Video Transcript: Stocks and Bonds

Okay, welcome back. In this video, we're going to discuss stocks versus bonds.  Okay, again, we're going to analyze firm ABC's balance sheet. Okay, so you'll  notice that the the bonds will equal debt, right? Those are debt instruments that  we use to fund our company's operations. Right, so we will sell our bonds into  the open market, and this will guarantee a fixed payment of some coupon rate.  Right, so 10% coupon, you know, they'll get paid 10% on the bond annually or  semi-annually, however that is constructed. And so, so a bond is a debt  obligation that we have to repay with interest over time, right? And a fixed, in a  fixed rate, okay, where stocks equal our equity. So, so the relative stock value is  going to be, or the nominal stock value is going to be relative to the  shareholders' equity on the balance sheet, right? So we'll discuss that moving  moving forward, right? So assets can be anything comprised of you know capital assets as far as plant, property, equipment, cash, receivables, right? Anything  that has to do with ownership, right? That we own, and that is our value of our  assets. Right, anything that we own that comprises of the company is known as  an asset. Okay, again, liabilities, anything that we have to pay out-a bank loan,  revolving line of credit, or we issue some bonds. So, so liabilities are payment  obligations on our assets, right? So, so in order to get shareholder equity, which  is the remaining value of your assets after you subtract out your liability. So, in  this case, in this case, we have $4 million in shareholder equity left over after we subtract out our liabilities from our assets. This is a pretty decent position to be  in. You know, you're at a 60% debt-to-equity ratio. You know, so so that's pretty  strong. You're not too overly leveraged here. So I think this company has got a  lot going on, going in the right direction, right? So now we have $4 million in  owners' equity. Okay, so now how are we going to distribute that back into  shareholders, right? So now we have we have this is supposed to say 1 million  shares of stock. It says 10, but it's supposed to say one. But so we have 1  million shares of stock that we are going to issue or that are issued in the market that is in the market available for trade, buy and sell. So we have 1 million  shares outstanding, and we have $4 million in equity remaining after we subtract out our liabilities from our assets. So let's discuss shareholder equity. Okay,  shareholder equity is equal to a firm's total assets minus its total liabilities and is  one of the most common financial metrics employed by analysts to determine  the financial health of a company. So the balance sheet is used very. It's very  common, right? It's it's used often to determine the health of a company, right?  It's a snapshot in time of how at any point in time of how a company is  performing then and there, okay. Shareholders' equity represents the net value  of a company or the amount that would be returned to shareholders if all the  company's assets were liquidated or sold off, and all of its debts repaid. Right.  So assets being liquidated means we are selling off all of our assets in order to  pay down debt, right? So shareholders' equity equals total assets minus total  liabilities. Remember, it represents the net value of a company, right? So the 

assets is the total value, whereas shareholders' equity is the net value after you  subtract out total liabilities. Assume company ABC's balance sheet shows 1.6  million in retained earnings held in cash, 4 million in stocks, and 4.4 million  equipment and other fixed assets. Right, so that gives us our 10 million dollars  in total assets. That's the balance sheet: 10 million dollars in total assets. Okay,  it also shows the following debts or expenses to be paid: $6 million in total  liabilities, and this is you know in corporate bonds. Let's just say, for instance,  this is in corporate bonds to keep it simple. These were just simple examples of  different types of liabilities, but for this example, we're going to say our $6 million is issued all in corporate bonds. Okay, so according to the balance sheet, ABC  has 10 million in total assets and 6 million in total liabilities. After subtracting the  liabilities from the assets, ABC shareholders' equity. Is $4 million right? So now  we can easily calculate the price per share, right? As we discussed in the earlier video, you will take 4000 $4 million in shareholder equity, and you'll divide that  by the 1 million shares. That will give us a $4 per share price. Okay, so so pretty  easy calculation to find our share price using the balance sheet, right? But  remember that the $4 per share price is the book value, not the market value.  So we're using the $4 share price as a benchmark as to whether we should buy  or sell or not buy the security, right, or the equity, or the stock of this company,  right? From the investor's perspective, you can you can determine if a  company's equity or shares of stock are undervalued, overvalued by comparing  the market price or the market value of the firm, right, which is the actual price  per share traded in the market, and you can compare that to the company's  owner's equity, which will be flowed through, and the stock price to the 1 million  shares. So you can compare those and determine if the company is overvalued  or undervalued. Now let's look at bonds. Okay, company ABC has total liabilities  in the form of corporate bonds totaling $6 million $6 million in corporate debt  equals 6000 bond certificates at a $1,000 face value price. Right, so we'll have  the $1,000 face value price. So we can purchase those certificates in the open  market for $1,000 Okay, but but we can see that this is a zero coupon bond. So  so so, in order to benefit the company, they did not issue a coupon payment,  which is a coupon payment is a fixed payment over the life of the bond, right  until maturity, that'll be paid out on a annual, semiannual, or quarterly basis,  depending on how the company structures the bonds for sale. So, because  there's no coupon payment throughout the life of the bond, the the this is known  as a zero coupon bond, right? So the company of the ABC company will not pay interest on the bonds until maturity, so it's backloaded, right? So this is a  backloaded bond certificate. Okay, so so so our firm. This is advantageous for  our firm because obviously, let's say that these are five-year bonds, right? And in this five-year period, we are really wanting to grow our company, but instead of  having to pay out a coupon payment every quarter, every six months, or every  year, we can retain that coupon payment over the five years, and we can 

