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SECURITIES

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May 17, 2021 2

Chapter objectives



Identify the various forms of securities

that available to companies;



Explain the main features and identify

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May 17, 2021 3

Securities



Stocks



Bonds

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May 17, 2021 4

Types of Stock

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How a stock is born?

<b>Sole proprietorships</b>

 Owned by a single.

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

<b>Partnerships</b>

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

company. These people work together as a <i>partnership.</i>

 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

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May 17, 2021 6

How a stock is born?



<b>Corporations</b>



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

<i>board of </i>

<i>directors</i>

. 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

“

<b>shares of common stock” </b>

(ordinary shares),

represent the

<b>ownership</b>

in the corporation. Those

who own this stock are

<b>part-owners</b>

of the

corporation

Shareholders Directors Officers

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May 17, 2021 7

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 <i><b>authorized</b></i> shares.

 Any authorized shares that are sold or otherwise distributed

(issued) are then known as <i><b>outstanding</b></i> 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 <i><b>treasury</b> stock</i>.

 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

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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

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Preferred stock-Characteristics



Fixed dividend: have a

<i>fixed </i>

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

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Preferred stock-Characteristics



Senior to common stock:



Seniority of preferred

<b>dividends</b>

:

Dividends are paid before common

stocks' dividends.



<b>Cumulative</b>

Preferred



Preferred stockholders’

<b>rights</b>

when a

company is dissolved: the first

stockholders to be repaid

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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.

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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 <i>quarterly </i>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?

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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.

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May 17, 2021 15

<b>Characteristics of a common stock</b>

Voting rights

Limited liability

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Common stock-Voting right



Cumulative and statutory voting



<b>Statutory voting</b>

: permits stockholders to cast

one vote for every share that they own. If there

are 5 different seats to be filled, the owner of

100 shares of stock could cast a maximum of

100 votes for each of the 5 different directors,

for a total of 500 votes, but no more than 100

votes for any single director.



<b>Cumulative voting </b>

: the shareholder can save

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<b>Bad Guys</b> Samuel Alice John Theresa Bob

vs. vs. vs. vs. vs.

<b>Good Guys</b> Carol Ted Cathy Maria Beth

<b>Bad Guys</b> Samuel Alice John Theresa Bob
Number of

votes 500 500 500 500 500

<b>Good Guys</b> Carol Ted Cathy Maria Beth
Number of

votes 150 150 150 150 150

<b>Bad Guys</b> Samuel Alice John Theresa Bob
Number of

votes

500 500 500 500 500

<b>Good Guys</b> Carol Ted Cathy Maria Beth
Number of

votes

0 0 750 0 0

<b>Statutory voting</b>

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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

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Common stock-Residual claim



In the event of liquidation, common

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Dividend and Capital gain



Dividend:



Common stockholders have the right to receive

<i>dividends </i>

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



<i>capital gain</i>

.



When a stock is sold after having been held for 12

months or less, the profit or loss is known as a

<i></i>

<i>short-term </i>

gain or loss. For stocks held longer than 12

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Common stock-Value

 <b>Face value</b> (par value)

 <b>Book value</b>: 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
 <b>Market value</b>: The current quoted price at which

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

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

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Bonds



The basic structure of bonds



Cash flow pattern of bonds



Bonds category



Corporate bonds



Government bonds

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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

<i>capital </i>

<i>markets</i>



Face value



Maturity date



Interest rate

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The

Basic Structure of Bonds

Cash Flow Pattern for a Traditional Coupon-Paying

Bond

<b>FIGURE 6-1</b>

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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 +

Face Value

Purchase

Price

Cash Inflows

to the Investor

Cash Outflows

to the Investor

0

1

2

3

4 n

Coupon

Coupon +

Face Value

Purchase

Price

Cash Inflows

to the Investor

Cash Outflows

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Bonds category



Issuer



Corporate



Government



Maturity



<1 year: Bills

or “Paper”



1- 7 years:

Notes



>7 years: Bonds



Interest payment



Coupon bonds



Zero-coupon

bonds

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Corporate bonds



Corporate bonds are long term bonds

issued by corporations.



Semiannual interest.



