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Bond and Stocks Financing

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Financing thru Stocks
Stocks are the owned capital of a business and that it is considered a permanent investment. Stockholders are people who invest in stocks and their ownership in the corporation is evidenced by a stock certificate. Stocks may be obtained thru:

* Subscription
* Purchase
* Issuance of stock dividends
Almost all of the initial capital of the corporation including a large segment of the future capital comes from the sale of stock.

Stock Financing
* Refers to the procurement of corporate funds through the sale of shares of stocks to prospective investors * It is a method of financing by increasing the equity capital. Major Classification of Stocks

Authorized capital stock, capital; and capitalization
Authorized capital stock- is the total amount of stocks of all classes authorized in the certificate of incorporation. * It may consist of the issued stocks and the un-issued stock of the corporation. Capital stock- represents the actual amount of stocks of all classes which are issued and outstanding any time and not necessary the total amount of authorized capital stock, a large part of which is un-issued. Capital- depends on whose point of view it is being defined. To accountants- capital refers to the total ownership of the business which is obtained by deducting the total liabilities from the total assets. To businessman- capital refers to all assets of the business regardless of where it came from whether equity capital or borrowed money. To economist- capital would be all productive assets used in the business excluding non-productive assets Capitalization- refers to the sum of the face or par value of all outstanding stocks and bonds issued by the corporation.

In case of no par value stocks the value carried in the balance sheet will be used. This can be computed by adding to the capital stock all bonded indebtedness issued by the corporation. Un-issued capital stock – this is a portion of the authorized capital stock which have not yet been subscribed and remains in the corporation. Issued capital stock – this refers to the stock already issued and outstanding. Outstanding stock – this refers to all issued and subscribed stocks which may be fully paid or partly paid which are held by stockholder other than the issuing corporation.

Treasury stocks – refers to those stocks issued and fully paid but re-acquired by the issuing corporation. Re-acquisition may either be through purchase, a gift and donation to the corporation. These stocks are not part of the outstanding stock unless sold by the corporation. They lose their voting rights and are not entitled to dividends. Call – a resolution passed by the board of directors to demand payment for the unpaid subscription. Interest may be collected by the corporation from the time the call is made. The following are the requirements for a call:

1. A board resolution must be made specifying the percentage of the unpaid balance due when and where and to whom payment should be made. 2. The resolution must specify the date of delinquency which shall not be less than 30 days nor more than 60 days from the date of the call. 3. A notice of a call for payment must be sent to the stockholder. Auction sale of Delinquent stocks

Advantages of Preferred stocks

Cases when stocks sold on auction can be recovered by the delinquent stockholder: 1. Defect or irregularity in the call for unpaid subscription 2. Defect or irregularity in the notice of delinquency

3. Defect or irregularity in the sale
Court action – there are instances when the corporation may want to sue the delinquent stockholder rather than resorting to auction sale. The Corporation has to comply with some legal requirements such as the notice and publication of the call to be able to file a lawsuit against the delinquent stockholder. Classes of stock

Stocks are divided into several classes providing numerous combinations of elements such as income, risk, and control of the corporation. Major classification of stocks

Two major classifications of stocks:
1. Common stocks
2. Preferred stocks
Common stocks – are the simplest form of ownership in a corporation. It only has the fundamental rights of the stockholder without any special preference or privilege. They are entitled only to the residual claim on the dividends and assets of the corporation. They only get their share of dividends and assets of the firm after the preferred stockholders have received their share. Preferred stocks – are those stocks with privileges and preferences aside from its fundamental rights which is similar to a corporation unless of course when specified otherwise. Two kinds of Preferred stocks:

1. Preferred as to assets – are those stocks which share in the distribution of the proceeds from the sale of corporate assets first before the common stockholders received their share. This only comes about when the corporation is either fully liquidating or partially liquidating to narrow down its operation. 2. Preferred as to dividends – are stocks entitled to receive dividend of the corporation first before the other stockholders of the corporation are paid their share. The preferential rate is specified in the certificate of incorporation and the stock certificate.

Advantages of preferred stocks

1. Preferred stocks will receive their dividends first before the common stockholders receive their share. 2. On the point of view of the corporation, the advantage of the issuance of preferred stocks compared to the issuance of bonds is that dividend payment may not be declared by the corporation in the event the board of directors believe that the corporation needs the income for expansion 3. Since payment of dividends is subject to the earnings of the corporation, the issuance of preferred stocks increases the firm’s financial leverage. 4. In case of mergers preferred stocks can be exchanged for common stocks of the acquired company.

