Some investors are terrified of losing money. So genius alchemists in the world of finance came up with a way to put bubble wrap around the portfolios of these anti-risk takers, producing what is known as the “Cushion Bond.”
Cushion bonds are callable bonds that have much higher interest rates than traditional bonds, like the 30-year Treasury. The goal for the investor is to protect herself from rising interest rates by providing a “cushion” between the bond’s rate and changes in borrowing rates in the broader economy.
Because of this “cushion,” an investor can expect to pay a higher price for a higher rate. The investor is limiting her downside with these bonds, but the upside potential is equally limited.
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Finance: What's the Difference Between S...186 Views
finance a la shmoop. what's the difference between stocks and
bonds? welcome to our little town. the last stop on our tour ends here at the
town square with an excellent display of stock. and then over here we have the [man in stocks]
bond .hey wrong tour! hi me again mister shmoop
you may remember me from such shmoop classics at the st. Valentine's Day
Massacre college 101 and the ever popular ode to a freakin comma. but today
I'm here to talk to you about the difference between a stock and a bond.
financial kind. yep long way to get here but the difference is really simple
stocks are about ownership when you own some shares of stock you own a piece of
something .when you own a bond you are essentially just the renting money to
someone .that's it .stocks and bonds get mentioned together all the time because
they're both investment vehicles .that is places to put your money. but as far as
what backed them up well they're really different animals. so let's dig in a bit
on stocks. meet whatever dot-com. it has 10 million shares outstanding. outstanding
not meaning that it's a strictly good company. it's just a term that refers to [kids smile on the couch]
the total number of shares of ownership of the company or said another way it
means that the Pie of whatever com is cited in to 10 million slices and each
slice is called yes shockingly a share. whatever.com trades publicly for 10
bucks share giving it evaluation of a hundred million dollars. that is
investors who are paying $10 a share for whatever com are valuing the company at
a hundred million dollars. that's 10 million shares times $10 to get you
there. yeah ten million slices of pie. big pie. okay so you decide to put all of
uncle Larry's inheritance money into whatever com at ten bucks a share.
that's a hundred grand. there we go. you are now the proud owner of 0.1% or [woman smiles holding money]
ten thousand shares of whatever dot-com congratulations.
maybe .well things with whatever dot-com go along just fine in one day you are
sweating on the Stairmaster and the ticker what scrolls buy on CNBC showing
up five hundred percent. the headline makes you giddy. woo of the whoo
you just turned your 100 from uncle Larry into 500 grand .why ?well
because Apple has just announced that it will pay 50 bucks a share on 10 million
shares that valued whatever dot-com it's 500 million dollars to buy the company.
yeah so whatever icon becomes now part of Apple. so you celebrate. but things
could have done different .condolences there .yeah stocks can go that way. [woman drives red sports car]
so he just turned uncle Larry's life savings that he gave to you and that you
invested in this risky new company into nothing. yeah nice job they're. a big fat
hundred grand smoking hole in your bank account .so yeah stocks carry a lot of
risk it can be good but oh it can be bad. check out this chart for the S&P 500 for
the last hundred or so years. well the S&P 500 is just an index or the
500 largest companies in the world generally speaking. but with a high
Western lean. on the selection of the company there goes Westerners who built
the index. well it's the most common representatives of performance when
investors ask so how's the market doing? anyway back to the chart. well you
can see from the early 1950s until the mid 1960s or so not much went on and
just kind of flat they're paying dividends then we had 70s and basically [stock market chart shown]
the market was flat for a decade but dividends went up and up and up. it's the
company still we're making a lot of cash profit.. and Reagan came into office in
the early 80s now 1980 there said give us our Iran hostages back and all that
and then the market took off and it went nuts. there's a little bit of correction
there nineteen eighty eight nine there is sell them and then blam the greatest
bull market in history all the way up until 2000. when things burst and yeah
it's been quite a ride. so you can see up down up down
but generally from 1950 to 2017 change up and up is really nicely up. that's
what we do here. alright but the main takeaway is that over time stocks went
up on average from here to here about eight or nine maybe ten percent a year.
so what does that tell you about stocks? well that risk is less generally [stock market chart shown]
speaking if you're able to hold stocks for a long time. that is over time the
markets in the capitalist system basically bail you out of problems if
you can hold the stocks long enough .so if you're 20 think lots of stocks. it's
you know you won't need the money for decades if you're a newly retiring 75
year old not so much. you just can't afford to live through a bad bear market.
so instead maybe you do halfsies with stocks and bonds or you go all-in just
on bonds. and live on a budge.t all right so what is a bond well take your
friendly cable and internet provider Comcast. they borrow money all the time
from the public so they can buy smaller cable companies and TV companies and
content companies or pay for programming you know or buy gum.
well the lion's share of Comcast bond offerings have paid about 5% a year
which isn't much but on the upside none have ever not paid their interest. in
fact waste fewer than 1% of bonds in the u.s. don't fully pay up.
meaning that in general for decently rated bonds that is bonds which are
rated by experts as being safe bets to fully pay off both principal and [bonds examined by experts]
interest almost never default. as Shakespeare said default is not in Our
Stars but in ourselves. and it's close enough. well but think about the
difference on an investment which compounds ie grows exponentially each
year at a rate of 5% for 20 years versus an investment that compound at 9% over
20 years. the difference is about 4% a year doesn't sound like much maybe, but
over time that's a really big difference. let's pull out of our handbag our handy
dandy rule of 72. which is a simple back-of-the-envelope calculation tool
that helps you figure out how many years it takes an investment to double .if an
investment grows at 10% a year it doubles in 7.2 years which means we lose
a full doubling in value of our investment here using the 5% bond. in 72
divided by 4 there we go for 18 years .so said a different way after 18 years have
just investing in bonds for suggest investing in stocks we end up with half
as much money if history repeats itself and it doesn't always. but it's something
think about. anyway that notion feels like a lot to pay for
the greater safety or certainty of a bond. all right so now you know your
stocks from your bonds and it'll come in handy if you're ever robbed by one of
them at gunpoint and have to you know pick them out of a lineup. [lineup shown]
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