COURSES OF STUDY IN CORPORATION FIMNCE AND INVESTMENT i aft "^"S^*^ t^'?*' L*^ INVESTMENT BANKERS MSOOIATOT OF AMERICA Hate QloUcgg of Agriculture 3ooo $6,500,000 LIABILITIES Common Stock ^$3,000,000 Preferred Stock 1,000,000 Mortgage Bonds 5% '■ ■ 1,000,000 Bills and accounts payable 250,000 Surplus 1,250,000 $6,500,000 [5] THE INCOME ACCOUNT OF A MANUFACTURING CONCERN IN ITS ECONOMIC ASPECTS $3,500,000 1,250,000 Goods billed Cost of material Maintenance, taxes and other current costs of production Labor Cost, other than cost of capital $2,750,000 Net . . . . 750,000 Interest and Dis- count . 125,000 Available for Div- idends $ 625,000 250,000 1,250,000 The wealth produced. The working (circulating) capital, the raw material increasing in value through the application of labor with the use of capital. The share of labor in the product. The share of the product. capital FINANCE IN RELATION TO: Working (circulating) of Commercial Banking. Capital — is the field Fixed Capital — is the field of Corporation Fi- nance and the subject of this course. Question i. The directors of a cotton mill corporation want to borrow $200,000, to buy bales of cotton. Would you consider that such financing came under the head of Corporation Finance as this syllabus has indicated the subject? Question 2. The directors of the same cor- poration want to erect an addition to the plant that will cost $250,000. Would the provid- [6] ing of funds for this purpose properly form one of the considerations of this course ? Question 3. From what sources could the cor- poration procure the funds called for by ques- tion 2? Question 4. How would the transaction be represented in each case in the Balance Sheet ? [7] TOPIC II Capitalization and the Investment Contract The term "Investment Contract" is used to indicate the terms under which an investor commits his funds to an enterprise. The rights and obligations created, whether represented by a share of stock, a bond or other security, constitute the Investment Contract. Lyon I, 1-49. Chamberlain, 72-99. Mead, 44-59. Risk, Income, Control, as incidents of the Investment Contract. Lyon I, 4-14. The Proprietor. Lyon I, 50-53. The Creditor: Unsecured. Secured. The Investment Contract as to the size of the commitment (denomination of the security). [8] Corporate securities as meeting the financial ability of the capitalist (investor). Lyon I, lo. The representative or fungible quality of corporate securities, i. e., one share or obliga- tion of a given issue just like another, facilitat- ing market transactions. Emery, "Speculation on the Stock and Produce Exchanges of the United States," pp. 38, 39. 74- THE INVESTMENT CONTRACT OF THE STOCKHOLDER Common stock. Lyon I, 12. Lough, 70. Preferred stock: Cumulative. Non-cumulative. As to Assets. Special agreements. Gerstenherg, 54-110. Lyon I & II, 15. Ripley, 95-100. Lough, 71-82. Participating stock. Lyon I, 18. Convertible stock. Lyon I, 20. [9] Redeemable stock. Lyon I, 25. Some special stipulations of the Investment Contract of Stockholders. Non-voting. Lyon I, 28. Vetoing. Lyon I, 23-24. Conditional voting. Lyon I, 28. Cumulative voting. Lough, 95-99. THE INVESTMENT CONTRACT OF THE CREDITOR The unsecured creditor: Notes (Financial notes to be distinguished from commercial paper in that they are issued to finance rela- tively fixed capital). Lyon I, 184, bottom. Chamberlain, 75. Ripley, 164-170. Lough, 131-141. Debentures. Lyon I, 36-38. Ripley, 141. Lough, 149-154. Equal security clause. Lyon II, 218. [ID] The unsecured creditor, Lyon I, 74. Mortgage bonds. Lyon I, 36. Income bonds. Lyon I, 39. Chamberlain, 7S~7^- Ripley, 139. Lough, 154-158. Convertible bonds. Lyon I, 43. Ripley, 115. Gerstenberg, 324-335 (reprint of special cir- cular). Lough, 158-160. Redeemable bonds. Lyon I, 181. Question i. How nearly like a bond can a share of stock be made? Indicate all the provisions you would put in a stock certi- ficate to make it as nearly like a bond as possible. Question 2. A corporation is capitalized and has earnings as follows: $2,cxx),ooo Common stock. ^1,000,000 6% non-cumulative preferred stock. Earnings available for dividends, $80,000. What criticism of the Investment Contract would you make from the standpoint of the preferred stockholder? Question 3. A corporation is capitalized and has earnings as follows: Common stock .... $i,cxx),ocx) Preferred, 6% cumulative . 1,000,000 Debenture bonds, 5% . . 1,000,000 Net earnings 210,000 Assume that the present investment in the property amounts to $3,000,000. The direc- tors are now proposing to increase the investment in the enterprise by selling at par $3,000,000 of six per cent, bonds secured by a mortgage on all the property of the company. Assume that the corporation will earn at the same rate on the additional as on the existing investment. What effect will the new bond issue have on the common and preferred stock and on the debentures? (Work this out specifically to show the result in figures.) Assume that subsequently the corporation cannot earn more than four per cent, on the total investment. What is the result on all classes of securities? What would the result have been if the new bonds had not been issued ? [12] TOPIC III Capitalization and the Investment Contract The Investment Contract of a Mortgage FORM OF ORDINARY REAL ESTATE MORTGAGE Gerstenberg, 176. It is impossible to get any knowledge of Cor- poration Finance without a clear understand- ing of the nature of a mortgage and the rela- tionships of the parties to it. The compiler of this syllabus knows from experience that many, even most, young men just beginning in business (and some older men) do not have any precise knowledge of the rights and liabilities involved in a mortgage. It is not desirable that the layman studying finance should seek the kind of an understanding of the field that the lawyer needs, but he must know the boun- dary points that determine the outline of the field. More than any other Investment Con- tract, the mortgage has influenced the develop- ment of methods of Corporation Finance. The corporate mortgage is only a development from the fundamental mortgage principles, and a study of a simple mortgage of a single piece of M13] real estate by an individual mortgagor to an individual mortgagee is the quickest way to get at the heart of the subject of corporate mortgage, mortgage bonds, the rights of bond- holders, etc. A mortgage is a conveyance (sometimes only a pledge) of the title to property to secure the repayment of a debt. The borrower re- tains possession of the property so long as he fulfils his obligation, and on completing his obligation he gets the title back. If the bor- rower fails to meet his obligations the lender may have the property sold to satisfy his claim. The Debt — usually evidenced by: Note or Bond. (Difference between note and bond. Bond an instrument under seal.) Effect of seal. The corporate seal as a seal to create a "sealed instrument" and as a means of authenticating the corporate signature. Secured by Mortgage: Mortgagor — the borrower. Mortgagee — the lender. Mortgaged or pledged property. Title. Possession. Covenants of the mortgagor (what the borrower agrees to do.) [i4l Defaults (Failure of the mortgagor to keep his agreements). Remedies of the mortgagee. Release of the mortgage. Transfer of the debt: (The lender sells the note or bond to another who now becomes the credi- tor of the mortgagee.) Assignment of the mortgage: (The lender selling the note or bond transfers the mortgage claim against the property to the buyer of the note or bond.) The mortgagor wants to sell the property: (Sale may be free from the mortgage in which event the mortgagor must pay the debt.) Sale subject to the mortgage: If purchaser does not assume the mort- gage, the property remains liable, but the purchaser does not become per- sonally liable. If purchaser assumes the mortgage he becomes the prin- cipal debtor, and the seller remains liable as guarantor, unless released by the mortgagee. Foreclosure and sale. Deficiency judgment, [IS] THE CORPORATE MORTGAGE To trustee for benefit of bondholders- Nature of a "trust." Trustee holds legal right but bondl;ioIders the beneficial interest. Why to a trustee: Otherwise would have to make each person lending funds one of the mortgagees with difficulties of transferring the security. Question i. A mortgages his house to B to secure a debt of $10,000. A fails to pay the debt and B forecloses. On the foreclosure sale the house is sold for $11,000. Who gets the extra $1,000? Question 2. Assume that on the foreclosure sale the house sold for only $9,000. What are B's rights? Question 3. A sells the house to C who takes it subject to, and assumes, the mortgage. A does not, however, get a release from B. C fails to pay the mortgage. On foreclosure the house sells for $8,000. C has only $1,000 of assets. What are B's rights? [i6[ TOPIC IV The Basis or True Income Return of Bonds Chamberlain, 403-415, 426-429. The matter of the basis or so-called true in- come return on bonds often puzzles the beginner. It is well for him to become familiar early with the general principles involved so that he may readily grasp the ordinary discussions of the subject of finance which assume a knowledge of these concepts. An instructor might well convey in a lecture all the information re- quired for this early preliminary consideration of the subject. DISCOUNT BOND A bond is an obligation carrying interest. It may, however, be sold at a discount. Chamberlain, 407. We have, therefore, in arriving at the real amount paid or received for the use of money in the case of a bond sold at less than par, a combination of the principles of interest and discount, as: [17] $1000. s% loyear bond at 95. Principal loaned, $gs°- Annual return received from coupons, $50. This (t. e., $50 return on $950) is equivalent to an interest rate of 5-26% Amount returned to lender at end of 10 years ^1000.00 But amount loaned 950.00 Amount of discount for the lo-year period 50.00 A correct calculation of the annual value of this would show it equi- valent to a per annum return of approximately iWr of i per cent. .37% 5-63% It is not necessary for the student to go into the mathematical principles of what is vari- ously termed net yield, net return, or true in- come return, comprising the annual value of interest and compound discount, involved in this computation until he gets into the course in Investments. PREMIUM BOND A bond may also be sold at a premium. Chamberlain, 409. $1000. 