Disadvantages of preferred stocks

1. Compared to bonds preferred stocks are costlier for the corporation. 2. It is also costly for the corporation because dividends are paid from the after tax earnings while interest paid to long term debt are tax-deductable.

Participating and Non-participating stocks

Participating preferred stocks – are those which still participate with the common stocks even after they have received their preferential rate but only after the common stocks have been given that same preferential rate as the preferred stocks.

2 kinds of participating preferred stocks:

1. Full participation
2. Partial participation

Full participation – referred to those preferred stocks that still participate with the common stocks after the common stocks have received the same preferential rates as those given to the preferred stocks. Example of Full participating preferred stocks:

Say a corporation issues 20,000 shares of common stocks with a par value of P100.00 per share and participating preferred stocks of 4,000 shares with a par value of P200.00 per share. They declare dividends worth P200,000. Preferential rate is 0.6 per share. Solution:

4,000 X 200 = 800,000 X .06 = 48,000 for participating preferred stocks
20,000 X 100 = P2,000,000 X .06 = 120,000 for common stocks
200,000 – 48,000 = 152,000 – 120,000 = 32,000, to be shared by the two classes of stocks as if they belong to one class of stock.
800,000 / 2,800,000 X 32,000 = 57,142.85 share of participating preferred stock 2,000,000/2,800,000 X 32,000 = 142,857.14 share of the common stock

Total share participating preferred stocks = P48,000 +9,142.85 = 57,142.85/4,000 shares = P14.29 per share of stock.
Total share of common stocks = P120,000 + 22,857.14 = P142, 857.14/2,000,000 = P7.14 per share. Non-participating preferred stocks – are only entitled to the preferential rate. All remainder of the dividends will go to the common stockholders. Comulative and non-cumulative stocks

Comulative stocks – are entitled to dividends even when dividends are not declared. Non-cumulative stocks – are stocks entitled to dividends only when dividends are declared. Callable and redeemable stocks

Callable stocks – are stocks that can be redeemed by issuing company before their maturity date. Redemption price is usually higher than the par value of the stocks to increase their salability. Preferred stocks are generally callable. Two kinds of redeemable or callable stocks:

1. Mandatory type of callable stocks
2. Optional type of callable stocks

Mandatory type of callable stocks – requires the corporation to redeem the stocks with in a specific period of time. Optional type of callable stocks – does not require the corporation to redeem the stocks. Sinking fund – is an amount set aside from the earnings of the corporation specifically earmarked for the redemption of the stocks. Indirect redemption – is used by the corporation to redeem those stocks that are not redeemable * It is done when the corporation is in a liquid corporation. The socks that are indirectly redeemed are called treasury stocks. Convertible stocks – are stocks that can be exchanged to other securities of the corporation either for another class of stocks or bonds at a specified ratio. Conversion ratio – is the rate at which a stock is exchanged with other stocks or bonds of the corporation. Advantages of convertible stocks:

1. It increases the salability of the stocks because the investor has the chance to diversify his investments. 2. It is also a protection to the stockholder against dilution of the shares of stocks of the corporation (that means reducing the value of the stocks and thus rendering it worthless). Par value and no par value stocks

Par value stocks – is one that has an assigned value on its face. * This can be found in the stock certificate. The par value is the minimum amount that the corporation should accept for the payment of the stocks below which the corporation is issuing a watered stock. No par value stocks – are those stocks without any designated price in its face. The certificate of incorporation specifies in the authorized capital stock the number of shares issued and not its peso value. For purposes determining the organizational fee to be paid, the par value is fixed at P100.00 per share. Restrictions in the issuance of no par value stocks:

1. No par value stocks may be sold for less than P5.00.
2. No par value stocks may be issued which are preferred as to assets. 3. Stocks without a par value cannot be sold on instalment basis. 4. Banks, trust companies, insurance companies and building and loan associations may not issue no-par value stocks. 5. Capital stock without par values cannot be issued without the prior approval of the public service commission. Guaranteed stocks – are those stocks whose dividend payments are assured by a corporation other than the issuing corporation. Deferred stocks – these are stocks whose dividend payments are postponed for a time in the future and that is subject to the lapse of a period of time or the occurrence of a particular event which allows the corporation to declare dividends.

