Characteristics of Bonds, Common Stock and Preferred Stock (Chapter 15

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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)

• Bonds Some Basic Terminology
• Bond Ratings
• Typical Characteristics of Corporate bonds
• Characteristics of Common Stock
• New Stock Issues
• International Stock
• Preferred Stock Financing

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BondsSome Basic Terminology

• Bond A long-term debt instrument.
• Par Value Principal or face value.
• Indenture Bond agreement (collateral pledged if
  any, dividend restrictions, limits on future debt
  offerings, etc.)
• Coupon Rate Stated interest payment divided by
  the par value.
• Current Yield Stated interest payment divided by
  the current bond price.
• 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).

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Bond Ratings

• Aaa, Aa, A, Baa, Ba, 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.
• Major Rating Services
• Moodys Investor Services
• Standard Poors Corp.

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Types and Characteristics ofCorporate Bonds

• Debenture Unsecured bond.
• Subordinated Debenture Claims honored after the
  claims of secured debt and unsubordinated
  debentures have been satisfied.
• Zero Coupon Bonds Do not pay any interest over
  the life of the bond (Sold at a deep discount).
• Junk Bonds High risk, high yield bonds.
• 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.

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• Mortgage Bond Secured by real property.
• 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).
• Convertible Bond Provides for conversion into
  common stock at a fixed price.
• Callable Bond Issuer has the right to call in
  the bonds prior to maturity. Usually, a premium
  that declines over time (e.g., one years
  interest initially) must be paid to bondholders.
  Most bonds contain some kind of call provision.

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Bond Issuers

• Treasury Bonds
• Issued by the federal government.
• Municipal Bonds
• Issued by state and local governments.
• Corporate Bonds
• Issued by corporations.
• Foreign Bonds
• Issued by foreign governments or foreign
  corporations.

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Characteristics of Common Stock

• 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.
• 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.
• 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

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Characteristics of Common Stock (Cont.)

• 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.)
• Proxy Most stockholders transfer their right to
  vote to some group (usually management).
• 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.)

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New Stock Issues

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

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Security Issuing Process
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Costs of Issuing New Securities

• Underwriting Spread
• Difference between what the public pays and what
  the corporation receives.
• Out-of-Pocket Costs
• Legal fees, accounting fees, etc.
• 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.

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International Stock

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

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Preferred Stock Financing

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