arb

 Cumulative preferred stock : carries a provision that stipulates that if any dividends have been omitted in the past, they must be paid out to preferred shareh[r]

SECURITIES

May 17, 2021

Chapter objectives

 Identify the various forms of securities

that available to companies;

 Explain the main features and identify

May 17, 2021

Securities

 Stocks  Bonds

May 17, 2021

Types of Stock

May 17, 2021

How a stock is born?

Sole proprietorships

 Owned by a single

 The owner Keeps all the profits, responsible for all the losses  Minimum of paperwork, difficult to raise capital for expansion

Partnerships

 The single owner joins with other people (partners) to help run the

company These people work together as a partnership.

 Both sole proprietorships and partnerships use part of their profits for

expansion, sometimes adding their own savings or borrowing money from banks

 Banks are usually unwilling to lend such businesses money for long

periods of time

 Both sole proprietorships and partnerships have other weaknesses as

May 17, 2021

How a stock is born?  Corporations

 can own property; have continuity of existence ;can sue or be sued; are legal entities considered to be “artificial persons”; can incur debts; and can raise capital easily.

 Run by a group of people known as a board of

directors Directors are elected by the common

shareholders, usually for a term of one year The directors choose the company’s officers.

 Corporation must issue certificates known as

“shares of common stock” (ordinary shares),

represent the ownership in the corporation Those who own this stock are part-owners of the

corporation

Shareholders Directors Officers

May 17, 2021

Corporate stock

 Authorized and Outstanding shares of common stock

 The corporation will be given permission by the authorized

organization (SSC) The shares the company is given permission to sell are the authorized shares

 Any authorized shares that are sold or otherwise distributed

(issued) are then known as outstanding shares

 Authorized shares that are not sold initially are called “authorized

but unissued” shares and may be issued by the corporation at a later time

 Treasury stock

 Sometimes a company may repurchase some of its outstanding

stock from shareholders Such stock is known as treasury stock

 A company therefore has two sources of stock to sell: authorized

but unissued stock (stock that has never been issued) and treasury stock (issued but repurchased stock) Once it has exhausted these two sources, it cannot issue any more stock

May 17, 2021

Preferred stock

 A preference or preferred stock

entitles the holder to a prior claim on any dividend paid by the organization over ordinary stocks, or to the

May 17, 2021

Preferred stock-Characteristics

 Fixed dividend: have a fixed dividend

rate, is announced at the time the stock is first offered and does not change over time.

 Multiple classes of stock:

 1 XYZ $4.00 preferred, XYZ $6.00 preferred  2 XYZ 7% preferred, XYZ 9% preferred

 3 XYZ A preferred, XYZ B preferred

 Par value

May 17, 2021 10

Preferred stock-Characteristics

 Senior to common stock:

 Seniority of preferred dividends:

Dividends are paid before common stocks' dividends.

 Cumulative Preferred

 Preferred stockholders’ rights when a

company is dissolved: the first stockholders to be repaid

May 17, 2021 11

Preferred stock-Category

 Cumulative preferred stock: carries a provision that stipulates that if any dividends have been omitted in the past, they must be paid out to preferred shareholders first, before common shareholders can receive dividends  Participating preferred stock: gives the holder the right to

receive dividends equal to the normally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition

 Convertible preferred stock: includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date

May 17, 2021 12

May 17, 2021 13

Preferred stock

 An investor is considering the purchase of 100 shares of Cartlidge Company 9% convertible preferred stock, $100 par The conversion price is 25.00

1 What is the dollar amount of the quarterly dividend the customer might expect?

2 If the client purchases the preferred stock and converts at a later date, what will he receive in exchange?

3 How might the yield on this preferred stock compare with the yield on another company’s straight

(nonconvertible) preferred of the same quality?

May 17, 2021

Common Stock

 Equity securities represent an

ownership interest in a corporation.

 Common stockholders are the residual

owners.

 Right to income  Right to assets

 Preferred Stockholders have

preference over common stockholders.

May 17, 2021 15

Characteristics of a common stock

1 Voting rights Limited liability

May 17, 2021 16

Common stock-Voting right

 Cumulative and statutory voting

 Statutory voting : permits stockholders to cast

one vote for every share that they own If there are different seats to be filled, the owner of 100 shares of stock could cast a maximum of 100 votes for each of the different directors, for a total of 500 votes, but no more than 100 votes for any single director.

