Introduction

Preferred stock is an equity security with properties of both equity and a debt instrument, and is generally considered a hybrid instrument. Preferred are senior to common stock, but subordinate to bonds in terms of claim-rights to their share of the assets of the company. Preferred stock usually carries no voting rights. May carry a dividend and May have priority over common stock in the payment of dividends and upon liquidation. Terms of the preferred stock are stated in a "Certificate of Designation". Preferred stocks are rated by the major credit-rating companies. The rating for preferred is generally lower, since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.

Why Do Companies Issue Preferred Stock?

There is no fixed charge that must be paid each year. There is no maturity. No dilution of control (unless convertible). The cost is less than the cost of common equity. Because the risk to the investor is less than that of common stockholders.

Features
Preferred stock is a special class of shares which may have any combination of features not Possessed by common stock. Preference in dividends-preferred have preference to dividends payments. A preference does not assure the payment of dividends, but the company must pay the stated dividend rate before paying dividends on common stock Preference in assets, in the event of liquidation Convertibility to common stock. Callability, at the option of the corporation Nonvoting

Preferred stock may be cumulative or noncumulative. A cumulative preferred requires that if a company fails to pay a dividend (or any amount) below the stated rate, it must make up for it at a later time. A stock without this feature is known as a noncumulative, or straight, preferred stock; any dividends passed are lost if not declared. Preferred stock may or may not have a fixed liquidation value. Preferred stock has a claim on liquidation proceeds of a stock corporation equal to its par (or liquidation) value. Almost all preferred shares have a negotiated, fixed-dividend amount. Some preferred shares have special voting rights to approve extraordinary events.

Types
In addition to straight preferred stock, there is diversity in the preferred stock market. Additional types of preferred stock include: Prior preferred stockMany companies have different issues of preferred stock outstanding at one time; one issue is usually designated highest-priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the payments on the prior preferred. Therefore, prior preferred have less credit risk than other preferred stocks (but usually offers a lower yield). Preference preferred stockRanked behind a company's prior preferred stock (on a seniority basis) are its preference preferred issues. These issues receive preference over all other classes of the company's preferred (except for prior preferred). If the company issues more than one issue of preference preferred, the issues are ranked by seniority. One issue is designated first preference; the next-senior issue is the second and so on. Convertible preferred stockThese are preferred issues which holders can exchange for a predetermined number of the company's common-stock shares. This exchange may occur at any time the investor chooses, regardless of the market price of the common stock. It is a one-way deal; one cannot convert the common stock back to preferred stock. Cumulative preferred stockIf the dividend is not paid, it will accumulate for future payment. Exchangeable preferred stock This type of preferred stock carries an embedded option to be exchanged for some other security. Participating preferred stock These preferred issues offer holders the opportunity to receive extra dividends if the company achieves predetermined financial goals. Investors who purchased these stocks receive their regular dividend regardless of company performance (assuming the company does well enough to make its annual dividend payments). If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend.

Perpetual preferred stock This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder (although there are redemption privileges held by the corporation); most preferred stock is issued without a redemption date. Put able preferred stock These issues have a "put" privilege, whereby the holder may (under certain conditions) force the issuer to redeem shares. Monthly income preferred stock A combination of preferred stock and subordinated debt Non-cumulative preferred stockDividends for this type of preferred stock will not accumulate if they are unpaid; very common in TRuPS and bank preferred stock, since under BIS rules preferred stock must be non-cumulative if it is to be included in Tier 1 capital.

Warrants
A warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is much higher than the stock price at time of issue. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. Frequently, these warrants are detachable, and can be sold independently of the bond or stock. Warrants are much like call options, but the money goes to the issuer, not an option writer, and it initially has a lifespan of many years. When the warrant is exercised the company issues new shares of stock, so the number of outstanding shares increases.

