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4 types of financial securities
-
Bond
: A security representing the long-term debt of a company.
-
Bank loan:
Indirect financing where the company borrows funds from a bank, which gets those
funds from savers. These claims are not traded in the financial markets.
-
Preferred stock
: A type of stock whose holders are given certain priority over common
shareholders in the payment of dividends. Usually the dividend rate is fixed at the time of issue
and no voting rights are given.
-
Common stock
:
Equity claims held by the “residual owners” of the firm who are the last to
receive any distribution of earnings or assets.
Balance Sheet Model of the Firm
.
The assets of the firm must be supported by the firm obtaining
financing (borrowing or issue equity).
The accounting balance sheet follows the cost principle and
records asset and claims at their historic costs when added to the balance sheet.
The
economic balance
sheet
also looks at assets and claims, but uses current market values.
Privately held company
: A company that raises capital by selling their securities directly to investors
rather than the general public.
Publicly traded Corporations
:
Corporations who fulfill registration and reporting requirements and are
authorized to sell financial securities to the general public.
Primary market transaction.
Corporations and other organizations, with the assistance of investment
banks, create financial securities and issue them to the investing public. This is how companies raise
capital.
Initial Public Offering (IPO):
The original sale of a company’s securities to the public. Also called an
unseasoned new issue.
Seasoned security offering (SEO):
A new public stock issued after the company’s stock has been
previously issued publically. Also called a seasoned new issue.
Rights offer:
An offer that gives a current shareholder the opportunity to maintain a proportionate
interest in the company before shares are offered to the public.
Crowdfunding:
Websites in which companies needing capital post information about their company and
invite individuals to invest. Crowdfunding bypasses the traditional financial intermediaries such as
investment banks and commercial banks.
Institutional investors:
These organizations pool large sums of money and invest those sums in
securities, real property securities, and other investment assets. Their role in the economy is to act as
highly specialized investors on behalf of others.
Secondary market transaction
: An investor holding a publicly traded security sells the security to
another investor. The company issuing the security is not part of this transaction. Once issued, these
securities are traded among investors
Direct financing
involves companies issuing financial securities through the financial markets to expand
and build their operations.
Indirect financing
involves financial institutions that are intermediaries between savers and borrowers.
An
Investment Bank
is a financial intermediary who provides a variety of services including aiding in the
sale of securities, facilitating mergers and other corporate reorganizations, acting as brokers to both
individuals and institutional clients, and trading for their own account. In the following example Nathan
works with an investment bank to create, price, and sell these new bonds.
An
Intermediary
is an institution that acts as a middleman, providing services to those with funds to
invest and those who need funds
Commercial Bank
: A financial intermediary that serves as an interface with savers and borrowers.
These banks accept deposits from savers that offer safety and a rate of return. They then lend these
funds out to individuals and businesses who need to borrow. Banks make a profit by lending out funds
at an interest rate that is higher than the rate they pay to their depositors.
Financial markets:
Markets in which financial securities are issued and traded.
Exchanges
: Organized public markets where companies list their securities for trading by investors.
These listed securities must adhere to securities laws and regulations to be traded on these public
markets. The exchanges provide a legal platform to ensure that the commitments made by participants
are realized. Exchanges are generally organized as profit-seeking companies.
Over-the-Counter (OTC) markets
are not centralized trading places but rather systems by which dealers
can offer to buy and sell securities among themselves and to their customers.
Dealer
:
A market maker that maintains an inventory and stands ready to buy and sell at any time. The
dealer makes a profit through the spread: by buying an asset at one price and selling the asset at a
higher price.
Broker:
An entity that brings security buyers and sellers together but does not maintain an inventory.
The broker makes a profit via a commission paid for services rendered in facilitating the trade.
Bootstrapping
involves using personal savings, selling personal assets, borrowing against assets, using
credit cards, and taking on personal loans to raise capital.
Venture capital:
Venture Capitalists develop businesses into viable, profitable companies through their
investment of capital that more traditional investors may not make.