5% bond, running for 10 years at the price of 105 . Principal loaned $1050.00 Annual return received from coupons 50-00 This would be a per cent, of . . . 4-762 But amount returned to lender at end of ten years is 1000.00 [18] This is less than the principal loaned by . 50.00 This amount of principal has been paid back to the lender in the period. A correct mathematical calculation of the value of this shows that it is equivalent to an annual per cent, of approximately iWir of I % . .387 Which is the computed annual amount compounded at the basis rate of 4.37s required to amortize the premium leaving a net return of approximately ... . 4-37S THE USE OF THE BASIS BOOKS Chamberlain, 426-429. Question: Determine from a basis book the approximate yield of the following bonds : RATE OF INTEREST RS TO RUN PER CENT PRICl 25 5 9S 20 3i 8S 12 4J 98 IS 6 loS 18 3 103 40 4 9S 5 S 97 3 4l lOI 3S 6 9S SO 4 i 92 [19] DIVISION II CAPITALIZATION IN RELATION TO INCOME, ASSETS, STATE CONTROL TOPIC V Capitalization in Relation to the Income Ac- count, Part I Lyon I, 50-56. Lyon II, 175-195. Chamberlain, 263, 279. Lough, 179-189. Unless the student is familiar with matters of accounting, the instructor will need to ex- plain fully the terms involved in the Income Account, and the student working by himself will need to feel that he has a sound under- standing of the Income Account. THE INCOME ACCOUNT For Railroads and Public Service Corpora- tions. Lyon II, 175-179. Gerstenberg, 166. Chamberlain, 263-275. [21] SHORT FORM LONGER FORM Gross Income- Operating^ Net Income- Fixed Charges Surplus- "Operating Revenue: (Classified according to kinds of business carried on) -Operation Expense: Conducting operations Maintenance -Net Operating Revenue -Taxes ^Income from other sources Deductions from Income (Interest "\ < Also requirements for amor- Rentals / I tization of discount and of debt Available for Dividends (Dividends '(Surplus Contingent Liabilities Concealing additions to the capital account through maintenance Concealing additions to the capital account through maintenance. Lyon II, 182. Skimping maintenance. Lyon II, 182. Income account of an industrial corporation. Lyon II, 186. Gerstenberg, 662, 782. Shipments billed. Cost of shipments: Cost of materials. Cost of manufacturing and selling. [22] Maintenance. Net manufacturing profit. Other income. Total net. Interest and other fixed charges. Surplus for dividends. Question i. A corporation is making gross earnings of $756,000, net earnings of $325,000. What is the operating ratio ? Question 2. A corporation is earning gross $1,845,962. The operating ratio is 70 per cent. Fixed charges are $225,000. (a) What amount is available for dividends? (b) By what percentage are the earnings in excess of fixed charges ? Question 3. The corporation indicated in ques- tion 2 has $1,000,000 6 per cent, preferred and $1,000,000 common stock. What per cent, is it earning on the common ? Question 4. A corporation has the following Income Account : Gross j!6,ooo,ocx) Operating 4,000,000 Net 2,000,000 Its capitalization is: First mortgage 6 % bonds . . . $4,000,000 General mortgage 4^% bonds . 5,000,000 Debenture S% Bonds 6,000,000 Preferred stock 6% 7,000,000 Common stock . . _. . . . 10,000,000 (a) What is the operating ratio? (b) What are the fixed charges? (c) How much is available for dividends on the preferred stock ? [23I (d) What percentage is that on the pre- ferred ? (e) How many times the amount required for preferred dividends is it ? (f) How much is available for dividends on the common stock? (h) How much is available for interest on the 1st mortgage 6% bonds? How much required? (i) How much is available for interest on the general 4i% bonds? How much re- quired ? [24] TOPIC VI Capitalization in Relation to the Income Account. Peirt II Lyon I, 56-82. Relative liability of different classes of busi- ness to variations in gross income. Railroads. Public Service Corporations. Industrials. Lyon, 56-68. Ripley, "Railroad Rates and Regulation," has some interesting matter on this subject : Tendency of operating ratio to increase on declines in gross and effect on net income. Lyon, 56-68. Providing business capital by borrowing. Lyon, 50-53. Ripley, 105-109. Borrowing limited by liability of net earn- ings to fluctuate. Lyon, 54. [25] Earnings available for interest, and the mar- gin of safety. Lyon, 54. Chamberlain, 276. Question. The X. Y. corporation has a gross income during a prosperous business period of $i,cx)o,cxx>. Its operating ratio is 70 per cent. It is subject to a decHne of 20 per cent, in its gross during a period of depres- sion and to an increase in the operating ratio at the same time of 5 per cent. Can it safely have a bond issue of $4,ocx3,ooo of 5% bonds? [26] TOPIC VII Capitalization in Relation to Assets. Part I Lyon I, 83-107. Ripley, 227-237, 248-255. Mead, 145-158. Lough, 172-179, 189-200. The issuance of securities for a consideration not really worth the par of the securities. Sale of bonds at a discount is equivalent to borrowing at a higher interest rate, i. e., a combined interest and discount transaction in- volved in the borrowing. The issuance of stock when the considera- tion received does not really have a value equal to the par of the stock called stock watering. Common Objections to Stock Watering. Lyon I, 83-85. Fraud on the buyer. As a means of concealing excessive charges. Proper Purposes of Stock Watering. Lyon I, 86-107. [27] As a means of arriving at a bargain — satis- fying the various interests. Special use for this purpose in carrying out underwriting transactions. What advantages there may be to the cor- poration in financing with watered stock. Giving par value to stock illogical. Stock without par value the better way. A New York statute permits it (on minimum paid in of ^5 a share) and Maine, Delaware. (New York Stock Transfer Tax — especially important because of transactions on N. Y. Stock Exchange — Stock without par value taxed 2 cents a share, the same as ^100 shares.) See also statutes of Virginia, West Virginia. Lough, 95. Question i. A mining corporation issues its stock with a par value of $100. Its entire capitalization is ^1,000,000 of common stock, and ^1,000,000 in cash was paid to the cor- poration for this stock, and used in the purchase of the mine, equipment for work- ing capital, etc. The ore has been carefully blocked out, and it is estimated that at the rate of working anticipated the ore will last 15 years. The mine is worked 5 years at the expected rate, and everything tends to show that the property was just worth the price paid for it. What is the value of the stock at the end of 5 years ? [28] Question 2. Certain real estate with an actual value of $250,000 and cash in the amount of $250,000 were turned over to a newly formed corporation for $750,000 par value of the stock of the corporation. The corporation expended the $250,000 in cash in erecting a loft building. Now, ten years later, the plot of land, without considering the value of the building, has an actual value of $750,000. (fl) What was the original relation of assets to par value? (b) What is the relationship now? (c) The promoters antic- ipated this increase in land value. Were they justified in capitalizing as they did? Question 3. The X. Y. corporation issued its $1,500,000 of common stock, and received for it land worth $1,000,000 and $500,000 in cash. Ten years later the land was worth only $500,000. Other assets were worth $500,000. Should the corporation reduce the amount of its stock outstanding ? Question 4. The promoters of a corporation have $1,000,000 to invest in the enterprise. They want to keep control. The enterprise, however, requires $3,000,000 of capital. It is of such a character that not more than one-third of the capital should be represented by bonds. The promoters have options on certain properties for which they will have to pay $500,000. Development will use up the rest of the required funds. The pro- moters want their cash contribution repre- [291 sented by the same kind of security as the cash contributed by any one taking any security except bonds. Suggest a capitali- zation and distribution of securities that will meet these requirements. [30I TOPIC VIII Capitalization in Relation to Assets. Part II Lyon, 83-107. (Same as previous topic.) Mead, 60-74. Relation of value of assets to amount of earnings. Equity above the mortgage : Stipulations to keep the equity good; Stipulation for maintenance to keep the value of the assets unimpaired ; Stipulation for the reduction of the debt (see special topic "Amortization," under topic XIX). The open mortgage — authorized and un- issued bonds: Lyon, 113. Heft, 6()-yi, 239-241 (Definition of "open" mortgage not in accord with accepted usage.) Mead, 65-72. (Especially good treatment of this topic.) How will the future issuance affect the equity? Stipulations tending to maintain the [31] equity as bonds to be issued only for a certain percentage of the value of new assets or bonds to be issued only on the retirement of senior bonds. Junior mortgages placed after open mort- gages. Stipulation in the junior mortgage that no more bonds shall be issued under the open mortgage. Junior mortgage placed after a mortgage maturing earlier than the junior mortgage. Heft, 272. Expectation of not having the prior claim ahead of it after the maturity date of the prior claim. Possibility of extending the maturity of the prior debt, and stipulations in the junior mort- gage against it. Question: The X Corporation Value of 6% First Mortgage Assets Bonds Issued and Outstanding $3,000,000 $1,000,000 Authorized and Unissued $1,000,000 Net Income: Twelve months just past, $300,000. Preceding twelve months, $290,000. The Trustee is authorized to certify the un- issued bonds on the following conditions: [32] (a) That the earnings for each of the two preceding twelve-month periods are at least three times the interest charge on the bonds outstanding and those to be issued. {b) That the par of the additional bonds is not in excess of 75 per cent, of the cost of additional assets required by the corporation. The directors want to erect and equip a new building at a cost of $800,000. 