Course name: Financial Management

Chapter note
Prepared by SM Nahidul Islam
Dept. of Finance & Banking
Islamic University, Kushtia.

Chapter Bond and Stock valuation

Questions at a glance:
1.
2.
3.
4.
5.
6.
7.
8.
9.

Definition of Bond & Describe the features of bond

Differences between common stock and Bond
Describe the differences between Bond and debenture
Definition of Common stock/ equity shares/ Ordinary shares & Features of it
Describe the differences between Share and Stock
Write the features of preferred stock
Why preference share is called a hybrid security
Differences between equity shares, preferences share and debenture / bond
Explain the linkage among financial decisions, return, risk and stock value

1. Definition of Bond & Describe the features of bond

Prepared by SM Nahidul Islam

Dept. of Finance & Banking
Answer: Bond is a long-term debt contract under which the issuer receives
money in exchange of promising to make interest payments and to repay the
principal on a specified future date. The main features of a bond are given below:
1. Debt indenture: Bond is a long term debt instrument.
2. Voting rights: The bond holders have not the rights to award votes and
cannot participate in taking decision of the company.
3. Par Value: The face value of a bond.
4. Coupon Interest Rate: The stated annual interest rate on a bond.
5. Maturity Date: A specified date on which the par value of a bond must be
repaid
6. Principal Investment Repayment bond issuers are obligated to repay
the full principal amount of a bond in a lump sum when the bond reaches
maturity
7. Minimum Investment Bonds are usually issued in $1,000 or $5,000
denominations.
8. Others: a. Call Provision b. Sinking Fund Provision c. Claims on asset

2. Differences between common stock and Bond

Answer: The main differences between common stock and bond are given below:

Points of
distinction
1. Meaning
2. Kinds of
instrument
3. Owners
4. Issued By
5. Participants
6. Derivatives
7. Yield Analysis

8. Claim on
income &
asset

Common stock

Bond

Common stock is the purest

and most basic form of
corporate ownership.
Equity

Bond is a long term debt

instrument used by business
and government.
Debt

Shareholders
corporation or joint-stock
companies
Market maker, Floor trader,
Floor broker.
Credit derivative, Hybrid
security, Options, Futures,
Forwards, Swaps
Gordon model, Dividend
yield, Income per share,
Book value, Earnings yield,
Beta coefficient
Have residual claim. Thus all
the risk is borne by equity
shareholders.

Bondholder
Public sector authorities, credit
and supranational institutions.
Investors, Speculators,
Institutional Investors.
Bond option, Credit derivative,
Credit default swap,
Collateralized debt obligation.
Nominal yield, Current yield,
Yield to maturity, Yield curve,
Bond duration, Bond convexity.
Have first claim on income and
asset.

Islamic University, Kushtia

Prepared by SM Nahidul Islam

Dept. of Finance & Banking

3. Describe the differences between Bond and debenture

Answer: The main differences between bond and debenture are given below:

Bond
Bonds have a lower rate of interest
and they are more secure.
Bondholders are paid first in a
bankruptcy
The company provides collateral for
the loan

Debenture
Debentures have a higher rate of
interest because they are basically
unsecured loans
Debenture holders do not have this
security.
The company does not provide
collateral for the loan

4. Definition of Common stock/ equity shares/ Ordinary shares &

Features of it
Answer: Common stock is the purest and most basic form of corporate
ownership. According to Van horne, Common stock is the security that
represents the ultimate ownership and risk position in a corporation.
Common stock / Equity shares consist of the following important features:
1. Voting rights: Equity shareholders have voting rights in the meeting of the
company with the help of voting right power; they can change or remove
any decision of the business concern.
2. Maturity of the shares: Equity shares have permanent nature of capital,
which has no maturity period. It cannot be redeemed during the lifetime of
the company.
3. Residual claim on income: Equity shareholders have the right to get
income left after paying fixed rate of dividend to preference shareholder.
4. Residual claims on assets: If the company wound up, the ordinary or
equity shareholders have the right to get the claims on assets.
5. Right to control: Equity shareholders are the real owners of the company.
Hence, they have power to control the management of the company and
they have power to take any decision regarding the business operation.
6. Pre-emptive right: Equity shareholder pre-emptive rights. The preemptive right is the legal right of the existing shareholders.
7. Limited liability: Equity shareholders are having only limited liability to
the value of shares they have purchased.