Efficient market: A market in which the price of the asset reflects its economic value.
Efficient market hypothesis (EMH).
States that prices of securities fully reflect available information.
Investors buying bonds and stocks should expect to obtain an equilibrium rate of return. Firms should
expect to receive the fair value for the securities they sell.
Technical analysis.
Seeks to predict future price movements by identifying patterns and relationships in
historic market information and then using these patterns to predict future prices.
Weak-form efficient market.
Theory that a market is efficient with respect to historical price
information.
Public information.
I
nformation available to the investing public.
Fundamental analysis.
Evaluates relevant economic, financial, political and other qualitative and
quantitative information in order to determine an asset’s intrinsic/economic value.
Semi-strong efficient market.
Theory that a market is efficient with respect to public information.
Private information:
.
Information that is not available to most investors.
Insider trading
. An insider is anyone with nonpublic, specific information. They cannot use their
information to take unfair advantage when trading with outsiders.
Strong-form efficient market.
Theory that a market is efficient with respect to all available information,
public or private.
The
Market value
of a bond is its economic value: the present value of the promised payments taken at
the bond’s opportunity cost.
Coupon payment
:
The amount of regular, per-period interest payments promised by the company
issuing the bond.
Principal/Face value
:
The amount borrowed and the amount bondholders should receive when the
bond matures. The face value of bonds is generally set at $1,000 per bond.
Opportunity cost:
The rate the bondholders expect to earn given the risk of the bond. It is the
opportunity cost of the bond in that it is the rate of return the investor should earn on other similar
bonds.
Maturity
:
The length of time the bond will exist and when the bond should repay the principal to the
bondholder.
Coupon rate
:
The annual stated rate of interest paid on the bond. This rate is set when the bond is
issued and does not change. This rate will set up the cash flows of the bond's time line.
Yield to maturity (YTM)
:
The current opportunity cost on all bonds of equivalent risk and maturity. It is
the rate required by market participants to invest in the bond. The yield will change with changes in
economic conditions and the risk of the bond. This is the discount rate that will be used to discount the
bond's cash flows to determine its economic value.
Interest only bond:
A bond that makes regular periodic interest payments and pays the entire principal
upon maturity.
Zero-coupon bond/discount bond
:
A bond that pays no interest and has a 0% coupon rate! At maturity
it pays the face value plus accumulated interest.
Convertible bonds
:
A type of bond that can be exchanged for common stock offered by the bond-issuing
company. This feature provides the stable income and fixed payment of the debt, but also allows the
bondholder to share in a company’s growth and profitability.
Call provision
:
Part of a bond indenture that allows the issuer to buy back the bond under certain
conditions.
Indenture
: Written agreement between the corporate debt issuer and the lender. Sets forth maturity
date, interest rate, and other terms.
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Protective covenant
: Part of the indenture that protects bondholders by limiting certain actions a
company might otherwise take.
Collateral
: Assets that are pledged as security for payment of debt.
Debenture
: A bond that is not secured by an underlying asset.
Amortized loan:
A loan with a scheduled number of equal payments, with each payment including both
interest payments and a partial payment on the amount on the loan's principal.
Interest rate risk
: The market price of a bond varies inversely with the current required rate of return.
Discount
: A bond sells at a discount when its market price is less than its face value. This occurs when
the coupon rate is less than the current YTM.
Premium
: A bond sells at a premium when its market price is greater than its face value. This occurs
when the coupon rate is greater than the current YTM.
Default risk
:
The risk that a bond issuer may not honor the provisions of the bond indenture, causing a
loss in value of the bond.
Investment Grade Bonds
:
Bonds are rated to have a relatively low probability of default and are
acceptable to prudent investors such as pension funds.
Speculative Bonds/junk bonds
:
Bonds are rated to have a higher probability of default. These bonds
would be attractive to investors who have a high tolerance for risk, but would not be held by companies
with fiduciary obligations, such as pension funds.
Dividends
:
are regular payments to the shareholders that generally represent a distribution of profit.
