Stocks, Bonds, and Mutual Funds - Video Tutorials & Practice Problems

Bond Definitions

Alright. So now let's discuss some definitions related to stocks, bonds and mutual funds. So let's start here with bonds. So bonds, these are financial securities that promise to repay the fixed amount of principle. So this is the key with bonds is that there's a principal amount that gets borrowed and they get paid back along with interest. So these are more typically like a loan. However they're like basically small loans that they get from a bunch of different people. Right? So the idea with the bond is maybe you want to raise $1 million, but instead of finding one person to borrow $1 million $1,000 bonds to 1000 people. Right? So by selling you're raising $1000 from 1000 different people is easier than raising one million from one person there. Okay. So it facilitates that borrowing. So some key terms here is the coupon payment and this is the interest rate, the interest payment stated on the bond. So the bond is gonna say, Hey I'm paying 8% interest, I'm paying 6% whatever it is, that's the coupon payment that's on the bond. Okay. Next is this idea of interest and that interest just like we've talked about with the interest rate, it's the cost of borrowing funds And it's usually stated as a percentage like 6% or 8%, something like that. So whenever we talk about the interest, well it has to be aligned with the amount of risk that's being involved in this lending, right? Because if it's a very risky company, well, they're gonna need to pay more interest than a very safe company. You can imagine uh that you know sketchy co is probably gonna have to pay you a higher interest rate than you know uh Apple Corp that you know has is a very big company with a lot of financial information, something like that. So how do we know how risky an investment is gonna be in bonds? Well there's rating agencies such as moody's and S. And P. That will rate company bonds. So when a bond goes to sell its bonds to the public, well they usually get rated, they're gonna have this rating that the public looks at and says okay this is a safe investment or a risky investment. So the investment grades you can see are very similar from the different investment, the different rating companies triple A. Generally being the best here, the highest credit quality down to B. C. D. All the way down right, the meaning default that they're unlikely to pay you back. Okay so we talk about investment grade bonds which are solid safe investments and non investment grade bonds are called junk bonds that generally have to pay a very high interest because they're seen as risky. Okay so that's it about bonds. Let's go ahead and pause and let's talk about stocks in the next video

Stock Definitions

So stock is different from bonds because it represents a stake in the company, you're gonna have partial ownership of the company. Where when you have a bond, well they're gonna repay you that principle, they're gonna give you that money back that you that you lent them, you're gonna get it back eventually. However, when you own stock you own ownership in the company, so the shareholders are entitled to a portion of the corporation's profit. Even if you own a very small part of the company, you own that share of the profit. Okay? However, the company doesn't generally just pay out all their profit just to their shareholders every year. Oh we made $1 million. Here's the million dollars we made. No, it keeps some of it as what we call retained earnings. If you've taken an accounting class, I'm sure retained earnings was spilled all throughout that class, retained earnings. We love to talk about that. So retained earnings is used to fund future projects, right? If you don't if you made some profit this year, but you don't pay it out to your investors, well you retained it to help you grow the business, right? However, when you when you make an investment, there's two ways that you make money by buying stock first, you get dividends and these are payments by the corporations to its stock to its shareholders. And this is payments of profit right? They're gonna take some of that profit and they're going to distribute it to the shareholders um Because they've earned some profit and they're not gonna retain it all. They give some of it back as dividends. The other way you make money is through capital gains. So that's the idea that there's gonna be an increase in the value of the stock. So if you bought the stock say bye For $5 the stock and you sell it for $15 man, you're a savvy investor there, right? You bought it for five. Let me make that fit on the screen there. Oops. What a savvy investor you bought it for? Five, Sold it for 15. Well those are capital gains, right? The change in the price of the stock. So those are the two ways that you make money, you either get dividends or you get capital gains from stock. Now the difference with stock from bonds is this idea of a maturity date, stocks do not have a maturity date. So when you buy a bond it says okay, in five years I'm gonna repay you the principal. You bought $1000 bond, you're gonna earn interest throughout those five years and then in five years you're gonna get that $1000 back. However with stock there's no maturity date, right? We expect these companies to keep on going on or why would we invest in them if we think they're going to go bankrupt? It wouldn't be a good investment, right? So corporations are assumed to continue indefinitely. So there's no maturity date, you're not expecting to get that principle back. So that's why the money comes from the dividends and the capital gains the appreciation of the value of the stock. Cool, Alright. Let's pause real quick and we'll discuss mutual funds in the neck.

Mutual Fund Definitions

Alright, so mutual funds are kind of like a grab bag of other investments instead of buying, say you know, shares of this company, shares of that company, shares of the company seeks shares. The company d you can just buy shares of a mutual fund and that already owns a broad range of investments. Okay. Mutual funds can own stocks, they can own bonds, they can own all sorts of different investments. Alright. So when you buy shares in a mutual fund, if you buy shares of a mutual fund that owns Apple, well you didn't buy shares of Apple, you bought shares of the mutual fund. Okay. So the idea here is that we're gonna have the firm's over here similar to a financial intermediary. We're gonna have the firm's over here, we're gonna have the mutual fund in the middle and then we'll have uh the investors over here we'll we'll say the households h h the households that are buying from the firms. So here the mutual funds are going to buy the securities of the firm's, they'll buy stocks and bonds from the firms and they'll give cash to the firm's the firm's will get that cash. And now the households will buy shares of the mutual fund. So they'll buy mutual fund shares instead of shares of of the investments directly of the firms, They buy shares of the mutual fund for cash. Right? So that's gonna help facilitate that money to the firm's. Now why would a why would a household by these mutual funds. It's the idea of diversification. So we'll get to that in a second. Um So one thing before we get to diversification, let's discuss how these funds are managed. The first one is an actively managed fund. Well, they just have a portfolio manager that's constantly buying and selling stocks, right? Constantly buying and selling stocks. That makes sense. Right, actively managed. Well, they're actively buying and selling stock. Think about it passively managed. Well, they're just gonna follow a specific stock index and hold more constant portfolios. They're just gonna, let's say follow the SMP and they're just gonna buy the same stocks that are in that index and just hold them and now you're diversified because you own this stock index. So that idea of diversification. It's the idea of reducing risk by replacing a single large risk with smaller unrelated risks. Right? It's the idea of don't place all your eggs in one basket. Right, let's carry six different baskets with one egg in each basket. That way, if we drop a basket we only lose one egg instead of all six eggs. Cool. So that's the idea of diversification. It helps you reduce risk by owning small bits of a whole bunch of different things. Cool. And that's what a mutual fund helps you do. Alright, let's go ahead and move on to the next video