What is the difference between stocks, bonds, and CDs, and what are their comparable risks as investments?
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Stocks represent an equity holding in a corporation. The value of stocks is not fixed and can change substantially as the demand and supply of stocks changes. This in turn is influenced by many factors some of which are the profit made by the corporation, the financial state it is in, the state of the economy, liquidity in the economy, actions of the Federal Bank, etc. The returns on investments made in stocks is in the form of capital appreciation and dividends issued by the corporation.
Bonds represent a debt holding with a corporation or a government. In reference to a corporate bond, it is a loan given to the corporation by the bond holder. The rate of return is usually fixed for bonds and varies with the credit rating of the issuing corporation. A corporation with a lower credit rating is more likely to default on the interest payments and if the corporation is closed down there is a possibility that bond holders may not get back anything. The interest rates offered on the bond varies with the risk that the bond-holder is exposed to.
Certificate of deposit or CDs are time deposits made with banks and similar financial institutions. The rate of return offered by CDs is fixed. Investments made in CDs are ensured against default by the FDIC up to a limit of $250,000 USD. This ensures that the amount deposited is not lost even if the institution it is made with declares bankruptcy or is liquidated.
Of the three asset classes described, the rate of return over a long term duration is usually highest for stocks, followed by corporate bonds, CDs have the lowest rate of return. The risk involved in the investment is highest for stocks, followed by corporate bonds; CDs are risk-free investments till the limit mentioned.
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