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2. Introduction
Due to globalization and liberalization of Indian economy, tremendous changes have taken place
in the Indian financial system. These changes occurred due to reform measures taken by the
Government of India. Some of the reform measures are- free pricing of equity shares, entry of
FIIs and private sector financial institutions, deregulation of lending rates, option of Indian
companies to tap foreign capital markets directly, opening up of banking and insurance industries
to the private sectors etc. All these measures has encouraged Indian capital markets to source the
growing needs of long term finance requirements of companies both in private and public sectors.
In capital markets, various financial instruments are used to raise capital resources such as
common stock, preferred stocks and debentures.

3. Common Stock
Common stock is a type of security that represents equity ownership in a corporation. The holders
of common stock receive voting rights in the general meetings of the company. They also elect
board of directors and formulate policies of the company. They get dividend only after the
dividend on all preferred stock are paid in full. At the time of liquidation, common stock holders
receive any remaining funds only after all bondholders, creditors and preferred stockholders have
been paid. Since common stockholders bear higher risk, they also get a chance to accrue higher
dividends, if the earnings of the company are higher.

3.1 Characteristics of Common Stock

The following are the characteristics of the common stock:

1. Being the owners of the company, common stockholders have the right to control and
manage the affairs of the company. However, their control is indirect. They have the right
to elect the board of directors and also to vote in the general meetings of the company.
2. The holders of the common stock also receive preemptive rights from the company. This
means that they can purchase additional shares (right issue) on the pro rata basis of their
current holdings. These preemptive rights can be renounced or forfeited by them
completely or partially. This right save the existing shareholders from the reduction in the
ownership as a result of the new equity issues.
3. The liability of the common stockholders is limited to the extent of the amount of their
original investment in the company.
4. At the time of winding up or liquidation, common stockholders have residual claims on
the assets of the company. They are the last to claim any remaining funds after the claims
of the creditors and preference shareholders have been settled or satisfied. In case of
insufficient liquidation value of the assets, claims of common stockholders would remain
unpaid.
5. Common stockholders receive residual income or profit of the company after all the
outstanding claims are satisfied. However, the decision regarding actual amount of cash
dividend is taken by the board of directors. They decide what percentage of profit should
be distributed as dividend and what percentage is retained by the company.

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6. All common stockholders carry right to vote on certain

matters in the general meetings of the company such as
electing the board of directors, merger & acquisitions, stock splits, changes in the
company capitalization etc.

3.2 Advantages of Common Stock

1. Common stocks are the permanent resources of the company without any liability of
repayment.

2. Common stocks do not create any obligation on the company to pay fixed rate of dividend.

3. Common stocks do not impose any charge on the assets of the company.

4. Common stocks provide liquidity to the investors as these are transferable.

5. Common stockholders maintain the control and share ownership rights in the income of the
company with their limited liability.

3.3 Disadvantages of Common Stock

1. Common stocks are not liked by the cautious investors as they are risky.

2. As the control of the management is left in the hands of common stockholders, there are
chances that the affairs of the company get manipulated.

3. Sometimes market value of the equity shares get increases due to higher dividends, this
results in speculative trading.

4. Overdose of common stock in the capital structure of the company may lead to over
capitalization.

5. The control of existing shareholders may get diluted because of sale of new shares to
outsiders.

4. Debentures
Debentures are creditorship securities issued by the company to raise medium and long term
funds from the public. Debenture holders are the creditors of the company to which company
pays interest at fixed rate and the principal amount at the stipulated time. They have no voting
rights. As per the terms of issue of the debentures, debentureholders are entitled to redeem their
debentures.

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4.1 Characteristics of Debentures