1. How many bonds can they issue to reim- burse the cost of the new assets ? 2. What percentage of the value of the assets is the present mortgage debt ? 3. What percentage of the value of the as- sets will the mortgage debt be when the addi- tional bonds are issued to pay for the new plant? 4. What percentage of the value of the assets would the mortgage debt be if all the authorized bonds were issued ? [33] TOPIC IX Capitalization in Relation to the State Lyon I, 220-283. Ripley, 281-312 (Very full treatment of the sub- ject for railroads.) Mead, 75-80. Gerstenberg, 337-349. (New Jersey Public Utili- ties Act) 351-357- (General principles regulating action by the Public Utility Commission of New Jersey upon petitions asking approval of proposed issues of securi- ties.) Public Service Commissions and their func- tions. Lyon I, 240. Regulations of: Rates. Service. Securities. Accounts. Competition. [34] Public Service Commission. Control of Capi- talization. Certificate of public convenience and ne- cessity. Gerstenberg, 345 (24). Capitalization in relation to valuation. Bases of valuation. Lyon I, 233-239. Investment. Replacement. Reproduction. Authority and Determination of the Com- mission on : The amount of securities to be issued. The purposes for which issued. The terms on which issued. Lyon, I, 248-259. [35] DIVISION III FINANCING NEW CAPITAL ASSETS — ^THE FINANC- ING THROUGH AND OF HOLDING COMPANIES AND SUBSIDIARIES — COMBINATIONS AND MER- GERS — INTERCORPORATE RELATIONSHIPS — ^THE FINANCING OF SPECIAL ASSETS, I. E., SUCH AS EQUIPMENT — SPECIAL USES OF THE COLLATERAL TRUST TOPIC X Intercorporate Relationships Mead, 255-278. Mead, 325-331. Mead, 338-347. Ripley, 143-147. Gerstenberg, 522-554. (Consolidation agree- ment.) Qerstenberg, 590-619. (Sherman Act, Clayton Act, Trade Commission Act.) Financing new capital assets. Mead, 255-278. Intercorporate Financial Relationships: The Collateral Security. [37] Authority of one corporation to own stock or other securities of another. Limitations imposed by anti-monopoly law. The operating corporation and the holding corporation. A corporation may be an operating com- pany only. A corporation may be a holding company only. A corporation may be both an operating and a holding company. Class of securities of one corporation owned by another: May own stock alone. May own bonds alone. May own stock and bonds. Amount of securities of one corporation owned by another giving rise to various situa- tions : May own all the stock. May own a majority of the stock. May own less than a majority of the stock but enough to effect actual practical control. May not own enough to control. May not own all the bonds or may own all the bonds of one issue when more than one issue. May own only part of bond issue. [38] If corporation owns a controlling amount of stock of another combination, or if less than a controlling amount but still an important minority, an intercorporate relationship exists; if corporation owns an unimportant minority, merely an investment. Community of interest. Ripley, 424. Corporation providing the funds may use its own credit to sell its own bonds to provide the funds. (It may pledge under a trust deed the stock or other securities it receives of the corporation to which it is providing the funds. This is the collateral bond.) The collateral bond. Mead, 325-331. Ripley, 143-147, 156. If a general obligation of the issuing corpora- tion and secured only by pledge of stock or bonds, a pure collateral bond. Bond may be secured by mortgage on tan- gible property and also by pledge of stocks or bonds. An interesting problem on Consolidation may be found in "Cole's Accounts," pp. 346-51. [39] TOPIC XI The Future Acquired Property Mortgage Lyon I, 108-143. The future acquired property mortgage: Why created — demand of the capitalist in bargaining over the Investment Contract. Effect on future financing of corpora- tion whose assets covered by future acquired property mortgage. Cannot give first lien on new asset to finance its acquisition unless bonds are redeemed through purchase or call. Lyon I, 114. Creation of new corporation to finance ac- quisition of new asset. Lyon I, 120. Parent corporation provides funds to the subsidiary: takes stock and bonds of subsidiary (discussed in previous topic). Parent corporation reimburses itself entirely or in part by: [40] (a) Selling bonds of subsidiary; or (fe) Guaranteeing and selling bonds of sub- sidiary (sell at a higher price by reason of the guaranty) ; Lyon I, 122. or (c) Selling its own bonds secured by pledge of bonds of subsidiary. Lyon I, 122. Since a lien now attaches to subsidiary, parent corporation may acquire assets of subsidiary subject to the lien. Use of the open collateral trust mortgage to finance acquisition of series of new assets. Lyon I, 124-126. Question: The X. corporation runs a little rail- way line from Y to Z. It is a narrow-gauge road, and the directors have decided that it would be profitable to convert it into a standard-gauge property and lay heavier rails. This will require about $i,ocx>,cxx). Present Capitalization : Common Stock .... $2,ocx3,ooo First mortgage 5% bonds, mortgage closed .... 1,000,000 Net earnings 135,000 How could the directors provide tne new capital? [41] TOPIC XII The Holding Company: Financial Combina- tions Lyon II, ig6-2io. Ripley, 412-418; 420-455. Mead, 348-374. Lough, 49-54. Holding company may be pure holding com- pany, i. e., not conducting any operations of its own. Ripley, 433-4SS- Company conducting operations of its own may be used as a holding company. Acquiring control of subsidiaries by swapping stock of holding company. Lyon I, 127. Acquiring control of subsidiaries by purchase of stock. Funds for purchase provided by sale of holding company stock. Lyon I, 127. [42 J Sale of holding company bonds unsecured by specific pledge of subsidiary stock. Secured by pledge of subsidiary stock. Lyon I, 128. Existing liens of subsidiaries. Possible creation of new liens on subsidiaries. Disadvantage of this to bondholders or pre- ferred stockholders of holding company. Lyon II, 203-205. Stipulations against this in the investment contract of the preferred stockholders or bondholders of the holding company. Lyon II, 206. Pyramiding for control by use of the holding company. Ripley, 524-532. General consideration of the income of holding companies. Lyon II, 196-210. Control through the same stockholders. Ripley, 423. Combinations of Public Utilities: Unity of Management. Central Power Plants. Gerstenherg Materials, 570-582. (Advantages claimed.) [43] Combinations in industrials. Combinations in railroads: (There is a large amount of material on the subject of trusts. Most of the argument, how- ever, relates to the economic and not to the financial aspects of combinations and is not germane to a course in Corporation Finance.) Financial arrangements on dissolutions of solvent corporations (i. e., to comply with anti- trust legislation). Gerstenberg, iooi-icx)8 (Dupont Co. dissolu- tion). [44] TOPIC XIII Financing a Combination by Means of the Lease; Special Financing of Union Terminals; Special Uses of the Collateral Trust Agreement Lyon, 1 31-136. Mead, 375-384. Ripley, 418-421. Gerstenberg, 556-569 (example of a corporate lease). The lease by one corporation of the property of another corporation : Authority to lease. Why the lease resorted to: Avoids the raising of capital to finance the purchase of assets. An annual fixed charge (rental) instead. Sometimes ea- sier to negotiate than a purchase. Terms of the lease: Maintenance of the leased property. Pay- ment of an amount of rental equal to fixed charges and a percentage return on the stock of the lessor corporation. [45] Guarantee of Interest and dividends. Lyon I, 133. Position of lease in receivership. Lyon I, 132; II, 227. FINANCING OF UNION TERMINALS Lyon I, 141-143. Terminal property owned by terminal cor- poration. Owning corporation leases property to enter- ing railroads. Rental — an agreement to pay rent sufficient to give a return on capital investment, i.e., an amount equal to fixed charges, etc. REALTY FINANCING Chamberlain, 366-372. Lyon I, 139. Use of the collateral trust to finance real estate loans. Deposit of real estate mortgages and uni- form issue of bonds against them. Federal Farm Loan Banks. U6] TOPIC XIV Special Financing of the Purchases of Railroad Equipment Chamberlain, 292-300. (Full treatment.) Cleveland and Powell, " Railroad Finance," 81-94 Ripley, 171 (brief). Financing the purchase of railway equipment by giving the lender a special claim on the equipment: The future acquired property mortgage prevents this being done directly. Railroad makes contract with manufac- turers for equipment; assigns contract to third party who makes conditional sale of equipment to railroad for series of notes (bonds) of railroad with title of equipment to pass to railroad when all notes are paid. Equipment mortgaged to secure notes. Lyon I, 149; II, 227. Conditional sale: Conditional sale and chattel mortgage recording acts. Special state acts. [471 Equipment bonds issued up to per