The main purpose of the assignment is to analyze the difference between common stocks, bonds and preferred stocks on the basis of ownership status, risk-return factor, voting rights, maturity period, nature of funding, etc. Bonds represents debts and gives the investors limited rights whereas stocks represent ownership in a company. The person who invests in common stock belongs to common stockholders group having voting rights and residual claim to income. The owners of the preferred stock enjoy limited rights only when dividends are missed. Five basic principles of finance are also required to be analyzed with relevant examples. Various facts related to Australian Bond Market like type of bonds traded in the Australian secondary market, differences between Australian government bonds and Australian corporate bonds, the relationship between coupon rate and YTM, etc. are also examined. This report contain the facts about the Australian Share market such as oldest share index in Australia, how it is measured and what does it measures, etc. Risk analysis and project evaluation also forms the part of this assignment.
Financial product and basic principle
1.1 Comparison of three key financial products common stocks, bonds and preferred stocks from the perspective of an investor
Ownership status: Bonds represents debts and gives the investors limited rights whereas stocks represent ownership in a company. The person who invests in common stock belongs to common stockholders group having voting rights and residual claim to income. The owners of the preferred stock enjoy limited rights only when dividends are missed.
Nature of funding: Long term investments are generally funded with the help of bonds and these are issued by government institutions, financial institutions and corporations. Both common and preferred stock is issued by companies in a centralized market.
Risks: Bonds are subject to lowest risks as the investor will earn the interest amount, no matter whether the company is making profits or not. Common stock, on the other hand, is subject to highest risk as the holders of common stock are not guaranteed for payment and preferred stock carries moderate risk and paid before common stockholders.
Income: As the bonds offer lowest risks, it generally provides moderate returns in the form of interest. Shareholders having preferred stock will earn moderate returns and receive dividends before the owners of the common stock and common stock provides highest returns but don’t have any guarantee of payment.
Voting right: The holders of common stock have voting rights in the meetings of shareholders whereas those having preferred stock do not always receive voting rights (Barocas 2018). Bondholders do not have any voting rights.
Maturity: The time of maturity, in case of bonds, is fixed at the starting stage or at the time of purchase whereas the maturity period of stocks depends only on the investors till what time they want to be invested in the company.
Priority in liquidation: Bondholders are paid first irrespective of the profitability of the firm as they are creditors of the company then preferred stockholders are paid-off before common stockholders.
Example: In 1919, Coca-Cola made its first IPO at the rate of $40 per share. The one who purchased one share of Coca-Cola at that time would now hold 9216 shares. The shares of Coca-Cola are listed on New York Stock Exchange (NYSE). As of 30 September 2019, the numbers of outstanding shares were 4.321 billion, market previous close of $57.68, and market open price of $57.65 (Market watch 2020). The total value of holding comes at $169475 million. The number of institutional holders is 2190 and the amount of total shares held is 2,930,570,313 (Nasdaq 2020).
1.2 Analysis of five basic principles of finance
Following are the five basic principles of the finance are as follows
Cash flow is what matters – increment cash received, not accounting profits, drives value.
Money has the time value – a dollar received today is more valuable to the recipient that a dollar received in the future.
Risk requires a reward – the greater the risk of an investment, the higher will be the investor’s required rate of return, and, other things remaining the same, the lower will be the investment’s value .
Market prices are generally right – An efficient market is one where the prices of the assets in traded in the market that is fully reflected on the information availed at the instant time.
Conflict of interest cause agency problems - Agency problems might end since the parting of the organization and proprietorship of the business. Organization might turn in their finest concern opposing to the attention of proprietorship.
For example – in the year 2019, the investment in the share of the CannTrust allowed the investor to face the high risk but the Rewards were similar to risk availed by them (Stock News 2020). The stock soared to above $10 per share. After the fallout, the stock was crashed to $0.75. However, the stock has shown stability and is now trading over $1 per share. The company was handed a delisting warning by the New York Stock Exchange (NYSE), to be listed in the NYSE the rules are clearly stated that the common share of the company has to be at least $1 US dollar per share over the 30 consecutive days.
2.1 Fact finding of the Australian Bond market
1) Listed or exchange traded bonds are traded in a liquid secondary market such as Australian Securities Exchange (ASX). Investors are not required to hold the securities till the time of their maturity (ASX 2020).
Australian bonds can be classified on the basis of nature of interest and type of issuer. The following are the types of bonds on the basis of nature of interest that are traded:
Fixed rate bonds: The interest on this type of bond is paid at a fixed rate throughout the life of the bond. They carry high credit quality and interest rate risk.
Floating rate bonds: Interest payments are made on the basis of the current interest rate in the market. Coupon rate is generally stated as a fixed margin over and above the benchmark rate.
Indexed bonds: The adjustments are made in the bond’s face value for the movements in a particular index such as CPI (Australia) or any other index. The payment of interest on these bonds is made on their adjusted face value.
On the basis of the type of issuer:
Government bonds: These are the fixed rate bonds issued in series. Coupon rate and maturity date of each series is different. Some of them have a maturity period of less than one year while others may have maturity period of more than 15 years.
