Loan stock refers to shares of common or preferred stock that are used as collateral to secure a loan from another party. The loan that is secured by the loan stock may also be referred to as a stock loan.
However, in British usage, loan stock often refers to corporate bonds or debentures, which are essentially loans that are subdivided into small units so they can be more easily bought and sold. In this context, loan stock is a type of fixed-income security issued by a company to investors, representing borrowed funds that the company must repay at a later date.
For example, if a company issues £1 million in 5% loan stock, it’s essentially borrowing £1 million from investors, and in return, it promises to pay those investors an annual interest of 5%. The investors hold units of the loan in the form of securities that can be traded on the open market. The company must repay the principal amount of the loan (i.e., £1 million) at a specified maturity date.
It’s important to note that the specific meaning of terms like “loan stock” can vary in different countries and different contexts, so it’s always a good idea to clarify what exactly is being referred to when the term is used.
Example of Loan Stock
Suppose a UK-based company, TechNova Ltd., wants to raise capital for its expansion plans but does not want to dilute its ownership by issuing more common stock. Instead, the company decides to issue loan stock, which is essentially a type of bond.
TechNova Ltd. issues £10 million worth of 10-year loan stock with an annual interest rate (coupon rate) of 5%. This means that TechNova Ltd. is borrowing £10 million from the investors who purchase this loan stock. In return, the company promises to pay these investors an annual interest of 5%, or £500,000 (£10 million * 5%), every year for the next 10 years.
The investors who purchase the loan stock receive the annual interest payments as income. At the end of the 10-year period, TechNova Ltd. is obligated to repay the principal amount of £10 million to the investors. The repayment of the principal is called the redemption of the loan stock.
Note that this loan stock can be traded on the open market, which means investors can buy and sell the loan stock to other investors. The market price of the loan stock may fluctuate based on factors such as the creditworthiness of the company, prevailing interest rates, and the time remaining to redemption.
Keep in mind that loan stock, like other forms of debt, involves risk. If TechNova Ltd. were to run into financial difficulties and fail to make the interest payments or repay the principal, the investors could lose their investment. The specifics of what happens in such a case would depend on the terms of the loan stock and the laws applicable to such situations.