8) What is the difference between stocks and bonds?

Stocks, or shares of stock, represent an ownership interest in a corporation. Bonds are a form of long-term debt in which the issuing corporation promises to pay the principal amount at a specific date.

Stocks pay dividends to the owners, but only if the corporation declares a dividend. Dividends are a distribution of a corporation’s profits. Bonds pay interest to the bondholders. Generally, the bond contract requires that a fixed interest payment be made every six months.

Every corporation has common stock. Some corporations issue preferred stock in addition to its common stock. Many corporations do not issue bonds.

The stocks and bonds issued by the largest corporations are often traded on stock and bond exchanges. Stocks and bonds of smaller corporations are often held by investors and are never traded on an exchange.

9) Does the income statement explain the change in the equity section of a balance sheet?

The income statement could explain the change in the equity section of a balance sheet. However, there are likely to be some other explanations as well.

Here is a list of the items that would cause an increase in the total amount of a corporation’s stockholders’ equity:

1. Positive net earnings or net income reported on the corporation’s income statement.

2. Some positive Other Comprehensive income items occurred but they are not to be reported on the income statement.

3. Additional shares of stock were issued in exchange for cash or other assets.

4. Donated capital was received.

Here is a list of items that could cause a decrease in the total amount of a corporation’s stockholders’ equity:

1. Negative net earnings or a net loss reported on the corporation’s income statement.

2. Some negative Other Comprehensive Income items occurred but they are not to be reported the income statement.

3. The corporation declared cash dividends.

To see all of the explanations for the change in the equity section of a balance sheet, you should review the statement of stockholders’ equity. This financial statement should be issued along with a corporation’s balance sheet, income statement, and statement of cash flows.

10) What is preferred stock?

Preferred stock is a type of capital stock issued by some corporations. Preferred stock is also known as preference stock.

The word “preferred” refers to the dividends paid by the corporation. Each year, the holders of the preferred stock are to receive their dividends before the common stockholders are to receive any dividend. In exchange for this preferential treatment for dividends, the preferred stockholders (or shareholders) generally will never receive more than the stated dividend. For example, the holder of 100 shares of a corporation’s 8% $100 par preferred stock will receive annual dividends of $800 (8% X $100 = $8 per share X 100 shares) before the common stockholders are allowed to receive any cash dividends for the year. Unless the preferred stock has a participating feature, this preferred stockholder will never receive more than $8 per share no matter how successful the corporation becomes.

The features of preferred stocks can vary. Examples include cumulative, convertible, callable, participating, and more.

Since the dividend on preferred stock is usually a fixed amount forever, once the preferred stock is issued its market value is likely to move in the opposite direction of inflation. The higher the rate of inflation, the less valuable is the fixed dividend amount. If the inflation rate declines, the value of the preferred stock is likely to increase, but no higher than the stock’s call price.

Most corporations do not issue preferred stock. Typically, corporations will issue only common stock and use debt.