3. intro finance

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1.INTRODUCTION:

George Bernard Shaw wrote that 'lack of money is the root of all evil.' Lack of funding is the

number one reason given for the failure of so many small businesses. Success today hinges

not only on providing a quality and timely product or service, but also on knowing how tofinance the business. All businesses face critical periods that can lead to temporary cash flow

problems. These problems can be anticipated and overcome if the small business owner has a

good working knowledge of the available sources of financing.

It's easy to despair when we've struck out for capital at our local bank. Don't. There are many

alternative places to raise money: private, institutional, and government. Some sources may be

better suited to a particular need: inception, survival, growth, expansion, or maturity.

Finance for small business may be derived from four main sources: equity, debt, leasing, and

grants. Before we examine the more common sources of financing, it's important to clearlyunderstand the difference between debt and equity capital.

In its most common (mortgage) form, debt capital requires a periodic payment of interest and

capital reduction, or a lump sum balloon payment upon maturity. New enterprises, without

adequate cash flow, can often ill afford debt servicing that can also adversely affect the

balance sheet, and with it, hopes of raising additional finance. On the plus side, interest

payments are tax-deductible and equity is not surrendered.

Contrast the trade-off with equity capital financing, which requires an ownership percentage

to be given up, but without interest payments (debt service). However, raising equity capital

is not without emotional strain on the founder, particularly if the operation of the companybecomes subject to the whims of the new partners. Then again, large stockholder equity can

result in a good credit rating. Among the sources for equity capital, we can include:

Fools, family, friends (in cash, credit cards, goods, and equipment and services). Most small

businesses in America had their beginnings from this source --inception.

Employee ownership is broadening its base and can lead to increased productivity, pride,

and security. Employees can participate via stock purchases, stock in lieu of salary, and even

by providing personal equipment. Employees can also provide direct loans or loan

guarantees--inception, survival, expansion.

2. Objective of the Study:

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The main objective of the study

To know about stock and bond as capital resources.

To determine which is more effective as capital resources.

3. Methodologies:

In order to make the report more meaningful and presentable, secondary sources of data and

information have been used widely.

4. Limitation of the Report:

In all respect limitation and weakness remain within which we failed to escape by any means.

These are follows:

Limitation of time: It was one of the main constraints that hindered to cover all aspects of the

study.

Lack of Secondary data: Lack of secondary information source that was not enough to

complete this study.

5. LITERATURE REVIEW:

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5.1; Bonds:

Unlike stocks which represent firm ownership, bonds are long-term securities representing

debt. Debts are obligations to repay borrowed money. Debt repayments can be broken down

into two parts. The principal is the amount borrowed and must be repaid in conformity to the

terms of the bond. Interest is the amount paid over the principal and is usually expressed as apercentage to be repaid in compliance with the terms of the debt. When a firm fails to make

payments to the bondholder, the firm is said to be in default which often leads to bankruptcy.

Bonds usually carry maturities of 10 years or more which distinguishes them from notes which

carry maturities of from 1 to 10 years. Both bonds and notes are called fixed-income securities

because they pay specific, regular payments to their holders.

5.2; Bond Features:

Raising long-term funds may be relatively inexpensive for a company with a sound financialtrack record. The ability to sell bond loans relies upon the issuing company's credit rating.

Nationally Recognized Statistical Rating Organizations, NRSOs, including Moody's and

Standard & Poor's, evaluate the issuer's creditworthiness. Companies receiving an "A" credit or

better are considered investment quality issues. Investors have a high likelihood of receiving

timely interest payments and return of principal at the bond issue's maturity date, according to

Morgan Stanley Smith Barney. As senior securities of the company, bondholders receive

payments before stockholders in the event of bankruptcy.

Interest paid on bonds is also tax-deductible. Stock dividends must be paid out to investors with

after-tax money. A company may also prefer to sell bonds at historically low interest rate

levels.

5.3; Bond Considerations:

The bond issuer must pay coupon interest on bonds whether the company earns a profit or not.

Unlike stock dividends, interruption of scheduled interest payments is considered bond default.

Default impacts the company's ability to borrow money in the future. Additionally, the

principal amount of the bond issue must be repaid to bondholders when it matures. Some

companies issue secured bonds. The issuer may be able to get a lower financing rate byproviding issue collateral. However, bondholder approval may be required to sell the assets

securing the bond before maturity.

5.4; Stocks:

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Shares of stock represent equity or ownership in a corporation which carry with them certain

guarantees such as dividends, voting, liquidation, and preemptive rights. Common stock is

considered residual interest in a firm which means stock value is based on the value of a

corporation that is left over after superior obligations are met. Senior obligations can include

debt repayments, taxes due, etc. Common stock is the most prevalent security traded in Capital

Markets.

5.5; Stock Features:

A company decides to sell stock when it needs long-term access to capital. Unlike bond loans,

issuing stock to owners called stockholders doesn't require the company's repayment of

investor principal. The company may elect to distribute some of its earnings in the form of

dividends. Investors like to receive cash or stock dividend income, but the decision to pay

dividends is elective.

The issuer bears no long-term fixed costs to issue stock. Unlike bonds or commercial paper, the

company doesn't need to budget interest and principal repayment costs. Issuing common stock

also helps the company raise capital without any impact to the company's bond rating.

Common stock issuance helps raise the company's debt-to-equity ratio.

5.6; Stock Considerations:

Issuing stock through an investment bank may be more expensive than issuing bonds. For thatreason, companies may decide against issuing shares.

