The Costs of Issuing Securities

Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we will identify two types of securities: bonds and stocks. You'll learn the process for issuing each type and the costs incurred. We'll also discuss the Securities and Exchange Commission, the regulating agency for stocks and bonds.

What Is A Security?

This year Julissa, the owner of Bicycling Is Cool (BIC), won an award for being 'entrepreneur of the year' for creating the first self-driven bicycle. A major bicycle manufacturer contacted Julissa after hearing the news and asked if she could fulfill 1,000 orders within the next few years. Julissa responded with an excited 'Yes'!

She immediately called her accountant, Mr. Rangel, since she will need a large amount of capital to finance the order. Mr. Rangel informed Julissa that she could apply for a loan or sell securities. While Julissa was familiar with the process of securing a loan, she was new to selling securities. A security represents an intangible, tradeable asset such as a bond or a stock. Let's take a closer look at each security and their associated costs.

Bonds and the Cost of Issuance

A bond is an intangible document that a corporation or government agency sells to bring cash into the organization. Mr. Rangel asks Julissa to think of a bond as an IOU. The purchaser would loan BIC $1,000 by buying the bond; in return BIC would pay the purchaser periodic interest payments and repay the bond in full at a later date.

While the process sounds simple, there are many steps and costs associated with selling bonds. The first step is to find an investment firm to underwrite the bond. Underwriting includes setting the price of the bond, as well as its interest rate and repayment date.

Prior to the bond being sold, it must be registered with the Securities and Exchange Commission (SEC). The SEC requires BIC to submit financial statements and other documents to analyze the company's financial health. In addition to paying filing fees to the SEC, BIC must outsource the compiling of data and required reports since it does not possess the competency in-house to complete such a task.

Lastly, BIC will incur direct marketing costs to promote and sell the bonds. The investment firm doing the underwriting also offers these services by purchasing the bonds from BIC and reselling them to the public for a profit. Mr. Rangel suggests that BIC hire the investment firm for this process. It has more experience in this area and the costs to BIC are cheaper than BIC selling its bonds directly to the public. BIC still has the costs of making periodic interest payments and repaying of the bond to the investor.

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