 Cumulative voting : the shareholder can save

May 17, 2021 17

Seat Seat 2 Seat 3 Seat 4 Seat 5

Bad Guys Samuel Alice John Theresa Bob

vs vs vs vs vs

Good Guys Carol Ted Cathy Maria Beth

Seat Seat 2 Seat 3 Seat 4 Seat 5

Bad Guys Samuel Alice John Theresa Bob Number of

votes 500 500 500 500 500

Good Guys Carol Ted Cathy Maria Beth Number of

votes 150 150 150 150 150

Seat Seat 2 Seat 3 Seat 4 Seat 5

Bad Guys Samuel Alice John Theresa Bob Number of

votes

500 500 500 500 500

Good Guys Carol Ted Cathy Maria Beth Number of

votes

0 750 0

Statutory voting

May 17, 2021 18

The ABC Corporation uses cumulative voting, while the DEF Corporation uses statutory voting.

1 With five directors to be elected, what is the

maximum number of votes that a holder of 250 shares of ABC common stock may cast for a

single director?

2 With six directors to be elected, what is the

maximum number of votes that a holder of 500 shares of DEF common stock may cast for a

single director?

3 Thomas Gomez purchases 250 shares of Zenobia Corporation and instructs his broker to hold the shares The following month Mr Gomez

purchases an additional 400 shares, and the

month after that he sells 300 shares What is his position with respect to shares of Zenobia

May 17, 2021 19

Common stock-Residual claim

 In the event of liquidation, common

May 17, 2021 20

Dividend and Capital gain  Dividend:

 Common stockholders have the right to receive

dividends if the board of directors declares them

 Dividends are usually paid in cash (cash dividends), but sometimes may be paid in additional shares (stock

dividends).

 Capital gains:

 Investors buy stock is to receive dividends; they may sell their stock for more than they paid capital gain

 When a stock is sold after having been held for 12 months or less, the profit or loss is known as a

short-term gain or loss For stocks held longer than 12

May 17, 2021 21

Common stock-Value  Face value (par value)

 Book value: The net asset value of a company, calculated by total assets minus intangible assets

(patents, goodwill) and liabilities It is the total value of the company's assets that shareholders would

theoretically receive if a company were liquidated  Market value: The current quoted price at which

investors buy or sell a share of common stock at a given time

 Intrinsic value: The actual value of a company or an asset based on an underlying perception of its true

May 17, 2021 22

Bonds

 The basic structure of bonds  Cash flow pattern of bonds  Bonds category

 Corporate bonds

 Government bonds

May 17, 2021 23

The Basic Structure of Bonds

 A bond is a promise to make periodic coupon

payments and to repay principal at maturity; breech of this promise is an event of default

 Bonds carry original maturities greater than one

year so bonds are instruments of the capital markets

 Face value

 Maturity date  Interest rate

May 17, 2021 24

The Basic Structure of Bonds

Cash Flow Pattern for a Traditional Coupon-Paying Bond

0 1 2 3 … n

I I I I I

F

0 1 2 3 … n

I I I I I

F

FIGURE 6-1

May 17, 2021 25

Cash Flow Pattern of a Bond

The Purchase Price or Market Price of a bond is simply the present value of the cash inflows, discounted at the bond’s yield-to-maturity

0 1 2 3 4 n

Coupon Coupon Coupon Coupon Coupon + Face Value Purchase

Price

Cash Inflows to the Investor Cash Outflows

to the Investor

0 1 2 3 4 n

Coupon Coupon Coupon Coupon Coupon + Face Value Purchase

Price

Cash Inflows to the Investor Cash Outflows

May 17, 2021 26

Bonds category  Issuer

 Corporate

 Government

 Maturity

 <1 year: Bills

or “Paper”

 1- years:

Notes

 >7 years: Bonds

 Interest payment

 Coupon bonds

 Zero-coupon

bonds

May 17, 2021 28

Corporate bonds

 Corporate bonds are long term bonds

issued by corporations.

 Semiannual interest.

 Bond indenture: the legal contract

that specifies the rights and

May 17, 2021 29 Types of Corporate Bonds

 Bearer bonds versus Registered bonds:

 Bearer bonds: not registered in buyer’s name,

attached coupon, the holder presents the coupons to get interest payment.

 Registered bonds : owner’s identification

information is recorded, coupon payments are mail to the registered owner

 Term versus Serial bonds

 Term bonds: bonds in which the entire issue

matures on a single date

 Serial bonds: bonds that mature on a series of

May 17, 2021 30 Types of Corporate Bonds

 Mortgage bonds versus Debentures

 Mortgage bonds: are backed by some type of real

property

 Collateral trust bonds: are backed by other

securities owned by the corporation;

 Equipment Trust Certificates: are backed by

rolling stock or equipment such as trucks, airplanes, railroad cars, or oil drilling rigs;

 Debentures: are similar to signature loans in that

no property is specifically pledged to back the loan.

