Shares, Bonds and Securities from POME by Gautam Koppala

Shares, Bonds and Securities:

Normally big projects shares, bonds are been bought by the people for bigger returns. Hence, protecting the shareholders is the main responsibility for the Project Directors/ Project Sponsors/ Project managers.  Also, being an employee for your organization, your Project would be providing you the shares, which increases your moral; responsibility towards organization. Hence, POME recommends understanding the basic concepts. Nothing in the POME went in to marine deep concepts, but only basic anatomy, which required for the Operations folks.

The equity component of the Balance Sheet contains the information relating to Projects ownership. Though we have focused almost entirely on the corporate form for our discussion, the structure of the Balance Sheet and the Income Statement are consistent across all business forms. In today’s marketplace, increasingly, there are variations on the basic business form based on a broad range of needs. Where there used to be only Proprietorships, Partnership Based Projects s, and Corporation Based Projects s as business forms, today there are also Limited Partnership Based Projects s, Limited Liability Partnership Based Projects s, Limited Liability Companies, Real Estate Investment Trusts, Corporation Based Projects s, Trusts, Associations, and other entities structured to meet particular needs or situations. Although each of these entity types has different characteristics, the generalized financial statement formats we have discussed are applicable to them all. Each has an Income Statement, a Balance Sheet, and a Cash Flow Statement, and although they may or may not be available to the public, they will be interpreted consistently and will respond to the same management actions.

When we deal with other than the corporate form, the Equity section takes on a different appearance, describing the ownership’s financial interests with terms such as Owner’s Capital, Partners’ Capital, and similar words. These correspond to Common Stock and Additional Paid-in Capital. Retained Earnings are interpreted consistently.

POME Case Study:

The Rewards for Success

”As you all know, the Board of Directors met last week. They’re thrilled with the results we’ve posted for the year, and they’ve asked me to talk to you about the stock purchase plan they’re putting in place. This year for the first time you’ll be able to purchase Projects stock as part of the Projects savings and investment program. ”

”That’s great, Koppala, but why are they making us purchase the stock? If we’re doing so well, why don’t they just distribute stock along to us?”

”There are a couple of reasons, Aleksei. If it were a gift, you might not value it so highly. And some people might not want to hold a lot of stock in the Projects. It’s very risky to have all of your resources dependent on one source. So we think some people will want to stick with the large, professionally managed mutual funds that are already available.”

”I understand what you’re saying, Koppala, but why are they making this offer? Won’t it lessen the control of the current owners?”

”It will do that, Enrique. But it will make owners out of a lot of people in the Projects. Do you remember when we started these sessions, Enrique, that the purpose of a for-profit business is to maximize the wealth of the shareholders in the long run?”

”I do. And that’s why I’m asking: Why would they want to share the wealth?”

”They want to share the wealth, so to speak, so that the people who work here have the same long-term objectives as the other shareholders. It’s the people who work here—Project Managers and staff and line workers—who really determine how well the Projects does. By letting you purchase a piece of the Projects, the board hopes that your interests will be the same as theirs. Everyone will strive their hardest to make sure the Projects increases in value.

”Let’s spend some time talking about this, so that you can go back and share the news with your department. People are going to have a lot of questions about why this is happening and whether it’s good for them. You need to be prepared to answer those questions. We’ll post an outline of the plan on the intranet at 11:30. People can check out the mechanics and the details there. But be sure you meet with everyone in your department today.”

 

Equity and Business Structure

Although several forms of business structure exist and more are being developed almost daily, the principal structures are Proprietorships, Partnership Based Projects s, and Corporation Based Projects s as described The differences in form appear in financial statements primarily in the equity section of the Balance Sheet. All these businesses have traditionally structured Income Statements with revenues and expenses, interest, and tax computations. All have current assets and fixed assets, current liabilities and, at least potentially, long-term debt. When it comes to equity, the terminology changes and some of the treatment changes as well. Additionally, and more importantly, each of these business types has distinguishing characteristics that make it more or less attractive under differing circumstances.

Proprietorships are businesses with one owner who is responsible for everything. The Proprietorship Based Projectsform does not really distinguish the business from its owner, as the owner takes on all responsibility for the obligations of the business, the management decisions for the business, and the financial control of the business. The Proprietorship Based Projectsis easy to form, requiring minimal registration and legal filings. In fact, there may be no filing required at all unless the business is subject to some local tax reporting, such as sales or meals tax reporting. All of the income and expenses of the business are considered to be an extension of the proprietor, who includes the financial activities of the business in his or her personal income tax returns. The owner undertakes personal liability for the obligations of the Projects and its existence continues only as long as the proprietor chooses to continue it. A Proprietorship Based Projects technically does not survive the proprietor although the owner may transfer the business to another proprietor. There are many, many more proprietorships in the United States than any other business form, but they represent only a very small percentage of the business volume and business wealth.

