Econ – Oct 21
Reading: Chapter 7,8 and 9
Today: Methods of Corporate Financing, Production Theory, Cost Theory
Methods of Corporate Financing
1 Bonds (Debt Financing)
A bond is a legal claim against the corporation. It represents debt.
The return to a bond is the interest rate that must be paid whether the corporation makes
profits or not.
Bondholders are not owners of the corporation rather they are creditors. In general, they
have no say in the corporation’s operations.
Bonds usually have a maturity date at which time the bondholders are repaid the face
value of the bond.
2 – Stocks (Equity Financing)
A stock is also called a share.
It represents ownership in the corporation.
All corporations must issue stocks.
Stockholders have a right to a portion of the company’s profits, called dividends. (Size
of dividend determined by board of corporation)
They are not however, assured of a fixed rate of return on their stocks.
*From investor’s point of view, stocks are more risky than bonds, so you hope they will
pay a higher return.
Holders of common stock elect the company’s board of directors and thus have some say
in the company’s operations. Holders of preferred stock do no have a vote but get
preferential treatment in the payment of dividends. (Generally preferred stock costs more,
unless its really worth having to vote)
The Markets for Stocks and Bonds
1 – The Primary Market – When a company issues new stocks or new bonds, these stocks
and bonds are bought and sold in the primary market. (First transaction of the new
2 – Secondary Market – A secondary market is a market in which existing stocks and
bonds are bought and sold. (already existing stocks, companies want their stocks to stay
high, but they don’t make money off of the sales of secondary market)
How to read stock exchange: 1 column name, 2 column volume sold (rounded to
hundreds in Toronto, thousands in NY), 3 column highest price traded that day, 4 th
column lowest price thaded that day, 5 column close price that was trading when stock
exchange closed, 6 column change in closing price from day before
What influences the demand for a stock in the secondary market?
1. Company’s earnings and perceived future earnings
2. Rate of return on the ‘nearest’ safer investment – aka rate of interest on bonds
(either corporate or government) when bond rates go up, demand for stocks goes
3. Past performance of the stock
4. Performances of competing companies 5. Performance measures (ea