1.0 Differenceof issuing shares and bonds as financial instrumentIssuingshares is useful for company to get funds without ban financing. A businessowner may have friends or family who are going to help out and in return for ashare in the company and looking for anangel investor to give the company a capital injection (Lowndes Jordan, 2015).There are some consideration of commercial and law for small business when itis looking at taking a new shareholder. The main issue is always got denied isthe compliance problem with securities legislation. Moreover, the effect of thelaw usually exist to protect investors and require company to take certainsteps before issuing shares to investors, this resources intended to be a smalloverview of those laws. Raisingthe capital or to get funds by issuing bonds is the most alternative to sell theshares because it allows a company to avoid releasing ownership as a part ofthe business.
A bond is a loan in the form of a debt security. The borrowerwill owes to the lender a debt and the borrower has responsibility to pay backthe principal and the coupon on the maturity of the loan. Bond allows theissuer to finance long-term investments with external funds (Patrick J Brown,2006). The loan guarantee can be the buildings, company’s land and the otherphysical assets that can be sold off if the issuer failed on repayment of theprincipal.
In bond markets, the wider range of assets can fulfill the functionof collateral. Ashare issue is an offer for investors by company or an industrial. These twocan raise equity in the market and very important from of investments forcommon people but gain a long term risk capital. Despite of that bond or loanstock issues to people or company to lend money on similar term for severalyears and this has a long term debt capital. However, issuing bonds by taking adebt is cheaper than bank overdraft or the cost of raising equity through ashare issue but also return on debt is tax deductible, since the return onequity is paid out of a company’s profits which are taxed before dividendpayments can be made to stockholders. Bondissue has high risks for bondholders rise as more debt is issued and the higherthe debt to equity ratio then the greater the risk because the debt agreementsmay turn out too limit for the company.
A company is much influenced is morelikely as it has to meet the coupon payment without pay attention to income.The cost to servicing the debt may rise beyond the ability to pay because ofexternal or internal events such as poor company management. The company may befined that problem runs in solvency problems if the amount of debt becomeshigher than the value of realizable assets itself. Thereby, the cost of debtrises as it proportion rises in relation to equity. The major differencebetween a share and a bond issue, there is a commitment to pay back the amountof money that has been invested after a number of years.
Thus, this is alsomake easier to collect the money in the first place, business plan must showsthe ability to repay the loans or increasing another loan to repay the initialinvestors within the time that already stated before. The advantages of shares is if the shares have limited rightsto withdraw or are transferable there is no obligation to repay back to them.Dividends are paid from profits if do not have profit, there is no dividend. Moreoverthe important reason about share issue is lending organizations, which is donot cover all financial requirement because really want to see the localcommitment evidenced by a share issue. However if you feel grants can cover allof your investment needs, a share issue will be worthwhile. If well organized,a share issue can attract a fresh layer of volunteers with a new ideas, getpress attention, and act as involving local businesses and support agencies.Furthermore, share income is unlimited money, not related with achievement ofoutput with the result that often stitched to grants and you also no need towait six months for the result.
In the other side bond issue will be financingby raising debt is the useful way to monitor all of corporation’s health, asthe ability to pay back the debt reflects the overall financial stability ofthe company. 2.0 Whatis Stock Splits, Bonus Issues, and Right Issues 2.1 StockSplitsAshare split happens when a board of directors authorize a changes in the specifiedvalue is made to lower the price market of share to make share more attractivefor potential investors. When a company’s share splits, the change in thespecified value is equal by equivalent change in the number of shares until thetotal value that has been made still same. Director’s decision to split sharesof the company to increase the amount of stock which circulate at a certaindate, thereby issuing more shares to current shareholder (Dennis, 2002).
Share’sprice in the market get affected by a share splits. In that during and aftersplit, the price of shares will decrease because the amount of stockoutstanding has been increased during the entire period. However, number ofoutstanding and the price of shares change but capitalization market stillconstant. Moreover, stock splits as the trading of company’s shares where atleast five shares are distributed to each four held (Jensen and Ross, 1969).Likewise, stock splits is a process of increasing the outstanding amount ofshares by decreasing the value of shares proportion, recapitalization achievedby changing the number of outstanding shares.
In addition, stock splits onlyincreasing the number of outstanding shares without changing any underlyingrisk and return characteristic of the firm (Weston, 1988). Among the firms thatare trading in 3 National Stock Exchange that have issued stock splits are;East African Cables Ltd, Sasini Tea, Equity Bank, Mumias Sugar Company, andKenya Commercial Bank.Theadvantages from stock splits is, the amount of potential buyers will increasebecause affordability of each shares is improved. The stock will automaticallystart to rise in price because of buying frenzy.
Thus, most of investors morelikely choose stocks that keep splitting because some of them conclude it as acompany’s future prospects. The drawback will arise if the company splits stockand the price of the company itself falls. Further, shares may fall below thisrequirement and will be taken out from exchange (Gallagher and Baker, 1980)2.2 BonusIssuesA bonus issues or scriptissue is a stock split in which a company issuing new shares without charge tobring its issued capital in line with its employed capital but increasedcapital will available for company after profits. Thus, this usually happen aftercompany made profits and then increasing its employed capital. In other words,a bonus issue can be seen as alternative to dividends. No new funds are raisedwith a bonus issue.