A Partnership Based Projects , belonging to two or more partners, often has more strength and more flexibility than a Proprietorship Based Projects because it draws from the financial and Project Managerial resources of more than one person and can, therefore, achieve greater size and complexity than most proprietorships. General Partnership Based Projects s involve all the partners in the obligations of the business, and in most general Partnership Based Projects s, each partner is responsible for all of the obligations of the business. Therefore, if one partner is unwilling, unable, or unavailable to pay for obligations of the business, the other partner or partners are obligated to cover them. This has led to a number of problems, which have been addressed by creating limited Partnership Based Projects s (LPs) and limited liability Partnership Based Projects s (LLPs). These entities, based on their structures, provide for protection for partners who are, in the first case, only financial partners, not active in the business, and in the second case, partners who were not involved in the situations that led to the liabilities. The establishment of limited Partnership Based Projects s and limited liability Partnership Based Projects s has defined special rules and characteristics that dictate the way these entities are treated for legal and tax purposes. Partnership Based Projects s are taxed only at the partner level, with the profits of the Partnership Based Projects  assigned to the partners on the basis of their Partnership Based Projects  agreement. Generally, there is a carefully constructed Partnership Based Projects  agreement detailing the management relationships as well as the financial participation of all partners. A Partnership Based Projects  technically does not survive the departure of a partner, although the major Partnership Based Projects  entities have defined the procedures for automatic reestablishment if a partner leaves or dies.

Corporation Based Projects s represent a relatively small percentage of the business entities in the United States, but they are responsible for the vast majority of all economic wealth and activity. In recent years tax considerations as well as issues related to congressional desire to foster economic development have resulted in a number of variations to the traditional corporate form and structure. The basics remain, however. A Corporation Based Projects  is considered an entity unto itself, separate and distinct from its ownership. Therefore, its life is not limited by the lives of its owners; the ownership may be transferred without any effect on the Corporation Based Projects . As a consequence, the capacity of a Corporation Based Projects  to borrow money, for example, is not limited by the financial strength of the owners, a problem that faces proprietorships and Partnership Based Projects s. The liabilities of the Corporation Based Projects  are the responsibility of the Corporation Based Projects ; the owners’ obligations are limited to the amounts of money they have invested and if the obligations of the Corporation Based Projects  exceed the capabilities of the Corporation Based Projects  to pay, the owners are not responsible for them.

Because Corporation Based Projects s are not limited the way other business types are, they offer more ways to reward Project Managers, notably through the opportunity to achieve an ownership position, making it easier for a Corporation Based Projects  to fill out its management staffing. In the 1990s the dramatic rise in high-tech start-up companies, led to the popular use of stock as compensation. As with access to equity investment, Corporation Based Projects s have more access to debt capital because the entity can be expected to continue, without a limit imposed because of the owners.

Recently, the Financial Accounting Standards Board (FASB), a major rule-making body overseeing the accounting rules used in the United States, has moved to require public companies that offer stock options as incentives to management to recognize an expense equal to the perceived value of the options. They argue that if options were not valuable, people would not want them. In the past stock options, the opportunity to purchase Projects stock in the future at a price defined when the option is granted, often were perceived to have zero value when they were granted. This issue is being actively debated as this text is being written. (In the Sarbanes-Oxley Act of 2002, the FASB has had some if its oversight responsibilities curtailed and reassigned to a quasi-government agency called the Public Companies Accounting and Oversight Board [PCAOB]).

Employee stock options, and particularly incentive stock options for executives, have come under increased scrutiny as a result of Sarbanes-Oxley. Companies are required to establish a value for them, which can be very difficult. There is a complex options valuation theory, known as the Black-Scholes Option Valuation Model, but it is difficult and confusing to compute and more confusing for shareholders to understand. Many companies have eliminated incentive stock option programs as a result of these regulations and the problems of valuation. Perhaps the most important consequence of all is that, when stock options are assigned value, when options are issued, they reduce the Corporation Based Projects ’s earnings, directly affecting the value of shareholders’ ownership.

Corporation Based Projects s are taxed on their earnings. The owners are not taxed on these earnings unless the earnings are distributed as dividends. The owners are only taxed on the cash dividends they receive (or could receive if they were not reinvested at the direction of the stockholder), which are generally paid out of the after-tax earnings. This is often referred to as the problem of ”double taxation,” and it is one of the characteristics that differentiate Corporation Based Projects s from other business forms. In 2003 Congress passed a change in the taxation of dividends as part of a major change in the tax law, significantly reducing the taxes to individuals on corporate dividends they receive.

