Question

In: Finance

Companies often find that basic financing (debt and equity) do not provide adequate sources of financing...

Companies often find that basic financing (debt and equity) do not provide adequate sources of financing and desire to access alternative sources of financing or additional pools of investors. In order to attack these investors they will often offer Hybrid financial instruments such as preferred stock, warrants, and convertible debt to potential investors. Please explain the basic characteristics of preferred stock, warrants, and convertible debt, how these can be viewed as providing both a comparable basic investment and an option, and how these additions or benefits impact the cost of capital for the issuing company.

Solutions

Expert Solution

Basic characteristics of preferred stock-

A.It is hybrid type of security which have element of both debt capital and equity capital

B. It will be having a fixed amount of payment in form of dividend.

C. These will also be having a preferential claim on the Asset than the equity shareholders

D. Preference share will not be having any kind voting rights other than associated with their own matters.

Characteristic of convertible debt are as follows-

A. These convertible debt have a conversion element attached to them and they can be converted to equity share.

B. This will be offering a fixed ratio for a particular period for conversion

C. They will be having characteristic of fixed income securities and the conversion feature will be giving the features of equity securities as well.

D.it will be purchased by those debt security holders who wish to equity shareholders in the long run

Characteristic of stock warrants are as follows-

A. Stock warrants Must be exercised before the expiration date.

B. Stock warrants are having a premium and that will be representing how much extra money one has to pay for shares when buying them

C.gearing of stock warrant will be a way to show how much exposure you have to the underlying share.

D. There are restrictions on the exercise because they are generally traded over the counter

This preferred stock and warrant as well as convertible debt will be viewed as a a method for providing hybrid instrument option for the company and they will be also impacting the cost of capital because they will be providing up with unlimited opportunities to the company in order to combine their capital structure with the different mixture of these hybrid securities and it will be viewed as a providing comparable basic investment and an option also regarding various kinds of conversion feature and they can be used for the longer term capital structure by the company also because they are highly transparent and they will be having hybrid characteristics of mostly debt and equities.


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