Bond indenture: the legal contract

that specifies the rights and

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<b>Types of Corporate Bonds</b>



<b>Bearer bonds </b>

<i>versus</i>

<b> Registered bonds:</b>



Bearer bonds

<b>: </b>

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



<b>Term </b>

<i>versus</i>

<b> Serial bonds</b>



Term bonds

<b>: </b>

bonds in which the entire issue

matures on a single date



Serial bonds:

bonds that mature on a series of

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<b>Types of Corporate Bonds</b>



<b>Mortgage bonds </b>

<i>versus </i>

<b>Debentures</b>



<b>Mortgage bonds: </b>

are backed by some type of real

property

 <i><b>Collateral trust bonds</b>: </i>are backed by other

securities owned by the corporation;

 <i><b>Equipment Trust Certificates</b></i><b>: </b>are backed by

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



<b>Debentures: </b>

are similar to signature loans in that

no property is specifically pledged to back the loan.

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More Bond Features



<i>Call feature</i>

– allows the issuer to redeem or pay off

the bond prior to maturity, usually at a premium



<i>Retractable bonds</i>

– allows the holder to sell the

bonds back to the issuer before maturity



<i>Extendible bonds</i>

– allows the holder to extend the

maturity of the bond



<i>Sinking funds</i>

– funds set aside by the issuer to

ensure the firm is able to redeem the bond at

maturity

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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.

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<b>Callable bonds</b>

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?

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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

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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.

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<b>Use the following </b>

<b>information to answer all </b>
<b>five questions: </b>

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 1 and April 15
b. February 15 and April 15
c. February 1 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

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Government bonds



Municipal bonds

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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

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<b>HOSE announces the details of delisting the following municipal bond</b>

- 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: <b>HIFU Bond Issue</b> <b>No.07/2006 </b>- issued through underwriting
- Bond symbol: <b>HCMA0706 </b>

- Face value: VND100,000

- Term to maturity (years): 05

- Issuing date: <b>September 1st, 2003 </b>

- Interest rate: <b>4.50%/6 months</b>

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

- Ex-right date: <b>August 1st, 2008</b>

- Record date: <b>August 1st, 2008</b>

- Delisting date: <b>August 4th, 2008</b>

- Trading will be stopped on the same day of delisting

- Principal and interest will be paid on <b>September 1st, 2008</b>.

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<b>Tax Exemption and Muni </b>

<b>Yields</b>

<i> </i>

<i><b>i</b></i>

<b> = </b>

<i><b>i</b></i>

<b>(1 - t)</b>

Where:

<i>i</i>

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

bond

<i>i</i>

= Before-tax rate of return on a taxable bond

t = Income tax rate of the marginal bond holder

<b>Example: You can invest in taxable corporate bonds that are paying</b>

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%

<i> </i>

<i><b>i</b></i>

<b> = </b>

<i><b>i</b></i>

<b>(1 - t)</b>

Where:

<i>i</i>

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

bond

<i>i</i>

= Before-tax rate of return on a taxable bond

t = Income tax rate of the marginal bond holder

<b>Example:</b>

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%

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<b>Types of Municipal Bonds</b>



<b>General Obligation Bonds</b>



bonds backed by the full faith and credit

of the issuer



<b>Revenue Bonds</b>



bonds sold to finance a specific revenue

generating project and are backed by

cash flows from that project



<b>General Obligation Bonds</b>



bonds backed by the full faith and credit

of the issuer



<b>Revenue Bonds</b>



bonds sold to finance a specific revenue

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

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

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<b>Explanation Moody’s S&P</b>
<b>Investment grade categories: </b>

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

<b>Explanation Moody’s S&P</b>
<b>Investment grade categories: </b>

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

<i>BBB-(continued)</i>

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<b>Explanation Moody’s S&P</b>
<b>Speculative investment grades:</b>

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

<b>Explanation Moody’s S&P</b>

<b>Speculative investment grades:</b>

Speculative issues; protection may Ba1 BB+
be very moderate Ba2 BB
Ba3

BB-Very speculative; may have small B1 B+

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Government bonds



<1 year: Bills or

“Paper”



1- 7 years: Notes

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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

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Rights (Preemptive rights)

 <b>Right to purchase shares </b>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

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Example

ABC company:



30.000 outstanding stocks, market

price: $20



New issue: 10.000 stocks,

subscription price: $17

Right’s value?

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Warrants



<b>Warrants </b>

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.

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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

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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

<i>not</i>

entitled to

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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 1 warrant per bond

that can be converted into 5 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?

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