Any notion that corporations or government agencies always have access to enough financial resources to keep moving forward is simply misguided. The truth is a lot of companies and federal/state governments are always looking for loans online to allow for expansion. The question is, what can these types of entities do to raise cash when needed?
The answer is selling off ownership to or borrowing from the public. When they endeavor to take on either of these options, they will usually issue a monetary instrument that indicates the amount of ownership or debt they are issuing. If this monetary instrument is exchangeable as a means of trade or purchase, it is generally referred to as a “security of finance”.
Types of Securities of Finance (Ownership)
Securities in the ownership realm are referred to as stock. If someone owns a share of stock in a company, they in fact own a proportionate share in the company. If the company is a publicly traded company, its shares of stock are readily available for sale or purchase on a public stock exchange.
Some of the characteristics of stock include proportionate voting rights in some cases. Investors also have the potential of receiving dividends if the corporation’s board of directors deems that to be an appropriate action. If a company is doing well, investors can reasonably expect the stock price to rise. The opposite is true if the company is generally under-performing.
As a means of raising capital, corporations have the ability to sell additional shares of stock. While it might dilute the value of the shares held by current investors, it is a viable way to raise additional capital. To do this often requires a vote by existing shareholders.
Types of Securities of Finance (Debt)
On the debt side, both companies and government agencies have the ability to raise cash by borrowing from the public. If they choose this option, they can issue bonds, T-Bills Commercial Paper, or debenture debt.
If a corporation or government issues these types of securities, they are doing so with the promise to pay interest and the full amount of principle at some point in the future. For the most part, the only collateral the investor has to bank on is the good name of the corporation or the government agency.
To help assess the creditworthiness of these organizations, there are agencies that offer unbiased credit ratings. Based on these credit ratings, investors can reasonably determine how much risk they are taking by making said investment. If a rating agency like Moody’s determines that a particular corporation or government agency presents a high risk, said corporation or government agency will have to offer a discount on the sale of the security. This discount effectively raises the effective interest rate that will eventually be paid to the investor.
Many of these debt securities can be traded on a public exchange. The valuation of the security will be determined based on the supply and demand principle. If an investor holds a debt security in a company that carries more risk than it did at the time the security was originally sold to the public, the seller will likely have to sell the security at a lower price. The opposite is true if the company has improved its risk ratio in the interim.
At the time a debt security reaches maturity, the investor holding the security at that time will be paid the principle amount plus any interest due.
If a US corporation or government agency issues publicly traded stock or debt securities, they are accountable to the stakeholders through the US Securities Exchange Commission (SEC). The SEC is responsible for collecting financial data on any entity that’s trading on a public exchange.
The financial data usually includes audited financial statements and ownership information. Failure to provide timely information to the SEC without reasonable cause could result in de-listing of any related securities from the appropriate exchanges.
For astute investors, both the ownership and debt options can provided a solid “return on investment” (ROI). It’s incumbent on each investor to work closely with their investment agents to determine what kind of security investments will fit best in their overall investment portfolio.
Interesting related articles:
- “What are Shares?“
- “What are Bonds?”