In the previous section, we mentioned the terms “stocks” and “bonds.” In this section, we will provide an overview of not only stocks and bonds but also other financial instruments like Treasury securities. Let’s begin by discussing each of these financial securities.
Treasury securities: Treasury securities are generally bonds that are issued by the U.S. government. The U.S. government is constantly investing in various projects that range from national defense to freeway improvements. When tax revenues fall short of covering these and other governmental costs, the U.S. Treasury will issue bonds. These bonds are effectively loans provided by the public to the government and will vary in length. Some of these bonds are as short as 60-day loans, while other bonds are loans that are paid over a 30-year period.
Corporate bonds: Just as the U.S. government might need to borrow money to cover costs or investments in new projects, firms also borrow from the public. Consider Google, the internet giant, whose parent company Alphabet is worth more than $1 trillion as of 2020. Google might be looking to invest another $50 billion in low-orbiting satellites; however, because of its size, the company cannot walk into a local bank hoping for a $50 billion loan. Instead, Google will likely issue bonds with a face value of $1,000 that make one or two annual coupon payments a year and might be paid back over a 20-year period. If Google were to go bankrupt, then as part of the bankruptcy, those who hold Google’s bonds would have access to the company’s assets when they were liquidated.
Stocks: Most finance students have heard of the many legends of those that have made or lost billions of dollars by investing in stocks. Before we can have that discussion, we need to become familiar with what a stock is. A stock is a share of ownership in a company. If Google did not want to borrow money from bondholders to finance the $50 billion low-orbiting satellite project, Google could sell shares of ownership in the company. Investors might be willing to buy shares of ownership in Google because they believe that this satellite project will be extremely profitable. Google will use the proceeds from the sale of these shares to fund the project. If Google were to fail, shareholders’ claims rank below those of bondholders when claiming the assets of the firm.
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