Characteristics of Bonds Common Stock and Preferred Stock

Characteristics of Bonds, Common Stock and Preferred Stock (Chapter 15 – pages 423 – 430) (Chapter 16 – pages 452 – 461 and 465 - 466) (Chapter 17 – pages 489 – 502) w w w w Bonds: Some Basic Terminology Bond Ratings Typical Characteristics of Corporate bonds Characteristics of Common Stock New Stock Issues International Stock Preferred Stock Financing

Bonds: Some Basic Terminology w Bond: A long-term debt instrument. w Par Value: Principal or face value. w Indenture: Bond agreement (collateral pledged if any, dividend restrictions, limits on future debt offerings, etc. ) w Coupon Rate: Stated interest payment divided by the par value. w Current Yield: Stated interest payment divided by the current bond price. w Yield-to-Maturity: That rate at which the present value of all future interest payments and the principal payment is equal to the current bond price. (most significant yield).

Bond Ratings w w Aaa, A, Baa, B, Caa, etc. Investment Grade - Baa or better Speculative or Junk - Ba or lower Used extensively to evaluate the risk of default on a bond issue. w Major Rating Services – Moody’s Investor Services – Standard & Poor’s Corp.

Types and Characteristics of Corporate Bonds w Debenture: Unsecured bond. w Subordinated Debenture: Claims honored after the claims of secured debt and unsubordinated debentures have been satisfied. w Zero Coupon Bonds: Do not pay any interest over the life of the bond (Sold at a deep discount). w Junk Bonds: High risk, high yield bonds. w Floating Rate Bonds: Interest paid is tied to some market rate (e. g. , yield on Treasury bonds). Market price remains relatively stable even though interest rates vary.

w Mortgage Bond: Secured by real property. w Sinking Fund: Typically, a requirement to retire a portion of the bond issue each year. Outstanding bonds may be purchased in the open market, or they may be called in by lottery if necessary. (May or may not include a call premium). w Convertible Bond: Provides for conversion into common stock at a fixed price. w Callable Bond: Issuer has the right to call in the bonds prior to maturity. Usually, a premium that declines over time (e. g. , one year’s interest initially) must be paid to bondholders. Most bonds contain some kind of call provision.

Bond Issuers w Treasury Bonds – Issued by the federal government. w Municipal Bonds – Issued by state and local governments. w Corporate Bonds – Issued by corporations. w Foreign Bonds – Issued by foreign governments or foreign corporations.

Characteristics of Common Stock: w Par Value: Typically, a meaningless figure. Affects accounting entries, but has no economic impact on the firm. Many firms do not even establish a par value on the common stock. w Classes of Common Stock: Most firms have only one class of common stock outstanding, where one share equals one vote, and stockholders share equally in dividends per share. Occasionally, other classes have been issued, where voting rights have been restricted, or different rights to dividends exist. w Majority Voting: Under majority voting, each share of stock allows one vote, and each position on the board of directors is voted separately. Therefore, a majority of shares has the power to elect the entire board of directors

Characteristics of Common Stock (Cont. ) w Cumulative Voting: Stockholders get one vote for each share owned times the number of directors to be elected. The stockholders may then cast all of these votes in favor of one or more of the candidates. In essence, cumulative voting gives a minority group of shareholders the power to elect one or more directors. Cumulative voting is practiced in California. (You are not required to learn the mathematical formulas concerning cumulative voting. ) w Proxy: Most stockholders transfer their right to vote to some group (usually management). w Preemptive Right: Existing stockholders have the right to purchase on a pro rata basis any additional shares sold by the firm. This right protects (1) control of present stockholders, and (2) existing stockholders against a dilution of wealth. (You are not required to learn the mathematical formulas associated with a rights offering. )

New Stock Issues w Initial Public Offering (IPO): – Stock in a closely held corporation that is offered to the public for the first time. w Prospectus: All new issues must be accompanied by a prospectus describing the new issue and the issuing company. w Red Herring: A preliminary prospectus that may be distributed to “potential buyers.

Security Issuing Process

Costs of Issuing New Securities w Underwriting Spread – Difference between what the public pays and what the corporation receives. w Out-of-Pocket Costs – Legal fees, accounting fees, etc. w Total Costs as a Percent of the Proceeds – Small issues are more expensive than large issues. – Common stock is the most expensive. – Bonds are the cheapest.

International Stock w Developed Countries – United Kingdom, Canada, Japan, Germany, etc. w Emerging Markets – Taiwan, Mexico, South Korea, etc. w American Depository Receipts (ADRs) w Closed-End Country Funds w Open-End International Mutual Funds

Preferred Stock Financing w Hybrid Instrument – Common stockholders view it like debt. Bondholders view it like equity. w Priority in Earnings and Assets – Rank ahead of common stockholders but behind bondholders. w Advantage to Corporate Investors – 70% of the dividends received are exempt from federal taxation. w Individual Investors – Often prefer bond investments rather than investments in preferred stock.