5. Describe the differences between Share and Stock

Islamic University, Kushtia

Prepared by SM Nahidul Islam

Dept. of Finance & Banking

Answer: The main differences between share and stock are given below:

Share
A share is one of a number of individual
units into which the capital of a company
is divided.
Shares may be partly or fully paid-up.
Shares cannot be transferred in fractional
amount
A share has a nominal value.

Stock
Stock is the capital in the form of a
fund which may be divided into any
desired amount.
stock must be fully paid
Stock can be transferred in any
fraction.
Stock has none.

6. Write the features of preferred stock

Answer: preferred stock has several features. They are discussed below:

1. Claims on Income and Assets: Preferred stock is a senior security as

compared to common stock. It has a prior claim on income before common
stock. It also has a prior claim on assets in event of liquidation.
2. Fixed Dividend: The preferred stock dividend rate is fixed and it is not tax
deductible.
3. Cumulative Dividend: It has cumulative dividend feature, requiring that
all past preferred dividend be paid before any common stock dividends are
paid.
4. Redemption: Preferred stock has a limited or fixed maturity after which it
must be retired.
5. Sinking Fund: A sinking fund provision may be created to redeem the
preferred stock.
6. Call Provision: The call permits the company to buy back the stock at a
stipulated price.
7. Participating: Preferred stock may, in some cases, have participation
features
which
entitle
stock to participate in extraordinary profit earned by the company.
8. Voting right: Preferred stockholders ordinarily do not have any voting
rights.
9. Convertibility: Preferred stock may sometimes be convertible partly or
fully into common k at a certain ratio during a specified period.
10.
Par Value: Preferred stock always has par value and this value is
important for repayment.

7. Why preference share is called a hybrid security

Islamic University, Kushtia

Prepared by SM Nahidul Islam

Dept. of Finance & Banking
Answer: A *hybrid security* is a security that combines elements of two
securities, such as debt and equity. Preferred stock combines the features of an
equity and debt instrument to raise capital for a corporation. So, preferred stock
is called hybrid security. As a hybrid form of financing preferred stock is similar to
bond insofar as:
1. It carries a fixed rate of dividend.
2. It ranks higher claim to income / assets than common stock.
3. It normally does not have voting rights.
4. It does not have a share in residual earning / assets.
On the other hand, it is similar to common stock in that:
1. The non-payment of dividends does not force the company to insolvency.
2. Dividends are not deductible for tax purposes.
3. In some cases, it has no fixed maturity date.
In above discus on undoubtedly we can say that preferred stock is a hybrid form
of financing, combining features of debt and common stock.

8. Differences between equity shares, preferences share and

debenture / bond
Answer: The main differences between equity shares, preferences shares and
debentures / bond are given below:

Points of
distinction
s
1. Control

2. Holder

3. Ownershi
p
4. Decision
making
process

Equity shares

Preferences
shares

Bond / Debenture

Have control over

organization because
of voting right
The holder is known as
shareholder.

Do not have control

over organization.

Do not have control

over organization.

The holder is known

as preference
shareholder.
The holders are not
real owner.

The holder is known

as debenture holder
/ bond holder.
The holders are
debtors of a
company.
Cannot participate.

The shareholders are

real owner of a
company.
The shareholder can
participate in the
decision making
process of a company

Cannot participate.

Islamic University, Kushtia

5. Maturity

Do not have maturity

period. Equity capital
permanently remains
with the organization.

6. Claim on
income

Have residual claim.

Thus all the risk is
borne by equity
shareholders.
Have residual claim.
Thus all the risk is
borne by equity
shareholders.

7. Claim on
asset

Prepared by SM Nahidul Islam

Dept. of Finance & Banking
May or may not
Usually have
have maturity
maturity period.
period depending
upon type of
preference
share (redeemable
or
Irredeemable).
Have preference
Have first claim on
over equity shares.
income.

Have preference
over equity shares.

Have first claim on

asset.

9. Explain the linkage among financial decisions, return, risk and stock value
A decision or action by the financial manager can have an effect on the risk and expected return of the
stock, both of which are part of the stock valuation model.

Islamic University, Kushtia