In this video, I discuss the financiering of a corporation via debt securities and equity securities as covered on the CPA exam. Start your free trialhttps://lnkd.in/g4hZAp2

Corporate finance involves various methods of raising capital, with two primary types being equity and debt securities.

Debt Securities (Bonds): These are instruments through which a corporation borrows money. Bonds can be of different types, such as secured mortgage bonds, unsecured debentures, or convertible bonds (which can be converted into stock). Holders of bonds are essentially lenders to the corporation and are thus its creditors.

Equity Securities (Stocks): This form of financing involves issuing shares of the corporation. Equity securities include not just shares but also stock warrants (options issued by the corporation allowing the purchase of its shares) and stock options (similar options but issued by a party other than the issuing corporation). Shareholders, who hold these equity securities, are the owners of the corporation.

Characteristics of Equity Securities: A corporation might issue a single class of stock where each share has identical rights. Alternatively, it might issue multiple classes or series of stock, each with different rights and privileges.

Consideration for Stock: The board of directors of a corporation typically decides the price of the stock. According to the Revised Model Business Corporation Act (RMBCA), stock can be issued in exchange for various benefits to the corporation. These benefits can include money, property, promises of future service, promissory notes, etc.

For example, a corporation might issue stock in exchange for a piece of real estate valued at a certain amount. This real estate then becomes an asset to the corporation, while the former owner of the property becomes a shareholder with a stake in the corporation equivalent to the value of the property exchanged.

Secured Mortgage Bonds: These are bonds backed by specific assets, typically real estate or property. If the issuer defaults on the bond, the bondholders have a claim on the underlying collateral. This security makes them relatively safer investments compared to unsecured bonds.

Unsecured Debentures: Unlike secured bonds, unsecured debentures are not backed by any specific assets. They are based solely on the creditworthiness and reputation of the issuer. If the issuer defaults, the bondholders are general creditors and have no claim on any specific assets. These bonds typically offer a higher yield to compensate for the increased risk.

Convertible Bonds: These are a unique type of bond that can be converted into a predetermined number of shares of the issuing company’s stock at certain times during the bond’s life, usually at the discretion of the bondholder. This feature offers the potential for capital appreciation through conversion into equity while also providing the regular interest payments and principal security of a standard bond.

Issuing stock is a common way for corporations to raise capital. Here are the advantages and disadvantages of this method:

Advantages
No Repayment Obligation: Unlike debt, issuing stock doesn't require repayment, reducing financial burden.

No Interest Payments: Stocks don’t incur interest costs, which can be beneficial, especially during financial downturns.

Access to More Capital: It can provide significant amounts of capital, often more than what can be raised through loans.

Shared Risk: Since shareholders are owners, the risk is distributed among them.

Attracting Talent: Stock options can be used to attract and retain employees.

Enhanced Public Image: A public stock offering can raise a company's profile, enhancing its market presence.

Disadvantages
Dilution of Control: Issuing new shares dilutes the ownership percentage of existing shareholders.

Dividend Expectations: Shareholders often expect dividends, which can be a financial strain.

Market Fluctuations: Stock prices can be volatile, influenced by market conditions and investor perceptions.

Regulatory and Reporting Requirements: Public companies face significant regulatory scrutiny and must disclose financial and business information.

Potential for Hostile Takeovers: Issuing more stock can make a company vulnerable to hostile takeovers.

Initial and Ongoing Costs: The process of issuing stock (especially in public offerings) can be expensive and complex.

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