Question

A common analytical definition of an asset is that it is “a claim on an uncertain future income stream”. Use this definition to clarify the similarities and differences between corporate stocks and corporate coupon bonds. That is, what are their income streams like and how do they differ; and what are the risks of owning them and how do they differ?

Answer 1

Essentially a corporation and a Public company can raise funds in many ways. It can either be through "Equity Shares ( Stocks of the company) or through Debt ( bonds ).

When it comes to Equity Shares ( Stocks ) , the issuer of the said stocks is never obliged to pay dividend or any share of the profit , this makes the income streams not constant .

In the case of bonds, the issuer borrows some capital / money from the holder and is liable to pay a fixed interest amount to the holder essentially making the income steam constant in nature   

When it comes to bonds , the time period for it is limited and fixed and the issuer pays off the holder at time of maturity. This makes bonds a type of loans for the company. Yet this isn't the same with stocks as stocks exist as long as the company does and at the time of company dissolution, the holder isn't neccessarily paid back the sum he/she initially did.

Bond holders are the creditors of the issuing corporation and not its owners and don't take part in the managerial decisions.

Stock holders are the owners of the issuing corporation and do take part it its managerial activities.This ownership exists till the shares are sold or the company dissolves.

When it comes to the corporate POV, Owing bonds is highly risky as they are liable to pay said fixed sum in a timely manner and are obliged to pay off the holder at time of maturity. Thus Big Corporations with a healthy treasury are likely to issue bonds when they find it easier to raise funds in that way and cheaper than bank loans.

In the case of shares or stocks , a corporation as a lighter tread in matters of dividend payment and paying off the stock holder as there doesn't exist any obligation to do so. The only main risk companies face is to raise funds in this manner as its highly unlikely for investors to trust any IPO or New company with investment and amount and frequency of dividends. Big and trusted corporations don't face this issue.

Bonds face certain risks and they are

1) Inflation Risks : It is when the payout and the intrest from the bond doesn't correlate with rise in intrest, thus making bond investments contract significantly.

2) Credit Risks: A risk where the company fails to pay the initial sum and intrest.

3) Intest rate risks: Rise in Bond Intrest rates will reduce the bond price and will essentially result in investors withdrawing and not investing on said bonds.

4) Liquidity Risks : This risk is when the bond holder find it difficult to sell of his bonds , that is when the bond holder finds it difficult to find any potential buyers willing buy the said bonds.