Stock purchase warrants – this is an instrument given to stockholders giving him the option to buy shares of stocks from the company within a specific period of time at a stipulated price. Founder’s shares – these are stocks given to the incorporators of the firm. It gives the founders an extraordinary participation in the profits of the corporation when the business is good. Promoter’s shares – are those stocks used for compensating promoters for the services they rendered in promoting the promotion. Dividends – are corporate profits or earnings set aside by the board of directors to be distributed to stockholders in proportion to their stockholdings. Kinds of dividends:

1. Cash dividends
2. Stock dividends
3. Property dividends
4. Scrip dividends
5. Liquidating dividends
Cash dividends – are distributed by the corporation when it has enough cash to declare as dividends.

Requirements in declaring cash dividends:
1. There must be an income of the corporation.
2. The firm has enough cash to be given out as dividends
3. The dividends are declared by the board of directors
4. Notices are sent to the stockholders informing them of the declaration of cash dividends. Stock dividends – arises when the board of directors decides to expand the business operation and therefore stockholders are given dividends in its equivalent in shares of stocks of the corporation. Requirements in the distribution of stock dividends:

1. There must be a corporate profit.
2. The profit must be declared by the board of directors in stocks. 3. The stock dividend must be approved by 2/3 of the outstanding stock in a meeting called for that purpose. 4. A notice must be sent to the stockholders.

Property dividends – are those dividends given at the discretion of the board of directors in the form of properties of the corporation such as goods or stocks owned by the corporation but issued by the other corporations. Scrip dividend – is a written certificate issued by the corporation to its stockholders entitling them to the payment of cash at some future designated date. Liquidating dividend may be either:

Liquidating dividend – generally dividend arises from the earnings of the corporation, but when a corporation is winding up its affairs or would like to narrow down its operation, they may declare liquidating dividends from the proceeds of the corporate assets sold. * Full liquidating dividends – come from the proceeds of the corporate assets when the corporation decides to close shop and the corporation ceases to operate. * Partial liquidating dividends – arises when the corporation cuts down its operation and some of the assets will have to be sold.

Bond financing

Corporate bonds – are issued by the corporation promising to pay the bondholder the face amount of the bond certificate at maturity date. Bond issue – is the aggregate amount of long-term indebtedness that a corporation create and is divided into small units with a fixed rate of interest. * Represents the entire indebtedness and every bond is a part of the indebtedness. * It is a means of raising borrowed capital at a cost lower than borrowing money from the banks or any financing institution. Bond certificates – are evidences of bonded indebtedness and are negotiable in that they can be bought and sold or transferred and they can be given as collateral for a loan. * The sale of bonds to prospective investors is an easier method of raising funds * It is a safer investment than stocks.

Rules in the creation of bonded indebtedness
1. The creation of bonded indebtedness must be approved by majority of the stockholders in a meeting called for that purpose. 2. Majority of the board of directors must approve it and must sign the certificate of approval. Features of a bonded indebtedness

1. It is in huge amount
2. It is of long duration
3. It is participated by several investors.
Distinction of bonds from other forms of loans:
1. Bonds are always issued for large amounts while loans may be made for small or large amounts. 2. Bonds are long-term indebtedness while loans may of short or long duration. 3. Bonds are participated by several creditors while loans are made by one or few borrowers. Similarities between bond and stocks:

1. They are both transferable.
2. They are both methods of gathering capital.
* They are both issued in huge amounts.
3. They both require the approval of the majority of stockholders and board of directors. 4. They are both registered with the Securities and Exchange Commission. 5. They both pay a filing fee to the SEC.

Differences between bonds and stocks:
1. Bonds are evidences of indebtedness while stocks are evidences of ownership. 2. Bondholders are creditors of the corporation while stockholders are the owners of the corporation. 3. Bonds earn interest
while stocks earn dividends.

