Question

14.

1. What is the difference between a secured and an unsecured loan?
2. Explain the term: Liabilities.
3. Differentiate between equity financing and debt financing.
4. What are junk bonds?
5. What is an IPO?
6. How are securities connected to the last Housing Bubble (it eventually burst in 2007)?

Answer 1

1. A secured loan is connected to a piece of collateral-something worthwhile like a car or a home. With a secured loan, if you don't repay the loan as agreed, the lender can take possession of the collateral. The most common types of secured loan are a car loan and mortgage. There is no collateral to protect an unsecured loan. If you default on the loan, the lender will not be able to take your property automatically. Credit cards, student loans, and personal loans are the most common types of unsecured loans. A loan secured tends to have lower interest rates as well. This means that a secured loan is usually a smarter money management decision vs. an unsecured loan, if you can qualify for one. And a secured loan will tend to offer higher borrowing limits, which will allow you to access more money.

2. In general, a liability is an obligation, or something you owe to someone else. Liabilities are characterized as the legal financial liabilities or obligations of a corporation that occur through business transactions. They may have limited liability or unlimited liability. Over time, liabilities are settled by transferring economic benefits including money, goods or services. Including loans, accounts payable, mortgages, deferred income, earned premiums, unearned premiums, and accrued expenses on the right side of the balance sheet.

3. Some businesses use a mix of debt and equity funding, but equity financing has some distinct advantages over debt financing. Key among them is that equity funding has no obligation to repay and provides extra working capital that can be used to grow a business. The main advantage of equity financing is that the capital gained through it is not expected to be repaid. Of course, holders of a business want it to be profitable and provide a decent return on their investment to equity investors, but without dividends or interest charges as is the case for debt financing. No additional financial pressure is imposed on the company by equity financing. Since there are no required monthly payments associated with equity financing, there is more capital available for the company to invest in the business growth. But that doesn't mean that equity funding is no drawback. Debt financing sometimes comes with restrictions on the activities of the company that might prevent it from exploiting opportunities outside the realm of its core business. Creditors look favorably on a relatively low debt-to-equity ratio that will benefit the company if additional debt funding has to be obtained in the future.

4. Securities with a high rating of credit are known as securities of investment grade. Default bonds are referred to as distressed or non-investment grade. Companies can issue low-grade bonds without long track records or with a questionable ability to fulfill their debt obligations. Since most brokers are not investing in these low-grade bonds, they are referred to as junk bonds. However, due to the very high interest rates typically offered by these bond issues, they are also referred to as high-yield bonds. Due to the high default risk of junk bonds, they are speculative. Default risk is the possibility that when the bonds mature, a company or government will not be able to pay its obligations. Defaults on bonds occur most frequently within the first few years of the issue of a bond.

5. An initial public offering (IPO) refers to the process of offering the public shares in a new stock issue of a private corporation. The issuance of public shares allows a company to raise capital from public investors. The move from a private company to a public company can be an important time for private investors to understand their investment gains entirely, as it usually provides stock discounts for current private investors. In the meantime, it also requires the involvement of public shareholders in the bid. Typically, a company planning an IPO will select an underwriter or subscriber. They will also choose an exchange where the shares will be issued and then publicly traded.

6. The 2008 financial crisis was caused by hedge funds by bringing too much uncertainty to the banking system. That's funny because hedging is used by investors to reduce risks. They use sophisticated investment strategies based on data. It enables their analysts to find out more about individual businesses than an average investor might have. They exploit any unfairly priced stocks and take advantage of them. This increases the fair value of share prices. Through reducing risk, hedge funds minimize the volatility of the stock market. Many hedge funds are investors that are very active. They buy enough shares for a vote on the board of the company. They have such an influence on the stock that the company can be forced to buy back stock and improve share prices. These can also make the company sell assets or companies that are low-producing, becoming more efficient and profitable.