Stock (Equity) Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed Preferred stock may

Stock (Equity)

Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed

Preferred stock may provide for cumulative dividends, conversion into common stock, voting rights (when dividend payments are missed), dividend participation, sinking funds, and/or call provisions (provides maturity)

Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1

Stock (Equity)

Common stock represents ownership in a corporation common stockholders vote for members of

the board of directorshas last claim on distribution of earnings

and assetsmay have preemptive rights to purchase

any additional shares sold by the firm


Common Stock

Classified Closely held Publicly held


Derivatives

Value depends on some underlying asset such as a stock or bond

Option - contract that gives the right to buy or sell an asset at a set price within a specified period of time Call: holder has the right to buy Put: holder has the right to sell Striking price: exercise price of the option


Derivatives

Convertibles - bonds or preferred stocks that can be exchanged for common stock at the option of the holder Conversion ratio defines the number of shares of

stock the convertible holder receives upon conversion

Futures - arrangement for delivery of an item at a set future date and at a set price


Derivatives

Swaps - an agreement to exchange cash flows or assets at a set time in the future


Derivatives

Hedge Funds- a private pool of funds constructed for the purpose of generating a specific range of returns, no matter what happens in the general stock market


Rationale for Using Different Types of Securities

Differences in trade-off between risk and expected after tax return

Appeal to broad market and different investment needs

Different securities are popular during different economic conditions or at different times


Which Financial Instrument is Best?

Issuer’s or investor’s viewpoint ?Bonds

fixed interest paymentsdoes not represent ownershipmay have restrictions on dividends interest expense is deductible



Preferred stock fixed payment - but not obligatedno voting rightshigher after-tax cost since dividends are not

deductible expenses



Common Stockno obligation of dividend paymentsno maturity date for “repayment” increases creditworthinessprospects affect termsgives control to stockholders shares the income of the firmhigher costs of distribution than debtdividends are not deductible


Risk & Returns on Different Classes of Financial Instruments


Financial Instruments in International Markets

American Depository Receipts (ADRs) represent ownership in stocks of foreign countries

that are held in trust by a bank located in the country the stock is traded

Foreign debt sold by a foreign borrower but denominated in the

currency of the country in which it is sold



Eurodebt debt sold in a country other than the one in whose

currency the debt is denominated Eurobonds Eurocredits: usually tied to London InterBank Offer

Rate (LIBOR) Euro-commercial paper (Euro-CP) Euronotes



Equity instrumentsEuro stock is traded in countries other than

the “home” country of the company, not including the United States

Yankee stock is stock issued by foreign companies that is traded in the United States


Chapter PrinciplesKey Financial Assets Concepts

Why are there so many different types of financial institutions? Different investors have different risk/return

tradeoff preferences Firms can raise funds more easily if they offer the

types of securities that investors want

What is debt? What types of debt exist? A debt is a loan Two classifications of debt are short-term and long-

term



What are bond ratings and why are they important? Bond ratings are based on both quantitative and

qualitative factors; give an indication of the default risk associated with a bond

What is equity? The value of the assets owned minus the amount

of debt that is owed



What are derivatives? Financial assets that have values based on the

values of other assets such as stocks and bonds

What are some of the more familiar types of derivatives? Options, futures, convertibles and swaps


End of Chapter 2

Financial Assets (Instruments)


Documents

Stock (Equity) Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed Preferred stock may