Bonds vs. Stocks Video Lecture | Stocks, Bonds, Equity and Valuation : Complete Knowledge - Entrepreneurship

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
liabilities.
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
certificates.
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
interest.
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
bankruptcy?
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
stockholders?
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.