Chapter 12

Definition of Terms
Financial Management Third Edition All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T), 2017 12– 2
The Capital Market

Stock Exchange in Malaysia

Market quotes
https://www.google.com/finance/

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 directors.
 As a trade-off—the preferred stockholders & bond
holders to receive their contractual returns ahead of
the common stockholders.

Common Stock
 Common stocks—the fundamental ownership

units of any firm
 Claim on Incomeresidual income
 Claims on Assetsafter satisfying creditors &
preferred stockholders
 Other Issuesvoting rights, preemptive rights

Public Offering
 Initial public offering (IPO)

 Seasoned equity offering
 Stock Exchange Listingadvantages &
disadvantages
 Listing Process
 Investment banks
 Listing Costs

New Issuance and Firm Value
 Stock prices decline when a company

announces a seasoned equity offering.
 In most cases, the decline is due to the private
or insider information known by the managers
asymmetric information.
 It provides some sort of signal to the market.
 The Cost of New Issues

Preference Share Capital and
Valuation

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

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.

Preferred Stock
 Preferred stock is part equity—resembles debt

since the dividend payments are fixed
 Also called a hybrid of equity and debt
 Claim on Incomeafter interests are paid
 Claim on Assetsranked ahead of common
stockholders
 Other Issuesno voting rights but convertible

Convertible Preference Shares
 These shares are corporate fixed-income

securities.
 Investor can choose to convert into a certain
number of the company’s common stocks—at a
predetermined time span or on a specific date.
 Conversion Premium—defined as: The Ringgit or
percentage amount by which the price of the
convertible preference shares exceeds the current
market value of the ordinary shares into which it
could be converted.

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
 Enhance the firm’s earnings per share
 Carry limited or no voting rights
 Carry fixed term of payments and cost of capital
for preference is fixed

Valuation
 Par value—the par value represents the claim of the

preference stockholder against the value of the firm.
 Preference dividend/Preference dividend rate is fixed—
see formula below for valuation of preference stock:

Example- Valuation
Find the price of a share of preference stock given

that the par value is RM100 per share, the
preference dividend rate is 8%, and the required
rate of return is 10%.
Using the formula,

Pp = (0.08xRM100)/0.10
= RM80
Loan Capital and Bond Valuation

Introduction
 Equity Capital
– Earns dividends
– The dividends can depend on the underlying
firm financial conditions
 Loan Capital
– Earns a fixed rate of interest
– Interest is independent of the underlying firm
financial conditions

Types of Loan
 Revolver
 Term Loan
 Mezzanine Loan
 Syndicated Loan
 Non-performing Loan

Loan Security
 Secured and Unsecured Loans

 Loan collaterals
– Soft assets
– Hard assets
– Cross-collateral assets
– Third-party guarantee

Risk of a Loan Capital
 Borrower-specific risk
– Reputation
– Leverage
– Volatility of earnings
– Collateral
 Market-specific risk
– Business cycle risk
– Interest rate risk
– Monetary policy risk
The Risk of a Loan Commitment
 Interest rate risk

 Take-down risk
 Credit risk
 Aggregate funding risk

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
 A bond indentureA bond indenture comprises of par
value, coupon rate, timing of interest, payments,
maturity date.

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 flows 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 and Bond Valuation (cont.)
 The effective rate of return can be obtained from the

followings:
Effective rate = (1 + periodic interest rate)m – 1,
where m is the frequency of payments per year.

Yield and Bond Valuation (cont.)
Example:
Find the effective rate of a bond with nominal
interest rate of 6% compounded monthly.
Solution:
Periodic interest rate = 6%/12 = 0.005
Effective rate = (1+0.005)^12 – 1 = 0.0617
= 6.17%

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Definition of Terms

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 ‘Capital’ refers to the use of equity and long-term

Financial Management Third Edition All Rights Reserved

 Common stocks—the fundamental ownership

Financial Management Third Edition All Rights Reserved

 Initial public offering (IPO)

Financial Management Third Edition All Rights Reserved

 Stock prices decline when a company

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Preference share—security which refers to a

Financial Management Third Edition All Rights Reserved

 Dividends paid before paying to holders of common

Financial Management Third Edition All Rights Reserved

 Preferred stock is part equity—resembles debt

Financial Management Third Edition All Rights Reserved

 These shares are corporate fixed-income

Financial Management Third Edition All Rights Reserved

 Prevent the dilution of control of the existing

Financial Management Third Edition All Rights Reserved

 Par value—the par value represents the claim of the

Financial Management Third Edition All Rights Reserved

Find the price of a share of preference stock given

Using the formula,

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

Financial Management Third Edition All Rights Reserved

 Secured and Unsecured Loans

Financial Management Third Edition All Rights Reserved

 Interest rate risk

Financial Management Third Edition All Rights Reserved

 A corporate or public bond is a long-term borrowing,

Financial Management Third Edition All Rights Reserved

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

Financial Management Third Edition All Rights Reserved

 The effective rate of return can be obtained from the

Financial Management Third Edition All Rights Reserved

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