cent, of cost of equipment. Railroad makes first cash payment of difference between par of the bonds author- ized and cost of equipment. Railroad's covenant to replace damaged, lost, or destroyed equipment, etc. Philadelphia Plan: Equipment leased (not sold on conditional sale) to railroad. Leases deposited with trustee who issues trust certificates against them. Tax exemption in Pennsylvania. Serial maturity of equipment securities and depreciation of equipment. [48] TOPIC XV Stock: Its Issuance and Sale Lyon II, 1-34. Mead, 91-1 17. Ripley, 268-274. (Check up with the reference to Lyon on the legal requirements.) (It should be noted that this is almost en- tirely a legal topic. Precisely what may be done depends on the law of the particular jurisdiction. This course can discuss the sub- ject only in its broad general outlines) : Stock, authorized, issued, outstanding. Authorized issue: Classes. Issuance of stock: Subscription for. Part paid and full paid. Payment for stock: By money, services, or property of the value of the par of the stock. Valuation of property paid for by stock. • [49] Treasury stock: Difference between authorized and un- issued stock and treasury stock. Not an asset of the corporation. How stock is sold for less than par: Treasury stock — corporation may sell at any price. Stock dividend: If the corporation has a surplus may declare it out in a stock divi- dend and stockholders pool their holdings to issue to the public. (For more of this see under the "Readjustment of the Cap- ital Account" topic XXIX.) Stock without par value. Lyon I, 84. Rights of stockholders to new issues of stock: Right to subscribe at par (or in some jurisdictions at a price stated and not to be sold at a lower price). Value of rights to subscribe. Equivalent to dilution of Surplus. Underwriting an issue of stock: May be sold to bankers or public when treasury stock. On issue of corporation not sold but under- written. [SO] Increasing the amount of stock authorized. Decreasing the amount of outstanding stock. The issuance of stock on conversion. Ripley, 276. Question i. A corporation has $i,cxx),ooo out- standing, $2,cxx3,ooo authorized and un- issued stock. A capitalist who is famihar with the affairs of the corporation offered to buy 500 shares of the authorized and unissued stock at $115 a share. The cor- poration wanted the money and the price was a fair price for the stock. Could the directors accept the offer ? Question 2. The X corporation announces that stockholders of record on the ist of April will have the privilege of subscribing to ^1,000,000 of new stock of the corporation at par. {a) The corporation has stock issued and outstanding of $5,000,000. A owns 25 shares of stock. How much of the new stock will he have a right to subscribe for? {h) A transfers his stock on the 25th of March to B by giving him a new certificate made out in the name of B. Who has the right to subscribe to the new stock? (c) On the 2d of April the stock of the corporation is quoted at $125 a share. What is tne value of the right accruing to one share of the old stock? [SI] (d) Assume that the stock of the X cor- poration is selling at $150 at the time of the announcement of rights. What should it sell for when it goes "Ex-rights"? [52 J TOPIC XVI Stock: Its Form and Transfer Lyon I, 166-173. The stock certificate: Face of the certificate. Power of attorney. Power of substitution. The certificate book: The stub. Transfer agent. Registrar of transfers. The stock book : Holders of record. Dividends to holders of record. Closing book over 'dividend period. Good delivery. (Rules of Committee on Securities, New York Stock Exchange.) [S3] Regulations regarding transfer. Transfer tax. Subscription receipts. Interim certificates. [54] TOPIC XVII Bonds: Their Issuance Form and Transfer Lyon I, 173-199. Mead, 299-324. Authority to issue bonds : Not limited by charter (ordinarily). Special statutory limitations (as that debt shall not exceed amount of stock). Borrowing and mortgage authorized by stockholders. Certification and Issuance: Execution and authentication of bond by signatures of officers and seal of corporation and certification of trustee. Conditions under which bonds may be issued stated in the investment contract (trust deed mortgage). Bonds redeemed after issuance are "dead" bonds and if reissued create a different debt, i. e. not with the same mortgage lien as out- standing bonds. Hold by a trustee if to be kept alive for sinking fund or otherwise. Terms of the bond: Maturity. Denomination. Interest rate. Interest dates. Registered and coupon: Registered as to principal. Interchangeable. Place of payment (Domicile). Payment in different monies. Prior redemption right. Bonds: Their transfer: Coupon by delivery. Registered — by transfer on books of cor- poration. Rules of transfer. Subscription receipts. Interim certificates. Temporary bonds. Definitive bonds. [S6] TOPIC XVIII The Corporate Mortgage and Trust Deed Hejt, 56-145. Gerstenberg, 183-254. (Reproduction of one corporate mortgage.) Recitals : Incorporation, authorization of bonds and mortgage, form of bonds, coupons and authen- tication. Granting clause: Description of property mortgaged or pledged. Issuance of bonds (with execution, authen- tication and registration clauses). Conditions under which bonds may be issued : Bonds to be issued immediately. Bonds reserved for refunding, or for the acquisition of additional assets, and condi- tions under which the trustee may certify bonds for issuance. [S7l Provisions for redemption: Sinking fund. Rights of redemption be- fore maturity. Covenants of the corporation. Agreements for maintenance, insurance, etc., against the issuance of further securities by sub- sidiaries whose securities are pledged. (In case of trust deed for debentures, against the creation of prior claims.) Covenants relating to the control of pledged securities. Provisions for audits, dividend payment, restrictions, etc., etc. General legal covenants. Remedies of trustees and bondholders, and special law clauses: Law covenants stating rights under the mortgage. Releases of mortgaged property. Defining the duties and protecting the trustee. Execu- tion and recording of the document. The corporate mortgage an elaborate invest- ment contract. [S81 TOPIC XIX The Maturity of the Debt Lyon I, 144-165. Gerstenberg, "Syllabus," 30, 31. Mead, 8i-go. Ripley, 130-132 (brief). An extension of the debt may be had by agreement. Chamberlain, p. loi, Par. 293; p. iii, Par. 340. Heft, 327. Position of junior lienor on extension of debt with senior lien. Covenants in junior lien agreement that senior lien debt will not be extended. Refunding: The refunding mortgage. Burden of the debt {i. e., the annual charge, against the corporation for interest and sinking fund or serial maturity). Lyon I, 152. Amortization of the debt: Serial maturity. [59] Special sinking funds. Repurchase of securities: Reserved right of redemption. Keeping bonds alive in the sinking fund. Tests of amortizattion provisions: 1. What assurance that amortization pro- visions will be carried out ? 2. How will they affect market ? 3. How evenly do they distribute the burden of the debt ? 4. Work involved in carrying out provisions. 5 Assurance that provisions equal require- ments. 6. Cost. [60] TOPIC XX The Corporate Income and Its Disposition Lough, 415-434, 465-481. (A good discussion.) Lyon I, 173-208. Chamberlain, 263-279. Ripley, 238-247. (On disposition of the sur- plus.) Mead, 171-254. (An especially full discus- sion.) Gross income. Income from operation. In- come from outside operations and other income. Income from operations — its liability to fluctuation. Income from the ownership of securities — character of this income. Income of the holding company: Influence of liens on the subsidiaries. Cost of conducting operations: Efliciency of plant. Efficiency of management, [61] Cost of maintenance : Is enough being expended to maintain efficiency of plant ? Are net earnings being shown at the ex- pense of maintenance ? Are expenditures on the capital account being charged to maintenance ? Taxes — the taxation of corporations. Lyon, "Principles of Taxation," 113-119. Net earnings and fixed charges. Disposition of the surplus income. Policy of building up a capital surplus and its relation to the maintenance of divi- dends. Gerstenberg, "Syllabus," 62. Ripley, 238-247. Lough, 422-434, 465-481. Reserves. Lough, 422-428. [62I TOPIC XXI Declarations and Payments of Dividend Lough, 425-464. Mead, Chap. 17, 18. Directors declare dividend: Power of directors over dividend declara- tion. To stockholders of record at a certain date. When paid. Closing of books to make up the record. Transfer of certificate while books are closed — ^who gets the dividend ? Quotations — ex dividend. Extra dividends : Special dividends. Stock dividends: (Purpose treated more fully later under read- justment of the capital account topic XXIX.) Distribution of surplus : (Dilution of surplus — lessening of surplus [63] per share of stock through subscription rights). Dividend warrants. Accumulated dividends on cumulative pre- ferred stock. May be good business for the common stock- holder to let preferred dividends accumulate, getting use of money for nothing. Rights of preferred and common stock- holders in distribution of surplus. [64] DIVISION IV THE DISTRIBUTION OF SECURITIES Lyon, 3S-IOI. Mead, 1 18-144. Lough, 201-228, 291-318. TOPIC XXII The Sale of Securities by the Corporation Direct to the public. Why not successful. To its own stockholders. Lyon II, 15. Underwriting the sale. Lyon II, 17. To investment bankers. Lyon II, 2. Lough, 319. Selling to the corporation's own stockholders. Stockholders' "rights." Gerstenberg, 358-366. Lough, 298-308. [65] Selling to investment bankers. Appraisals — engineer's report. Gerstenberg, 457-488. Audits — expert accountant's reports. Legal opinions: Title to property. Legality of procedure for