Chapter 8 OSC, PSC Loan

Capital and Bond Valuation

Madam Siti Amiroh Md Isa
Ordinary Share Capital
 Introduction

• ‘Capital’ refers to the use of equity and long-term debts—

bonds or long-term borrowings.
• Equity comprises of common stock and preferred stock.
• Common stockholders are given the controlling power—
voting rights on the appointment of top managers and dir
ectors.
• As a trade-off—the preferred stockholders & bond holder
s to receive their contractual returns ahead of the commo
n stockholders.

** common stock = ordinary share (saham biasa open/sell to public.

Ex: ASB)
** preferred stock = preference share (saham keutamaan only open/
sell to existing shareholder in the company)
 Ordinary Share Capital

• Common stocks—the fundamental ownership units of

any firm (equity)
• The term “owner” refer to common stockholder (known
as ordinary shareholders)
• CS does not mature, and is deemed to be in existence
until the winding of the firm or if the firm undertakes a sh
are repurchase and the stock is subsequently cancelled.
 Ordinary Share Capital

Ordinary share which is also known as common shares.

Consist of voting right in the proportion with shares held
by shareholders. Mean shareholder are giving a right to vot
e in AGM.
Received or given by the owner of a company to increase
their capital.
Potential to give the highest financial gains but also have
high risk.
Amount of dividend payable on equity share is not fixed.
 Shareholders’ Rights
The ownership of share entitles shareholders to four basic
rights, unless specific rights are withheld by agreement.
1. Vote
2. Dividends – entitle dividend after distribute first to
Debenture and PSC
3. Liquidation – In the event of liquidation (bankrupt/close
business) shareholder hv right in decision making to decide
whether continue or stop the operation!
4. Preemption - Preemptive rights are a contractual clause
giving a shareholder the right to buy additional shares in
any future issue of the company's common stock before the
shares are available to the general public
 New Issuance and Firm Value

• Stock prices decline when a company announces a seas

oned equity offering.
• In most cases, the decline is due to the private or insider
information known by the managers asymmetric inform
ation.
• It provides some sort of signal to the market.
• The Cost of New Issues
 Repurchase of Stock
• Repurchase of stock—result in the number of shares in
the secondary market being reduced
• A share repurchase is a transaction whereby a
company buys back its own shares from the
marketplace. A company might buy back its shares
because management considers them undervalued.
The company buys shares directly from the market or
offers its shareholders the option of tendering their
shares directly to the company at a fixed price. https://ww
w.investopedia.com/terms/s/sharerepurchase.asp
• Also known as a share buyback, this act reduces the
number of outstanding shares, which increases both the
demand for the shares and the price.
What Happens After a Share Repurchase

Because a share repurchase reduces the number of shares

outstanding, it increases earnings per share (EPS). A higher
EPS elevates the market value of the remaining shares. Aft
er repurchase, the shares are canceled or held as treasury
shares, so they are no longer held publicly and are not outst
anding.
Reasons company buy back their shares
 Benefits of a Share Repurchase

• A share repurchase shows that the corporation believes i

ts shares are undervalued and is an efficient method of p
utting money back in shareholders’ pockets.
• The share repurchase reduces the number of existing
shares, making each worth a greater percentage of the
corporation. The stock’s EPS increases while the price-to
- earnings ratio (P/E) decreases or the stock price
increases.
• A share repurchase demonstrates to investors that the
business has sufficient cash set aside for emergencies
and a low probability of economic troubles.
https://www.investopedia.com/terms/s/sharerepurchase.asp
 Common StockZero Growth

Example:
Common StockConstant Growth
PREFERENCE SHARES CAPITAL
 Introduction

• Preference share—security which refers to a class of

ownership in a company that gives the first priority to
preference (preferred) stockholders to claim on their
assets and earnings before common stock
• Lower risk faced by preference stockholders as
compared to that of common stockholders
• Do not have voting rights or have restricted voting rights
 Preference Shares Capital

• PSC have a higher claim on the issuing company's

assets than common shareholders. In the most extreme
case, this means that preferred shareholders must be
paid for their interest in the company before common
shareholders in the event of company bankruptcy and
liquidation.
• The day-to-day implication of this claim is that preferred
shares guarantee dividend payments at a fixed rate,
while common shares have no such guarantee. In
exchange, preferred shareholders give up the voting
rights that benefit common shareholders.
 Features of Preference Shares

• Dividends paid before paying to holders of common

stock.
• Preference share is a relatively more secure investment
compared to ordinary shares.
• Preference shareholders do not wish to be confronted
with as much risk as that attached to ordinary shares.
• Preference shares rank ahead of ordinary shares in the
payments of dividends and repayments in the event of
winding up.
 Benefits of Preference Shares

• Prevent the dilution of control of the existing shareholders

• Unable to subscribe for additional shares in the firm
through a rights issue
• Firm has to undertake a private placement for funds with
third parties
• Enhance the firm’s earnings per share
• Carry fixed term of payments and cost of capital for
preference is fixed
• Non-payment of preference dividends does not pose
solvency risk. In contrast, if a firm defaults in its payment
of interest, debt holders have a right to sue and wind up
the firm.
LOAN CAPITAL AND BOND VALUATION
 Introduction
• The part of a company's capital employed that is (1) not
equity capital, (2) earns a fixed rate of interest instead of
dividends, and (3) must be repaid within a specified
period, irrespective of the company's financial position.
• Loan capital may be obtained from a bank or finance
company as long-term loans, or from debt-equity investors
in the form of debentures or preferred stock (preference
shares), and is usually secured by a fixed and/or floating
charge on the company's assets. Unlike debt capital, it
does not include short-term loans (such as overdraft). Also
called borrowed capital.

