Question

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1. Why bonds?, bond issuance (bond offering) versus stock issuance from a corporate perspective in terms of capital need. In other words, what are some of pros and cons of this two pathways of corporate financing options? One, through "Debt Financing" (long term liability section in financial reporting, ch.14) as opposed "Equity Financing" (ch.13 paid-in-capital of equity section of financial reporting)? Please also think about the related concept of "Financial Leverage". Please discuss ups/downs (pros and cons) between the two capital raising/structure.

2. Now everything said and done with bonds, what is then difference between bonds and loans(bonds vs. loans as long-term debt)? Please discuss as many difference as you think of, from a corporation perspective as well as from an investor/lender perspective.

Answer 1

Point 1: See as far as bond particularly is concerned , it is a type of security issued by a company to have some finance in return of some percentage of interest to the bond purchaser or holder and this comes under " debt financing". So i shall give the comparison of debt financing and equity financing from the company's point of view below:

Debt financing:

1. It is a type of corporate financing which lets the company use the money of the public for its operations and pay them a certain amount of interest on a regular basis till the time that principal money is with the company. Its main types are issuance of debentures and bonds.
2. The main point of difference from the equity financing is that... the bond/debenture holder gets no partnership rights or is not a stake holder of the company. He/she only gets the interest on the money lended to the company and no other priviledges or rights in the other company operations or conductions.
3. The company does this kind of issuance to limit the number of stake holders in the company and also to avoid the large number of active members in the operations of a company. Just keeping them out of the hierarchy and also benefiting them in a certain way. There is no dilution of the ownership.
4. Here, the holders have no connection with the profit/loss of the company. If the firm is in a great boom the holders are not given any kind of bonus etc. and if the firm is in losses then they are again unaffected . They are given a fixed amount of interest whatever may be the financial condition of the firm, so the company is worry less in times of profit.
5. Also and lastly it gives a tax benefit to the firm, because payment of interest is treated as an expense and thus lowers the final profit and there fore the tax payment is reduced to a certain extent.

Equity financing :

1. This kind of financing is issuing of shares/stock for a certain face value and using that money for the corporate's operations.
2. The holders are not paid any interest here, rather they get many rights as stake holders in the company and are calculated as part owners of the company.
3. The comapny uses this kind of issuance because the holders are equally liable to lose their money in times of losses to the firm because they completely form a part of the company and are ready to let go their shares in case of losses. The company is not liable to pay any dividend in case of loss.
4. In this form of financing , the company pays a dividend which is the part of final profits after the payment of interest to debt financers and other expenses of the company. So the comapny is not liable to pay any dividend in case of losses but pay a higher dividend in case of profits.
5. To some extent the holders of this seccurity are also personally liable in case of heavy losses to the firm and thus the firm feels strong by issuance of this kind of security. The holders if , are expecting a higher dividend or bonus in times of profits then they are also ready for losing the money they have put in, in case of losses and that's what the company is at a plus. The payment like to the debt holders is not compulsory.

This was the basic comparison of the two capital structures.

Financial leverage : This term stands for the capacity of a company to use its securitites basically debt financing securities or preferrence securities. It means the form uses the outside money more and more and just goes on with a small payment of interests as compared to putting in the whole money itself. The more it uses the outside money , higher is its financial leverage.
But it has a risk in case of excess leverage, that, it increases the interest payments and thus the share holders get a decreased earning per share as the final profits decrease after the interest payments and the shareholders get a lesser dividend and thus they turn unhappy and the firm's financial image loses. So it has to be a balance of leverage and earning per share.

POINT 2:

Bonds are the instruments used by companies and loans are an agreement between generally banks and its customers.
Bonds are more tradeable than loans because don't prefer taking "loans" as a technical term used in the subject.
Loans if we talk about in terms of invester perspective, then:
Its really uncertain when partically a word of mouth is the only agreement between the two parties.
If two small businesses are involved in taking loans from each other, they may have a document involved called agreement and which contains the percentage of money to be received as interest by the lender and the time period in which it has to be paid without fail, else its enforceable to the Law as stated in the agreement.
Also in some cases, a security is kept by the lender in terms of a valuable good which values more than the loan amount and in case of failure of re-paying the principal amount the lender sells the good of the needy and realises his money.