May 17, 2021 31

More Bond Features

 Call feature – allows the issuer to redeem or pay off the bond prior to maturity, usually at a premium

 Retractable bonds – allows the holder to sell the bonds back to the issuer before maturity

 Extendible bonds – allows the holder to extend the maturity of the bond

 Sinking funds – funds set aside by the issuer to ensure the firm is able to redeem the bond at maturity

May 17, 2021 32

Convertible bonds

Conversion value = Current market price of common stock received on conversion

* Conversion rate

 Ex: In 2007, Titan corporation had a convertible bond issue outstanding Each bond, with a face value of

$1,000, could be converted into common stocks at a rate of 285.71 shares of stock per $1,000 face value bond (the conversion rate) In June 2007, Titan’s

common stock was trading at $9.375 per share While this might look like conversion would be very

profitable, Titan’s convertible bonds were trading at 267.875 percent of the face value of the bond

May 17, 2021 33

Callable bonds

Call schedule for DuPont Debenture due 2023

 In 2004, DuPont had a $300 million callable debenture issue outstanding

 The face value of each bond was $1.000

 Maturity date of 15/01/2023, was callable as a whole or in part not less than 30 days nor more than 60 days

following January 15 of each year from 2005 to 2013

 If the bonds are called in 2008, how much per bond will the bond holder receive?

May 17, 2021 34

Why Corporations Sell Bonds

 To get funds for major purchases.  To fund ongoing business activities.

 When it is difficult or impossible to sell stock.  To improve financial leverage.

 Interest paid to bondholders is a tax

May 17, 2021 35

Why Investors Buy Corporate Bonds  For interest income.

 Investors know the interest rate

 Interest will be paid to investors twice a

year, with the payment based on the

interest rate and the face value of the bond.

 Appreciation of bond value.

 May be able to sell a bond with a fixed

interest rate to someone else at a higher price if overall interest rates fall.

 Bond face amount will be repaid at

maturity.

May 17, 2021 36

Use the following

information to answer all five questions:

XYZ 8% debentures mature in 2020 They pay interest F&A15 They are trading at 1071/2

1 What is the nominal yield of the bonds?

a 8%

b more than 8% c less than 8%

d cannot be determined

2 Interest payments will be made on:

a February and April 15 b February 15 and April 15 c February and August 15 d February 15 and August 15

3 An owner of 10 bonds (10M) would receive annual

interest of:

a $8 b $80 c $800 d $8,000

4 How much would 100 bonds (100M) cost at the price

indicated?

a $1,075 b $10,750 c $107,500 d $1,075,000

5 The collateral for these bonds is:

a rolling stock

b other stocks and bonds c a mortgage on real

May 17, 2021 37

Government bonds

 Municipal bonds

May 17, 2021 38

Municipal bonds

 Issued by state and local governments

 Purpose: fund temporary imbalances

between operating expenditures and receipts or to finance long term capital outlays.

 Sources of repayment: tax or revenue

May 17, 2021 39

HOSE announces the details of delisting the following municipal bond

- Issuer: The Ho Chi Minh City Investment Fund for Urban Development (HIFU) - Address: 33-39 Pasteur, Dist 1, HCM City

- Tel: (84-8) 8214244 Fax: (84-8) 214243 - Bond type: municipal bond

- Bond name: HIFU Bond Issue No.07/2006 - issued through underwriting - Bond symbol: HCMA0706

- Face value: VND100,000

- Term to maturity (years): 05

- Issuing date: September 1st, 2003

- Interest rate: 4.50%/6 months

- Interest payment method: made annually and at the fixed interest rate (coupon bond)

- Ex-right date: August 1st, 2008

- Record date: August 1st, 2008

- Delisting date: August 4th, 2008

- Trading will be stopped on the same day of delisting

- Principal and interest will be paid on September 1st, 2008

May 17, 2021 40 Tax Exemption and Muni

Yields

ia = ib(1 - t)

Where:

ia = After-tax (equivalent tax exempt) rate of return on a taxable bond

ib = Before-tax rate of return on a taxable bond t = Income tax rate of the marginal bond holder

Example: You can invest in taxable corporate bonds that are paying 10% annually on municipal bond Your marginal tax rate is 28% The after-tax rate of return on the taxable bond is:

10%(1-.28) = 7.2%

ia = ib(1 - t)

Where:

ia = After-tax (equivalent tax exempt) rate of return on a taxable bond

ib = Before-tax rate of return on a taxable bond t = Income tax rate of the marginal bond holder

Example: You can invest in taxable corporate bonds that are paying 10% annually on municipal bond Your marginal tax rate is 28% The after-tax rate of return on the taxable bond is:

10%(1-.28) = 7.2%

May 17, 2021 41

Types of Municipal Bonds

 General Obligation Bonds

 bonds backed by the full faith and credit of the issuer

 Revenue Bonds

 bonds sold to finance a specific revenue generating project and are backed by cash flows from that project

 General Obligation Bonds

 bonds backed by the full faith and credit

of the issuer

 Revenue Bonds

 bonds sold to finance a specific revenue

May 17, 2021 42

 Bonds are rated by the issuer’s default risk  Large bond investors, traders and

managers evaluate default risk by

analyzing the issuer’s financial ratios and security prices

 Two major bond rating agencies are

Moody’s and Standard & Poor’s (S&P)

 Bonds assigned a letter grade based on

perceived probability of issuer default

 Bonds are rated by the issuer’s default risk  Large bond investors, traders and

managers evaluate default risk by

analyzing the issuer’s financial ratios and security prices

 Two major bond rating agencies are

Moody’s and Standard & Poor’s (S&P)

 Bonds assigned a letter grade based on

perceived probability of issuer default

May 17, 2021 43

Explanation Moody’s S&P Investment grade categories:

Best quality; smallest degree of risk Aaa AAA High quality; slightly more long-term Aa1 AA+ risk than top rating Aa2 AA Aa3 AA Upper medium grade; possible A1 AA- impairment in the future A2 A+ A3 A-Medium grade; lack outstanding Baa1 BBB+ investment characteristics Baa2 BBB Baa3

Explanation Moody’s S&P Investment grade categories:

Best quality; smallest degree of risk Aaa AAA High quality; slightly more long-term Aa1 AA+ risk than top rating Aa2 AA Aa3 AA Upper medium grade; possible A1 AA- impairment in the future A2 A+ A3 A-Medium grade; lack outstanding Baa1 BBB+ investment characteristics Baa2 BBB Baa3

BBB-(continued)

May 17, 2021 44

Explanation Moody’s S&P Speculative investment grades:

Speculative issues; protection may Ba1 BB+ be very moderate Ba2 BB Ba3 BB-Very speculative; may have small B1 B+

assurance of interest and principle B2 B payment B3 B-Issues in poor standing; may be in default Caa CCC Speculative in a high degree Ca CC Lowest quality; poor prospects of attaining C C real investment standing D

Explanation Moody’s S&P

Speculative investment grades:

Speculative issues; protection may Ba1 BB+ be very moderate Ba2 BB Ba3 BB-Very speculative; may have small B1 B+

assurance of interest and principle B2 B payment B3 B-Issues in poor standing; may be in default Caa CCC Speculative in a high degree Ca CC Lowest quality; poor prospects of attaining C C real investment standing D

May 17, 2021 45

Government bonds

 <1 year: Bills or

“Paper”

 1- years: Notes

May 17, 2021 46

Eurobonds, Foreign bonds, Brady and Sovereign bonds

 Eurobonds: long term, issued and sold

outside the country of which they are denominated, bearer, traded mainly in London and Luxembourg.

 Foreign bonds: long term, issued by firms

May 17, 2021 47

Rights (Preemptive rights)

 Right to purchase shares means securities issued by the joint stock companies together with an

additional share issuance in order to secure that the existing shareholders will have the right to buy new shares according to the determined conditions

 Characteristics:

 Only for common shareholder  Not raising capital

 Subscription price is lower than market price of common stock

May 17, 2021 48

Example

ABC company:

 30.000 outstanding stocks, market

price: $20

 New issue: 10.000 stocks,

subscription price: $17 Right’s value?

May 17, 2021 49

Warrants

 Warrants means securities issued

together with the issuance of preference shares or bonds,

permitting the securities holder to buy a certain amount of common shares at the pre-determined price during a certain period of time.

May 17, 2021 50

Warrant-Characteristics

 Strike price > market price  Long-term

 Time-varying strike price

 Issued by firm When a warrant is exercised,

firm gives share to warrant’s holder  result

an increase in number of shares

 If strike is below market value, this dilutes

value of existing shares

May 17, 2021 51

Warrant

 The warrant contains provisions for:

 the number of shares that can be

purchased per warrant.

 the price at which the warrant can be

exercised.

 the warrant expiration date.

 Warrant holders are not entitled to

May 17, 2021 52

Example

FunFinMan, Inc., is currently financed entirely with common stock The firm is composed of $10 million in common stock ($5 par

value) and $20 million in retained earnings The company is considering issuing $10

million of 8%, (Face value=$500), 20-year debentures including warrant per bond that can be converted into shares of

common stock at an exercise price of $40 per share How will this impact the How will this impact the

capitalization of the firm?