Investors may see the issuance of secondary stock offerings as a negative financial indicator.

Conversely, investors see a company's decision to buy back or repurchase shares as a bullish

(upward) indicator of future performance. A company may spend cash in many ways for the

benefit of shareholders. The company sees no better investment than its own shares in this

scenario.

6. REPORT PART:

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Given the poor performance of stocks over the past year and the past decade, there has been

ample discussion about the relative performance of stocks versus bonds. Some even argue that

investors should allocate entirely to bonds, not only because bonds are the safer investments,

but because they believe bonds will outperform stocks over the long run.

Table 1 shows the performance of the S&P 500 and Intermediate-Term and Long-TermGovernment Bonds over various time periods. Not only have the average annual stock returns

been poor over the last 10 years, but relative to bonds, stock returns look mediocre over the last

20, 30, and even 40 years.

Table 1: Compound Annualized Total Returns (%) Ending March 2009

Source: Ibbotson

By looking at the returns over the last 40 years, the argument that bonds might outperformstocks looks to be valid. But, one should view this with skepticism. First, note that over the 20-,

30-, and 40-year periods, stocks actually performed quite well, even if some bond categories

did better. Over the very long term, it is no longer a contest. Chart 1 gives the results of the

capital market returns over the last 83 years. During this longer period, stocks easily beat

bonds.

Chart 1: Ibbotson SBBI Chart: Stocks, Bonds, Bills and Inflation 1926-20081

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Source: Ibbotson

Table 2 looks at a longer history of U.S. stocks. The returns on the stock market have been

consistently high over almost two centuries. The returns over the last 40 years are roughly

comparable to the more distant returns.

Table 2: Annualized Compounded Total Returns %2

Long-term history provides two major insights:

Stocks have outperformed bonds.

Stock returns are far more volatile than bond returns, thus more risky. Given the

additional

Stocks vs. Bonds in the Future:

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To try to figure out the future, let us look in more detail at what happened during the last 40

years.

Chart 2: Historical Returns Decomposition Over the Past 40 Years (April 1969-March2009)

Source: Ibbotson

Despite the substantial decline in yields over the last 40 years, Chart 2 shows the bulk of the

bond returns come from the income return portion, or yield. On average, the bond income

return from coupon payments was more than 7%. Capital gains caused by the yield decline

made up the additional return.

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Today, yields are much lower. Table 3 presents the current bond yield information. As of the

end of the first quarter of 2009, the Long-Term Government Bond yield was 3.55% and the

Intermediate-Term Government Bond yield was only 1.68%. For bonds to continue to enjoy the

same amount of capital gains over the next 40 years, a rough estimation would put the yield

into negative territory, especially for Intermediate-Term Government Bonds. This is simply

impossible, because it implies that investors would be willing to lend their money to a borrower

and pay the borrower an interest rate. Over the last 40 years, bond investors have enjoyedabundant returns because of a high-yield environment followed by a steady decline in yields.

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Table 3: Bond Yield %

Source: Ibbotson

To analyze which asset class is more likely to outperform going forward, lets take a deeper

look at the historical data and the current market environment. We analyze each component of

returns going forward for stocks and bonds as follows:

Bond returns = current yield + capital gain

Stock return = current yield + earning growth + P/E changes

First, given the current low-yield environment, it would be almost impossible for bonds to

generate the same amount of capital gains as they did in the past. In fact, a reasonable estimate

might be that there will be no more capital gains going forward, since yields may be at least as

likely to rise as to fall3. If there were no future fall in yields, all of the return would have to

come from the coupon return. That means the total returns for bond investments would likely

be between 2 to 3%.

For stocks, the dividend yield in 2008 for the S&P 500 was 1.92%. If stocks produce more than

2% in capital gains per year on average, they will likely beat bonds. Stocks capital gains can be

decomposed into nominal earnings growth and changes in the P/E ratio4. Historically, U.S.long-term nominal earnings growth has been roughly 5%, which is comparable to the nominal

GDP growth. If we assume the market valuation level (operating P/E of S&P 500) stays at the

same level over the next 40 years, then we would have an equity return of around 7%. Even if

we forecasted a decline in the valuation level, the 10 year average P/E level would need to fall

from just about 20 to below five to get equity returns around 3%.

7. CONCLUSIONS:

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Bonds not only have outperformed stocks by a large margin over the past year because of the

financial crisis, but also roughly matched stocks over the past 40 years. This begs the question,

will bonds continue to outperform?

Upon closer examination, we show that stock returns over the last 40 years were virtually in

line with the long-term historical average. On the other hand, bond returns were not only muchhigher than their historical averages, but also higher than their current yields. This high bond

return is due to higher interest rates in the 1970s and a subsequent declining interest rate

environment. This scenario for bonds is very unlikely to repeat in the future, given todays low

interest rate environment. Investors hoping bonds will outperform in the coming years will

likely be disappointed.

Stocks tend to outperform bonds over time, but are much more risky, even over longer periods.

Bonds can outperform stocks over a long period, but investors need almost perfect timing to get

in and out of the market to realize such returns. We believe the right strategy is to follow a

disciplined asset allocation policy that considers the return and risk tradeoffs by takingadvantage of the diversification benefits between stocks and bonds over time. Here we can

bring to a close that for capital sources stock is more preferable than bond.

Bibliography

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Books

1. Richard B Chase, F Robert Jacobs, Production & Operation Management for Competitive

Advantage, Eleventh Edition.

Publications

1. www.sonalibank.com.bd

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