These payments are not guaranteed: the Board of Directors will declare—issue a dividend—only if they
believe the company has enough cash or profits.
Capital gain
:
An increase in the value of an asset over its purchase price.
Stock buybacks
: A company can use buy back its shares from the stockholders. This gives the
shareholders a (hopefully) capital gain and cash, It also reduces the number of shares outstanding.
Preferred stock:
A form of equity that has preference over common stock in the payment of dividends.
Preferred shareholders receive dividends before common shareholders. Preferred stock dividends are
generally fixed and do not have voting rights in the corporation.
Common stock
: A financial security that represents ownership in a company: the right to all residual
cash flows after the claims of the company's stakeholders have been satisfied. Common shareholders
control the company through their election of the board of directors.
Investment horizon
:
The time period that the investor plans to hold the stock.
Return on Equity (ROE)
:
The rate of return that shareholders get on their investment in the corporation.
The
Retention Ratio
is the proportion of earnings (Net Income) that is retained and reinvested in the
company.
The
clientele effect
holds that some investors prefer companies with steady dividend payments, while
other investors prefer growth in the stock price rather than the income from dividends.
The
price/earnings ratio (P/E)
is the ratio of the stock price divided by the company's Earnings per Share
(EPS).
Earnings per Share (EPS)
:
The net income of the company divided by the number of shares. This states
the income of the company on a per-share basis, which is useful when we're evaluating the price of a
single share of stock.
-
There are two types of markets. In auction markets like the NYSE, brokers and agents meet at a
physical location (the exchange) to buy and sell their assets. Brokers don’t own the asset, they
serve the major function of getting buyers and sellers together, and earn their keep via
commissions set as a portion of the price agreed to by the buyers and sellers. Think real estate
brokers who get home buyers and sellers together.
-
Dealer markets like NASDAQ represent dealers operating in dispersed locales who buy and sell
assets themselves, usually communicating with other dealers electronically or literally over the
counter. Dealers do own the traded asset, and will buy from some parties and sell to others from
their inventory. Dealers make their profit by buying the asset from one party (bid price) and
selling it to another party (ask price). The ask price is higher than the bid price and the dealer
keeps the difference, which is called the bid-ask spread.
The present value of the inflows is the economic value of the asset: the future cash flows discounted at
the opportunity cost.
The present value of the outflows is the price paid for the asset.
Investors are always looking for a good deal—to pay less than the economic value. This goal is reflected
in the IRR and NPV decision rules.
On average, the only return that is earned is the required return—investors buy assets with returns in
excess of the required return (positive NPV), bidding up the price and thus causing the return to fall to
the required return (zero NPV); investors sell assets with returns less than the required return (negative
NPV), driving the price lower and thus the causing the return to rise to the required return (zero NPV).
Ignoring trading costs, on average such investors merely earn what the market offers; the trades
all have zero NPV. If trading costs exist, then these investors lose by the amount of the costs.
Investors may make a killing in some market periods, but will likely be killed in other market
periods.
There are investors who seem to consistently beat the market, but their occurrence is no more
that we would expect in a random distribution.
Gambling is a zero-sum game. One gambler wins and the other gambler loses, as anyone who
has bet on a sports event, or an election, can attest to.
Economic activity, including investing in financial securities is risky, but unlike gambling can
produce an acceptable rate of return.
Unlike gambling, the stock market is a positive sum game; everybody can win. Investors make
investments that produce an expected return that compensates them on average for the time value
of money and the risk of the expected cash flows. The ability of the markets to connect
businesses that need capital with investors with capital is a major engine of economic growth.
An implication of this is that, on average, the typical market participant cannot earn excessive
profits from a particular trading strategy. However, that does not mean that a few particular
investors cannot outperform the market over a particular investment horizon. In fact, given
probabilities their absence would be troubling.
In summary, the coupon rate is the contractual rate set in the bond indenture, whereas the YTM is the
current market required rate of return on the bond.