reinvest that back into our operation. Right, so that's the advantages of having a  zero coupon bond. Right, but hopefully our progress and our growth will go as  planned, and so we'll have an excess or marginal retained earnings, right?  Greater, greater than we would have, right? So hopefully we'll have a marginal  retained earnings from the non-issuance of the coupons, right? So that way,  when we're ready to backload pay them or pay them at the end of the maturity  when the bond comes to full maturity, we can then we will then have to pay the  coupon payment out and hopefully we're positioned well enough and have a  strong enough free cash flow basis that we can make the coupon payment. We  don't want to default, right? Either way, that coupon payment is going to be  made and shareholder equity, right, will not be dispersed out in the form of  dividends if we cannot pay off our coupon because debt has got to be paid down first, regardless before any equity is distributed. Okay, so like I said earlier, a  coupon payment is a regular payment of interest on a bond, right? And it's fixed,  and you'll have a rate, and it'll be paid. Typically, bonds are paid as regular  bonds, and the coupon payment is paid out, you know, accordingly. You know,  annual, semiannual, quarterly. However, right? But in this case, we want. I  wanted to kind of throw in the language of a zero coupon bond, so that you may  become a little more familiar with that terminology. So let's look at company  ABC, and let's say they go bankrupt. Right? Who will bear the burden of a  bankruptcy restructure first? Or will it be the the debt holders, or or will it be the  shareholders? Right? Who will bear the burden of the bankruptcy, right? So let's  say our assets are going to be liquidated, and we will have our assets valued at  a discounted basis from $10 million to $8 million right? So we notice we still  have $6 million in liabilities, right? So as we look at this, you'll be able to see that our assets have decreased, right? Because of the liquidation, right? They're  going to be sold at a discount to market value. So, but liabilities remain the  same. Okay. So, so notice even though we are filing bankruptcy, right, and we're going to be restructured. Liabilities, more than likely, right, and a liquidation of a  company, liabilities will not change, right. So the liquidation, the sale, unless  debt will have to be restructured, if assets as a revalued group of assets is  discounted down. If it's let's say that the assets were discounted down from 10  million to 5 million, right? So now our assets are less than our liabilities. Now the liabilities will have to restructure and proportionate to the liability structure, right? So if so, if it's you know let's say it's a line of credit and let's say it's a bank loan  and and then let's say you know you've issued some other kind of short-term  payables, right? Those those liabilities or obligations will be valued down to the  amount of the discounted asset value if the discounted value of the assets is  less than the liabilities. But in this case, for simplicity reasons, let's say that the  10 million gets discounted down to eight. Therefore, liabilities will not have to  restructure, right? So now you'll see that in our previous example, right, our  equity, our shareholder equity was at $4 million and this is before the 

bankruptcy, right? So now we are going through a bankruptcy, a liquidation, and  now our value on our assets have been discounted to 8 million, right? But but  we have enough cash still to pay down our liabilities. So liabilities will be paid  down first. Our debt obligations have to be paid down first by law, right? So, so  your shareholders, right, or the individuals or entities that have the claim on the  equity through ownership, right, of stock shares, right, they will see their equity  or their value be cut down, right, to 2 million because now, if you look, you have  the 8 million in assets minus the 6 million in liabilities. Liabilities don't have to be  restructured because we have enough cash or we have enough value in our  assets to pay down liabilities, right? So now our equity will take the hit, right? So here you can see that we had the 4 million in equity, right? But here now, after  we subtract out six from the eight, now when we have 2 million in equity, right?  So as the liquidation process goes through, right, we take a hit in the equity. So  obviously, the shareholders to answer the question will take the hit or bear the  burden on the restructure because liabilities will always be paid down first. So  now, back to shareholders. Instead of $4 million being distributed out to  shareholders, now they will only be distributed out 2 million, and their holdings  have then been cut in half.