Introductory Concepts – Securities Regulation

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  • Purpose of Selling Securities
  • Securities are primarily sold to raise funds for investment, e.g. the launching of a business venture/ expanding existing venture (private company goes public ^becomes a reporting issuer)

o To purchase assets that will be used to produce goods/services for which there is a demand sufficient to generate profits comparable to that of other investment opportunities of similar risk.

  • Types of Securities

Two main types of securities

  • Debt: Funds can be borrowed, offering interest payments and principal repayment

o Includes trade credit (e.g. ST accounts payable), short-term bank loan (e.g. line of credit), long­term bank loan (e.g. with security interest – property and/or adherence to ratio tests that may indicate risk of bankruptcy), commercial paper (obligation to pay specified amount at specified date), bonds (evidence of indebtedness secured by an asset of borrower), debenture (unsecured evidence of indebtedness)

o Other characteristics of bonds/ debentures:

  • Call feature: allows borrower to repurchase bond after specified date for specified price (usually prem to face amount/ par value)
  • Sinking fund: indenture may provide for a fund built up each year to redeem some portion of bonds before maturity or to meet the obligations to pay at maturity
  • Convertible: right to convert bonds into shares
  • Warrant: right to buy securities from issuer for exercise/striking price during a specified period
  • Equity: rights to share in the distribution of the profits and the proceeds remaining after the sale of the assets of the business and payment of amounts borrowed.

o Common Shares: most frequent bundle of rights in a company that includes the following rights

  1. Right to vote (on important matters – e.g. election of directors, how company will be managed etc.)
  2. Right to dividends (not obligation – corp can decide to declare dividends to which each common share has a right a share in $ or in stocks where there is a stock dividend)
  • Liquidation right: entitled to share pro rata in any proceeds of liquidation (to the extent proceeds remain after satisfaction of other claims)

o Preferred Shares: given preference wrt distrib of dividends and proceeds of liquidation (usually non-voting). May carry the following special features:

  1. Cumulative: if div are not declared or are not suff to pay full amount of annual preferred div on preferred shares, amount unpaid carries over to the next year (usually preferred shares are cumulative)
  2. Participating: participate in div beyond the specified preferred amount (preferred amount + included in common share amount left over)
  • Redemption/Call provision: if shares are redeemable by the company (to facilitate financing of company at specified price)
  1. Retraction rights: permits shareholder to tender share to co and co has to buy it back at specified price

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