CHAPTER 7 DEBT CAPITAL is the capital that a business raises by taking out a loan It is a loan made to a company that is normally repaid at some future date Funds from a Lender Characteristics INTEREST PRINCIPAL DEBTOR REPAYMENT SYNDICATE LOAN Group of institutions lending money Still one source Generally 3 5yr Loans Usually contain MORE terms you have to adhere to covenants than bonds BOTH Qualitative and Quantitative Ratios 1 Revolving Credit Loan like a corporate credit card funds can be borrowed and repaid multiple times over the term of the loan No monthly payment instead payments are only made on the funds withdrawn from the credit account For liquidity or Short term Financing For example if you have a credit card with a credit limit of 1 500 and you make apurchase of 400 the amount of credit you have available is 1 100 But when yourepay the 400 your credit limit goe s back to 1 500 assuming you haven t chargedanything else on the card 2 Swingline Loan 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 For Liquidity purposes short term financing or paying off other debts or loans A Loan that grants institutions to large amounts of cash in order to cover possible shortfalls from debt 3 Term Loan Amortizing loan with usually quarterly negotiated amounts of principal repayment over the life of the loan Usually used for funding a project or Acquisition EQUAL Payments and SET dates Securitized Loans Securitizations Bank loans where some assets of the company are legally transferred to an entity that will change ownership from company to lender if a predefined trigger occurs Very low interest rates because of this guarantee of repayment The assets are usually very liquid ones accounts receivable or finished goods inventories so the lender can be assured of quick repayment even under the worst circumstances Require much detailed documentation reporting and therefore legal administrative costs to set up Function as a revolving credit facility can borrow and repay multiple times through life Usually short term 1 3 years with higher rates the longer the term Are frequently renewed so they continue for long periods of time even though the current term is short BENEFITS GAURANTEE OF REPAYMENT Leasing A form of financing where the creditor legally owns the asset purchased Potentially lower interest rates because asset ownership gives the lender benefit of a tax depreciation adjustment to their earnings Generally structured as TERM LOANS with even payments and a residual balance at the end of the lease life less than 100 amortized over the life of the lease The legal agreement specifies end of lease asset ownership options return assets to lender or buy them at the end BENEFITS Not long term equipment Can upgrade Technology if cash flows are tight protects your balance sheet Not a debt but an EXPENSE TERMS OF BONDS a INDENTURE The written agreement between the corporation and the lender detailing the terms of the debt issuer Who s borrowing rate terms etc b PAR VALUE FACE AMOUNT the amount paid to a bondholder at the maturity date given the issuer doesn t default Market Value Par Value Premium Market Value Par Value Discount c COUPON the stated interest payment made on a bond d COUPON RATE the annual coupon divided by the face value of a bond Annual Coupon Dividend e SECURITY collateral and mortgages associated with loans used to protect the Face Value bondholder f PROTECTIVE COVENANTS A part of the indenture limiting certain actions that might be taken during the term of the loan usually to protect the lender s interest Positive Covenants Thou shall Negative Covenants Thou shall not g SENIORITY a security that ranks above another security in the event of the company s bankruptcy or liquidation Should the company go bankrupt or face another liquidating event holders of the SENIOR MOST SECURITY will be in line to receive repayment of their invested MONIES FIRST before other creditors receive any payment Debt Equity Secured Unsecured Preferred Common h SINKING FUND account managed by the bond trustee for the purpose of repaying bonds or to fund a future capital expense Usually for buying back bonds or calling in a fraction of outstanding bonds i CALL PROVISION An agreement giving the corporation the option to retire and repurchase a bond at a specified price prior to maturity Usually has a higher yield than non callable j PUT PROVISION A condition that allows a bondholder to resell a bond back to the ISSUER at a price which is generally par on certain specified dates prior to maturity A bond with a put provision will generally be priced higher than one without k DEBENTURE An unsecured debt for which no specific collateral or physical assets is pledged usually with a maturity of 10 YEARS OR MORE Backed by general creditworthiness and reputation of issuer Corporations and Governments l NOTE An unsecured debt usually with a maturity UNDER 10 YEARS when the bond is issued Corporate coupons are usually paid TWICE a YEAR w SEMI ANNUAL compounding Public Bonds vs Private Placements Private The sale of securities to a relatively SMALL number of SELECT investors as a way of raising CAPITAL Does not have to be registered with the SEC Public Securities made available for sale on the public market also a way of raising capital Usually have FEW covenants and are going to be pay back In addition no leverage ratios Ratings of Bonds Bond Rating Firms Moody s Standard and Poor s S P and Fitch The debt ratings are an assessment of CREDITWORTHINESS of the corporate issuer The definitions of creditworthiness used by Moody s and S P are based on how likely a firm is to DEFAULT anytime the Indenture is violated and the protection credits have in the event of default Bond ratings are ONLY concerned with the possibility of default Rating firms don t always have the same rating of a firm Split Rating Best quality bonds and have LOWEST DEGREE OF RISK INVESTMENT GRADE Low quality bonds and have ASSOCIATED RISK SPECULATION GRADE TREASURY NOTES backed by the FED MUNICIPAL BONDS are issued by LOCAL GOVS SOVEREIGN BONDS A debt security issued by a national government foreign within a given country and denominated in a foreign currency The foreign currency used will most likely be a hard currency and may represent significantly MORE RISK to the bondholder ZERO COUPON BOND A debt security
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