Chapter 1: Characteristics of Securities & Other Financial Instruments Flashcards
Equity Securities
Represent an ownership interest in the company
Common Stock
Most common equity security.
Subordinate to all debt and preferred stock.
Rights of Common Holders
Voting
Optional dividends
Limited liability
Preemptive rights
Preferred Stock
Acts similar to debt instruments.
Rights to dividends
Non-voting
Senior to common stock
Preferred Stock Dividends
Not guaranteed.
If cumulative, must be paid in full before dividends to common stock.
Convertible Preferred Stock
Can be converted to common.
Favored by pre-IPO investors.
Included in the calculation of fully diluted EPS.
Callable Preferred Stock
Issuer can redeem the stock
Participating Preferred
Holders share in the issuer’s profits.
Putable Preferred
Holder can force issuer to redeem the stock.
Hybrid Preferred (Trust Preferred Security)
Issuer creates a trust.
Trust purchases L-T debt of issuer.
Interest on debt is paid as dividends to Trust shareholders.
This is really a debt instrument.
Rights (Subscription Rights)
Limited duration privilege granted to existing shareholders to participate in a new issue before it is offered to the public.
Offered at a price below the public offer price.
Usually a 1:1 subscription ratio.
Transferrable and tradable.
Warrants
L-T (min. 5 year) securities that allow the holder to purchase company stock at a predetermined price.
Typically sold with bonds and preferred stock.
Exercise price is significantly higher than the market price at issuance.
Stock Appreciation Rights (SARS)
Holders benefit from the difference between the current market price and the grant price of the stock.
Paid in any combination of cash and stock.
Taxable as ordinary income.
Employee Stock Options
Non-cash form of compensation.
Employee pays the grant price for the stock when exercising.
Generally non-transferable.
Depositary Receipts (DRs)
Popular way for companies to raise capital in foreign markets.
American Depositary Receipts (ADRs)
DRs that are traded on U.S. exchanges.
Priced in U.S. Dollars.
Sponsored ADRs
Issued at the request of the foreign company.
Hold the same rights as the regular shareholders.
Level I ADR Sponsorship
Fewest barriers to entry.
Trade OTC.
Level II ADR Sponsorship
Requires GAAP accounting.
Subject to SEC registration and reporting.
Trades on the Big Boards.
Level III ADR Sponsorship
Applies to foreign companies that are planning a U.S. public offering.
Has the most stringent requirements.
Un-sponsored ADRs
Issued without the cooperation of the foreign company.
No reporting obligation.
Trades OTC.
Global Depositary Receipts (GDRs)
DRs that are not issued in the U.S.
Bond Indenture
The terms that apply to a bond
The Trust Indenture Act of 1939
Requires the use of indentures & mandates certain disclosures and provisions that protect bondholders.
Requires issuer to appoint trustee that has liquidation power.
Requires periodic financial reporting.
SEC exempted issues with a total value of less than $5.0 million.
Maturity
The date when a bond is due and the issuer pays the holder the bond par value.
Coupon
A bond’s interest rate.
Usually paid semi annually.
Unsecured Bond
Not backed by collateral.
Usually a higher coupon than secured bonds.
Secured Corporate Bonds
Backed by collateral.
Mortgage Bond
Secured by a mortgage on a commercial property.
Equipment Trust Obligations
Secured by equipment.
The collateral’s title is held by a trustee until the bond is paid off.
Collateral Trust Bonds
Secured by other securities rather than fixed assets.
Typically use securities of subsidiary companies as collateral.
Guaranteed Bonds
Bonds issued by one company and are guaranteed by another, usually a parent.
Not secured.
Callable Bonds
Issuer has the right to redeem the bonds before maturity.
Includes a call premium
Bond Conversion Ratio
Par Value / Conversion Price of Equity
Bond Conversion Parity
MV of Bond / Conversion Ratio
Represents the stock price at which a holder can convert without a loss or gain.
Eurobond
A bond issued in a currency other than the issuer’s home currency and where it is located.
Variable Rate Bond
Interest payments are benchmarked to another interest rate (LIBOR, etc).
Rate periodically adjusts.
Income Bonds
Interest payments are conditional on sufficient earnings.
Usually issued as part of a bankruptcy or reorganization.
Zero Coupon Bonds
No interest payments.
Sold at a significant discount to par value.
Eliminates reinvestment risk.
Current Yield
Annual coupon amount in $ / Market Price of Bond
Represents the actual income rate of return.
Yield to Maturity (Premium)
(Annual coupon pmt - (premium/yrs to maturity))/avg. of par and market price
Represents the estimated return a holder would receive if held to maturity.
Yield to Maturity (Discount)
(Annual coupon pmt + (discount/yrs to maturity))/avg. of par & market price
Represents the estimated return a holder would receive if held to maturity
Yield to Call (Premium)
(Annual coupon pmt - (premium/yrs. to call)) / avg. of par and market price
Represents the yield the holder would receive if the issuer calls the bond.
Yield to Call (Discount)
(Annual coupon pmt + (discount/yrs to call)) / avg. of par and market price
Represents the yield a holder would receive if the issuer calls the bond.
Yield to Worst
Represents the lowest yield possible an investor could receive on a bond.
Discount Yield (Bond Equivalent Yield)
(Discount/Par Value) x (365 / Days to Maturity)
Expresses the effective yield on a bond that does not pay interest in order to compare to interest paying bonds.
Spread
The difference between two different yields
Duration
Measure’s the sensitivity of the price of a fixed income security to a change in interest rates.
Convexity
Measures how a bond’s duration changes with changes in interest rates. A higher convexity means lower sensitivity to interest rate changes.
Treasury Bills
Short term government securities. Terms of 4, 13, 26, and 52 weeks.
Don’t pay interest, sold at a discount.
Treasury Notes
Medium term securities with 2,3,5,7,and 10 year terms.
10 yr. note is frequently used a a benchmark.
Treasury Bonds
Long term securities. Currently issued with 30 term. Pays interest semi-annually.
Treasury Inflation-Protected Securities (TIPS)
Fixed coupon that pays 2x / year. Principal amount changes according to changes in the CPI. 5, 10, and 30 yr. terms.
Savings Bonds
Series EE - fixed yield
Series I - variable interest
Municipal Bonds
Issued by state and local governments.
Exempt from federal tax and local tax within issuing jurisdiction.
General Obligation Muni Bond
Backed by tax revenue. Usually voted on.
Revenue Muni Bonds
Used to fund a specific project and backed by that project’s revenue stream.
Asset Backed Securities
Notes that are originated by an institution that are backed by a pool of assets, usually mortgages.
Derivatives
A security or contract in which the value is derived from or tied to the value of an underlying asset.
Most commonly used to hedge.
4 Main Types of Derivatives
- Futures Contract
- Forward Contract
- Option Contract
- Swap