Over the past half-century a consensus has formed among experts about the way to run the finances of a company. During the same time period a consensus also formed about the way to manage a portfolio of stocks and bonds. The principles that have emerged all relate to the relationship between investors and the companies that issue securities. That relationship is subtle, and studying it has been fruitful. Each new breakthrough about how to choose securities for a portfolio has had implications for how corporate financial managers should run the finances of a company, and has given insights into which securities the company should issue and which projects it should undertake.

The principles of portfolio optimization and the principles of corporate financial management have developed during the same time frame and in tandem with each other. This half-century of development has identified several main principles, each of which has shown its validity and its usefulness. Together they constitute a paradigm that has gained widespread acceptance. In this chapter we call that paradigm the Standard Model, and we show these principles and how they work. Each individual principle makes sense, and statistical evidence shows it adds value. These principles work synergistically, so a company that follows them all does better than a company that follows only one of them.

These principles did not immediately revolutionize the practices of corporate financial managers everywhere. First they gained universal acceptance among theoreticians, and then they gained acceptance among portfolio managers. Among corporate financial managers, they gained acceptance more slowly.

Among financial managers at large corporations, this set of principles has become the completely dominant view. The recent wave of financial scandals illustrates in a perverse way how completely dominant this view has become. Managers at Enron and WorldCom were trying so hard to apply the set of principles, and were so determined to be the best at applying them, that they broke laws and reported fraudulent data. They went to extremes to create the appearance that they were especially successful at applying the principles.

As U.S. financial markets attempt to rebuild the credibility they lost and recover from the blows they suffered, and as U.S. corporations attempt to rally their stock prices, leaders reaffirm their conviction that the set of principles is valid. As large U.S. corporations replace top managers and directors, each newly appointed person makes a point of affirming and endorsing the Standard Model.

Outside the United States, top managers of large publicly-traded corporations have been slower to accept the validity of the Standard Model, and some still express disagreement with the principles. They argue that the Standard Model is inappropriate for one reason or another and condemn the extreme behavior that sometimes occurs when managers slavishly follow the principles. Outside the United States, old paradigms of financial management and old rules of thumb still have some shreds of legitimacy. Their days are numbered, however, and the old rules will soon pass from the scene. These non-U.S. managers may express resistance, but despite the merit of some of their arguments, the Standard Model will eventually triumph completely over all competing paradigms that dictate how to run a corporation’s financial affairs.

The Standard Model has inexorably become dominant for a simple reason: Applying these principles lowers a company’s cost of capital. Every company needs to lower its costs, whether those costs are for raw material, labor, or obtaining capital. No company can willingly give its competitors a cost advantage, so if one company lowers its cost of capital, the others in the same industry sector have to lower theirs, too.

The first practitioners to adopt the Standard Model were institutional portfolio managers. There are several reasons they were quicker to grasp its advantages than corporate financial managers. One is that the first breakthrough was a scientific analysis of the tradeoffs involved in selecting securities for a portfolio. Another is that their performance was in plain view, and it was easy to measure and rank. They were supposed to earn high returns without taking excessive risks. Hundreds of institutional portfolio managers were trying to do the same thing and trying to outperform each other. Any observer could easily see which ones were particularly successful or unsuccessful. For managing portfolios of securities, the Standard Model’s guiding principles are much better and much more helpful than the old rules of thumb that in bygone days institutional portfolio managers attempted to apply.

how to use the Capital Asset Pricing Model to explore the relationship between risk and return as you calculated the required rate of return on an investment. You saw the problems that can occur when you try to assess the relative riskiness of different investments. This same problem exists when you look at business investments, whether they be acquisitions of fixed assets or acquisitions of whole companies. This problem is compounded by the need to acknowledge and accommodate the requirements of different providers of funding to the Projects. One way to address this issue is through a computation known as the cost of capital.

The cost of capital is the return required to satisfy the provider of a particular type of capital to be used in the business. For providers of debt financing this cost is interest. For the provider of preferred stock financing the cost is the dividend that the stock receives. The provider of common stock financing measures his or her return in terms of earnings per share and evaluates that return as a percentage of the price paid for the stock.

In finance textbooks, the return to the shareholder is described as the dividend on the common stock. It is used in a valuation model, known as the Gordon Model or the Dividend Capitalization Model or more recently as the Free Cash Flow (the amount of money that can be withdrawn from a business) Model, as the basis for valuing common stock. However, these descriptions become problematic for those companies that pay no dividends or that are growing and consuming all the funds generated, leaving no money that could reasonably be withdrawn. For these reasons, we look at the return to the common shareholder as the earnings of the business, whether paid out or retained. After all, the earnings really do belong to the shareholders.

