Every share you buy this term comes from another investor, not from the company. So who actually gets your money, and what did you just buy?
Learning objectives. After this week you can (1) tell a stock from a bond; (2) explain why riskier assets have to offer more expected return; and (3) compute the return on one of your own holdings.
Remember this: a stock makes you an owner, a bond makes you a lender, and more risk is the price of more expected return.
1) Stocks vs. bonds: owning vs. lending
A stock is a share of ownership in a company. You gain or lose as its price moves, and you may receive dividends, a share of profits paid out to owners. A bond is a loan to a company or government: the issuer pays you interest and repays the principal (the amount lent) at maturity (the end date). If a firm goes bankrupt, bondholders are creditors and get paid before stockholders.
2) The risk-return tradeoff
Nobody would hold a risky asset unless it offered a higher expected payoff than a safe one. That extra return is compensation for risk. It is why stocks have historically returned more than bonds, and bonds more than cash or a savings account, and why a single stock is riskier than any of them. Return counts the price change plus any income:
Total Return % = (Ending Price − Beginning Price + Dividends) ÷ Beginning Price × 100
| Buy price | Sell price | Dividend | Total return |
|---|---|---|---|
| $50 | $55 | $0 | 5 ÷ 50 × 100 = 10% |
| $40 | $44 | $2 | 6 ÷ 40 × 100 = 15% |
The $40 stock rose only $4, but the $2 dividend lifts its total return from 10% to 15%.
3) Where shares come from
In the primary market a company sells new securities to raise money. For stocks, the first sale is an IPO (initial public offering). In the secondary market, investors trade existing securities with each other. Every trade you place in the arena is a secondary-market trade: the company gets nothing, but the trading sets the price.
Quick self-check
(a) You buy at $80 and sell at $88, no dividend. Return? (b) You buy at $100, sell at $107 and collect a $3 dividend. Total return? (c) Who is paid first in a bankruptcy, stockholders or bondholders? (Answers: 8 ÷ 80 = 10%; 10 ÷ 100 = 10%; bondholders.)
Common mistakes
- Forgetting the dividend. Price return is not total return.
- Dividing by the ending price. Return always divides by what you started with.
- Calling a bond ownership. A bondholder is a lender, not a part owner.
This week in the arena
Your Holdings table shows each position's Avg cost (what you paid per share), its Price and its Gain/Loss. Pick one holding and compute (Price − Avg cost) ÷ Avg cost × 100 yourself, then check it against the percent in its Gain/Loss column. Note whether it is a stock or a bond ETF. The arena does not pay dividends into your cash, so its figures are price return only.