Definition
Loan stock refers to shares of a company that have been borrowed as a form of debt financing. These shares pay a fixed interest to the investors (lenders) and must be repaid at a specified future date. Unlike regular shares, loan stockholders do not get any voting rights in the company.
Key Takeaways
- 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 is secured by the value of the specific stocks.
- It can also be a way for companies to raise capital; instead of borrowing from a bank, the company issues loan stocks to the public. Individuals who buy these stocks become lenders to the company.
- These debt securities are often tradable and can be bought and sold on the market. However, they carry a degree of risk if the underlying company becomes insolvent and cannot repay the loan.
Importance
Loan stock, a critical category of corporate financing, represents long-term loans that corporations borrow from investors.
The significance of loan stock comes from its inherent features such as the provision of a consistent interest rate to the investors, regardless of the corporation’s profit or loss, essentially establishing a secure investment source.
It also allows corporations to borrow funds without giving up equity, maintaining ownership control.
The lending period extends over several years, offering companies the benefit of time for repayment.
For these reasons, the concept of loan stock is important to both the company in terms of raising capital and preserving ownership as well as to the investors who receive a secured return Independently of the company’s performance.
Explanation
Loan stock serves a dual purpose in business finance. Primarily, it is a way for companies to raise capital without resorting to issuing more shares, potentially diluting existing share ownership.
By issuing loan stocks, companies can borrow directly from investors, with the promise to repay the loan amount (the principal) at a specified future date, along with regular interest payments throughout the term of the loan. This process empowers businesses not only to fund expansion or specific projects but also to manage their debt, capital structures and liquidity in a flexible manner.
On the other end, for investors, loan stock represents an opportunity to gain a fixed return on investment, typically higher than that offered by bank deposits or government bonds. It also presents a more secure investment compared to shares as the interest payment and principal repayment are obligatory, irrespective of the company’s performance or profitability.
Importantly, however, such securities do involve risk, as if the company fails to repay on time, the investor may lose their initial investment.
Examples of Loan Stock
Corporate Bonds: These are a type of loan stock traded in capital markets. Companies issue such bonds to finance their expansion, investments, and acquisitions. The investors buy such bonds and earn an interest until the maturity date, when the principal amount is repaid back. An example would be Tesla’s $
8 billion debt offering in 2017 to help fund its Model 3 production line.
Government Bonds / Treasury Bonds: Governments often issue bonds, which is technically a type of loan stock, to fund its expenses such as infrastructure projects or social programs. These bonds are considered safe investments as they are backed by the full faith and credit of the government. For instance, the U.S. government issues U.S. Treasury bonds to support federal spending.
Convertible Bonds: These types of loan stocks are unique in the fact they can be converted into a predetermined amount of the company’s equity at certain times during its life. Companies such as Salesforce.com and Bank of America have issued convertible bonds to generate funds while also offering potential future equity to attract investors.
FAQs about Loan Stock
What is Loan Stock?
Loan Stock is a type of fixed-interest security, a loan made by an investor to a company. The company then provides the investor with some rights and interest over a specified period. This acts as a form of debt investment where the investor is essentially the lender.
Is Loan Stock the same as a Bond?
Yes, Loan Stock is considered similar to bonds. Both are ways for companies to raise capital, but with Loan Stock, the company must pay back the principal amount of the loan in addition to the fixed interest.
What is the risk involved in Loan Stock?
The risk involved with Loan Stock is that if the company fails to pay back the loan, the investor may lose the invested amount. However, in the case of company’s liquidation, holders of Loan Stock are often considered priority creditors.
What is the return on Loan Stock?
The return on Loan Stock is usually fixed and is in the form of interest, also known as a coupon. The interest rate is usually higher than that offered by banks or other financial institutions.
Can Loan Stock be traded?
Yes, like other securities and shares, Loan Stock can be bought and sold on the open market. Prices can fluctuate depending on the company’s financial health and market conditions.
Related Entrepreneurship Terms
- Convertible Loan Stock: This refers to a type of loan where the lender has the option to convert the loan into ordinary shares in the borrowing company at a predetermined date.
- Debenture: This is a debt instrument issued by a company for a specific period of time, with the promise to pay back the principal along with a fixed rate of interest.
- Secured Loan Stock: This is a type of loan stock that is backed by the borrower’s assets. If the borrower defaults, the lender has the right to seize the assets to recover their investment.
- Bond: A bond is similar to loan stock in that it is a way for companies to borrow money. The investors who buy the bonds are essentially lending the company money.
- Coupon Rate: This is the annual interest rate paid on a bond or loan stock, expressed as a percentage of the face value.
Sources for More Information
- Investopedia: A comprehensive website offering a wealth of information on all aspects of finance and investing, including loan stock.
- Corporate Finance Institute (CFI): Provides online financial training and knowledge like loan stock.
- Moneyterms: An educational finance and investment website, including in-depth discussions of loan stock.
- Financial Times: Renowned resource offering news and analyses of finance markets, including loan stock.