Cost of capital recognizes that each source of funds has its own cost. By calculating each element’s cost and weighting the costs according to the weighting of the funding sources, you can easily compute the weighted average cost of capital (WACC).

 

Investing includes many terms with which every investor should become familiar in order to make educated decisions. Additionally, the different shares, such as authorized, treasury, outstanding and etc. have different characteristics. Thus it is important to become acquainted with the different types of shares so that you make successful investment choices.

Types of Shares:

Some of the major types of shares include:

  • Authorized Shares

When a Macro Project is created it is authorized to issue a total number of shares of stock, which is what is called authorized shares. The number is liable to changes under the agreement of the shareholders. Additionally, not all authorized shares have to be offered to the public and many companies decide to keep some of the shares for later uses.

  • Treasury Shares

These are the shares that the Macro Project doesn’t offer to the public or the employees. They are kept for other uses.

  • Restricted Shares

This type of shares is used in different compensation plans. Additionally, companies use restricted shares as part of various incentive plans for their employees. In order to sell a restricted share, the holder should ask for the permission of the SEC.

  • Float Shares

Float shares are the shares that are traded on the open market. These are actually the shares that investors trade with.

  • Outstanding Shares

These shares include all the shares that a particular Macro Project has issued. These include float shares as well as restricted shares.

 

Bonds:

In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. Other stipulations may also be attached to the bond issue, such as the obligation for the issuer to provide certain information to the bond holder, or limitations on the behavior of the issuer. Bonds are generally issued for a fixed term longer than ten years.

A bond is simply a loan, but in the form of a security, although terminology used is rather different. The issuer is equivalent to the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds.

Note: The certificates of deposit (CDs) or commercial paper are considered to be money market instruments and not bonds.

In some nations, both terms bonds and notes are used irrespective of the maturity. Market participants normally use the terms bonds for large issues offered to a wide public and notes for smaller issues originally sold to a limited number of investors. There are no clear demarcations. There are also ”bills” which usually denote fixed income securities with terms of three years or less, from the issue date, to maturity. Bonds have the highest risk, notes are the second highest risk, and bills have the least risk. This is due to a statistical measure called duration, where lower durations mean less risk and are associated with shorter term obligations.

 

 

 

Bonds and stocks are both securities, but the major difference between the two is that stock-holders are the owners of the Macro Project (i.e., they have an equity stake), whereas bond-holders are lenders to the issuing Large Project. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is perpetuity (i.e., bond with no maturity).

Features of Bonds:

The most important features of a bond are:

  • Nominal, principal or face amount—

The amount on which the issuer pays interest, and which has to be repaid at the end.

  • Issue price—

The price at which investors buy the bonds when they are first issued, typically $1,000.00. The net proceeds that the issuer receives are calculated as the issue price, less issuance fees, times the nominal amount.

  • Maturity date—

The date on which the issuer has to repay the nominal amount. As long as all payments have been made, the issuer has no more obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term of up to thirty years. Some bonds have been issued with maturities of up to one hundred years, and some even do not mature at all. In early 2005, a market developed in euros for bonds with a maturity of fifty years. In the market for U.S. Treasury securities, there are three groups of bond maturities:

    • short term (bills): maturities up to one year;
    • medium term (notes): maturities between one and ten years;
    • long term (bonds): maturities greater than ten years.
  • Coupon—

The interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which coupons had attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.

  • Coupon dates—

The dates on which the issuer pays the coupon to the bond holders. In the U.S., most bonds are semi-annual, which means that they pay a coupon every six months. In Europe, most bonds are annual and pay only one coupon a year.

  • Indenture or covenants—

A document specifying the rights of bond holders. commercial laws apply to the enforcement of those documents, which are construed by courts as contracts. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or super-majority) vote of the bond holders.

  • Optionality:

A bond may contain an embedded option; that is, it grants option like features to the buyer or issuer:

    • Callability—some bonds give the issuer the right to repay the bond before the maturity date on the call dates.. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
    • Puttability—some bonds give the bond holder the right to force the issuer to repay the bond before the maturity date on the put dates; Also, known as put option.
      • Call dates and put dates—the dates on which callable and puttable bonds can be redeemed early.
  • sinking fund provision

Of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.

  • Convertible bond

Lets a bondholder exchange a bond to a number of shares of the issuer’s common stock.

