Question

What are bonds? What are their features and how are they traded?

b. What are stocks? What are their features and how are they traded?

c. How do you calculate an annual rate of return?

d. You buy a share of stock for $100 and it pays no dividend. A year later the market price is $105. What is the rate of return?

e. You buy a share of stock for $100 and a year later the market price is $105 and it pays a dividend of $2. What is the return?

Answer 1

a) Bonds are a type of debt which is issued by companies to raise funds from the investors. The key features of a bond are its face value or its par value, the coupon rate on the bond which is pad periodically, the price of the bond at which the investors purchases the bond, maturity period and the Yield to maturity. Maturity period is the bond life at the end of which the bond face value is paid back. The yield to maturity is the return an investor receives the bond by holding it until maturity. The bond can have additional features such callable, put able, convertible bond and it can also have collateral attached to it. The bonds once issued in the primary market is traded in the secondary market similar to any other stocks however the liquidity in the bond is less than stocks.

b) Stocks are issued as units of shares to investors which gives them ownership in the company. The key feature of a stock or a common stock is that each stock has one voting rights and it gives ownership to the individual in the firm. The stockholder is paid dividend from the profits but are not fixed. The price of stock in the market is significantly different than the its par value. Once the stocks are issued in the primary market it trades in the secondary market where a large number of buyers and sellers are there. The liquidity in the stock market is comparatively very high.

c) The annual rate of return is calculated as the ending value divided by the beginning value to the power one by number of period and then we subtract the one from

(ending value/Beginning value) ^ (1/Number of years) – 1

d) The rate of return = (105/100) – 1

=0.05 or 5%

e) Here the return would be = (105 -100 + 2)/100

=0.07 or 7%