4. Bondholders have prior claims over the profits and assets of the corporation over the stockholders. 5. The principal in a bonded indebtedness is returned to the bondholder upon maturity of debt while stocks are permanent investments in the corporation. Bond certificates – are negotiable instruments given to buyers of bonds and they evidence the long-term indebtedness of the corporation to the bondholder. * It is generally payable to bearer and it contains fixed rate of interest that the corporation has to pay the bondholder

* It contains the general stipulation as to the amount of principal of each unit and maturity date or definite date of redemption. * They are usually issued in various denominations like 100, 500, 1000, 5000. Trust indenture – a document which embodies the terms and conditions of a bonded indebtedness. * It indicates the rights and privileges of the bondholders, the manner of its fulfillment and the duties of the trustee. Trustee – is appointed to make possible the collective management of the bond issue since the bond isuue is participated by hundred of bondholders. Contents of the trust indenture

1. The total amount of bonded indebtedness
2. The maturity date of each issue
3. The serial issue and the size of each issue
4. The type of security pledged
5. Terms and conditions of the mortgage pledge securities 6. Rate of interest and how often paid
7. Maturity date of each serial issue
8. Manner of redemption
9. Remedies available to bondholders in case of default on the part of the issuing corporation 10. Replacement of mutilated lost or stolen bond certificates. Parties to a bond issue
1. The corporation
2. The bondholder
3. The trustee
Duties of the trustee
1. To authenticate the bond issue
2. To enforce the rights of the bondholders
3. To enforce the faithful execution of the terms and conditions of the bond issue 4. To act as a transfer agent

Authenticating the bond issue – this means that the trustee certifies that the bond is part of a particular issue by affixing his signature on the bond certificate. * It signifies that the bond belongs to a particular series and such bond is a legitimate participates in a right or lien on a specific asset of the corporation. To enforce the rights of the bondholders – if the corporation fails to pay the bondholders at maturity of the bonded indebtedness, the trustee will undertake foreclosure procedures on the assets pledge. * Since bondholders cannot act individually, the trustee has to enforce their right as a group. Act as a transfer agent – as transfer agent the trustee is responsible for the recording of sales and purchased of bonds in the books of the corporation in the name of the new owner. Assets that could be offered as collaterals:

1. Real estate properties
2. Chattel mortgage that is mortgage on movable properties
3. Credit guarantees of financial institutions
4. Sinking fund
5. Guarantee of a parent company to its subsidiary company 6. Stocks and bonds issued by other companies owned by the corporation Mortgage contract – is a written contract whereby a real or personal properties are pledged to secure a loan. It confers on the debtor the right or lien on the property mortgage. Mortgagor – who is the debtor

Mortgagee – who is the creditor

* The mortgagor gives the right to the mortgagee the right to foreclose the properties if the debtor fails to pay the debt upon maturity. Lien – is the right of the mortgagee over the mortgaged properties. The right is conferred by a mortgage contract on the mortgagee. The lien may confer the right of ownership, possession, or foreclosure. * It may also give the right of possession to the mortgagee, but the title to the property remains with the mortgagor or the debtor. Foreclosure – refers to the process of enforcing the lien on a mortgage property. This is done through sale. Kinds of corporate mortgage:

1. Open –end mortgage – this is a contract which authorizes the issuance of bonds without specifying the number to be issued. * May issue bonds in whatever amount * Corporation can make as many issues as it deems necessary as long as there are investors. * All issues are presumed to be under the same contract.

* In case of foreclosure of the properties pledged, the proceeds from the auction sale shall be participated by all bondholders 2. Close –end mortgage – this is a mortgage contract under which a corporation can issue bond which will be issued all at the same time. * Bondholders have equal rights over the mortgage property. * Buyers of these bonds are aware of the number of bonds issued and secured by the corporate properties. 3. Limited open – end mortgage – similar to open-end mortgage except that an upper limit is placed on the maximum amount of the indebtedness that a corporation can create which may be outstanding under the same mortgage. * It is similar to close-end mortgage in that a maximum amount of bonded indebtedness that may be issued is fixed. Restrictive clause – is a clause attached to an open-end mortgage and is intended to protect the bondholders against possible abuses that the corporation may have in the issuance of bonds. Three kinds of restrictive clauses:

1. After acquired clause
2. Escrow provision
3. Covenant of equal coverage

After acquired clause – a clause usually attached to a corporate mortgage which provides that the bondholder’s lien is not only on the current corporate property pledged but also on all assets that may eventually be acquired by the issuing corporation within the life time of the bonded indebtedness. * The clause makes the security stronger as years go by.