  • Exchangeable bond

Allows for exchange to shares of a corporation other than the issuer.

Types Of Bonds:

  • Fixed rate bonds

Bonds have a coupon that remains constant throughout the life of the bond.

  • Floating rate notes (FRN’s)

Bonds have a coupon that is linked to a money market index, such as LIBOR. for example three months USD LIBOR + 0.20%. The coupon is then reset periodically, normally every three months.

  • High yield bonds

Bonds that are rated below investment grade by the credit rating agencies. As these bonds are relatively risky, investors expect to earn a higher yield. These bonds are also called junk bonds.

  • Zero coupon bonds

Bonds do not pay any interest. They trade at a substantial discount from par value. The bond holder receives the full principal amount as well as value that has accrued on the redemption date.

  • Inflation linked bonds,

Bonds, in which the principal amount is indexed to inflation. The interest rate is lower than for fixed rate bonds with a comparable maturity. However, as the principal amount grows, the payments increase with inflation.

  • indexed bonds,

Bonds, for example equity linked notes and bonds indexed on a Projects indicator (income, added value) or on a country’s GDP.

  • Asset-backed securities

They are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBS’s), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs).

  • Subordinated bonds

They are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.

  • Perpetual bonds

They are also often called perpetuities. They have no maturity date. The most famous of these are the UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today. Some ultra long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are sometimes viewed as perpetuities from a financial point of view, with the current value of principal near zero.

  • Bearer bond

It is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets.

  • Registered bond

It is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.

  • Municipal bond

It is a bond issued by a state, Country, local government, or their agencies. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.

  • Book-entry bond

It is a bond that does not have a paper certificate. As physically processing paper bonds and interest coupons became more expensive, issuers (and banks that used to collect coupon interest for depositors) have tried to discourage their use. Some book-entry bond issues do not offer the option of a paper certificate, even to investors who prefer them.

  • Lottery bond

It is a bond issued by a state. Interest is paid like a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.

  • War bond

It is a bond issued by a country to fund a war.

  • Gilt-edged bonds:

Highly rated bonds, whose issuers have a long-standing reputation of paying interest on time.

  • Term bonds: Bullet bonds

Bonds, whose principal is payable at maturity.

  • Back bond: Virgin Bond

A Eurobond created by the exercise of a warrant.

  • Cushion bonds:

High-coupon bonds which sell at only a moderate Premium because they are callable at a price below.

  • Junk bonds:

High-risk bonds issued by companies with credit ratings below investment grade (a ranking given by the credit rating agencies. Such bonds are also called high-yield bonds as they offer investors higher yields than bonds of financially sound companies. They are usually issued to finance leverage operations.

  • Collateral bonds:

An American term, to indicate those bonds which are secured by collateral such as the pledging of mortgages (collateral mortgage bonds).

  • Eurobond:

A Bond issued by a company or a government in a market other than that of its currency of denomination. Eurobonds are then sold internationally and not in just one domestic market (e.g. a German corporation may issue euro-dollar bonds on the London capital market). The main Eurobonds include the Eurodeutsche Mark bonds, Eurodollar bonds, Euro French Franc bonds, Euro sterling bonds and Euro yen bonds, although the nationally denominated European Eurobonds will be phased out within Europe.

  • Convertible bond; convertibles:

Bonds issued by a corporation which may be converted into the corporation’s Common stock/Ordinary shares within a specified time period and at a specific price, at the option of the holder.

  • Guaranteed bond:

A bond issue where a third party (e.g. parent company) guarantees the fulfillment of the terms of the issue.

  • Clip and strip bonds:

These are bonds whose principal and coupon portions may be split and sold separately.

  • Debenture:

A term indicating a fixed-interest bond secured against the issuing Project’s assets (these may consist either of specific assets of the Project or of its assets in general). Debenture bonds are distinct from ordinary bonds, the latter being unsecured. Debentures will be paid whether the issuing Project makes a profit or not and, in case of liquidatio, debenture holders have priority over ordinary bond holders on the Project’s remaining assets. Debentures can be bought and sold on a stock exchange.

Preferred Stock

We continue our discussion of equity focusing on corporate form, so the discussion that follows looks at owners’ equity specifically from a corporate perspective. In some Corporation Based Projects s, the first line of the Equity section is Preferred Stock. Corporation Based Projects, whose management wishes to distinguish owners from other investors who may not have an ownership role, issue Preferred Stock.

Preferred Stock is so named because it has certain preferences under special circumstances. For example, preferred stock does not generally have a vote on corporate matters or actions. However, under certain circumstances, such as if the Projects has not paid any preferred stock dividends for a specified number of periods, preferred stock owners may not only have votes, but may actually control the voting process. This preference for ownership of the interests of the preferred stockholders gives these investors some control over the management of their investment.