Calculate a bond’s Price.
Lycan, Inc., has 7 percent coupon bonds on the market that have
9 years left to maturity. The bonds make annual payments and have a par value of
$1,000. If the YTM on these bonds is 8.4 percent, what is the current bond price?
N = 9 years
I/YR = the YTM of 8.4%
PMT = The coupon payment: 7% x $1,000 = $70
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
Push PV, which gives us the value of the bond today: $913.98
N = 9 years
PMT = The coupon payment: 7% x $1,000 = $70
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
PV = The price of the bond, which is the present value of the coupon payments and face value
= -$961.50. Note, as this is what the investor pays for the bond, it’s entered as a”-“.
With the four pieces of information entered, we just press
I/YR = the YTM of 7.61%
Calculate a bond’s price with semiannual compounding.
Harrison Co. issued 15-year bonds
one year ago at a coupon rate of 6.1 percent. The bonds make semiannual payments. If the
YTM on these bonds is 5.3 percent, what is the current dollar price assuming a $1,000 par
value?
N = 14 years, which converts to 28 periods.
I/YR = the annual YTM of 5.3%, converts to a semiannual rate of 2.65%
PMT = The coupon payment: 6.1% x $1,000 = $61 converts to semiannual coupon payments of
$30.50
FV = The par value of the bond is $1,000 (Bonds are generally priced at $1,000)
Push PV, which gives us the value of the bond today $1,078.37.
Calculate a bond’s coupon rate.
Barnes Enterprises has bonds on the market making
annual payments, with 12 years to maturity, a par value of $1,000, and a price of $963.
At this price, the bonds yield 6.14 percent. What must the coupon rate be on the bonds?
N = 12 years
I/YR = the YTM of 6.14%
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
PV = The price of the bond, which is the present value of the coupon payments and face value = -
$963. Note, as this is what the investor pays for the bond, it’s entered as a”-“.
With the four variables entered press PMT = The coupon payment of $56.95
The coupon rate is $56.95/$1,000 = 5.70%
Calculate a bond’s YTM with semiannual compounding.
Stein Co. issued 15-year bonds two
years ago at a coupon rate of 5.4 percent. The bonds make semiannual payments. If these
bonds currently sell for 94 percent of par value, what is the annual YTM?
N = 26 semiannual periods
PMT = The semiannual coupon payment is $27
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
Price = $940
Push I/YR which gives us the semiannual YTM of 3.037%.
The annual YTM is 3.03 x 2 = 6.074%
Calculate a bond’s coupon rate with semiannual compounding.
Volbeat Corporation has
bonds on the market with 10.5 years to maturity, a YTM of 6.2 percent, a par value of
$1,000, and a current price of $945. The bonds make semiannual payments. What is the
annual coupon rate on the bonds?
N = 21 semiannual periods
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
Price = $945
Semiannual I/YR = 3.1%.
Punching PMT = The semiannual coupon payment is $27.40
Zero Coupon Bonds.
You find a zero coupon bond with a par value of $1,000 and 17 years
to maturity. If the yield to maturity on this bond is 4.9 percent, what is the price of the bond?
Assume semiannual compounding periods
N = 34 semiannual periods
I/YR = semiannual discount rate of 2.45%
PMT = 0
FV = The par value of the bond = $1,000 (Bonds are generally priced at $1,000)
PV = Price of $439.13
You’ve just purchased a Honda CR-V for $34,000. You’re financing this with a 36-month
amortized loan, at an annual interest rate of 12% and monthly payments.
After the first month, what is the amount of your loan?
N = 36 payments
I/YR = 12%/12 = 1% per month
PV = $34,000
FV = $0
PMT = $1,129.29
Your loan balance after your first payment
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Interest paid in the first month: $34,000 x .01 = $340
Reduction in loan balance: $1,129.29 - $340 = $789.29
New balance on your loan: $34,000 - $789.29 = $33,210.71
What price would a newly issued 10-year bond,
paying interest annually, with a 10 percent coupon bond sell for?
