Question

Compare and contrast the features of common stock. Describe the characteristics of long-term debt. Distinguish between floating rate & fixed rate corporate bonds.

Answer 1

The features of common stock are followings -

• The common stocks have residual claim on the profit of the company as they have claim on the profit of the company after paying all other liabilities like interest to debt, taxes and dividends to preferred stock holder.
• But common stocks have unlimited earning potentials as the residual profit of the firm is distributed among common shareholders.
• Typically common stockholders have voting rights in the company.
• Common stocks do not have a maturity date

Long-term debts are the instruments which have maturity of more than one year and considered for long term investment. The example of long-term debt instruments are treasury bonds, treasury notes, corporate bonds, zero coupon bonds etc.

The fixed rate corporate bonds pay a fixed amount of money to its investors so the is considered as secure income investment. The risk-averse investors prefer these kinds of investments. Although they are also expose to various kind of risk like interest rate risk, credit risk, default risk, maturity risk, liquidity risk etc.

For floating rate bonds, coupon rates vary with market interest rates and it is reset at regular and short-term intervals. Therefore the floating rate bonds will be favored by the investors when it is anticipated that interest rates will go up.

Therefore an increase in interest rate will decrease the price of fixed rate bonds but if it is a floating rate bonds, it will adjust with an increase in interest rate and it will be less affected and vice-versa