Corporate bonds: They are quite similar to the government bonds except in this, finance is raised for the corporate business activities. Degree of risk is higher but they can offer higher returns than government bonds.
2) There are the agencies which provide the credit rating service in Australia, namely, Standard & Poor, Moody, Fitch, DBRS. The outlook of the Australia’s bonds is stable, thus marked with AAA rating (Trading economics 2020).
3) Key differences between Australian Government Bonds and Australian Corporate Bonds are as follows:
Australian Corporate Bonds are riskier than Australian Government Bonds.
The bond market for Australian Government Bonds is larger than the Australian Corporate Bonds.
Government bonds are generally fixed rate or indexed to rise in prices. On the other hand, corporate bonds can be floating, fixed or inflation associated bonds.
The maturity period of corporate bonds is between 3-7 years whereas the tenure of government bonds may go out to 30 years.
The returns offered on corporate bonds is usually higher then offered on government bonds (Money smart 2020).
4) The total anticipated return that is expected to be earned if the bold is hold by the investor until maturity is known the Yield to Maturity. The relationship between YTM and coupon rate helps in determining whether the bond will set at discount, premium or at par.
If coupon rate of bond is higher than YTM then bond sells at a premium.
If coupon rate of bond is lower than YTM then bond sells at a discount.
If they are equal then bond sells at par.
5) The value of a bond is affected by the change in interest rates. This type of risk is termed as interest rate risk. The price of the bond decreases with the rise in interest rates and vice versa.
Bond price = ∑CN/ (1+YTM)N + P/(1+i)N
2.2 Fact finding of Australian Share market
1) The name of the listed stock market in Australia is Sydney Stock Exchange. It has been granted market license by ASIC (Australian Securities & Investments Commission). It helps in raising the finance required for expansion and modernization by the companies which are growth oriented (SSE 2020). It develops markets in various sectors like Oil & gas, mining, real estate, etc. It ensures effective listing facilities to corporations and efficient trading facilities to traders, brokers and investors for buying and selling of securities. 2185 stocks are listed on the Australian market at present.
2) The approximate market value of the listed entity is regarded as market capitalization. It is calculated by multiplying the number of ordinary securities by the last traded price of the securities of previous trading day (ASX 2020).
3) The oldest share index in Australia is All Ordinaries Index. It is considered as the benchmark stock market index for Australian corporations. It is maintained by ASX. It measures the performance of top 500 companies that are listed on ASX.
It = It-1 x AMVt/AMVt-1,
Here, It = All Ordinaries Index at time t, It-1 = All Ordinaries Index at time (t-1), AMVt = Aggregate Market Value at time t, AMVt-1 = Aggregate Market Value at time (t-1).
4) (ASX 2020)
(5) Rising trend
3.1 Sensitivity analysis
3.2 NPV Break Even analysis
According to the calculation stated above, the company must sell at least 32,000 unoit with the 10% decrease in the price to achieve the break-even analysis. The sensitivity analysis of the company measures the uncertainty in the output of a mathematical model or the system that can be divided and allocated to the different sources of the uncertainty in its inputs. A related practices is uncertainty analysis, which has a greater focus on the qualification and should be showed in the calculation. The company on the current basis is earning more than the option given for the value to be changed in the drivers for the company.
ASX. 2020. Bonds. [Online]. Available at: https://www.asx.com.au/products/bonds.htm [Accessed on: 25 January 2020].
ASX. 2020. Charting. [Online]. Available at: https://www.asx.com.au/prices/charting/index.html?code=XAO&compareCode=&chartType=line&priceMovingAverage1=&priceMovingAverage2=&
volumeMovingAverage=&timeframe= [Accessed on: 27 January 2020].
ASX. 2020. Market capitalization and number of ordinary securities published on asx.com.au. [Online]. Available at: https://www.asx.com.au/prices/methodology-for-market-cap.htm [Accessed on: 27 January 2020].
Barocas, B.J. 2018. The Corporate Practice of Gerrymandering the Voting Rights of Common Stockholders and the Case for Measured Reform. U. Pa. L. Rev., 167, p.497.
Market Watch. 2020. Coca-Cola Company. [Online]. Available at: https://www.marketwatch.com/investing/stock/ko [Accessed on: 25 January 2020].
Money smart. 2020. Corporate bonds. [Online]. Available at: https://www.moneysmart.gov.au/investing/investments-paying-interest/bonds/corporate-bonds [Accessed on: 25 January 2020].
Nasdaq. 2020. Coca-Cola Company (The) Common Stock. [Online]. Available at: https://www.nasdaq.com/market-activity/stocks/ko/institutional-holdings [Accessed on: 25 January 2020].
SSE. 2020. Sydney Stock Exchange. [Online]. Available at: https://sseinitiative.org/fact-sheet/ssx/ [Accessed on: 27 January 2020].
Trading economics. 2020. Australia- Credit Rating. [Online]. Available at: https://tradingeconomics.com/australia/rating [Accessed on: 25 January 2020].
Stock News, 2020. CannTrust: A High Risk/Reward Investment https://stocknews.com/news/ctst-canntrust-a-high-risk-reward-investment/
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