Chapter 7 Finance Exam 2 Study Guide Debt capital Capital a business raises by taking out a loan Normally repaid at a future date o Characteristics of debt include things like fixed payments and required dividends Syndicated loan market loan facilities provided mainly by groups of bank lenders some institutional participation If the loan is secured the company will pledge its general assets or specific ones such as Accounts Receivable etc as security instead of specific collateral 3 5 years in tenor more control These loans usually have more covenants than bonds qualitative quantitative ratios Interest rate usually credit float spread the base market rate o Coupon payments are adjustable adjustments are tied to an interest rate index such as the treasury bill interest rate or the 30 yr treasury bond rate o Typically have put provisions see below o The coupon rate has a floor and ceiling and can be capped Three general forms all have covenants o Revolving Credit Facility like a corporate credit card Funds can be borrowed and repaid multiple times over the term of the loan For the lowest interest rates to be effective there must be a 2 day notice in order for borrowing to occur Daily liquidity or for later projects o Swingline Facility usually embedded within a revolving credit facility A small subset of the total dollar limit of the revolving facility may be borrowed and repaid on the same day as notice is given o Term Loan Amortizing loan with usually quarterly negotiated amounts of principal repayment over the life of the loan Securitized Loans o Very safe for lenders they will either get or the pledged collateral and very short term Low interest rates because of the level of safety o Usually short term 1 3 years with higher rates for longer terms Loans are renewed often so they last a long time even though the term is short Some assets of the company are legally transferred to an entity that will change ownership from the company to the lender if they default o The bank will do a thorough inspection of the assets before you are approved o Assets pledged are typically very liquid such as Accts Receivable or finished goods so if the company defaults the lender will be paid quickly A lot of documentation is required so there are legal administrative I T costs to set up o These reports are redone every month while loan is outstanding Function as a revolving credit facility can borrow and repay multiple times Leasing a form of financing where the creditor legally owns the asset Potentially lower interest rates asset ownership by creditor gives the lender the benefit of a tax depreciation adjustment to their earnings Usually structured as amortizing loans o Even payments and a residual balance remains at the end of the lease life o Less than 100 of the amount is amortized over the life of the lease The legal agreement specifies end of lease asset ownership options o return assets to lender or buy them at the end for a typically low price Public Bonds issued by corporations funded by pensions mutual funds financial inst 401K etc Debt can be very highly structured there are a lot of lenders but they are disconnected from the borrower Usually a minimum of 250 million per issue Registered vs Bearer o All corporate bonds are registered with the IRS o Bearer bonds are private with the only proof of ownership being your certificate of ownership You must claim interest The downside is that if someone takes your certificate they can claim to own the bond and take interest Mortgage securities mortgages are secured by real property Collateralized bonds asset backed securities like mortgage backed securities o Usually issued by a financial institution rather than a corporation Debenture completely unsecured o Can have a maturity date 10 years Notes have a maturity date of 10 years Seniority senior bonds are 1st in line to get paid o Subordinated bonds are 2nd in line higher interest due to higher risk o Junior bonds are last in line Indenture legal document explaining the bond s characteristics like face amount security etc o Coupons the regular interest payments o Coupon rate stated rate for the bond s interest paid 2x per year Annual coupon face value coupon rate Compounding period is semi annual However interest is given as an annual quote To make it semi annual Divide the Coupon 2 Multiply the number of Years 2 Example A 1 000 bond with an 8 coupon rate is maturing in 10 years If the quoted YTM is 10 what is the bond price Bond value 40 1 1 1 05 20 05 1 000 1 05 20 Bond value 498 49 376 89 875 38 o Face amount same as par value It is the principal amount of the bond that will be repaid at the end Par value typically 1000 for corporate bonds o Maturity the number of years until the face value of the bond is paid bacl o Security secured bonds are backed by pledged assets unsecured bonds are not o Repayment arrangements for interest and principal amounts are also in the indenture o Sinking fund the lender will deposit some money into an account to prepare to repay the principal amount of the bond Usually only low credit quality companies that are more likely to default do this o Protective covenants same as term loan there are many provisions to comply with usually less in bonds than loans If you are defaulting you need a waiver from your creditor o Call provision a bond can be called to retire early at the issuer s discretion usually at a certain date for a higher price stated in the indenture Call premium a callable bond will have a higher interest rate o Put provision a condition that allows a bondholder to resell a bond back to the issuer at a price generally par on certain stipulated dates prior to maturity Adds security for the bond holder Public Bonds A bond issued by a U S government sponsored agency o Backed by the U S government but not guaranteed by the government agencies are private entities o Set up in order to allow certain groups of people to access low cost financing especially students and first time home buyers Private Placements Private placement provides funding through direct negotiation with one or a select number of private financial institutions The private financial institution is effectively providing a loan to the issuer that must be repaid over time o Private placement bonds are not publicly issued or publicly traded and typically do not require a rating from a credit rating agency Sovereign Bonds issued by a national government within a given country denominated
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