Bonus shares are issued by cashing in on the free reserves ofthe company. The company assets build up its reserves by retaining a half ofits profit over the year but the part that is not paid out as dividend).However, these free reserves increase and the company want to issuing the bonusissue can change a half of the reserves into capital.2.
3 RightIssuesThemain products are traded in the capital market is stock and the main purpose ofcapital market in the country is trading stocks. In addition, traded in thecapital market have various types of bonds and stock derivatives. One of theproducts of the derivative shares is a right issue or limited offer of shares. Moreover,right issue is a translation of the legal provisions which governing apreventive right in every old shareholder in a limited liability company, whereevery shareholder which listed in the shareholder list is entitled to get rightto buy every new or issued shares in the company portfolio. Right shares areusually issued at a discount as compared to the prevailing traded price in the market.
The existing shareholders get allowed a prescribed time or date within whichneed to exercise the right or the right will be forgotten. Right issue is thecommon stockholders as the owner of the corporations have a preventive right tosubscribe to new offerings, these right have been interpreted in a limited way(Brealy and Myres, 2000). Thefirst feature of right issues is the rights shares may allow special treatmentto existing shareholders, where existing shareholder have right to purchaseshares at a lower price on or before a specified date.
The shares are issuedwith discount as a compensation for the stake dilution that will take placepost issue of additional shares. Second feature, the existing shareholders cantrade the right to other interested market participants until the date at whichthe new shares can be purchased. In addition, the right are traded with thesame way as equity shares. The next feature is the amount of right issue forshareholders usually at a proportion of existing holding. The last, existingshareholders can choose to ignore the right. However, may not do as existingshareholding will be diluted post issue of additional shares and make loss forthe result for existing shareholder. A company maylook to raise a large capita amount for projects that may be have a longergestation period, some project where debt or loan may not available or suitableor expensive usually makes the company raising capital by this way.
Therefore,company want to improve debt to equity ratio or searching to buy a new companymay opt for funding by right issue route however sometimes company’s problemsmay issue right shares to pay back debt to ease the financial strain. 3.0 Convertible Bonds3.1 Brief explanation of convertible bonds ConvertibleBonds are fixed income instruments that can be converted become fixed number ofshares of the issuer at the option of investor.
Bonds can be converted becomeother shares other than the issuers are called exchangeable bonds. Thus,convertible is are attractive hybrid securities. On the other side, they havethe advantages of debt instrument that pay fixed coupon and will be redeemed atmaturity at a specific price that already determined before but enclosedconversion option gives the investor with participation in upside potentialfrom underlying equity. Moreover, the conversion right give the bond holderwith the good choice than better-of-two-choices option. At maturity, theconvertible bonds are worth the higher of their redemption it means the pricewhich the issuer had agreed to buy back that bonds or the market value of theunderlying shares.
Furthermore, a convertible Bond is a straight bond with anattractive equity call option, due to this call option, the convertible willparticipate in increase of underlying equity. However, the fixed income givescapital protection if the share price fall.3.2Characteristic of convertible bonds 3.2.
1 Payoff profile The x-axis display theunderlying share price when y-axis shows the price of the Convertible Bond. Thedotted diagonal points the intrinsic value that also called parity. Paritydeliberate the value that the investor will receive upon conversion of the bondand parity is a lower boundary for the price of the convertible. Furthermore,the yellow line outlines is convertible’s fair value if the share price raises,the fair value of the convertible bond increases as well. Thus, as the priceincreases, the relation between shares and bonds become more direct until thebond price behavior and risk profile feature characteristic of the underlyingequity. On the other hand, if the price share decreases, the bond’s sensitivityto its underlying share price will fall and the bond will not fall until thesame extent as the equity.
The level will prevent convertible from fallingfurther down is shown in the above graph as the bond floor(grey) which is alsoa lower boundary for the price of convertible. Same as straight debt, aconvertible have the risk of the issuer not being able to pay back theprincipal at maturity. That credit risk is explained in the graph as the steepfall of the bond floor as the bond price on the left-hand side. Moreover, thebest risk-return profile is in red area where the convertible’s potentialupside is the biggest while the downside risk is relatively low. RMF focuses onconvertible bonds priced in that area. 3.2.
2 Investment Categories 220.127.116.11 Yield instrument(out-of-the-money) ConvertibleBonds where the underlying share price trades is below the conversion pricehave low equity sensitivity and run like fixed income securities. The majorprice factors are the interest rate level and the issuer’s credit spread.
18.104.22.168 Hybrid instrument(all-the-money) ConvertibleBonds where the underlying share price trades close to the conversion price aredeal with balanced convertibles because of their asymmetric payoff figure. Theyhave a medium sensitivity to change in the underlying equity.
That all bondsare influence by the share price performance and excitability movements as thechange in interest rates and the issuer’s credit figure. The main of new issuessend off as balanced convertibles. 3.
2.2.3 Equityalternative (deep-in-the-money) ConvertibleBonds where the underlying share price trades extremely above the conversionprice are highly responsive to change in the equity considering theirresponsive to change in interest rates and/or credit spreads is low. Thesebonds trade at a pointless premium or even a small discount to parity.
Deep-in-the-moneyconvertibles will almost exactly be reformed into the underlying shares atmaturity.