Features
Warrants are call options that give the holder the right, but not the obligation, to buy shares of common stock directly from a company at a fixed price for a given period of time. Warrants tend to have longer maturity periods than exchange traded options. Warrants are generally issued with privately placed bonds as an equity kicker. Warrants are also combined with new issues of common stock and preferred stock, given to investment bankers as compensation for underwriting services.

Types of Warrants
Traditional Traditional warrants are issued in conjunction with a Bond (known as a warrant-linked bond), and represent the right to acquire shares in the entity issuing the bond. Warrants are issued in this way as a 'sweetener' to make the bond issue more attractive, and to reduce the interest rate that must be offered in order to sell the bond issue.

Naked Naked warrants are issued without an accompanying bond, and like traditional warrants, are traded on the stock exchange. They are typically issued by banks and securities firms. These are also called covered warrants, and are settled for cash. Third Party Warrants Third-party warrant is a derivative issued by the holders of the underlying instrument. Government issued Also, when a government agency issues cheques which they are unable to pay (due to lack of money) but are redeemable some point in the future, usually with interest, these are also called warrants. Warrant Pricing and the Black-Scholes Model Warrants are worth a bit less than calls due to the dilution. To value a warrant, value an otherwise-identical call and multiply the call price by:

Where n = the original number of shares nw = the number of warrants Gain from exercising a warrant can be written as:

Convertible Bonds
A bond that can be converted into a predetermined amount of the company's equity at certain times during its life, usually at the discretion of the bondholder.

Types
There are many variations of the basic structure of a convertible bond. Vanilla convertible bonds are bonds which may be converted at the option of the owner into the shares of the issuer, usually at a pre-determined rate. They may or may not be redeemable by the issuer prior to the final maturity date, subject to certain share price performance conditions. Exchangeables (XB) are bonds which may be exchanged into shares other than those of the issuer. Strictly speaking, they are not convertibles, but they share certain common evaluation characteristics. Mandatory convertibles are short duration securitiesgenerally with yields higher than found on the underlying common shares that are mandatorily convertible upon maturity into a fixed number of common shares. Mandatory exchangeables are short duration securitiesgenerally with yields higher than found on the underlying common shares that are mandatorily exchangeable upon maturity into a fixed number of common shares. Contingent convertibles (co-co) only allow the investor to convert into stock if the price of the stock is a certain percentage above the conversion price. Etc. Value of Convertible Bonds
The value of a convertible bond has three components: 1. Straight bond value=SBV 2. Conversion value (CV): is the value if converted into common stock at the current price. 3. Option value: Value of a Convertible bond exceeds both SBV and CV. It is the value for waiting since the value in the future is greater.

Similarities between warrants and options: 1. Both are American call options on the equity of the firm. 2. Both are usually protected against stock dividends and stock splits. 3. Neither is protected against cash dividends. Differences between warrants and options: 1. Exercise period of a warrant is usually several years. 2. Warrants are issued by the firm. Options are issued by individuals.

3. When a warrant is exercised the firm receives the exercise price from the investor and the firm simultaneously issues new shares. 4. When a warrant is exercised, a firm must issue new shares of stock. 5. This can have the effect of diluting the claims of existing shareholders.

Reasons for Issuing Warrants and Convertibles

A reasonable place to start is to compare a hybrid like convertible debt to both straight debt and straight equity. Convertible debt carries a lower coupon rate than does otherwise-identical straight debt. Since convertible debt is originally issued with an out-of-the-money call option, one can argue that convertible debt allows the firm to sell equity at a higher price than is available at the time of issuance. However, the same argument can be used to say that it forces the firm to sell equity at a lower price than is available at the time of exercise.

Why are Warrants and Convertibles Issued

1. Convertible bonds reduce agency costs, by aligning the incentives of stockholders and bondholders. 2. Convertible bonds also allow young firms to delay expensive interest costs until they can afford them. 3. Support for these assertions is found in the fact that firms that issue convertible bonds are different from other firms: The bond ratings of firms using convertibles are lower. Convertibles tend to be used by smaller firms with high growth rates and more financial leverage. Convertibles are usually subordinated and unsecured.

