Shareholders are the owners of publicly traded companies. Bondholders are lenders or creditors, if you will. Corporate bonds carry a lower risk than stocks because bondholders are higher on the ladder when making claims on a company's assets. In the event of liquidation, paying bondholders therefore takes precedence over satisfying stockholders. The two basic kinds of stock are common and preferred. Bonds come in basic varieties with the main differences being the type of issuer — a municipality, a corporation or the U.S. government.
Common stock shares may be categorized by classes. For example, a company may issue Class A and Class B stock. However, there is no uniform description from company to company. One publicly traded company may issue a Class B stock that carries voting rights. Another company's Class B stock may have no voting rights attached. Shares of common stock are bought and sold on the major exchanges. Investors in common stock anticipate growth and an increase in share prices and plan to receive dividends.
Preferred stock shares have characteristics in common with corporate bonds. Preferred shares pay fixed dividends and there is little variation in price of individual shares. Preferred shares usually carry no voting rights but preferred shareholders hold claims on assets before common shareholders. The board of directors of the company must vote to pay dividends on preferred stock shares with no guarantee that the dividends will be paid. However, not paying dividends hurts the credit reputation of the company.
Municipal bonds are issued by state and local governments to finance public projects, such as roads or waterworks, or to generate revenue. Thus, munis come in two types: general obligation bonds and revenue bonds. General obligation municipal bonds are backed by the financial strength of the issuing government and its power to tax. Revenue munis are backed by proceeds from the project being funded. For example, a municipality may issue bonds to finance the construction of a new electrical plant with investors paid from the profits generated. The tax treatment of munis is attractive to high-income investors, as municipal bonds are exempt from federal taxation and state taxation in the jurisdiction of issue, provided the taxpayer also resides there.
Most corporate bonds pay interest on a set schedule. Corporate bonds carry various levels of risk, depending on the creditworthiness of the issuer. Corporate bonds are also issued with varying levels of maturity. Issues of corporate bonds carry different provisions in the indenture, the legal agreement attached to the issue that details what the issuer's responsibilities are and the payment schedule. One example of a provision a corporate bond may have is convertibility. A conversion provision allows the bondholder the option to trade the bond for a specific number of the company's stock shares. Corporate bonds are rated by the level of assessed risk. A bond rated AAA has almost no risk of default. Different rating agencies use slightly different grades for labeling bond ratings.
Treasury bonds, issued by the United States Treasury pay low interest rates because they carry virtually no risk of default. Known as fixed-income securities, Treasury bonds mature in one to ten years depending on the issue. Treasury bills mature in one year or less and Treasury notes mature in one to 10 years. Agency bonds are issued by U.S. government agencies such as the Government National Mortgage Association, a.k.a. Ginnie Mae. Agency bonds pay higher interest rates than Treasury bonds, but have a low level of risk because investors assume the federal government would not let an agency default on an issue.
- BetterInvesting: Little Common About Preferred Stock
- California State University Sacramento: Common Stock Basics
- Finance: Investments, Institutions, Management; Stanley G. Eakins
- Investment Analysis and Portfolio Management; Frank K. Reilly and Keith C. Brown
Vicki A Benge began writing professionally in 1984 as a newspaper reporter. A small-business owner since 1999, Benge has worked as a licensed insurance agent and has more than 20 years experience in income tax preparation for businesses and individuals. Her business and finance articles can be found on the websites of "The Arizona Republic," "Houston Chronicle," The Motley Fool, "San Francisco Chronicle," and Zacks, among others.