issuance. Sales at auction — Public Service Corporations, Lough, 308-310. [66; TOPIC XXIII Syndicates: The Joint Account Lyon II, 102-156. Lough, 339-353- Financing the purchase of securities by the investment banker. Cooperation in the purchase and sale of securities • For greater banking power. For greater selling power. Formation of the joint account. The syndicate manager. Purchase of the securities by the syndicate. Members' contribution to price — members' capital and borrowed capital. Carrying the securities: Undivided carrying. Divided carrying. The syndicate price. I67I Releasing securities as collateral for the loan in order to make deliveries. The take down price, or price of purchase by the selling member from the syndicate. Effect in keeping profits undistributed. Broker's commission. Members' selling commission. Territory. Advertising. Duration of the account. [68] TOPIC XXIV The Joint Account: Distribution of Profits and Losses: Underwritings Lyon II, 102-156. Mead, 159-170. Unlimited (or undivided) liability accounts: Distribution of profits. Distribution of unsold securities or of losses. Limited (or divided) liability accounts : Distribution of profits and of unsold secur- ities or of losses. The underwriting as a form of the syndicate, to be distinguished from the ase of the term as an assurance against loss on a sale by the corporation in lieu of a purchase for which see Topic XXII. The formation of a second syndicate to purchase from the first syndicate or original purchaser: Restricted and large underwriting groups. Application for the underwriting. Allotments of subscriptions. [69] TOPIC XXV Work of the Bond Houses Chamberlain: Work of the Bond House. (En- tire). Lyon II, 35-101. Lough, 319-328. Selling securities by the investment bankers. Organization of an investment banking house. Negotiating, investigating, statistical, exe- cutive, buying, selling, accounting, and record keeping departments. Work of the statistical department, analyses, preparation of circulars, etc. Work of the cashier's (accounting) depart- ment : Receiving and delivering securities. Taking care of loans, substitutions, etc. Keeping accounts. Work of the selling organization: Mailing list. Circulars. I70I Work of the securities salesman: Selection and training of salesmen. Territory and methods of work of salesmen. Work of the banking house in creating and supporting a market [71] TOPIC XXVI Listing Securities On and Selling Them Through the Stock Exchange Lyon II, 157-174- Chamberlain, 62-68. Gerstenberg, 162-170. (An application for list- ing.) Lough, 328-338. Reasons for and against listing an issue of securities on the stock exchange. Listing requirements : Application to committee on the stock list. Expense. Location of transfer agent and registrar of transfers. Mechanical preparation of securities. Documents required. Other information required. Promotions. [72I Mead, 14-24. Gerstenberg, 457-468. (An engineer's report for a promotion.) Gerstenberg, 499-521 . (An agreement to purchase assets, etc.) [73] DIVISION V THE CORPORATION IN FINANCIAL DIFFICULTIES, RECEIVERSHIPS, BANKRUPTCIES, REORGANIZA- TIONS, READJUSTMENT OF THE CAPITAL AC- COUNT, RECAPITALIZATION TOPIC XXVII Receiverships and Reorganizations Lyon II, 220-307. Ripley, 371-388. Mead, 406-426. Cleveland ^Powell " Railroad Finance," 227-270. Lough, 573-592. Default and application for receiver. Financial management of property in re- ceivership. Receivers' certificates. Protective committees : Powers. Calling for deposit of securities : Depositaries. [75] Certificates of deposit. Listing. Policy of security holders with regards depositing. Foreclosure suit. Appraisal and auditing. Books that should receive special mention in connection with the subject of reorganiza- tion are: " Railroad Reorganization," by Stuart Daggett, which is a study of various railroad reor- ganizations. "Corporate Promotions and Reorganizations," by Arthur S. Dewing, which is a study of the promotion and reorganization of various industrial enterprises. "Some Legal Phases of Corporate Financing, Reorganization, and Regulation," by Stet- son, Byrne, Cravath, Wickersham, Mon- tague, Coleman, and Guthrie, is a book of great value. Though primarily for a lawyer, a man who is studying the financial aspects of these topics can get much of value from it. [76] TOPIC XXVIII Reorganizations Readjustment of the capital account recap- italization. Lyon, 220307. (Same as previous topic.) Heft, 335, 404. Ripley, 338-411. Mead, 427-460. Lough, 593-606. The financial plan of reorganization. Filing reorganization agreement. Giving depositors an opportunity to with- draw. Declaring plan operative or inoperative. Extension of time to deposit. Decree of foreclosure. Upset price. Provision for cash requirements : Assessments. Sale of new securities. [77] Underwriting and purchasing syndicate. Readjustment of the capital account recap- italization. Lyon, 296-307. Mead, 365-405. Gerstenberg, "Materials," 910-934. (Recapi- talization of Chicago & Alton.) Gerstenberg, "Materials," 935-965. (Readjust- ment of debt, Hudson & Manhattan R.R. Co.) Gerstenberg, "Materials," 966-1000. (Reorgan- ization of B. & O.) Distribution of securities on dissolution under Anti-Trust Act. * Gerstenberg, 1001-1008. (Dupont Powder Co.) [78] TOPIC XXIX Promotions Lough, 229-290. Mead, 14-24. Gerstenherg, 457-468, 499-521. Cooper, " Financing an Enterprise." Gerstenherg, " Syllabus," Chapter XV. Requisites of a successful enterprise. Cooper, 27-47. A sound undertaking. Sufficient capital. Efficient management. A sound undertaking: Investigation. (Industrial enterprise) Basis of enterprise. Title to property. Cost of construction. Capacity and market. [79] Environment. Conditions of operation. Lough, 229-240. Cooper, 48-65. Investigation. (Transportation enterprise) Cleveland l^ Powell, 14-19. Basis of enterprise: Population, capital, and resources. Survey (for advantageous operating and cost of construction). Grades, curvature, and cost of right of way. Charter. Investigation: (Gas, electric lighting, street railway.) Basis of enterprise : Population and area. Cost of production and market at price that will produce a profit. Assembling and preliminary financing. Lough, 240-249. Who act as promoters, legal status. Lough, 250-264. Promoting combinations. Lough, 265-290. [80] BOOKS REFERRED TO IN THE OUTLINE OF A COURSE IN CORPORATION FINANCE Byrne — Some Legal Phases of Corporate Financing, New York Bar Association Lectures — Byrne, Stetson, Cravath, Wickersham, Montague, Coleman, Gu- thrie, New York, 1917, MacMillan, $2.75. Chamberlain — The Principles of Bond Investment. By Lawrence Chamberlain, 1911. New York, Henry Holt & Company, $5.00 net. Chamberlain — The Work of the Bond House, New York, 1912, Moody's, ^x.oo. Cleveland — Railroad Finance. By Frederick A. Cleve- land and Frederick Wilbur Powell, New York, D. Appleton & Company, $2.75 net; by mail, ^2.95. Cole — Accounts, Their Construction and Interpretation. By William Morse Cole, Professor of Accounting, Harvard University. Revised edition, 1915. Bos- ton, Houghton Mifflin Co., $2.50. Cooper — Financing an Enterprise. By Francis Cooper. Fourth Edition. 19x5. New York, Ronald Press Co., $3.00. Conyngton — The Modern Corporation. By Thomas Conyn^on. A condensation of the matter con- tained in the larger corporate works of Conyngton. 1913. New York, Ronald Press Co., $2.00. Conyngton — Corporate Management. By Thomas Co- nyngton. Covering the legal management of cor- [81] ■ porations after they are in operation. Details the procedure under the charter and by-laws, recording the minutes, transfer of stock, rights, powers, and responsibilities of stockholders, directors, and offi- cers with forms for minutes, motions, resolutions, reports, stock certificates, etc. — Third edition. 191 1. New York, Ronald Press Co., $3.50. CoNYNGTON — Corporate Organization. By Thomas Co- nyngton of the New York Bar. A manual for busi- ness men covering the legal features _ involved in incorporating a Business. Third edition. 1913. New York, Ronald Press Co. $4.00. Daggett — Railroad Reorganization. By Stuart Daggett. Boston, Houghton Mifflin Co., 1908. $2.cx). Dewing — Corporate Promotions and Reorganizations. By Arthur S. Dewing. Boston, Houghton Mifflin Co., ^2.50. Emery — Speculation on the Stock and Produce Exchanges in the United States. By Henry C. Emery. New York. MacMillan Co., 1904. $2.00. Paper ^1.50. Fisher — Elementary Principles of Economics. By Irving Fisher, Professor of Political Economy, Yale Uni- versity. New York. 1912. MacMillan Co., $2.00. Gerstenberg — Materials of Corporation Finance. By Charles W. Gerstenberg, Professor of Finance, New York University, School of Commerce, Ac- counts and Finance. New York, 1915. Prentice Hall, $5.ca. Gerstenberg — Syllabus of Corporation Finance. New York, 19x5. Prentice Hall. 50 cents. Heft — Holders of Railroad Bonds and Notes, Their Rights and Remedies. By Louis Heft. New York, E. P. Dutton & Co., 1916. $2.00. Hatfield — Modem Accounting. By Henry Rand Hat- field, Ph.D., Professor of Accounting, University [82] of California. New York, D. Appleton & Co., $2.00. By mail, $2.14. Lough — Business Finance. By William H. Lough. The Ronald Press, New York, 1917, pp. 631. $3.00. Lyon — Corporation Finance. By Hastings Lyon. Com- plete Edition. iqi6. Vols. I and II bound to- gether. Boston, Houghton Mifflin Co., $3.00. Mead — Corporation Finance. By Edward S. Mead, Ph.D., Professor of Finance, University of Penn- sylvania. New York, D. Appleton & Co., $2.25. Montgomery — Auditing Theory and Practice. By R. H. Montgomery, C. P. A. Second edition. 