Question

Some companies' common stocks pay cash dividends, while others' do not. However, most bond issues do pay periodic interest. The preferred stock financing option also pays a dividend. Based on your readings, please respond to the following questions below: From the investor's point of view, analyze the advantages and disadvantages of the three investment alternatives—common stock, bonds, and preferred stock. Why would an investor select an investment in bonds over common stock, even if the return on the common stock investment is higher? From the firm's perspective, evaluate the pros and cons of using different combinations of debt, common stock, and preferred stock to raise funds. Why do some firms use preferred stock and others do not? Is it a matter of subjective preference, or are there sound theoretical reasons for the use of specific sources of funding? How does an investor's evaluation of the investment alternatives differ from the evaluation by a company trying to raise funds?

Answer 1

1.

	Common Stock	Preferred Stock	Bonds
Advantages	Huge profit, Minimum Liability Maximum profits,Simplfied investment process, Capital Gain and Dividend types of income,	One advantage of preferred stocks is their tendency topay higher and more regular dividends than the same company's common stock. Preferred stock typically comes with a stated dividend. in the event of bankruptcy and liquidation, preferred shareholders have a higher claim on company assets than common shareholders. This makes preference shares, also called preferred shares, particularly enticing to investors with low risk tolerance.	Bonds are a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and or repay the principal at a later date, which is termed the maturity. The volatility of bonds (especially short and medium dated bonds) is lower than that of equities ( stocks ). Thus bonds are generally viewed as safer investments than stocks. Bonds are often liquid – it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much. Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount). There are also a variety of bonds to fit different needs of investors.
Disadvantages	High risk investment, Lack of control on business of company, last one to get paid in company liquidation process.	From the investor's perspective, the main disadvantage of preference shares is that preferred shareholders do not have the same ownership rights in the company as common shareholders. The lack of voting rights means the company is not beholden to preferred shareholders the way it is to equity shareholders	Bonds are subject to risks such as the interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.

2. Bonds are a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and or repay the principal at a later date, which is termed the maturity.

The volatility of bonds (especially short and medium dated bonds) is lower than that of equities ( stocks ). Thus bonds are generally viewed as safer investments than stocks.

Bonds are often liquid – it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much.

Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount).

Owing to the aforesaid reasons with more defensive investment startegy, less risk appetite investors prefer to invest in bonds instead of highly risky common stock,.

3. There are two broad categories of financing available to businesses: debt and equity.

Debt financing: The borrower accepts funds from an outside source and promises to repay the principal plus interest, which represents the "cost" of the money you initially borrowed.Borrowers will then make monthly payments toward both interest and principal, as well as put up some assets as collateral as reassurance to the lender. Collateral can include inventory, real estate, accounts receivable, insurance policies or equipment, which will be used as repayment in the event the borrower defaults on the loan.

Pros and cons of debt financing-Debt financing is widely available in one form or another for most small business owners. It is a popular avenue for many businesses because the terms are often clear and finite, and owners retain full control of their operations unlike an equity financing arrangement.

However, the repayment and interest terms can be steep depending on the loan. Borrowers typically begin making payments the first month after the loan has funded, which can be challenging for a startup because the business isn't on firm financial footing yet.

Another disadvantage of debt financing is the potential for personal financial losses if it becomes impossible to repay the loan. Whether a business owner is risking their personal credit score, personal property or previous investments in their business, it can be devastating to default on a loan.

Equity financing: Equity financing means selling a stake in your company to investors that hope to share in the future profits of the business. Business owners who go this route won't have to repay money in regular installments or deal with steep interest rates. Instead, investors will be partial owners who are entitled to a portion of company profits and, perhaps, even a voting stake in company decisions depending on the terms of the sale.

Pros and cons of equity financing- Unlike debt financing, equity financing is a lot harder to come by for most businesses. This type of funding is well suited for startups in high growth industries, such as the technology sector, and it requires a strong personal network, an attractive business plan, and the foundation to back it all up. However, companies that score investments will have capital on hand to scale up and will not be required to start paying it back (with interest) until the business is profitable.

Equity financing allows the business owner to distribute the financial risk among a larger group of people. When you aren't making a profit, you don't have to make repayments. And if the business fails, none of the money needs to be repaid.

Ultimately, the decision between whether debt or equity financing is best depends on the type of business you have and whether the advantages outweigh the risks. Do some research on what is the norm in your industry, and what your competitors are doing. Investigate several financial products to see what suits your needs, and if you are considering selling equity, do so in a manner that is legal and allows you to retain control over your company.

4. Preference shares act as a hybrid between common shares and bond issues. As with any produced good or service, corporations issue preferred shares because consumers – investors, in this case – want them. Investors value preference shares for their relative stability and preferred status over common shares for dividends and bankruptcy liquidation. Corporations value them as a way to provide equity financing without diluting voting rights, for their callability and, sometimes, as a means of fending off hostile takeovers.

Most shareholders are attracted to preferred stock because it offers consistent dividend payments without the lengthy maturity dates of bonds or the market fluctuation of common stocks. These dividend payments, however, can be deferred by the company if it falls into a period of tight cash flow or other financial hardship. This feature of preferred stock offers maximum flexibility to the company without the fear of missing a debt dividend payment. With bond issues, a missed payment puts the company at risk of defaulting on an issue, and that could result in forced bankruptcy.

Some preferred shareholders have the right to convert their preferred stock into common stock at a predetermined exchange price. And in the event of bankruptcy, preferred shareholders receive company assets before common shareholders.

In most cases, preference shares comprise a small percentage of a corporation's total equity issues. There are two reasons for this. The first is that preferred shares are confusing to many investors (and some companies), which limits their demand. The second is that stocks and bonds are normally sufficient options for financing.