Stock and bond markets: what are they and how do they work?

At its core, these are just places where investors can buy or sell different types of investments.

Depending on your interests, goals, and appetite for risk – you might want to concentrate on one area or select a few.

These markets used to be hard to access and you’d either have to be an elite member of society or have powerful connections to get involved.

Stock markets have been around in one form or another since the 1300s. The original purpose was exchanging debts and loans, giving birth to the bond markets – something we’ll cover a little later.

As business and trade developed, so too did the ability to invest. Eventually, this interlinking exchange system spread throughout Europe. Until… a problem needed a solution.

Sea voyages during the 1600s to remote places in Asia and the East Indies were proving to be both extremely profitable, and extremely risky.

A successful voyage could lead to great wealth. But, an unsuccessful venture could lead to immediate bankruptcy.

What we have now is just a faster and more sophisticated system.

You can easily buy stocks and shares from stock markets around the world.

When investing, you are buying pieces of companies, and get to share in the profits or losses.

Companies sell shares to raise money. They then use these funds to grow, reinvest in the business, or develop new technologies.

Lots of companies, particularly UK firms, still pay a dividend.

Other stocks generate returns through capital appreciation. The stock becomes worth more, so your shares become more valuable.

You’ll need to use a brokerage account to access most stock exchanges.

Unfortunately, Pret and Costa Coffee haven’t carried the torch from the past, but perhaps someday you’ll be able to exchange shares in cafes again.

Well, technically you can. Just take your mobile phone with you, buy a coffee, then buy or sell stocks and shares whilst you sit, sipping your cappuccino.

It may shock you to hear that this market is not somewhere that allows you to trade James Bond memorabilia, it’s a little drier.

Bonds, treasuries, and gilts all refer to pretty much the same thing. It’s basically a way for governments and businesses to issue debt.

You can then buy some of this debt and get a reward for lending your money for a period of time.

Although they’re not stocks, it was the buying and selling of debt that actually led to the creation of stock exchanges.

Originally, informal markets popped up as a way for Venetian merchants to trade or exchange debts with each other.

Hence the inspiration for Shakespeare’s ‘The Merchant of Venice’.

Hundreds of years later, debts and loans are still an important part of the market.

Most governments and businesses pay for things using debt. Whether that’s to pay for a war, finance a global pandemic, or access money banks aren’t willing to lend them.

Here’s the basic system that fuels the bond market:

1. Someone wants to borrow money.
2. You loan an amount of money to them by purchasing a bond.
3. At an agreed date you are paid the original principal plus some interest.

Although a bond itself is quite simple, the bond markets are terribly complex.

There’s a global interlinking of debt between countries. Some are more credit worthy than others, and certain companies are more reliable than others.

Everyone gets a credit rating. Just like the one that gets checked when you want to take out a loan.

What makes the bond market more complicated is that there are secondary markets where these various debts can be resold.

The result is that you end up with a giant web weaved of debt. And if one strand snaps, it can lead to a tangle or a complete break in the whole web.

Bonds are a little different to stocks. Often, you can’t access the majority on stock exchanges, you have to buy them directly or with a specialist broker.

The main ways to buy bonds are:

• Buy directly from the government – HM Debt Management Office in the UK and from the US Treasury in America.
• Purchase savings bonds directly from a bank or building society.
• Buy corporate bonds from companies using a broker.
• Invest in collective funds such as unit trusts or open-ended investment companies (OEICS).

In practice, buying bonds from banks tends to be the most straightforward but the return won’t knock your socks off.

Government bonds like gilts tend to be very secure, but offer a low return because it’s a ‘safe’ investment.

Like with most investments, opting for a higher risk can lead to a higher reward.

So, if you buy bonds from a government or company with a lower credit rating, there’s likely a better return on offer. But, also a higher chance of default (them not paying you back).

These are the two key markets that you should try and get a basic understanding of.

Most of the global economy runs using the stock and bond markets as giant cogs, keeping everything ticking over.

Even if you decide not to invest, brushing up on how these markets work will open your eye to what happens with money on a global scale.