The bond has a coupon rate of 10%. This means that the bond promises to pay
10% interest per year. As
bonds are set a face values of $1,000, the annual coupon paid would be 10% x $1,000 = $100
Suppose you buy a 7 percent coupon, 20-year bond
today when it's first issued. The bond pays interest annually, If interest rates suddenly
rise to 15 percent, what is the value of the bond?
Calculating the present value of the bond’s cash flows at the new discount rate of 15%, gives us a
value of
$499.25. You have had a very, very bad day!
N = 20 I/YR = 15 PV = $499.25 PMT = $70 FV = $1,000
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provide general account answer assap
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general account answer nned
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Select the description that best fits each term or phrase. A. Records and tracks the bondholders’ names. B. Is unsecured; backed only by the issuer’s credit standing. C. Has varying maturity dates for amounts owed. D. The legal contract between the issuer and the bondholders. E. Can be exchanged for shares of the issuer’s stock. F. Is unregistered; interest is paid to whoever possesses them. G. Maintains a separate asset account from which bondholders are paid at maturity. H. Pledges specific assets of the issuer as collateral. 1. Registered bond 5. Convertible bond 2. Serial bond 6. Bond indenture 3. Secured bond 7. Sinking fund bond 4. Bearer bond 8. Debenture
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All corporate bonds coupons are payable by cash only.
True
False
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Select the item that best fits each description A through H.
Description
A. Records and tracks the bondholders' names.
B. Is unsecured; backed only by the issuer's credit standing.
C. Has varying maturity dates for amounts owed.
D. The legal contract between the issuer and the bondholders.
E. Can be exchanged for shares of the issuer's stock.
F. Is unregistered; interest is paid to whoever possesses them.
G. Maintains a separate asset account from which bondholders are paid at maturity.
H. Pledges specific assets of the issuer as collateral.
Items
Bearer bond
Bond indenture
Convertible bond
Debenture
Registered bond
Secured bond
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If bonds payable are not callable, the issuing corporation
a.can exchange them for common stock
b.can repurchase them in the open market
c.is more likely to repurchase them if the interest rates increase
d.must get special permission from the SEC to repurchase them
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Why might a company choose to raise money through bonds, rather than take out a note payable or issue stock? What are the advantages and disadvantages of bonds? What does it mean to issue a bond at a "premium" or at a "discount"?
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Identify the following as either an advantage (A) or a disadvantage (D) of bond financing for a company.
a. Requires payments of both periodic interest and par value at maturity.
b. Bonds require payment of par value at maturity.
C. Bonds do not affect owner control.
d. A company earns a lower return with borrowed funds than it pays in interest.
e. A company earns a higher return with borrowed funds than it pays in interest.
f. Bonds require payment of periodic interest.
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Finance
A corporation can raise money by selling stocks and/or bonds. From an investor's perspective, what is the difference between a bond and stock? O 1. If an investor owns a corporate bond, the investor owns a part of the company. O 2. A corporation guarantees interest payments to a bond investor but does not guarantee dividend payments to stock investor. O 3. A corporation guarantees dividend payments to a stock investor but does not guarantee interest payments to bond investor. O4. Stocks can appreciate in value, bonds do not change value.
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Which ot the following features would decrease the value of a corporate bond?
A.The bond is sinior debt obligation
B.The bond is convertible into shares
C.The bond is secured by a mortgage on real estate
D.The borrower has the option to repay the loan before maturity
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Identify the following as either an advantage (A) or a disadvantage (D) of bond financing for a company.
a. Large payments of par value are made at maturity.
b. Unlike equity, bonds do not affect ownership of a company.
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d. A business earns a higher return with the funds from the bond than it pays in interest.
e. Requires payments of interest even when cash flows are low.
f. Bond interest payments reduce total taxes paid.
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PIPE transaction gives issuers faster access to capital.
The securities are virtually always sold to the investors at a discount to the price at which they would sell in the public markets.
PIPE transactions are registered with the SEC.
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Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education