1916. New York, Ronald Press Co., $S-oo. Pratt— 7"*? Work of Wall Street. By Sereno S. Pratt, Formerly Secretary New York Chamber of Com- merce. New York, D. Appleton & Co., ^2.00. Ripley — Railroads; Finance and Organization. By Wil- liam Z. Ripley. New York, Longmans, Green & Co., 1915. ^3-00. Seligman — Principles of Economics. By Edwin R. A. Seligman, Professor of Political Economy, Colum- bia University. New York, Longmans, Green & Co., $2.50. Stockwell — Net Worth and the Balance Sheet. By Her- bert G. Stockwell, C. P. A. A book for readers who are not accountants, explaining the nature of the financial statement or business "oalance sheet"; what it shows, how to read it, and how it is used for the guidance of business concerns. 1912. New York, Ronald Press Co., Cloth, $1.00. Sullivan — American Corporations. By John Sullivan, Professor of Law, University of Pennsylvania. New York, D. Appleton & Co., $2.25. Taussig — Principles of Economics. By F. W. Taussig, Professor of Economics, Harvard University. New York, 1911. MacMillan, 2 vols, each volume $z.oo. [83] OUTLINE OF A COURSE IN INVESTMENT Full titles of books referred to will be found in the bibliography at the end of the outline OUTLINE OF A COURSE IN INVEST- MENT THIS COURSE ASSUMES A KNOWLEDGE OF THE SUB- JECT INDICATED IN THE SYLLABUS OF A COURSE IN CORPORATION FINANCE TOPIC I What is Investment? Chamberlain, 1-13. Raymond, 1-4. This first topic will serve to connect the course with the general principles of economics, and with the preceding course in Corporation Finance. Use of capital in production. Increasing importance of capital in produc- tion. Theory of interest : Demand for capital. Reward for saving. True interest. Premium for risk. I 87] Lyon, "Corporation Finance," Part I, pp. 224- 232. Commitment of capital with management. Commitment of capital without manage- ment. Demand for this increase with increasing complexity of economic life. Commitment of capital with limitation of risk. As proprietor: Corporations — preferred stock. Partnership^ — special partnership- Individual — rental. As lender: Risk, Income, Control. Lyon, "Corporation Finance," Part I, pp. 1-17, 29-30. Relationship of Investment and Speculation. Definition of investment for purposes of this course. An investment is : 1. A commitment of capital for use in production; 2. Entrusted to the management of an- other; 3. For which the primary purpose of the [88] capitalist in making the commitment is to receive income by reason of the use in pro- duction (a transaction primarily for profit due to change in price is not an investment but a speculation, even though the capital so committed is used in production) ; 4. In which the estimated risk for use in production is not so great that the premium for risk is greater than the true interest. For purposes of this course we will regard land as capitalized and treat it as capital. Apply this definition of investment to: Real estate proprietorship. In use. Not in use. Mortgages. Corporate stock. Corporate bonds. Municipal bonds. (Show how government and municipal loans come under the head of commitment of capital in production.) [89] TOPIC II Tests of an Investment Chamberlain, 13-62. Investment tests: 1. Security of principal: As affected by management. Judgment in making the original com- mitment. Maintenance of assets. From the nature of the business. From the investment contract. 2. Stability of income : As affected by management. From the nature of the business. From the investment contract. 3. Fair income return: True interest plus premium for risk. 4. Marketability. 5. Value as collateral: Depends on quickness, closeness, and sta- bility of market. 6. Tax position. [90] Federal, state, and local. 7. Freedom from care. 8. Acceptable duration. 9. Acceptable denomination. 10. Appreciation. The term "investment contract" will be used as expressing the obligations of the party (government, municipality, corporation, in- dividual) to which or whom the use and man- agement of the capital is entrusted, and the rights of the investor who has made the com- mitment of his capital. Look up several corporations and set down the securities issued by each, find the quotation and compute the yield to show the effect of the investment contract, i. e., as : UNION PACIFIC PRICE YIELD Common (8% div.) 147 S-44 Preferred 4% 83 4.82 Convertible 4%, 1927 .... 94 4.70 First and Ref. 4%, 2008 .... 91 4.40 First and Land Grant 4%, 47 . 98 4- 10 Risk arising out of the nature of the business: Security of principal. Stability of income. This sub-topic, stability of income, refers back to the discussion of the relative fluctua- tions of income from diflFerent businesses dis- cussed in the preceding course in Corporation Finance. See Lyon, "Corporation Finance," Part I> PP- 50-82. [91] As to security of principal apply test of risk from nature of the business to several kinds of business, as for example to: Mail order business; establishing a new magazine; owning and operating timberland; conducting an ostrich ranch; making war munitions; building railroad through new country; flouring mill; starting an electric light plant. As to stability of income apply to several kinds of business: Making railway equipment; street rail- way; the lumber business; steam railroad; gold mining; contracting business; grocery store. [92] TOPIC III Government Bonds Raymond, 5-93. Only the general knowledge of government finance that any fairly well-informed citizen has is necessary for the special study of govern- ment and municipal obligations as investments. A more thorough-going knowledge of public finance, however, is desirable. For this sub- ject standard large works are: Bastable, C. F., "Public Finance." Adams, H. C. "Science of Finance." Plehn, Carl C, "Introduction to Public Fi- nance," New York, is a shorter work. Of Bastable, especially pp. 1-220 and 612- 769 should be read and of Plehn, pp. 1-102, 366-465 and corresponding Topics in Adams. The rest of these books is a discussion of taxa- tion. Though a knowledge of the problems of taxations is desirable, it hardly has the same importance as a basis for the study of invest- ment in the public debt as other and more general matters of public finance. For a brief I93] simple discussion of taxation, especially as af- fecting investments, see : Lyon, "Principles of Taxation," Boston. Hough- ton Mifflin Co. This was originally a report to the Invest- ment Bankers Association. General tests of credit applicable to all creditors: Ability to pay. Willingness to pay. Ability to pay — depends on: Capital. Labor. Ability to pay as applied to government obligations depends on: Natural resources. Productivity: Capital. Labor. Population. Number. Moral and intellectual quality. Willingness to pay: The willing debtor. The unwilling debtor. [94] (a) When compulsion cannot be brought to bear. (b) When compulsion can be brought to bear. Government obligations : No compulsion — people cannot sue the sov- ereign. Unwillingness to pay due to change in gov- ernment. Secured government bonds: As on customs receipts — but enforceable only by consent or with force; deposit of collateral. Ability to pay — resources of the country. Land — agricultural, forest, mineral. Labor — numbers, intelligence, energy. Capital — sufficient for extractive indus- try sufficient for manufacturing. Amount of debt used unproductively. Total debt less debt used productively equals true net debt. National Debt — paper money plus bonds. External and internal loans. Look up New York quotations on foreign bonds and show how price is affected by invest- ment contract as to place of payment and in I 95] general the problem of foreign exchange in relation to foreign government. Special foreign issues: British consols. , French rentes. Foreign issues dealt in the American mar- ket. Canadian securities. [96] TOPIC IV United States Government Bonds Chamberlain, 115-122. Chamberlain (Appendix), "A Gamble in Gov- ernments." If the bond man studying this topic does not already have available the following: "National Banking Act." " Federal Reserve Act." "Postal Savings Bank Act." he can procure them on application to the Bureau of Printing, Washington, D. C. See list of books at the end of this outline. United States Government Bonds: HISTORY OF DEBT OF UNITED STATES Present United States interest bearing debt (as of June 30, 1916.) 2% Consols 1930 $ 646,250,150 3% Loan 1908-18 198,992,660 4% Loan 1925 162,315,400 2% Panama 1916 54,611,420 2% Panama after 1918 .... 30,000,000 3% Panama 1961 50,000,000 2?% Postal savings 31-33 . . . 5,508,060 24% Postal savings 193 S ■ • • • 933.54° [97] To which there has since been added 3f% Liberty Loan 1932-47 . 2,ooo,ocx3,ooo 4% Liberty Loan 1927-42 . 3,ooo,ooo,ocx3 (or more, as this goes to press the amount has not been determined). Look up current quotations on United States Government Bonds and compute bases. (The following are as of August 19, 1916): 2% Apr. 1930 99 2.10 4% Feb. 1925 no 2.60 2% Panamas 1936 98-^ 2. 10 3% Panamas 1961 lOI-i 2.96 Explain yield differences. Bonds available for circulation. Tax on 2s 1%. Tax on old 4s 1%. 3 s and new Liberty loans not available. Provisions of Federal Reserve Act for re- demption of United States Bonds, and for issue of Reserve notes. Postal savings bonds — provisions of act. Use of bonds to secure circulation. Freedom from taxation. "Federal Reserve Act," sees. 111-118. "National Banking Act," sees. 55-70. [98] TOPIC V State Bonds Chamberlain, 122-158. Raymond, 94-139. Secrist, "An Economic Analysis of Constitu- tional Restrictions upon Public Indebted- ness In the United States." Commercial and Financial Chronicle, State and City Supplement, history of state debts. Scott, "Repudiation of State Debts." This is an entire book on the subject which, though out of print, is available in libraries, referred to for those who want further reading. For the purpose of the course, the references to Chamberlain and to Raymond, pp. 102-128, are ample. In considering these defaults the political situation at the time of them should be kept in mind, and the fact that the purchasers from the state governments in many cases knew the political situation. Constitutional provisions in state constitu- tions on debt. Look up and write out the provisions for your own state. l99] A convenient reference is to the Chronicle, State and City Supplement. Raymond, p. 130. Purposes of State Debt. Look up and write out the debt statement of your own state showing the purposes for which bonds were issued. State Credit. Look up and make out statement of quota- tion and compute basis fot bonds of each state. Chronicle quotation supplement. New York — Special provision giving different basis for different issues. Especially explain New York quotations. (The quotations given represent prices in the fall of 1916). Basis N. Y. 3s I9S9, 99f 3.00 N. Y. 4s 1961, losf 3.7s N. Y. 4|s 1963, list 3-8o t (When held as capital, surplus, etc., of sav- ings bank, trust company, insurance com- pany, 1% on par of 3s held and |% on par of 4s deducted from tax. Tax law 1903). Explain Virginia quotations (the quota- tions given represent prices in the fall of 1916). 