Why Are Bonds Less Risky for a Corporation As Opposed to Stocks?
Many corporations choose to invest money in both stocks and bonds. This money may be invested for a number of different reasons. For example, if the company has ample cash reserves, such as money set aside for a pension fund, in lieu of letting the funds collect interest, it may seek to invest the money in liquid securities, such as stocks and bonds. In some cases, bonds may be a less risky investment than stocks.
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Bonds
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A bond holder is entitled to payment from the party that issued the bond. If the bond issuer does not default, then the bond holder will be compensated at a designated time. One of the advantages of bonds, as an asset, is that investors can choose what sort of risk they want to take when investing in bonds. Riskier bonds generally command a higher interest rate for the holder while more stable ones offer a smaller rate of return.
Bond Ratings
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One of the chief measures for determining the risk of a bond is its rating. Ratings are issued by bond rating companies, which look at the financial stability and credit history of the issuer and attempt to determine the likelihood that it will default on bond payments. Riskier bonds receive lower grades. A company that wants to invest in conservative bonds would likely choose highly rated bonds as their issuers are unlikely to default.
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Stocks
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Stocks, by contrast, do not have a formal rating system. While some stocks may be considered more secure than others -- for example, a well-established stock that regularly turns a profit is called a "blue-chip" stock -- the price of a stock reflects the performance of the company. If the company is expected to perform poorly, then the price of the stock may decrease. Yet, some stocks also carry a higher potential for appreciation than many bonds.
Considerations
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Bond ratings are only an estimate of a bond's stability. In some cases, a bond issuer that receives a bond rating firm's highest rating may still default. As with all securities, bonds are not a sure thing. However, bonds are generally not subject to the kind of asset-wide devaluation that can beset stocks in times of economic turmoil. In these circumstances, even blue chip stocks can see their prices fall, albeit often only temporarily.
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