01/08/2017

Key Concepts and Skills

Chapter 15
Describe the basic features of common and
preferred stock.
Understand the different types of bonds and
how bond characteristics impact the required
Long-Term Financing yield.

McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 15-1

Chapter Outline Features of Common Stock

15.1 Some Features of Common and Preferred Voting rights (Cumulative vs. Straight)
Stock Proxy voting
15.2 Corporate Long-Term Debt Classes of stock
15.3 Some Different Types of Bonds Other rights
15.4 Bank Loans Share proportionally in declared dividends
15.5 International Bonds Share proportionally in remaining assets during
liquidation
15.6 Patterns of Financing
Preemptive right first shot at new stock issue to
15.7 Recent Trends in Capital Structure maintain proportional ownership if desired
15-2 15-3

1
 01/08/2017

Features of Preferred Stock Debt versus Equity

Debt Equity
Dividends Not an ownership interest Ownership interest
Stated dividend must be paid before dividends can Creditors do not have voting Common stockholders vote
be paid to common stockholders. rights
for the board of directors and
Interest is considered a cost of other issues
Dividends are not a liability of the firm, and doing business and is tax
Dividends are not considered
preferred dividends can be deferred indefinitely. deductible
a cost of doing business and
Creditors have legal recourse
Most preferred dividends are cumulative any if interest or principal are not tax deductible
missed preferred dividends have to be paid before payments are missed Dividends are not a liability of
common dividends can be paid. Excess debt can lead to the firm, and stockholders
financial distress and have no legal recourse if
Preferred stock generally does not carry voting bankruptcy dividends are not paid
rights. An all-equity firm cannot go
bankrupt
15-4 15-5

The Bond Indenture Bond Classifications

Contract between the company and the Registered vs. Bearer Forms
bondholders that includes: Security
The basic terms of the bonds Collateral secured by financial securities
The total amount of bonds issued Mortgage secured by real property, normally
A description of property used as security, if land or buildings
applicable Debentures unsecured
Sinking fund provisions Notes unsecured debt with original maturity less
Call provisions than 10 years
Details of protective covenants Seniority
15-6 15-7

2
 01/08/2017

Required Yields Zero Coupon Bonds

The coupon rate depends on the risk Make no periodic interest payments (coupon rate =
characteristics of the bond when issued. 0%)

Which bonds will have the higher coupon, all The entire yield to maturity comes from the
difference between the purchase price and the par
else equal? value
Secured debt versus a debenture
Cannot sell for more than par value
Subordinated debenture versus senior debt
Sometimes called zeroes, deep discount bonds, or
A bond with a sinking fund versus one without original issue discount bonds (OIDs)
A callable bond versus a non-callable bond Treasury Bills and principal-only Treasury strips are
good examples of zeroes
15-8 15-9

Pure Discount Bonds Pure Discount Bonds: Example

Information needed for valuing pure discount bonds: Find the value of a 30-year zero-coupon bond
Time to maturity (T) = Maturity date - todays date
Face value (F)
with a $1,000 par value and a YTM of 6%.
Discount rate (r)
$0 $0 $0 $1,000
$0 $0 $0 $F

0 1 2 T T
0 1 2 29 30
1

Present value of a pure discount bond at time 0: F $1,000

PV
F (1 (1.06) 30 $174.11
PV r) T
(1 15-10 15-11

r)T

3
 01/08/2017

Floating Rate Bonds Other Bond Types

Coupon rate floats depending on some index value Income bonds
Examples adjustable rate mortgages and inflation- Convertible bonds
linked Treasuries
Put bonds
There is less price risk with floating rate bonds.
The coupon floats, so it is less likely to differ There are many other types of provisions that
substantially from the yield to maturity. can be added to a bond, and many bonds have
Coupons may have a collar the rate cannot go several provisions it is important to
above a specified ceiling or below a specified recognize how these provisions affect required
floor. returns.
15-12 15-13

15.4 Bank Loans 15.5 International Bonds

Lines of Credit Eurobonds: bonds denominated in a particular currency and
Provide a maximum amount the bank is willing to lend issued simultaneously in the bond markets of several
countries
If guaranteed, referred to as a revolving line of credit
Foreign bonds: bonds issued in another nations capital
Syndicated Loan market by a foreign borrower
Large money-center banks frequently have more demand
for loans than they have supply.
Small regional banks are often in the opposite situation.
As a result, a lager money center bank may arrange a loan
with a firm or country and then sell portions of the loan to
a syndicate of other banks.
A syndicated loan may be publicly traded.
15-14 15-15

4
 01/08/2017

15.6 Patterns of Financing The Long-Term Financial Deficit

Internally generated cash flow dominates as a source Uses of Cash Flow Sources of Cash Flow
(100%) (100%)
of financing
This preference has increased through time Capital Internal cash
Net stock buybacks accelerated in 2002-2007 spending flow (retained
80% earnings plus Internal
Declined in 2008, likely as a result of the financial crisis depreciation) cash flow
80%
Financial
deficit
Net
working
capital plus Long-term External
other uses debt and cash flow
20% equity 20%
15-16 15-17

15.7 Recent Trends in Capital Structure Quick Quiz

Which are best: book or market values? Describe the basic characteristics of common
In general, financial economists prefer market values. and preferred stock.
However, many corporate treasurers may find book Differentiate between cumulative voting and
values more appealing due to the volatility of market
values.
straight voting.
Identify the rights of shareholders and
Whether we use book or market values, debt ratios
for U.S. non-financial firms have been below 50 bondholders.
percent of total financing. How would the following characteristics
impact the yield on a bond:
Callable
Sinking Fund
15-18 15-19