2Escrow provision – this clause is designated to curb excessive issuance of bonds by the corporation. * This is usually included in the mortgage indenture. It consists of the following: 1. Limitations on subsequent issues may be based on percentage of the newly acquired assets of the company. 2. Limitation on additional bond issue may be based on the interest income to be paid. Covenant of equal coverage – this clause usually included in the indenture of unsecured bonds. * The clause provides that the debenture bonds, which are unsecured, equally share in the lien of a mortgaged property incurred after the debenture bond issue. Corporate mortgage containing the after acquired clause is a very costly method of financing. Various methods of financing: 1. Refunding mortgage

2. Through the financing companies
3. By leasing corporate properties
4. By means of subsidiary companies
5. By merger or consolidation with another company
Classifications of bonds
Bonds may be classified under the following categories:
1. Purpose
2. Security to be offered
3. Interest income for investors
4. Manner of paying interest
5. Manner of paying the principal upon maturity

1. 1Purpose
a. For construction, expansion, and working capital

b. Consolidated or unified bonds – if the corporation deem it necessary to consolidate their issues into one large issue, under a consolidated mortgage, such unification will have to be called a new name such as 1st consolidated issue. * The company may have several consolidated bonds, depending on the issues made by the corporation. * If there are several consolidated bonds we may call them, 1st consolidated bonds, 2nd consolidated bonds, 3rd consolidated bonds, etc. c. cRe-organization bonds – are bond issued in the re-organization of the corporation

* Its purpose is to cut down the bonded indebtedness and reduced fixed obligation of the corporation. * It also adjusts the claims of the bondholders against the old party of the corporation. * Are unsecured and generally issued under a junior mortgage on the property of the corporation. d.dFunding or re-funding bonds – funding bonds are those issued for the purpose of raising funds to retire previously issued bonds. * These bonds are not issued in the capital market but are given to old bondholders in exchange for the old issues they hold. 2. 2Security to be offered

a. 1st, 2nd, 3rd lien, etc. on mortgaged properties – these are used to indicate the order of lien placed placed against mortgage properties. * The 1st mortgage has the 1st lien or right over the mortgaged properties. The 2nd mortgage has the 2nd lien and the 3rd mortgage has the 3rd lien and etc. b. bDebenture bonds – these refers to bonds that are not secured by a specific property and therefore issued against the general credit of the issuing corporation. * These bonds sometimes termed unsecured bonds. It usually contain a clause which is called the covenant of equal coverage. c. Collateral trust bonds – are bonds secured by the stocks and bonds of the corporation owns of other companies or their subsidiary companies. d. dAssumed, guaranteed, endorsed bonds

Assumed bonds – are the bonds issued by another company the payment of which is assumed by the company either by purchase, merger or consolidation. * These bonds are therefore known as assumed bonds.

Guaranteed bonds – these are bonds whose return of the principal as well as the interest payments, are guaranteed by the issuing or assuming corporation. Endorsed bonds – are bonds endorsed by another corporation. Usually, it is the mother company endorsing the bonds of its subsidiary company or companies. 3. 3Interest income for investors

a. Bonds with stipulated interest rates – fluctuations of company earnings, do not affect the payment of interest. b. Income bonds – are bonds whose interest payments are paid only when the corporation earns an income in excess of other fixed charges or upon the happening of an event or the lapse of a particular period of time. c. cProfit sharing bonds – these are bonds which are entitled to share in the excess profits of the corporation in addition to its fixed interest rates. d. dParticipating bonds – these bonds are usually issued during the re-organization of the company. It was designed to reduce the fixed interest obligation of the corporation by offering lower interest on the bonds. e. eTax exempt bonds – these are bonds whose interest earnings are not subject to government stocks. Sometimes called tax-free bond. 4. 4Manner of paying interest

a. aRegistered bonds – are bonds where the by-laws require that the purchaser’s name be recorded in the books of the corporation. b. bCoupon bonds – are bonds with interest bearing coupons attached to the bond certificate. c. cInterchangeable bonds – these are bonds such as coupon bonds or registered bonds which could be exchanged for other types of the corporation. 5. 5Manner of paying the principal upon maturity

a. aLegal tender money –
b. bRedeemable or callable bonds – these are bonds which could be redeemed by the issuing corporation before their maturity dates. c. cConvertible bonds – these are bonds which could be convertible to other securities of the issuing corporation d. dSerial bonds – these are single bonds but divided into series with varying dates of maturity. The maturity dates may be 6 months, a year or even several years. e. eSinking fund bonds – are bonds issued by the corporation with the agreement that a sinking fund must be maintained by the corporation.

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