Read more: http://www.businessdictionary.com/definition/l

oan-capital.html
 Introduction

Equity Capital (shares)

– Earns dividends
– The dividends can depend on the underlying firm
financial conditions
Loan Capital (borrowing loan)
– Earns a fixed rate of interest
– Interest is independent of the underlying firm financi
al conditions
 Types of Loan
Revolver - A revolver refers to a borrower—either an individual
or a company—who carries a balance from month to month,
via a revolving credit line. Borrowers are only obligated to
make minimum monthly payments, which go toward paying
interest and reducing principal debt. Revolvers are used in
finance by corporations to fund working capital needs, which
are expenses for day-to-day operations such as payroll.
Term Loan - A term loan is a loan from a bank for a specific
amount that has a specified repayment schedule and either
a fixed or floating interest rate. A term loan is often
appropriate for an established small business with sound
financial statements. Also, a term loan may require a
substantial down payment to reduce the payment amounts
and the total cost of the loan.
 Types of Loan

Mezzanine Loan- ?
Syndicated Loan- ?
BOND
 Basic Features of a Bond

• A corporate or public bond is a long-term borrowing

, issued by a corporation to individuals, institutional
investors and financial institutions.
• Bond features can be illustrated as follows;
– par value or face value (usually RM1000.00)
– coupon rate (interest payment)
– number of year to maturity
 Valuation of a Bond

B0 = I1 I2 I3 In  P
   ... 
1  k 1
1  k 2
1  k 3
1  k n
Where
B0 = price of a bond
It = interest payment to be received at time t
P = principal to be received at maturity T
k = yield or internal rate of return
 Example

Below are details of 3 types of bonds which are Bond A, AA

and AAA. The value of each bond are as follows:

Bond Par Value Annual Coupon Years to Required

(RM) Interest Rate Maturity Return (%)
(%)
A 800 5 7 6
AA 800 7 3 7
AAA 800 4 5 3

Calculate the value of bond A, AA and AAA, then give a

comment based on the value obtained. (Can refer TMV
table).
 Answer
BOND
A Value of the bond A = Interest x (PVIFA k,n) + (Principal x (PVIF k,n)
= (RM800*5%) x (PVIFA 6%,7) + 800 x (PVIF 6%,7)
= RM40 X (5.5824) + 800 X (0.6651)
= RM223.30 + RM532.08 = RM 755.38
Comment : PV = RM 755.38 which slightly differs from the par value where
RM 755.38 < 800, therefore the bond is selling at discount.
AA Value of bond AA:
= Interest x (PVIFA k,n) + (Principal x (PVIF k,n)
= (RM800*7%) x (PVIFA 7%,3) + 800 x (PVIF 7%,3)
= RM56 X (2.6243) + 800 X (0.8163)
= RM146.96 + RM653.04 = RM800
Comment : PV = Value of AA equal to par value where RM800 = RM800,
therefore the bond is selling at a par where no discount or premium.
AAA Value of bond AAA = Interest x (PVIFA k,n) + (Principal x (PVIF k,n)
= (RM800*4%) x (PVIFA 3%,5) + 800 x (PVIF 3%,5)
= RM32 X (4.5797) + 800 X (0.8626)
= RM146.55 + RM690.08 = RM836.63
Comment : PV = RM836.63 which slightly differs from the par value
where RM836.63 > 1000, therefore the bond is selling at a premium.
 Notes!
FORMULA = Interest x (PVIFA k,n) + (Principal x (PVIF k,n)

PVIFA is from TABLE

TVM for PRESENT PVIF is from TABLE
VALUE ANNUITY TVM for PRESENT
VALUE SINGLE
 Yield and Bond Valuation

• The yield on a security is the interest rate or discount

rate that discounts all the cash flows from the security
such that the sum of the present value of the cash flo
ws will equal the market value or market price of the
security.
• The expected rate of return for a bond is also the
rate of return the investor will earn if the bond is
held to maturity, or the yield to maturity.
• Thus, when referring to bonds, the terms expected
rate of return and yield to maturity (YTM) are often
used interchangeably.
 Yield Curve

• The "term structure" of interest rates refers to the

relationship between bonds of different terms.
When interest rates of bonds are plotted against
their terms, this is called the "yield curve".
• The term structure reflects observed rates or yields
on similar securities, except for the length of time
until maturity, at a particular moment in time.
• There are three main patterns of yield curves.
– Normal yield curve
– Flat yield curve
– Inverted yield curve
 Yield Curve (cont.)

(1) Normal

(2) Flat (3) Inverted

 Yield Curve (cont.)

• Three theories for the yield curve.

• Expectations theory states that the term structure is
determined by an investor's expectations about
future interest rates.
• Liquidity preference theory states that investors
have a natural preference for holding cash rather
than other investments, even low risk ones such as
government securities.
• Market segmentation theory states that there are
different categories of investors who are interested
in different segments of the curve.
THANK YOU