Essay Sample: Appraising the Effects of Different Classes of Securities

Securities are a group of financial instruments that can be converted into cash by a company (Kidwell et al., 2016). They are used by companies to source finances or acquire certain assets for the company. Securities are exchanged and are dealt with through a securities exchange. These securities have a significant impact on the contents of financial statements as they are directly involved in the business financing of the company. The most common classes of securities are common stock, preferred stock, debentures, and derivatives (Brigham et al., 2016). In this study, the effects of these classes of assets on the contents of financial statements are appraised.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Order now

Common Stock

Also referred to as equity shares. These securities are regarded as the primary sources of finance for a company. They are sold or traded through a securities exchange market, for example, the New York Stock Exchange. Equity shares allow someone to own part or become a member of a company when he or she purchases them. Before people are allowed to buy a company's shares, the company has to be listed on the stock market after meeting all the requirements of a publicly listed company. The first shares of the company are acquired through an Initial Public Offer (IPO) which allows owners of those shares to become the first members or shareholders of the company (Lazonick, 2017). The company raises finances by selling shares, and the holder of the stocks acquires the controlling interest in the company. The holder of the equity shares has a right to profits of the company and is entitled to vote during annual general meetings of the company.

Consequently, these equity shares have a direct effect on the financial statements. An increase in the value of equity shares means there will be an increase in the value of the firm. The firm will use the money from selling the stocks to acquire more assets and increase the level of investments thus leading to an increased value of the company (Damodaran, 2016). Also, when the equity shareholders increase the company, is at risk to share its profits to shareholders in the form of dividends. Therefore, this is likely to reduce the amount of retained earnings which may generally impact the value of the firm. Moreover, the market for equity stocks is highly volatile. Thus the performance of a company's stock may entirely affect the performance of the business since it is required to indicate the attractiveness of the business through the book balances in the financial statements.

Preference Stock

Preference shares are regarded as a hybrid source of income to the company. They are also acquired through the securities exchange and are used to increase the financing of the company. The holders of preference shares have a fixed claim on the income of the company whether there is profit or not; the company has to pay preference dividends (Watson, 2015). Just like equity shares, preference shares are effective on the value of the firm, where an increase will increase the financial position of the company while a decrease lowers the financial position of the company.

Bonds

These are fixed-income securities that have a fixed maturity date until when the company is required to compensate all the bondholders the total liabilities owed to them. The liabilities are in the form of the bond amount plus the interest on the bond. The bonds are used as an alternative source of finance to the company. Bonds have an impact on the financial statements as it increases the value of the firm in the statement of financial position (Nimtrakoon, 2015). When a company lists a bond, it means, the value of the long-term liabilities will increase thus increasing the value of equity in the statement of financial position. Also, the bonds affect the financial cost of the company in the income statement. An increase in the value of bonds means the firm has to pay more financial costs in the form of interest on the bond which reduced the income of the company. Therefore, bonds have a double effect on the contents of financial reports as they affect the profitability of the company as well as the net worth of the company. When the value of the bond is higher than the value of equity, the company will be regarded as highly geared, and this may affect the investor's decision on the company.

Derivatives

Derivatives are securities that are valued from other securities of a company. Options, forwards, swaps, and futures contracts are the most common types of derivative securities. Derivatives have an impact on the interest rates and exchange rates of a company's transactions (Ikpefan, 2016). Also, they operate on a volatile business environment thereby increasing risk on the business. Therefore, derivative securities affect the return on equity of the company.

Conclusively, classes of securities affect the content of financial reports. Equity shares, preferred stocks, and bonds affect the value of the firm and impact on the structure of the firm. Also, bonds affect profitability by increasing the financial costs of the company - furthermore, the impact of the derivative on the return on equity of the company.

References

Brigham, E. F., Ehrhardt, M. C., Nason, R. R., & Gessaroli, J. (2016). Financial Managment: Theory And Practice, Canadian Edition. Nelson Education.

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Ikpefan, O. A. (2016). Derivatives/Finance for Non Finance Managers/Global Treasury Management.

Kidwell, D. S., Blackwell, D. W., Sias, R. W., & Whidbee, D. A. (2016). Financial institutions, markets, and money. John Wiley & Sons.

Lazonick, W. (2017). The functions of the stock market and the fallacies of shareholder value.

Nimtrakoon, S. (2015). The relationship between intellectual capital, firms' market value and financial performance: Empirical evidence from the ASEAN. Journal of Intellectual Capital, 16(3), 587-618.

Watson, L. (2015). What's the deal with preference shares?: investment insights. Personal Finance Newsletter, 2015(414), 8-9.