Other preferences include the right to receive cash dividends before any cash dividends may be paid to common stockholders. If the preferred stock is ”cumulative,” preferred shareholders have the right to receive all back dividends that were not paid before any cash dividends may be paid to common stockholders; and the right to receive repayment of invested amounts before any such redemption payments may be made to common stockholders if the management decides to liquidate the Projects. Unlike common stock dividends, dividend amounts for preferred stock are generally specifically defined, providing a clear value for each share. These preferences are really not very important, except if there is some prospect of financial difficulties.

However, some investors are interested in specific and predictable cash flows, and the dividends for preferred stock are generally higher than is interest on debt, because preferred stock, falling below debt in the repayment hierarchy, is riskier than debt, even subordinated debt. Therefore, the predictable dividends offered by companies through their preferred stock may be attractive to investors. Another reason for investing in preferred stock is a tax preference offered to Corporation Based Projects s that invest in the stock of other Corporation Based Projects s. The Internal Revenue Code offers a ”dividends received deduction” equal to 70 percent of the value of such a dividend to the receiving Corporation Based Projects , increasing the after-tax value of such dividends. As a result, Corporation Based Projects s with excess cash that they expect to be able to hold for at least 46 days, to satisfy a qualification rule, may choose to invest in the preferred stock of other Corporation Based Projects s, purchasing the preferred stock so as to qualify for the dividend, holding the stock for the requisite time period, and selling the stock to reestablish the cash position in advance of its requirement. Thus, we can see how the marketable securities investment practices of one type of Projects relate to the capital funding needs of another.

Preferred stock has some hybrid characteristics that make issuing it interesting and complex. From a lender’s perspective, preferred stock looks like equity: its return is paid out of after-tax income and is paid after interest is paid on debt, its claim on assets is subordinate to that of the lender, and it provides capital to the Projects that serves as security for the loans. However, to the common stock holder preferred stock looks much like debt: it receives its payment before any payment to the shareholders, it has a higher priority claim on assets in the event of financial distress, and under normal circumstances its owners have no say in corporate decisions.

Some preferred stock issues offer another type of opportunity for investors. Convertible preferred stock, in addition to the preferences identified above, may also offer the shareholder the opportunity, if desired, to convert the preferred stock into common stock at a defined rate. Often, this conversion privilege is offered when the stock price is low but expected to increase. The shareholder has the option to convert or not as he or she chooses, but receives the higher dividends as long as the investment is held in preferred stock form. Therefore, if the common stock price is well below the conversion price, preferred stock will be held. If the common stock price rises, the shareholder has the choice, but can continue to hold the preferred stock and receive the dividends. If, at some point, the common stock price rises enough, the shareholder may opt to convert the preferred stock into common stock and then may choose to sell all of the common stock for cash that will be significantly higher than the original investment, or sell some of the common stock in order to recover the investment while continuing to hold some of the common stock in order to continue to benefit from the rising market price.

As you can see, understanding how finance works contributes to the shareholder’s ability to judge investment alternatives. Obviously, the investor’s ability to anticipate what will happen to the Projects and to its stock also helps. This ability comes from understanding financial management and financial reporting and being able to interpret the information contained in the financial statements and explanatory information provided by the Projects.

Common Stock

Common stock represents the actual ownership of the Projects. The shares of common stock, if there is only one class, each signify an equal portion of the Projects. There may be a few shares, each with a relatively large portion or millions or billions of shares outstanding, each of which owns an infinitesimal part of the ownership. However, in widely held companies a relatively small percentage may represent a substantial and influential position.

Common stock may be issued for cash investment or as a reward for effort on behalf of the Projects. In the stock market of 1999, for example, there were numerous examples of companies entering the public market through an Initial Public Offering (IPO) and instantly making employees of the Projects, who received part of their early pay in stock, extremely wealthy. These employees, who may own a very small percentage of the Projects, benefit from the sale to the public of a large number of shares, resulting in a significant dilution of their ownership position, but also translating into very substantial increases in their wealth in terms of the market price of the shares after offering multiplied by the number of shares they hold.

Common stock ownership conveys certain rights to the owner, including the right to vote on certain corporate matters including the membership of the Board of Directors, the right to vote on the number of shares to be issued, the right to vote on matters that guide management, and sometimes the right to preserve their ownership position in the event the Projects issues additional stock. This last right, included in the by-laws of some Corporation Based Projects s and mandated by law in some states, is called a preemptive right, and assures that a shareholder cannot be diluted from a position of influence to one without influence without his or her consent. Perhaps the most important ownership right is to vote for the Board of Directors and through that vote to influence the direction of the Projects.

