Definition
Loan stock refers to shares of common or preferred stock that are used as collateral to secure a loan from another party. The loan that the stock secures often carries a higher interest rate above the dividend issued on the underlying stock. This form of borrowing is a type of secured debt and it is often used by corporations for short-term financing needs.
Phonetic
The phonetic pronunciation of “Loan Stock” is: /loʊn stɒk/
Key Takeaways
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- Loan Stock refers to shares of common or preferred stock that are used as collateral to secure a loan from another party. The loan earns a fixed interest rate, much like a standard loan, and can be secured or unsecured.
- A unique feature of Loan Stock is its traded feature. Unlike traditional loans, Loan Stocks can be bought and sold between various parties. Although the borrowing party initiates the agreement, they can transfer the debt obligation to another party by selling the stock. The purchasing party then assumes the obligation to repay the debt.
- Finally, Loan Stock is a helpful resource for companies that need to raise capital but do not want to apply for a loan or issue bonds. It can provide a flexible financing option because it can be packaged and sold on a more incremental basis as opposed to a standard loan.
“`The above HTML code produces the following output when rendered in a web browser:1. Loan Stock refers to shares of common or preferred stock that are used as collateral to secure a loan from another party. The loan earns a fixed interest rate, much like a standard loan, and can be secured or unsecured.2. A unique feature of Loan Stock is its traded feature. Unlike traditional loans, Loan Stocks can be bought and sold between various parties. Although the borrowing party initiates the agreement, they can transfer the debt obligation to another party by selling the stock. The purchasing party then assumes the obligation to repay the debt.3. Finally, Loan Stock is a helpful resource for companies that need to raise capital but do not want to apply for a loan or issue bonds. It can provide a flexible financing option because it can be packaged and sold on a more incremental basis as opposed to a standard loan.
Importance
Loan stock is an important business/finance term as it represents a vital method of raising capital for corporations. These are long-term loans that a company can take from individuals who are not shareholders, providing the company with more capital to invest in business activities. Loan stock is important because it involves a formal agreement where the company promises to repay the lenders, usually with a fixed interest rate. This creates a secure investment for the lender, making it an attractive offer for potential investors. Consequently, it provides companies with the potential to invest and grow without diluting their ownership or control which they might have to compromise if raising funds through selling equity. Therefore, understanding loan stocks helps in strategic decision-making towards a company’s capital structure and overall financial management.
Explanation
Loan Stock is a vital financial investment instrument used by corporations when they require an external financing source. Essentially, loan stock serves as a form of debt capital that corporations can leverage to raise the necessary funding for various objectives, including business expansion, product development, research and innovation, and more. This form of raising capital is often preferred when the company does not want to issue additional shares that could dilute existing shareholders’ equity, thereby enabling the company to maintain and control their existing ownership structure.Loan stock is beneficial not only for corporations but also for investors. For investors, purchasing a company’s loan stock allows them to become lenders to the company, earning interest over the loan period. These investors earn profits via the regular interest payments set at a fixed rate that are made by the company, offering a predictable return on investment. This makes investment in loan stocks appealing to investors who prefer fixed, regular income streams. At the end of the loan period, the principal amount is returned, completing the transaction.
Examples
1. General Motors Company Loan Stock: In 2009, during the financial crisis, General Motors issued loan stock to the U.S. Treasury as part of its bailout deal. The U.S. Treasury essentially provided a loan to GM, which GM could repay either in cash or by issuing shares of its common stock. This loan stock was essentially a form of debt financing that was convertible into equity.2. Microsoft Corporation’s 2020 Corporate Bond Issue: Microsoft Corporation, despite having a large cash reserve, issued loan stocks worth $5.75 billion in 2020. The bonds were a form of long-term debt that Microsoft would pay back to the investors over a period of time. They did this to take advantage of the low-interest rates at the time and finance their ongoing operations and expansions.3. Tesla Inc.’s Convertible Bond Issue: In 2014, electric carmaker Tesla Inc. issued convertible bonds (a type of loan stock) worth $2 billion. Investors who bought these bonds were lending money to Tesla, and they had the option to convert this debt into equity if Tesla’s stock reached a certain price. This allowed Tesla to raise the funds it needed to expand its operations and build new factories.
Frequently Asked Questions(FAQ)
What is Loan Stock?
Loan Stock refers to shares of common or preferred stock that is used as collateral to secure a loan from another party.
Who can issue a Loan Stock?
Both public and private companies can issue a loan stock, usually as a way of raising capital.
What is the risk associated with Loan Stock?
The primary risk associated with loan stock is default. If the company can’t pay back the loan, investors could potentially lose their entire investment.
Is Loan Stock considered as debt or equity?
Loan Stock is considered as debt. Even though it involves issuing shares, it falls under debt because the company is obliged to pay back the amount borrowed.
Does Loan Stock provide dividends to investors?
Yes, just like ordinary shares, loan stocks also provide dividends, but it’s subject to the company’s profitability and dividend policy.
What are the interest rates on Loan Stocks?
Interest rates on Loan Stocks, also known as coupon rates, vary depending on the issuing company’s credit rating, market conditions, and the term of the loan.
Are Loan Stocks transferable?
Yes, loan stocks are usually transferable and can be bought or sold in the secondary market unless specified otherwise.
When is the repayment for Loan Stocks due?
The repayment for Loan Stocks, also known as the maturity or redemption date, is generally fixed and specified at the time of issuance.
What happens if a company defaults on a Loan Stock?
In the event of default, the loan stockholders have the right to claim assets of the company to recover their investment, although they stand behind bondholders in the repayment hierarchy.
How are Loan Stocks different from Bonds?
Although similar, the key difference lies in the collateral. Bonds are unsecured and often backed by the general credit of the company whereas loan stocks are secured against specific company assets.
Related Finance Terms
- Convertible Loan Stock: These are loan stocks that the holder can convert into ordinary shares at a pre-agreed price
- Secured Loan Stock: This type of loans are backed up by an asset or collateral, decreasing the risk for the lender
- Unsecured Loan Stock: This type of loans is not backed up by any asset or collateral, increasing the risk for the lender
- Floating Rate Loan Stock: This refers to loan stocks that have a variable interest rate
- Redeemable Loan Stock: These are loan stocks where the company undertakes to buy them back at a future date