6% deferred certfs. 1871 Brown Bros. Certfs. S3.2 Basis 3s Riddlebergers 1932, 91J 3.72 3s 1991, 83 3.70 [100] Develop history and present standing of Virginia-West Virginia controversy. Chamberlain, 384, note, et seq. Raymond, 114-118. 220 U. S. I. (Supreme Court Reports.) 238 U. S. 202. (Supreme Court Reports.) [lOl] TOPIC VI Municipal Bonds Chamberlain, 159-225. Raymond, 140-161. This reading for two topics, VI and VII. Write out quotations and compute yields for municipal bonds of ten municipalities, of essentially different populations and in dif- ferent states. Chronicle quotation supple- ment. Look up quotations and yields in a consider- able list of representative municipals — large and small municipalities and variously distrib- uted geographically. Willingness to pay: Compulsion can be brought to bear. New England — execution. Generally — mandamus. Classes of Municipals: County. City. [102] Town. Districts: School. Park. Sewer, etc. Levee. Drainage. Irrigation. Why municipalities borrow (long term) money : To equalize burden of expenditures. There is a theory that a municipality should not be in debt because non-productive. But the debt may be very essentially productive. The dollar the citizen does not have to give up in taxes he can use in his own business. But the way public business is conducted requires special restrictions. It should be hedged in by conservative principles because of the small personal responsibility. The individual goes broke in his own business if he isn't sound. But if the community is unsound in its business no particular in- dividual suffers a sufficiently severe penalty to make the penalty a sufficient deterrent. [103] TOPIC VII The Municipal Statement and Significance of the Items in It Reading as for Topic VI. Chamberlain, 159-225. Raymond, 140-161. Ability to pay. MUNICIPAL STATEMENT CITY OF R Total Bonded Debt . $20,747,475 Water Debt .... $^,^26,000 Sinking fund .... 1,488,244 10,414,244 Net Debt .... $10,333,231 Assessed Valuation Real Estate . . . $215,285,489 (assessment Personal .... 26,661,470 about actual value) $241,946,959 Tax Rate $19.73 per $1,000 Population 248,465 Look up and write out the statement for one municip- ality. See Chronicle, State and City supplement. Nature of municipal assets. Revenue-producing assets. [104] Sinking funds. Debt ratio. Assessed valuations. Why in this country not generally up to actual value? The tax rate of one municipality should be read in connection with the total rate including the county and state rate. A rate may be high, not only because of a low assessment but because the municipality is making im- provements out of taxes instead of issuing bonds, or it may be reducing its debt by meet- ing the maturity of bonds without refunding. Lyon, "Principles of Taxation," 92-93. Tax rate. Its relations to assessed valuation. Debt limitations. Undoubtedly the existence of an absolute tax limit adversely and seriously affects the credit of municipalities which are so limited. The Ontario situation in which the munici- pality may not create further debt if the tax rate exceeds a limited amount is a debt rather than a tax limitation. Look up and write out the debt limitation for your own state. [losl TOPIC VIII Term of Municipal Bonds; Sinking Fund vs. Serial Maturity; Savings Bank Tests for Municipal Credit Chamberlain, 230, Sec. 667; 213-220. Raymond, 142-151. Term of municipal bonds : Massachusetts method of limiting the term by statutory requirement setting out the term permitted in accordance with the probable life of the improvement for which issued. Canadian requirement of engineers' cer- tificate setting forth the probable life of the improvement. The by-law authorizing the bonds must limit their term accordingly. Serial maturity vs. sinking fund. The uncertain value, as shown by experi- ence, of the municipal sinking fund. If available, the special report of the New Hampshire Tax Commission for 191 6 on Mu- nicipal Finances makes a very clear statement of the difficulties of the municipal sinking fund. [106] The conditions stated are probably representa- tive rather than peculiar. General reference may be made also to the reports of the New Jersey Commission for the Survey of Municipal Financing which may be available in the bond houses. Savings bank tests for municipal credit. Look up the tests for municipal credit applied by the savings bank laws of New York, Massa- chusetts, and Connecticut. Keep in mind that these represent very severe tests, and see the reference to these tests under Topic XXV. Select five municipalities, the population of which is up to the requirements of the savings bank investment law of New York, Massa- chusetts, or Connecticut, and apply the tests of one of those laws to see if the bonds of the municipalities are legal savings bank invest- ments for that state. If any of them are not indicate what test bars them out. [107] TOPIC IX Authorization, Issuance, Sale, and Validity of Municipal Bonds Chamberlain, 225-242. Authorization of Municipal Bonds. State constitutional limitations and au- thority under legislative act, authorizing and prescribing methods of issuance. Vote of electors sometimes required. Vote of municipal administrative body (as city council) sometimes sufficient. Municipality selling bonds. There follows a form of request for informa- tion about a proposed issue of bonds by a mu- nicipality sent by a bond house to a municipal- ity. MUNICIPAL BOND STATEMENT OF BROWN, JONES & CO. Amount to be sold Per cent? Purpose of issue Date and hour of sale Sealed bids or auction? [io8] Bonds to be dated 191 To mature Oi)tional? Principal where payable ? Interest payable when? where? Law issued under Denomination ? Are bonds tax exempt ? where ? May bonds be registered as to principal? interest?. . Any deposits required ? Assessed valuation, real and personal property, for 191 $ True value (estimated) taxable property . . .$ Total bonded debt, including this issue $ Floating debt $ Amount of bonds outstanding (included in above) issued for Water Works, owned by City $ Sinking fund held against Water Bonds $ Sinking fund held against other bonds $ Population State or U. S. Census, 191 Population estimated 191 Private Sale — sometimes not permitted by legislative act. Public Sale. Advertising for bids. All or none bidders. Awarding the bonds. Bid price must be par or better, European practice not so. There is perhaps the beginning of a willing- ness with us to permit municipal bonds to be [109] sold at a discount. Minnesota, for example, permits it under some circumstances. See Fischer, "Selling Over the Counter" — In- vestment Bankers Association Annual Re- port, 1 91 3. There is an interesting Dutch method by which all bonds are allotted at the lowest bid accepted. Those who bid higher than the lowest bid are given full allotments at the lowest price. This seems equitable. All get their bonds at one price and one purchaser has no advantage over another in re-selling. Reasons for holding municipal bonds invalid: 1. The legislative act relied on held uncon- stitutional. 2. Exceeding limit of indebtedness. 3 . Lack of statutory authority. 4. Statutory requirements for proceedings not complied with. Validating Acts. (It should be said in con- nection with validating acts that they cannot override constitutional provisions, and that a complicated procedure leading to delays in operation may make them something of a nui- sance.) Georgia has a validating act. Opinion of Attorneys General as to legality, Texas and Oklahoma. [no] Certification of bonds for genuineness of signature and as within the limits authorized. Done by certain trust companies. By state of Massachusetts for municipal notes. [Ill] TOPIC X General Considerations of Municipal Credit; Municipal Bonds and Taxation; Special Markets for Municipals; Municipal Repudiation Chamberlain, 173-179, 237. Raymond, 152-153, 159. Chamberlain, Sections 699, 704, 705, 707. Wrightington & Rollins, "Tax Exempt and Tax- able Investment Securities." (At the moment of writing out of print, but may be republished by Financial Publishing Co., Boston.) Municipal repudiation. Chamberlain, 173, 179. Raymond, 152-153. Examples. Causes. Results in credit. General considerations of municipal credit. Chamberlain, 237. Raymond, 152-153, 159. [112] Character of population. Record of good faith. Location, prosperity, and probable future growth of the community. Municipal bonds and taxation. Chamberlain, Sections 699, 704, 705, 707. Exemption from state and local taxation. Exemption from Federal income tax. Income from municipal bonds is not subject to either the normal tax or the surtax, and does not have to be reported. Reasons for exemption from Federal income tax. Federal government has no constitutional right to tax an agency of a state government. Are the municipal bonds of your own state subject to taxation in the state? Look up in State and City supplement in the "Chronicle." Special markets for municipals: Savings banks. Trustees. Postal savings funds. Rich