The value of the common stock shown on the Balance Sheet reflects only the par value of a share of common stock multiplied by the number of shares outstanding. It does not represent the amount paid for the common stock unless either the par value and the amount paid per share are the same or there is no par value for a share. The par value represents the minimum per share value that a share owner would be responsible for if the Projects fails. If the shareholder has already paid that amount, then the entire amount that he or she could lose is the amount already invested. This differs from the exposure to risk of proprietors or general partners in the other principal forms of Projects organization structure.

Additional Paid-In Capital

The difference between the par value and the issue price of a share goes into the line identified as ”Additional Paid-in Capital.” On some balance sheets Additional Paid-In Capital is identified as ”Paid In Surplus” or ”Capital in Excess of Par.” Regardless of its identification, Additional Paid-In Capital is positioned on the balance sheet immediately below Common Stock and represents the rest of the capital invested by the shareholders that was received by the Projects. It has nothing to do with the price of a share paid on any stock exchange, over the counter, or between shareholders. For example, if a Projects issues shares having a par value of $1.00 for $25.00 each, the $24.00 difference between issue price and par value would be Additional Paid-in Capital. For shares issued in a public stock offering, after the initial sale, when a second investor purchases the shares from the first shareholder (through a broker) for $40.00 per share, the shareholder receives the whole $40.00 and recognizes a capital gain of $15.00 (net of commissions and fees), reflecting the difference between the issue price, $25.00, and the purchase price, $40.00, and no additional money goes to the Projects.

Retained Earnings

The amount of profit that the Projects earns and retains in the business, that is, does not pay out in dividends, is recorded as Retained Earnings. These amounts, adjusted each period for the profits after taxes and dividends, reflect the perceived success of the Projects and enhance the ”shareholders’ wealth.”

The section of the Balance Sheet made up of Common Stock, Additional Paid-in Capital, and Retained Earnings represents the book value of the shareholders’ ownership. The relationship of the book value to the market value is determined by the price-earnings ratio. Although it has less to do with the book value of the shares than the current market atmosphere, it is generally felt that those Corporation Based Projects s that are performing well and increasing the book value of the shares are also going to perform well in the market. Therefore, the measures of performance and financial success generally focus on Balance Sheet and Income Statement performance measures.

Stock Repurchase Plans

More and more frequently companies are establishing stock repurchase programs, arranging to buy back common stock from shareholders, generally at prices higher than the current market prices. These programs enable the companies to transfer cash and value to only those shareholders who want it, whereas a dividend would be distributed to all shareholders, possibly costing the Projects more and requiring the shareholders to deal with tax and investment issues on their own. If a stock repurchase takes place at a price higher than the shareholder paid, it results in capital gains, and may offer a tax benefit (although as a result of the tax changes in 2003, taxes on dividends and on capital gains are approximately the same). Other consequences of stock repurchase programs include concentrating ownership in management and shareholders who support management, raising earnings per share and therefore possibly raising the stock price in the market, and utilizing excess cash for a purpose that enhances the return on equity.

The Investment Marketplace

Companies that are looking for equity, whether for the first time or the umpteenth time, often look to the public for funding. The sale of common stock is the most frequent method of raising substantial capital. The first time stock of a particular Projects is sold to the public is called the Initial Public Offering (IPO) and it often occurs with substantial publicity. Because these companies are often unknown to the investing public, a complex series of meetings and presentations are arranged to bring the Projects to visibility in the investment community. The IPO process is a very exciting and challenging time for the Projects, and provides a unique opportunity for the management to tell its story to the investment press and the investment bankers and brokers who will help make the offering successful. There is a lot written about the IPO process, a very specialized marketing effort.

Subsequent offerings, to add more equity and provide funding for expansion or acquisitions, generate less publicity and are managed carefully to provide capital and not disrupt the orderly market for the stock. In some cases the additional equity is marketed to one or a limited number of institutional investors in a private placement that effectively brings substantial capital into the Projects and limits the disruption to management inside or the existing market outside.

When companies go public, that is, issue stock in a public offering, they often seek to be listed in a stock market that provides a place or a system for the orderly purchase and sale of the Projects’s stock from shareholder to shareholder. These markets do not directly involve the Projects at all, although the management is very aware of the value placed on the shares in the market. There are a number of organized exchanges where Projects shares are traded. The largest and most well known of these is the New York Stock Exchange (NYSE). The NASDAQ (National Association of Securities Dealers Automated Quotation) market has become the center for much stock market activity. Daily trading volume on NASDAQ is comparable to that on the NYSE and is increasing. More recently, an alternative marketplace has arisen through the Internet and it is likely that electronic stock trading will become the predominant means of exchanging shares in the years to come. In fact, a number of smaller companies have issued their shares to the public over the Internet, bypassing the traditional markets entirely.

