stiff competition between them. Generally, bonds are considered safer compared to stocks, though their return is lower. Therefore, when the value of stocks is high, that of bonds fall.

The success of the economy has a direct effect on stocks. When the economy is doing well, the stocks will boom. When the economy is no longer doing well, the prices of stocks fall. At this point, investors move over to bonds because of their regular interest payments.

There are times when the value of stocks and bonds go up at the same time. This is caused by a lot of money in circulation, liquidity, or reduction in the chase for investments. Also, it is possible for stocks and bonds to fall at the same time; investors going on a selling spree causes this. When this happens, it is usually followed by a rise in the price of gold.

Stock Market Explained

An ecosystem set aside solely for the purpose of buying and selling derivatives and equity securities is called a stock market. When we say equity securities, we mean common stocks, while derivative talks about futures and options. Now, trading of stocks requires its own platform, which is called a stock exchange, and the acquisition of stocks from a company gives the buyer a small stake in the company. This stake is considered valuable or not based on the performance of the company. The more success a company achieves, the more valuable its stock becomes.

One of the perks of the stock market is regulation. It gives investors the confidence to trade, knowing that their assets are safe. The stock market also features two components, just like the bond market, namely the primary and secondary markets. The primary market serves for the issuance of initial public offering (IPO), while the secondary market is where the actual trading happens.

Where are Stocks Traded?

A stock exchange is a central marketplace where investors can come to trade stocks. Two types of stock exchanges exist, and they are the physical exchanges and virtual exchanges. In the case of the physical exchanges, human presence is needed for trading to commence. Virtual exchanges mainly require a network of computers to perform their duties.

Listed below are some of the most prominent stock exchanges in the world:

NASDAQ

This is an electronic exchange with global recognition. It is home to a list of stocks belonging to companies with smaller capitalization. Various industries are represented on this exchange; some of them include the healthcare, financial, technology, consumer goods and services, and utility industries. Nasdaq is among the platforms that contribute to the US technology sector benchmark index.

New York Stock Exchange (NYSE)

Going by market capitalization, this exchange stands shoulders tall above all others, ranking as the world’s most extensive exchange. Securities belonging to many old and successful conglomerates are listed on the NYSE. Over the years, the NYSE has been passed from one owner to another due to a sequence of mergers. The current owner of the exchange is the Intercontinental Exchange (ICE), an acquisition that took place in 2013. About thirty of the biggest names on the NYSE are featured on the Dow Jones Industrial Average (DJIA), the world’s most-watched index.

The American Stock Exchange (AMEX)

Whenever a new asset class or product is about to be launched, this stock exchange is used to facilitate it. Bought in 2009 by the NYSE Euronext, the stock exchange is now known as the NYSE Amex Equities. It is also the first exchange to launch an ETF. This exchange lists mainly stocks with small capitalization, and it is an electronically operated platform.

One body oversees the regulation of these markets, and that is the US Securities and Exchange Commission (SEC), the SEC is in charge of enforcing financial policies and laws on these markets.

Key Differences

The stock market has a central place for buying and selling of equities while the bond market does not. The stock market is prone to a lot of risk factors like geopolitical risk, currency risk, interest rate risk as well as liquidity risk. These can influence a company’s cash at hand, debt and its bottom line.

Bonds are, however, not immune to risks. Their most significant risks include interest rates and inflation. When interest rates go up, the price of bonds goes down. Purchasing a bond from a financially unstable company amounts to credit risk. The company is very likely to default on interest payments.

Comparing the two markets side-by-side, it is safer to invest in bonds, like the U.S. treasury securities, than in stocks because the latter is more susceptible to volatility.

Summary

A financial market is a converging point for people who desire to grow their financial portfolio or companies who are seeking more funds for their projects. These individuals and companies have increasingly gravitated towards the bond market and stock market because of the benefits derived from them. Where the bond market lets participants trade and issue bonds, the stock market allows them to trade and issue stocks.

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