1. Debenture has a fixed rate of interest, the payment of which is compulsorily irrespective
of the profit earned. The interest on debentures is tax deductible and is payable
semiannually/quarterly/annually.
2. Debentures are generally secured against the present and future immovable assets of the
company.
3. Debentureholders have no voting rights in the company general meetings of the
shareholders. They do not dilute the control of the existing shareholders.
4. A company has to create Debenture Redemption Reserve for the redemption of
debentures whose maturity exceeds 18 months. The debenture redemption reserve should
be equivalent to 50% of the issue/redemption amount before the redemption of
debentures commences.
5. A company can repay the amount of the debentures to the debentureholders after the
specified period. The debentures can be redeemed either by DRR (sinking fund) or the
call & put (buy-back) provision.
6. Under call/put (buy- back) provision, a company can redeem its debentures before
maturity period at a specified price. The call price may be higher than the par/face value,
generally by 5%, the difference being the call premium. The put option gives the
debentureholders a right to seek redemption at predetermined prices at the specified time.
7. Debentureholders are the creditors of the company not the owners. When a company sold
its debentures to the investors, then it appoints a trustee through an indenture/trust deed.
Trust deed is an agreement between the trustee (a FI/bank, insurance company/firm of
attorneys) and the issuing company. In trust deed, description of debentures, rights of
issuing company, rights of debenturholders, responsibilities of trustees etc. are specified.
8. A debentureholder can converts its debentured into equity shares. The ratio of conversion
and the period during which conversion can be affected are mentioned at the time of issue
of debentures.
9. All the debentures of the borrowing company must be compulsorily rated by the one or
more recognized credit rating agencies.

4.2 Types of Debentures

There are different kinds of debentures depending upon the conditions of their issue:

1. On the basis of Security

a. Secured or Mortgage Debentures- These debentures are secured by a mortgage

on the assets of the company. These are also known as mortgage debentures.
These debentures provide the debentureholders a right to recover their unpaid
amount of interest and principal amount out of the assets secured by the
company.
b. Unsecured or Naked Debentures- These debentures do not carry any security on
the assets of the company.

2. On the basis of Record

a. Registered Debentures- These debentures are registered with the company. The
interest and principal amount of such debentures are payable only to those person
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whose name appears in the debenture ledger of

the company. Such debentures are transferable
through transfer deed.
b. Bearer Debentures- These debentures are not recorded in the company registers
and transferable by mere delivery. The principal amount and the interest is
payable to the holders of the bearer debentures.

3. On the basis of Redemption

a. Redeemable Debentures- These debentures are issued for a specified period. The
principal amount of such debentures is payable at par or premium on the expiry
of such period. The redemption of such debentures can be done by annual
drawings or by purchasing from the open market.
b. Non- Redeemable Debentures- These debentures are not redeemed during the life
time of the company. Such debentures are payable only when the company goes
into liquidation or when the company decides to redeem.

4. On the basis of Convertibility

a. Convertible Debentures- These debentures can be converted into equity or

preference shares of the company on the expiry of the predetermined period. At
the time of the debenture issue, all the conditions and terms of conversion are
announced.
b. Non- Convertible Debentures- These debentures cannot be converted into shares
of the company.

5. On the basis of Priority

a. First Mortgage Debentures- These debenture are redeemed in priority to other

debentures.
b. Second Mortgage Debentures- These debentures are redeemed after the
redemption of first mortgage debentures.

4.3 Advantages of Debentures

1. Debentures are attractive to those investors who prefer safety of the principal and a
regular fixed income.
2. Debentures do not carry any voting rights thus they do not dilute the control of the
existing shareholders.
3. Debentures help the company to trade on equity and thus increasing the return for the
shareholders.
4. Debentures offer financial flexibility as a company can redeem its debentures whenever it
has surplus funds.
5. As interest paid on debentures is tax deductible, thus the company gets the tax benefit by
issuing debentures.
6. Debentures is a cheaper source of finance as compared to bank loan and public deposits.

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4.4 Disadvantages of Debentures

1. A company is requires to pay interest every year irrespective of the profits earned
therefore it is more risky.
2. Debentureholders like secured debentures as they prefer safety of their investment.
Therefore, those companies who are not willing to give its assets as security may find it
difficult to raise funds through issue of debentures.
3. Banks and other financial institutions do not provide funds to those companies whose
capital structure is heavily loaded with debentures.

5. Preferred Stock
Preferred stock is a hybrid instrument that includes the features of both an equity and a debt
instrument. It is also called preference shares, preferred shares or preferreds. Like a bond,
preference stock pays fixed periodic (dividend) payment and like a common stock, it is generally
listed on a stock exchange. Preferred stock is senior to common stock but subordinate to bond, as
a claimant to the income/assets.