 

Accounting For Equity

One of the ways to consider the accounting effect of different transactions is to consider what will happen to equity as a result. For example, if a Projects incurs a loss, the ultimate effect, through the closing of the Income Statement into retained earnings is a reduction in shareholders’ equity. Similarly, if a Projects increases its sales and profits, the ultimate effect will flow through the Income Statement to affect the owners’ wealth. Though many analysts focus on the effect on cash of different actions, the real concern should be directed toward the net worth of the Projects

Consider this flo Assume that the sales department wants the Projects to carry more inventory in order to satisfy customers’ desires for faster delivery. To purchase more inventory, the Projects will have to either use its cash or borrow funds from a bank. If it uses the cash, the Projects reduces its ability to invest the cash and increase its income. If the Projects borrows money, it incurs interest expense, lowering both profits and retained earnings. The cost of carrying the inventory, as we saw, results in higher expenses and therefore has a depressing effect on profits until it is sold. The test of the suggestion, therefore, must be to assess whether the higher investment in inventory will add to or detract from the profits of the Projects, ultimately affecting the equity on the Balance Sheet.

To complicate this analysis a bit, consider whether the impact will be to lower profits this year, but increase them in future years. Now we must add time value of money considerations as well as assessment of the likelihood of the forecast to the assessment. These kinds of considerations are a significant part of the financial management of a business and require that the Project Managers understand the financial implications of such decision making.

The equity on the Balance Sheet reflects the ownership of the Projects. Whether the Projects is a proprietorship, Partnership Based Projects , or Corporation Based Projects , or some variation on one of these, the equity remains the reflection of the ownership values.

The principal forms of business structure are:

  1. Proprietorship
  • single owner
  • general liability
  • limited access to capital
  • ease of establishment and dissolution
  • single level of taxation
  1. Partnership Based Projects
  • multiple owners
  • general liability
  • somewhat limited access to capital
  • Partnership Based Projects  agreement usually required
  • automatic dissolution when partner leaves
  • single level of taxation
  • Corporation Based Projects
  • one or more owners
  • limited liability
  • required legal documentation for establishment
  • easier access to capital
  • unlimited life
  • double taxation of earnings on distribution

Common Stock represents ownership and has certain rights, such as voting for directors and on major corporate actions.

Preferred stock is investment that may include an ownership interest under certain circumstances and provides certain preferences, predominantly related to the distribution of corporate assets.

Most accounting transactions eventually have an impact on equity, generally through the Income Statement, where the net income after taxes and dividends becomes the change in retained earnings.

 

POME Prescribe:

About Planning

ü   Plan ahead: Before you plunge headlong into work, spend some time planning your project.

ü  Break down work into tasks(WBS): Breaking down the project into smaller tasks (and mini-tasks if required) ensures that you have a systematic approach.

ü  Keep it visible and visual: Plotting a chart or graph about work progress and tacking it in a prominent place on your soft board (or keeping the softcopy on your desktop) ensures that your progress is visible to you.

ü  Infrastructure: A reliable server lays the foundation for efficient work. Good infrastructure and equipment translate to smooth functioning for any task.

ü  A step-by-step plan is the best way to ensure you know where you are going.

ü  In project management, the bulk of the work happens after the planning phase. How well this implementation of the plan happens depends on how thorough and specific the planning and documentation was. Bad planning translates to bad implementation.

ü  Good planning alone does not ensure good implementation. Follow-through becomes vital here. As the leader, the project manager ensures that the team sticks to the plan.

ü  As a project manager, you need to check that everyone is following the functional spec and style guide, that they are using the proper naming conventions and version controls, and that backup files are being saved on the server. Rules are useful only insofar as they are implemented and followed.

ü  Be prepared: Know your stuff front-wards, back-wards, and every way in between. This does not mean that you need to say everything you know. Being prepared helps you to quickly answer questions and convey that you know what you are talking about.

ü  Understanding the goals: A project is truly successful only when you are meeting the need for which it was created. Identifying the scope and requirements at the outset and also acknowledging that in the real world, these can change is a good starting point.

ü  Getting it right from the outset: The most important part of a project’s life cycle is the identification of its requirements.

Gautam KOppala,

POME Author

 

Related Loan News

Both comments and pings are currently closed.

Comments are closed.