Intangible Asset
An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. Enterprises frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licenses, intellectual property, market knowledge and trademarks.

Examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights. Market and technical knowledge may give rise to future economic benefits. controls those benefits. An enterprise

The future economic benefits flowing from an intangible asset may include revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the enterprise. Features of Intangible Assets 1. without Physical Substance For Future Economic Benefits Under the Control of Entity Should Have Identifiable Cost Not physical in nature Specific identification and recognizable description Legal existence and legal protection Subject to private ownership and transferability Tangible evidence or manifestation of the intangible asset An identifiable birth date Subject to termination

Types of Intangible Assets

The most important types of intangible assets are: Brands Publishing rights Intellectual property Licenses Brands Brands enable consumers to identify products or services which promise specific benefits. They arouse expectations in the minds of customers about quality, price, purpose, and performance. A brand stands out from commodities because commodities lack identity. (J. Hugh Davidson, Effective Marketing).

Publishing Rights These are rights for commercially exploiting creative and knowledge based materials. From a legal point of view, the principal publishing rights are copyrights (books, articles, photographs, illustrations, and so on), trademarks (titles of magazines, books, and so on), and get-ups (formats, appearance, and so on). Intellectual Property Intellectual property usually covers patents, trademarks, registered designs, and copyrights. The owner of an intellectual property is legally protected against its unauthorised use. License A license is an agreement through which a licensor assigns certain rights to a licensee in return for a consideration. Financial Management in Intangible Intensive Companies The primary drivers of wealth in todays economy are intangible assets. Superior returns and dominant competitive position can be achieved only through a judicious use of intangible assets along with other assets. The dramatic rise in the importance and value of intangibles can be traced to fundamental changes in the structure and scope of business enterprises. The heightened competition in the wake of globalization, deregulation and technological changes is forcing companies to depend on continual innovation of products and services to survive and grow. The proportion in which tangible and intangible assets are employed, tend to vary widely across firms. Firms in sectors such as information technology, biotechnology, pharmaceuticals, and fast moving consumer goods seem to be more intangible intensive companies whereas firms in sectors such as oil, automobiles, and steel are more tangible asset intensive.

Characteristics of intangible intensive firms:

1. Intangibles are non rival in nature-they can be deployed simultaneously in multiple uses. 2. Intangibles have hazy property rights as imitations are made by competitors. 3. Inherently very risky-riskiness of intangibles is substantially higher than that of physical and financial assets. 4. Do not have organized and competitive markets. 5. A very large portion of the value of an intangible intensive firm is accounted for by the future growth value. 6. Empirical evidence indicates that investors systematically misprice the shares of intangible intensive companies.

7. Returns on R&D are substantially higher than the returns on physical assets and above the risk adjusted cost of capital. 8. Managers often fly blind when they invest in intangibles. 9. An intangible intensive company depends heavily on the vision, ideas, drive, technical capabilities, and business acumen of its key executives, particularly in its formative stages.

Implications for financial management

1. an i-I business is a high risk high return proposition. The rewards for success are enormous and the penalties for failure are severe. 2. the hazy property rights associated with most intangible assets poses a considerable challenge. Exploiting the potential of A MACHINE IS FAIRLY MANAGEABLE PROPOSITION but using fully the knowledge, expertise and talent of employees and patents, trademarks, and copyrights owned by the company is far more challenging. 3. Since a very large portion of the value of intangible intensive companies reflects future growth expectations, managers of such a business must constantly strive to convert the potential value into actual value and invest judiciously to replenish and enhance intangible assets. 4. Such a company has to rely primarily on equity financing due to the following reasons: The business risk of such a firm is high. Lenders are typically averse tp grant loans against intangible assets. These firms have valuable growth options. I-I firms should rely on retained earnings as equity financing may not be feasible or desirable. 5. Investor has difficulty in figuring out the real worth of an intangible intensive company, meaningful investor communication is particularly important for such a firm. It should communicate its value firm-the fundamental economic process of innovation. 6. In order to ensure the sustained commitment of its key executives in its formative stage, the firm may have to offer them substantial equity in the company.

