Stock prices fluctuate daily in response to supply and demand. When the demand for a stock exceeds its supply, the price rises. However, when the demand for a stock declines, its price falls. The rise and fall of stock prices also generally affects the price of other securities, including bonds. Because falling stock prices cause investors to become more conservative and seek the safety of bonds, then bond prices typically rise when stock prices fall.
A share of stock represents a unit of ownership in a company. Stockholders can profit from owning stocks by receiving dividends from the company, or they may sell the stocks when the price increases. By law, publicly traded companies must provide financial information to their stockholders at the end of each quarter. Stockholders also have the ability to vote on decisions made within the company.
A bond is a loan an investor makes to a company or government body. In return for the loan, the investor typically earns interest on the investment. He will also receive his principal after the bond matures. Either the holder can keep the bond until maturity, or sell it to another investor. Unlike a stock, a bond doesn't confer any ownership interest in the company to its holder.
When stock prices fall, investors typically behave more conservatively. Because bonds pose a lower risk of loss than stocks do, investors tend to purchase bonds over stocks when stocks appear volatile. This increased demand for bonds often exceeds the supply, which causes the price of the bonds to rise. As long as the demand for bonds remains high, the price remains high. However, if stock prices rise and investors behave less conservatively, bond prices typically decrease.
Bond prices can fluctuate in response to changes in market interest rates. Investors typically purchase the security that offers them the highest profit. Thus, when market interest rates increase, securities carrying the market interest rate provide better returns, and the price of bonds decreases. Threats of inflation can also decrease the price of long-term bonds because the bond's interest rate won't increase over time to compensate for the change in the economy.
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