This stock has the following rights:

1. A preferential right to receive a fixed rate of dividend for the entire duration of the
company.
2. A preferential right to be repaid capital in case of liquidation of the company.

5.1 Characteristics of Preference Stock

The important Characteristics of preferred stock are as follows:

1. Preferred stock has preference over common stock in the payment of dividend. It means
that company must pay the preference dividend in full before the payment of dividends
on common stock. When the company goes into liquidation, the preferred stockholders
must be paid off before the holders of common stock. Thus, preference stock is less risky
than a common stock.
2. Preferred stock dividends are fixed and stated as a % of par value. These are also known
as fixed income security.
3. If the company is not able to pay dividends on its preference stock, then all unpaid
dividends are carried forward and paid before any dividend is paid to common stock
holders.
4. Preferred stock may be converted into a predetermined number of shared of the
of purchase,
conversion rate is set at a rate that is not attractive to the investors. However, if there is an
increase in the price of the common stock, investors then convert it to common stock and
realize an immediate gain by selling it.
5. Preferred stock may be participating that allow the holders a chance to participate in
additional earnings of the company, if any, left after the equity and preferred dividends
have been paid. They may also allow to participate in the residual assets in case the
company goes into liquidation.

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6. Preferred stocks have no voting rights. An exception to

this rule may exist if the preference dividend is in
arrears for a considerable period of time.

5.2Types of Preferred Stock

The main types of preferred stock are as follows:

1. Cumulative Preference Stocks The cumulative preference stockholders are entitled to

receive arrears of dividend in subsequent years in case the company is unable to declare
dividend in any year. Furthermore, they will be paid first before paying any dividend to
common stockholders.
2. Non-Cumulative Preference Stocks- Non cumulative stockholders are not entitled to
receive any arrears of dividend, if the dividend is not paid in any year.
3. Participating Stocks Participating stocks provide the holders an opportunity to receive
additional dividends if the company achieves its predetermined financial objectives such
as earnings or profitability goals. Those investors who invest in participating stocks
receive regular dividend irrespective of the company performance and also receive an
extra dividend on the achievement of predetermined goals. These holders also get an
opportunity to share in surplus asset in case of winding up of the company.
4. Non- Participating Stocks- The holders of non- participating stocks are not allowed to
receive additional benefits.
5. Redeemable Preference Stocks- Redeemable preference stocks enjoy the right to be
redeemed or repaid on or after a certain date according to the terms of their issue.
6. Irredeemable Preference Stocks- These stocks cannot be redeemed or repaid during the
life time of the company.
7. Convertible Preference Stocks- These stocks gives the holders a right to convert their
shares into common shares after a specified date or period according to the terms of the
issue. After the conversion of preferred stock into common stock, the change is
irreversible and the holder cannot convert the common stock back to preferred stock.
8. Non- Convertible Preference Stock- These stocks do not provide any right of
conversion to the holders.

5.3Advantages of Preferred Stock

1. Preference stock are liked by those investors who favour safety of investment and fixed
rate of return.
2. Preference stock carries restricted voting rights thus there is hardly any chance of dilution
in control over the company.
3. As the dividend on the preference stocks is fixed, they do not impose massive burden on
the company.
4. The company is able to raise long term funds through issue of preference stock without
offering its assets as security.
5. Preference shareholders enjoy stable fixed rate of dividend.

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5.4 Disadvantages of Preferred Stock

1. Raising of funds through preference shares is expensive as dividend paid on preference

shares is not tax deductible.

2. The creditworthiness of the company may be adversely affected due to the existence of
preference stock.

3. The flexibility of the company may get restricted due to issue of preference stock.

4. There is dilution in the rights of the equity shareholders over the assets of the company
because of issue of preference shares.

6. Summary
Common stock is a type of security that represents equity ownership in a corporation.
Common stockholders have the right to control and manage the affairs of the company.
However, their control is indirect.
Debentures are creditorship securities issued by the company to raise medium and long
term funds from the public.
Debentures are classified on the basis of redemption, record, convertibility, redemption
and priority.
Preferred stock is a hybrid instrument that includes the features of both an equity and a
debt instrument. It is also called preference shares, preferred shares or preferreds.
There are different types of preference stocks such as cumulative, non-cumulative,
participating, non-participating, redeemable, non-redemable, convertible and non-
convertible.

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