investors (to avoid taxation). t"3] TOPIC XI Tax Districts; the Problems of Overlapping Debt Areas; Special Assessment Bonds Chamberlain, pages 243-251, 205-211. Chamberlain, sections 48^3, yzz-jzS, 532, 576. Overlapping government areas and the prob- lems of total debt against given values. Chamberlain, 205-211. Tax Districts. Chamberlain, 243-251. As a means of escaping debt limitations. A special report of the New Hampshire Tax Commission in 1916 on Municipal Finances presents a good discussion of the general topic. Practice work — ^Take a given municipal area, as a county, and compute the total debt per- centage of the values, taking all the debt for which the values are liable. Allot to the area a part of the state debt in the pro- portion of the state valuation to the valua- tion of the area taken. State and City sup- plement of the "Chronicle" will furnish the material. [114] Special assessment bonds. Chamberlain, Sections 483, 722-726, 532, 575. Reasons for issuing special assessment bonds. True special assessment bonds — i. e., which have a claim only against the abutting property. Municipal special assessment bonds, i. e., bonds which are a general obligation of the municipality, but for which the municipality holds the abutting property liable. Special assessment bonds are not taxed under the Federal Income Tax. Practice work — Examine the debt of a muni- cipality of 250,cxx> inhabitants or over and make out a list of the various purposes for which the municipality has incurred bonded debt. State and City Supplement,"Chronicle. " I "Si TOPIC XII Buying and Selling Securities 'You and Your Broker," 35-58. Buying a bond: The order — to salesman or by mail or in person over the counter. Where delivered — at bank — but may even be brought around personally by salesman. How delivered: Shipped by express, or Registered mail insured. Express company an insurer. How insured if mailed. Draft attached : (Just like the shipment of any goods ex- cept that here the goods themselves are at- tached to the draft instead of a bill of lading which it is necessary to have in order to get delivery of the goods.) Computation of prices: Sold at a price and accrued interest. [116] Sale and transfer of bonds. Registered. Coupon. Business of safe deposit company. Inheritance tax — notice to comptroller, but New York case, Appellate Division, has said that securities in safe deposit box are not in custody of safe deposit company. The practice of giving notice nevertheless continues. l"7l TOPIC XIII Real Estate Mortgages as Investments Chamberlain, 46-61. Though the bond man himself is not dealing in real estate mortgages, they constitute a com- petitive investment, and he should know some- thing about them. The real estate mortgage as an investment. Our land capital financed by borrowing just the same as any other capital. Nature of a mortgage as security. Rights under — reviewed by reading ordinary form of mortgage. Gerstenherg, " Materials of Corporation Finance," 176. Form of Mortgage: Consideration. Description (location). Granting clause. Defeasance clause. [118] Right of sale on default (foreclosure). Covenant to keep insured. Principal due on default in interest. Further assurance — to execute any further instruments, etc. Right of entry on default, and to apply in- come to payment of debt. Right to receive on default. Right of mortgagee to pay taxes and cov- enant of mortgagor to repay. (Usual provision in New York City mortgages that the mortgage becomes due on any change in the tax law af- fecting it.) Equities — Savings bank and trustee require- ments for State and City Supplement, "Chroni- cle." ["9l TOPIC XIV Investing in City Mortgages Practical Real Estate Methods. Read the follow- ing chapters: Mortgage loans on real estate. Margins on mortgage loans. Building loans. The city mortgage: Business building. Dwelling. Vacant lots. Appraisals: Correct appraisals based on actual selling price, not on capitalized earnings. Who makes — reliability of. Buyer selects own appraiser or insists on one he knows. What proportion of value in land and in building makes the best basis for security? Rates of income. [120] Application for loan. Putting through transaction. Investigation of physical security dis- cussed in previous topic. Personal obligor. (Generally not much regarded in New York but may become important.) Title: Title guarantees in New York and some other places. Fees for New York County first examina- tion $65, plus $$ for each $1,000, up to $40,000. Then $2.50 a $1,000. Reissue title insurance, New York County: $32.50, plus $5 a $1,000, plus $2.50 per $1,000 for over $40,000. Of course these figures quoted by a New York company for New York County on a certain date are given merely as an approximate indication of this business. Disbursements : Title search or insurance. Appraisal fee. Survey fee. Recording tax. Drawing up documents. Brokers fee 1% and up, [121] Lending on new mortgage: Purchase money. New loan. Builder's mortgage. (Advanced as building goes up.) Insurance: Taxes and tax liens. Taking mortgage by assignment. (Cove- nant that there is due and owing the stated sum.) Form of Assignment. Sale of property subject to mortgage. (Does not release original obligor but puts him in the position of guarantor, but mort- gagee may, if he wishes, release original obligor. Work of the mortgage broker: How he finds borrowers. How he finds lenders. Who does the work: Brokers. Mortgage companies. The real estate and trust fund law firms. The amortized mortgage running for longer time. [122] Mortgage bonds — collateral mortgages. Mortgage bonds — on single buildings. The guaranteed mortgage, |% for guarantee and care. A form follows, showing elements to be considered in making a mortgage investment. APPLICATION FOR LOAN ON BUSINESS PROPERTY Robert Jones applies to the City Savings Bank for a loan secured by first mortgage on property described be- low: First mortgage — $42,000 at S% for three years Obligation — Robert Jones Location — Worcesterfield, N. Y., 107 Main Street Dimensions of lot — 62.3' x 121 feet Dimensions of building — 62.3' x 85 (about) — Stories — one story; Walls for three stories Condition of building— Good, Building materials — -Brick Present use — Stores — all rented. Annual rent — $5,000. Owner's value $65,000 Assessed value, 1916, Land $50,000 Building 9,000 $59,000 [123] TOPIC XV Farm Mortgages and Land Bank Securities Robins, "The Farm Mortgage Handbook." The Federal Farm Loan Act, 64th Congress, 1916. The Federal Government had some interest- ing material prepared while farm loan legis- lation was under consideration, especially: Thompson, C. W., "Factors Affecting Interest Rates and Other Charges on Short Time Farm Loans." Thompson, C. W., "Costs and Sources of Farm Mortgage Loans in the United States." Farm Mortgages. Rural credits legislation, federal and state. Rates. Who invest in: Insurance companies. Savings banks (Vermont). Farm mortgage association. Farm mortgage bankers and their meth- ods. [124] The following chapter headings from Mr. Robins's book indicate the scope of the subject. This little bbok may very profitably be read through. It is ex-parte, giving a view of the subject by a dealer in the security, but an ex- cellent statement. Rural credits. The negotiation of farm mortgages. The marketing of farm mortgages. Investors in farm mortgages and the record of the farm mortgage as an investment. The qualities of a farm mortgage as an invest- ment. Essential differences between mortgages on farms and mortgages on urban real estate. ["Si SECTION II INVESTING IN CORPORATION SECURITIES For information about corporations and their securities, constant reference should be made to such reference books as : Poor's Manuals. Corporation Service Manual. Moody's Analyses. Manual of Statistics. Commercial & Financial Chronicle, Weekly and Special Supplements. For quotations: Quotation Supplement, Commercial and Financial Chronicle. Quotation record in the weekly Com- mercial and Financial Chronicle. [127] TOPIC XVI General Investment Considerations of Cor- poration Securities Chamberlain, 69-1 14. Nature of business : Is it a fixed capital or non-fixed capital business; i. Robins — The Farm Mortgage Handbook. By Kingman Nott Robins. New York. 1916. Doubleday, Page & Co., $1.25. Secrist — Bulletin of the University of Wisconsin No. 637, Economics and Political Science, Series Vol. 8, No. i. "An Economical Analysis of Constitutional Re- strictions upon Public Indebtedness in the United States." By Horace Secrist, University of Wis- consin. 1914. 40 cents. Sprague — The Accountancy of Investment. By the late Charles E. Sprague, C. P. A. Revised by Leroy L. Perrine, C. P. A. Third Edition, 1914. New York, Ronald Press Co., $soo- Stocks and the Stock Market. Annals of the American Academy of Political and Social Science. Philadelphia. 1910, ^1.50. Thompson — Costs and Sources of Farm Mortgage Loans in the United States. By C. W. Thompson. Wash- ington. 1916. Apply Bureau of Prmting. [169] Thompson — Factors Affecting Interest Rates and Other Charges on Short Time Loans. By C. W. Thomp- son. Washington. 1916. Apply Bureau of Printing. Various Authors — Bonds as Investment Securities. American Academy of Political and Social Science. 1907. ^i.jo. Various Authors— Prartica/ Real Estate Methods. Thirty chapters written by different authors. New York. 1914. Doubleday, Page & Co., $2.50. "Various Authors — You and Your Broker, Magazine of Wall Street. New York. 1917. $1.00. Wolfe — The Examination of Insurance Companies. By S. Herbert Wolfe. New York. 1910. The In- surance Press, $3.00. ZarTman — The Investment of Life Insurance Companies. By L. W. Zartman. 1906. New York. Henry Holt & Co., $1.50. The Philadelphia Commercial Museum main- tains a financial department open to subscribers, from which they may obtain financial informa- tion. [170] THE COTJNTBT LIFE FBEBS OABDEN CITT, M. T. f^4 tjist."" -' .'^i