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Understand economics at your own pace: step-by-step guided courses, and exercises to practice.
Share or bond?
Become a co-owner of a company, or lend it money?
R = (P₁ − P₀ + income) / P₀ × 100 — for BOTH securitiesProblem / motivation
You have saved €1,000 and want to invest it. Two pieces of advice keep coming back: “buy shares”, “go for bonds”. Behind those two words lie two radically different CONTRACTS — and everything else (income, risk, bankruptcy) follows from the contract.
The course “Return and risk” set out the definitions in two sentences; here we compare them IN DETAIL. Buying a SHARE means buying a part-ownership of a company: you become a CO-OWNER — with a vote at the general meeting — and sometimes collect a DIVIDEND: a portion of profits… which that meeting DECIDES each year to pay, or not. Buying a BOND means LENDING: you become a CREDITOR of a company or a state, which MUST pay the interest set out in the contract (the coupon, most often fixed) and then repay the sum lent on an agreed date.
One more word, because it will serve throughout: your PORTFOLIO is simply the set of securities you hold — your collection of investments. The course first unrolls the face-off between the two contracts, line by line; then the saver's real question: what SHARE of each, in the portfolio?
Assumptions
In your view, which assumptions are needed for this model to hold? Jot down your ideas — no lead is wrong, this is your worksheet.
Your worksheet is still empty. Go for it: propose at least one idea.
0 idea(s) proposedFormalization
The course “Return and risk” built THE formula that measures any investment: R = (P₁ − P₀ + income) / P₀ × 100. It holds as it stands for a share as for a bond — the income is called a dividend here, a coupon there. So the comparison is not about the formula: it is about what you KNOW IN ADVANCE of each term at the moment of buying.
For a share, only P₀ — the price paid — is certain. The dividend? Decided each year by the general meeting, possibly nil (assumption 2). P₁, the selling price? Never guaranteed, and with no maturity to force an exit (assumption 3). The return on a share is therefore an EXPECTED return in the sense of the previous course: an average of scenarios, not a promise.
For a bond held to maturity, everything is written in advance: coupon set at issue (most often), face value repaid on the agreed date. Barring a DEFAULT by the issuer (Limits step), its return is KNOWN from the moment of purchase. (Sold BEFORE maturity, on the other hand, it is worth the market price, which moves with interest rates — precisely the subject of the course “Bond prices and interest rates”.)
There is the complete face-off: status (co-owner / creditor), income (voted, possibly nil / owed by contract), maturity (none / fixed date), bankruptcy (paid last / repaid first), certainty (expected return / known return barring default). That leaves the saver's question: BLENDING the two — the share of equities in the portfolio becomes the dial of the return-risk pair, set at the next step. Click each term:
Solving / calculation
A saver invests €10,000: 30% in shares, 70% in bonds with a 3% coupon (assumed free of default and held — the assumptions of the Limits). A good year on the market: shares do +20%. A bad year: −10%. Let's unroll both scenarios, then set the share of equities yourself.
- Split the capital (share of equities: 30%)
10,000 × 30%€3,000 in shares, €7,000 in bonds - FAVOURABLE scenario: shares +20%, coupon 3%
3,000 × 1.20 + 7,000 × 1.03= €10,810 (+8.1%) - UNFAVOURABLE scenario: shares −10%, coupon 3% all the same
3,000 × 0.90 + 7,000 × 1.03= €9,910 (−0.9%) - Reading it: expected value (50/50 scenarios) and spread
(10,810 + 9,910) ÷ 2; 10,810 − 9,910expected €10,360 (+3.6%); spread €900 — that is 9 points of return (8.1 − (−0.9))
At 30% equities, you EXPECT +3.6% while accepting to end up anywhere between −0.9% and +8.1%. It is the pair from the previous course, made adjustable: more equities = higher expectation AND wider spread. The coupon, for its part, falls due in both scenarios — it is what cushions the bad year.
portfolio = equity share × (1 + scenario) + bond share × (1 + coupon)Set the share of equities and the scenarios: the two outcomes, the expected return and the spread follow (capital: €10,000). Watch the spread close up as the share of equities comes down — that is what a cautious profile is. (The profile thresholds are indicative markers, not a rule.)
Economic interpretation
Share or bond: not “the good one against the bad one”, but two contracts — and the dosage between them makes the saver's profile.
The shareholder bets on SUCCESS: they vote at the general meeting, hope for dividends and a rising price — and accept being paid last if it all goes wrong (assumption 4). The bondholder bets on THE WORD GIVEN: coupon owed, face value repaid at maturity, whatever happens to profits. That is exactly why a share must offer a higher expectation — the risk premium of the course “Return and risk”, reread in the light of the contract.
In the simulator, the share of equities sets everything: 10% = a narrow spread, sleeping soundly; 70% = a higher expectation, jolts accepted. There is no universal right setting — the horizon matters (savings for 30 years from now can absorb jolts, savings for next year cannot). (And spreading each pocket across MANY securities — diversifying, already met in the previous course — reduces dispersion without sacrificing the expectation. Above all remember: the equity/bond dosage is the first choice, before even choosing WHICH securities.)
The face-off also reads from the ISSUER's point of view. Issuing shares means raising EQUITY: nothing to repay, but you share decision-making power and future profits. Issuing bonds means TAKING ON DEBT: you keep the controls, but the coupon is owed even in bad years. A company's financing choice is the exact mirror of the saver's investment choice.
Limits / critiques
Exercises
You hold 40 shares at €18 and 6 bonds of €500. What is your portfolio worth (in €)?
The general meeting decides to pay NO dividend this year. Can the shareholder demand one?
€5,000 invested 100% in shares: +30% or −10% next year, on a coin toss. What is the EXPECTED value of the portfolio (in €)?
True or false: a share has a maturity — the company repays your stake after a few years.
You buy a government bond. Are you a co-owner of the state?
A company goes bankrupt. Out of what is left, who is repaid FIRST?
The same €5,000, this time invested in bonds with a 4% coupon (no default, held to maturity). Value in one year (in €)?
A company wants to finance a factory WITHOUT sharing decision-making power or future profits. It will rather issue…