Question

2 Stocks (Chp 15) (a) Why are the main differences between preferred stocks and common stocks? (b) Please write out the procedures, and state what you need to know in order to convert bonds into common stocks?

Answer 1

Answer 1

Common stock : They are generally the owners of the organisation that take part in governance and management of the company.
common stockholders receive higher returns in long term.
They are reported in equity section of the balance sheet.
During liquidation, the common stockholders are paid at last after payment of preferred stockholders, debenture holders, and debtors in full.

Preference shareholder: are the shareholder who has priority over distribution of dividend then the common stockholders.
They have features of both common stocks and bonds which is a plus point for preferred stock share holders.
At the time of liquidation, the claim over asset is higher of preferred shareholders.

Difference between preferred and common stock is as follows :

1. Voting right : common stockholders has voting right whereas preferred shareholders are deprived of voting rights.
2.Claims : In liquidation time the preference shareholder has greater right of claims over common stock.

3. Conversion : preference share capital can be converted into fixed number of common stock but common stock do not has this feature.

4. Dividend : Preferred shareholders recives fixed dividend where is common stock holders are paid only when organisation earns profit.

Answer 2.

Bonds are required to convert into common stock if the organisation provides the option of conversion in equity shares initially or after a certain period of time.

• It is beneficial for the bond holders to convert the bond into equity in following two conditions.
• If the total value of equity share exceeds bond value.

If the organisation is performing well and the return on equity is expected to be greater than bonds interest.

Procedure of conversion of bonds into equity.
1.The bond conversion should be done on the conversion ratio determined by the organisation for example 40 : 1 it means 40 equity shares for 1 bond.

There are various conversion options with bondholders

1. conversion of bonds into common stock at the end of the maturity.
2. conversion mandatory : The bonds are to be converted into common stock with compulsion in the particular ratio and at a particular price level.
3. Reversible conversion : In this category the bondholder are given right of conversion or to keep them as bond till maturity.