Page 205 - Finance for Non-Financial Managers

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Finance for Non-Financial Managers
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Bond A negotiable instrument that is typically sold by pub-
lic companies, pays interest quarterly, and is usually publicly
traded during its life (just like company stock). Bonds are
not collateralized, but they’re often issued with insurance, purchased
by the issuing company, that guarantees payment of principal and inter-
est in the event the issuer defaults.This provision typically gives such
bonds the highest investment grade rating, because it removes essen-
tially all the ownership risk except interest rate fluctuation.
Debenture A bond that may be sold publicly or privately, but that
has no collateral to back it up except the strength of the issuing com-
pany.These instruments are similar to bonds and are often enhanced
by being convertible into the common stock of the issuer under cer-
tain circumstances.
pays the lender interest only for some period of time, thus con-
serving the company’s cash and enabling management to make
the most of its cash resources. Later, the lender may choose to
convert the debt into shares of stock at a predetermined con-
version ratio. Result: the company stops paying high interest
and surrenders a reasonable amount of ownership.
Here’s how it works. A company issues a convertible deben-
ture with provisions that call for interest to be paid periodically,
usually quarterly, but no principal. At some time in the future,
the bond is callable, meaning the company can buy it back
(usually at a premium over its face value) and retire it, in effect
paying off the loan. In the interim, the bond can be converted
into stock at any time, at a conversion ratio that is advanta-
geous to the company.

Capital Stock—Types and Uses

This section reviews some of the types of stock and how they’re
used to finance a business.
Common Stock—Fundamental Ownership of the Corporation
Common stock is the basic form of ownership of a corporation.
In the classic scenario, a company’s management issues stock
to investors in return for their cash and then uses the cash to