Financing Choices and Claims

Preferred Stocks
Preferred Dividend yield
Dividend payments are not strict obligation
No voting rights (usually); no dilution
Less risky for issuer than a bond
More risky for investors than a bond
Tax rebate for corporate investors but not for
issuers
Convertible into common
Perpetual or long term maturity

Warrants
Used as sweeteners by smaller firms to issue
debt
Call option to buy stocks at exercise price
Fresh stocks to be issued when exercised
Detachable and tradable
Almost never exercised before maturity but
sold

Close to maturity; excess dividends; step up prices

Warrants
Brings in funds when it is actually needed for
growing firms
Dilutes share price and EPS
Generates returns more than straight bond
but less than equity
Maturity less than debt
Non-callable

Warrants
Advantages:

Low coupon debt

New capital when needed

Disadvantages:

Potential dilution
Wait for capital untill maturity of warrants

Convertibles
Bonds or preferred stocks can be exchanged
for common stock
No new fund comes in when exercised
Conversion ratio and price
Prevention against dilution
Straight bond + conversion option
Call features embedded
Non-detachable; Floor values

Convertibles
Convergence of market value to conversion
value
Dividends Vs. coupons
Call feature

Generates returns more than straight bond

but less than equity
Conversion is sure at prices more than
conversion price and if called

Convertibles
Advantages to issuers:

Sell debt at lower coupons

Sell stocks at higher prices than current

Disadvantages:

If stock appreciation is significant, unnecessary

dilution
If stocks fell, debt ratios increases
Low coupon payment ends with conversion

Convertibles
Agency costs:

Information asymmetry for issuing debt

Information asymmetry for issuing equity