Loan Stock

What is Loan Stock?

Loan stock refers to the loan, in which borrowers with the portfolio of eligible securities, secure capital, or finance from certain investors with the possession of considerable capital in hand. They are equally ready to enter a contractual agreement to park their funds with the respective borrowers in return for securities.

  • The collaterals used to secure a loan are considered very critical and valuable for the lender. The collateralized stocks are of public sector enterprises listed on the major recognized stock exchanges. These are unencumbered so that they can be easily liquidated in the market.
  • The lender may consider physical ownership of the collateral security during the period of the loan. If the borrower defaults on the loan, the lender will keep the collateralized stock with him. The lender is supposed to return the security to the borrower once they pay the loan amount with interest.
  • The loan stock, as in the case of standard commercial loans, carries a fixed rate of interest. The Loan stock could be secured and an unsecured one. The secured loan stock can also be convertible loan stock provided in the agreement that after a specified period, the or in certain terms and conditions, the loan would convert into equity shares, which base on the predetermined rate.
Loan-Stock

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Source: Loan Stock (wallstreetmojo.com)

The Risks for Lenders and Borrowers in Loan Stocks

Let’s discuss the risks for lenders and borrowers.

For Lenders

The lenders, when issuing loans, stand to lose if the value of collateralized security falls as the market value of security bound to move according to the market factors which are out of control. In such a case, the value of the security offered to secure loans does not guarantee in the long run.

When the value of collateral security falls, then these securities become insufficient to cover the outstanding loan amount. Subsequently, borrower defaults on loan, then lenders stand to experience the losses as the value of the security is not sufficient to cover the value of the issued loan.

For Borrowers

As borrowers keep their respective shares or any other stocks as security to secure the loan amount, the lender stands to benefit from the transaction in case borrower defaults on loan. It increases the chances that the lender will become the owners of the business as they own the required security with voting rights.

It could be a terrible ordeal for business owners if the lenders have entered into the transaction with the sole intention of gaining ownership of the entire business with associated voting rights.

Loan Stock as Business

Many businesses are running and functioning with the only intention of providing finance on loan stock-based transactions. This business helps the borrower to secure finance based on the value of securities and their implied volatilityImplied VolatilityImplied Volatility refers to the metric that is used in order to know the likelihood of the changes in the prices of the given security as per the point of view of the market. It is calculated by putting the market price of the option in the Black-Scholes model.read more and creditworthiness. Business generally calculates LTV in line with banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more when home’s value is being assessed before securing a home mortgage.

Following are the critical points to be noted in case of loan stock:

  • The maximum amount that would be issued with loan stock;
  • The maturity date when the loan would be redeemed;
  • Fixed-rate of interest on the amount of loan to be charged;

Process of Doing Loan Stock Transaction

Advantages of Loan Stock

The different advantages are as follows.

Disadvantages of Loan Stock

The different disadvantages are as follows.

  • Selling stocks to secure new finance means the business is giving up partial business with the lenders, which include the potential share of future earnings and profits. If the business turns positive and doing well as compared to its peers, there are chances that the value of the shares the business will increase further much higher than the value of the loan being borrowed.
  • It is a well-known fact that the shareholders have legal and voting rights, which to some extent, limit the actions of the business in their favor. As the lenders become new shareholders, they are expected to take away some portion of profits that would have otherwise belong to the existing shareholders.

Conclusion

This article has been a guide to what is loan stock and its meaning. Here we discuss the process of doing loan stock transactions and risks for lenders and borrowers. We also discuss the advantages and disadvantages. You can learn more about accounting from the following articles –

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