Approaches to Valuing Intangible Assets There are three broad approaches to valuing an intangible asset: approach

Cost Approach The Cost Approach is based on the premise that a willing buyer would pay
no more for an intangible asset than the cost to produce such asset. Alternatively, when considering market conditions and the time value of money, it may be more prudent to purchase the asset as is, if in the long run the cost to develop it yourself proves higher than the purchase price. The Cost Approach typically involves two types of cost, reproduction cost and replacement cost. Reproduction cost refers to the cost to actually reproduce an exact replica of the intangible asset, without considering changes over time that may affect the cost (e.g., increased efficiency through the use of computers). On the other hand, replacement cost involves examination of what it would take to build the asset using current knowledge and technology. Once the cost to either reproduce or replace the intangible asset has been determined, we must consider the effects of depreciation and obsolescence.

Market Approach According to the market approach, the value of an intangible asset may
be established with reference to the prices at which comparable assets have been traded recently in the market place. The market approach is theoretically appealing because it is objective, credible, and relevant. However, there are practical problems in using the market approach. First, the activity in the market for intangible assets is rather limited. Second, intangible assets tend to be highly unique, making comparison rather difficult. Income Approach The most relied upon approach in valuing intangible assets is the Income Approach. Here, we determine intangible asset value by examining the future or expected income our intangible asset will generate. There are two main types of income approaches, the yield capitalization approach and direct capitalization approach. Both are loosely premised on four steps: (1) the determination of an appropriate income measure, (2) the estimation of a time period, (3) the projection of the income, and (4) the appropriate determination of a capitalization rate.

THE ECONOMIC APPROACH TO VALUATION

Several methodologies are used to value an intangible asset on the basis of economic value. These methodologies involve two broad steps: 1. Estimate the cash flow/ earnings. 2. Capitalize the cash flows/ earnings.

Estimate the Cash Flow / Earnings The cash flows/ earnings associated with an intangible asset may be estimated in the following ways: identification method

Direct Identification Method If the only significant asset of the business is the intangible asset, it is possible to readily identify the cash flows/ earnings associated with the intangible asset. Examples of this are the earnings/ cash flows generated by a library of film, music, or copyrights. Brand Contribution Method The brand contribution represents the profit or cash flow generated by an intangible asset which is in excess of the profit generated by the underlying business. There are four methods commonly used for estimating the brand contribution: utility cost method, return on capital method, premium profits method, and retail premium method. Royalty Method Under the royalty method, you ask the question: What is the estimated post tax royalty (after deducting the costs associated with maintaining the licensing arrangements) that can be earned from the intangible asset under a hypothetical licensing arrangement? To answer this question, you have to get a handle over: (i) the turnover that the intangible asset is expected to generate, (ii) the royalty rate, and (iii) the cost of maintaining the licensing arrangement. Capitalise the Cash Flows / Earnings Once the cash flows / earnings associated with an intangible asset have been estimated, the next step is to convert them into a capital value. The two commonly used methods of doing this are:

Discounted Cash Flow Method According to the discounted cash flow method, the value of an intangible asset is equal to the present value of the net cash flows expected to be generated by the asset. The discount rate used for calculating the present value is the weighted average cost of capital, reflecting the business and financial risks associated with the investment. Earnings Multiple Method According to the earnings multiple method, the value of an intangible asset is estimated by multiplying the earnings attributable to that intangible asset by a suitable earnings multiple (PE ratio). The earnings multiple method is commonly used in valuation exercises. A business firm may be valued by looking at the PE (price-earnings) ratio for comparable companies and applying it to the earnings of the firm to be valued. The scope for applying the earnings multiple method to intangible assets may be somewhat limited because there are very few transactions involving the sale of intangible assets separated from the underlying business.