Contract Equity: Everything You Need to Know
Contract equity refers to a convertible bond that the owner is able to exchange for common stock when the bond reaches maturity.3 min read
Updated November 24, 2020:
Contract equity refers to a convertible bond with either a mandatory conversion or mandatory redemption feature that the owner is able to exchange for common stock when the bond reaches maturity. The market value of the common stock must match the amount of the equity contract note's principal value. When the equity contract bond owner doesn't want the common stock offered, the note is sold to settle the conversion for the owner, who then receives cash in lieu of the common stock.
Equity Forward Contracts
An equity forward contract is for buying a single stock, a portfolio of stock, or a future-dated stock index. The equity forward on these stocks works in specific ways:
- Individual stock lets the investor make a sale of stock in the future at a price that's guaranteed.
- If the guaranteed price ends up being lower than the market price when the time of the sale arrives, the investor still gets the price that was guaranteed.
- However, if the market price when the time for the sale arrives is higher than the guaranteed price, the stock owner still gets only the guaranteed price and not the higher market value.
- Equity forward contracts on stock portfolios function in the same manner as forward contracts on individual stocks.
- Dealers create a quote for the future price of securities based on a list of the bonds that are held in a portfolio instead of entering a separate contract for each security on a separate basis.
- Forward contracts on stock indexes give managers of portfolios the opportunity to protect a portfolio's value and reduce or completely eliminate the risk of a portfolio that copies a major stock index.
- Rather than contracting for each security, a manager is able to enter a forward contract that allows for selling the index at a preselected future date.
An equity agreement details the way a group of partners in investing divide ownership when a new business is started. The agreement lists how payoffs, profits, responsibilities, and stocks are divided among the partners. These documents are legally binding agreements prepared by an attorney. However, standard agreements can be found online. These agreements can be very simple or extremely complex.
Complex or Simple Equity Agreements
Complex equity agreements typically require the services of a lawyer. An agreement becomes complex when involving multiple partners, unusual or intricate details regarding repaying investors or distributing profits, and even the consideration of employees as investors.
If the list of partners is small, a simple equity agreement is suitable. Simple equity agreements include such details as:
- Company name
- Investor names
- Contract duration
- Amounts invested by each partner
- How funds invested will be used
- Investor returns
- Signature of all involved parties
Why Partnership Equity Agreements Are Necessary
Even if your partner is your best friend, things can quickly dissolve when you start to discuss what you each get for your investment and what each partner has to do as part of the partnership. Asking your partner to sign a partnership agreement doesn't mean you doubt your partner's integrity. It protects your interests. It also details the roles and responsibilities of each partner, as well as the rewards for fulfilling those roles and responsibilities.
Equity and Debt
Debt and equity are two ways to classify the funds that pass between savers and investors. The two main contractual forms a person or company can use for funding are equity and debt. One exception is that governments have only the option to raise funds from debt because only businesses are permitted to raise equity.
- With a debt contract, the lending party provides funds and the borrower repays at a predetermined time along with interest.
- As long as debt contract payments are made promptly, the borrower is able to make all decisions about how to manage the business and assets.
- With an equity contract, the borrower makes payments to the shareholders from the profits earned by the business.
- Shareholders in an equity contract sometimes prefer to reinvest the profits to maximize future returns.
One problem sometimes noted by shareholders with this type of funding is not knowing how the borrower is managing the funds the shareholder has invested.
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