6) Debt Capital Markets

Question 1

how can a company raise funds without diluting ownership

Answer 1

debt

Question 2

what is the benefit of equity ownership vs debt ownership

Answer 2

equity ownership: no interest payments
debt ownership: no dilution of ownershp

Question 3

how do small and medium sized company raise debt

Answer 3

borrow from commercial banks

Question 4

what can larger companies due to raise debt

Answer 4

issue bonds

Question 5

what are bonds

Answer 5

investors lend money to borrower (company), and charges an interest rate until borrower repays money

Question 6

what are the four types of bonds

Answer 6

1) fixed rate bonds
2) floating rate bonds
3) equity related bonds
4) asset backed securities

Question 7

what are fixed interest rate bonds

Answer 7

pre determined rate of return, interest rate is fixed across life of bonds (typical maturity is 5/10/20 years)

Question 8

what are floating rate bonds

Answer 8

moves across lifespan and are variable (federal interest rate +3%)

Question 9

what are equity related bonds

Answer 9

bonds that pay interest and can be converted to equity

Question 10

what are asset backed securities

Answer 10

different assets added to SPV (Special purpose vehicle), cash flows from assets used to repay bond owners and used as collateral

Question 11

why do large coporatiions prefer bond finances instead of bank loans

Answer 11

bonds interest rate are cheaper than bank loan interest rate

issuing bond is less restrictive than bank loans

Question 12

why would smaller firms prefer bank loans over bond financing

Answer 12

scale helps reduce the magnitude of fixed costs, small and large firms face the same fixed costs with bond financing

bond loans are also sizeable, 100 millions

Question 13

drawbacks with bond financing

Answer 13

1) it is difficult to deal with too many investors
2) complexity

Question 14

what are the there types of fees with bond offerings

Answer 14

management, underwriting and selling (same as equity offering)

Question 15

are bonds or equity easier to price and why

Answer 15

bonds, investors take comfort in credit rating industries

Question 16

do banks get paid more fore equity or debt offering

Answer 16

equity, debt financing is easier

Question 17

are debt or equity financing faster

Answer 17

debt

Question 18

how fast is debt financing

Answer 18

25-35 days

Question 19

explain the bond issuance process

Answer 19

1) hire an advisor (Investment bank) to be book runner

2) banks contact other banks to form a syndicate

3) hire a credit rating agency, credit rating assigned, sometimes hires multiple agencies

4) contact investors for provisional conditions

5) bookbinding process (how much to buy at what price)

6) banks underwrite and sell

Question 20

what are junk/high yield bonds

Answer 20

debt securities of lower quality (lower probability of repaying)

Question 21

how do lenders compensate for high risk borrowers

Answer 21

sky high interest rates

Question 22

what does it mean for the economy if investments in junk bonds decrease

Answer 22

recession incoming

Question 23

what is a securitization

Answer 23

group of loans/receivables grouped together in an SPV

Question 24

how do financial authorities regulate a banks capital

Answer 24

financial authorities ask banks to maintain a specific capital adequacy ratio

Question 25

how do you calculate capital adequacy ratio

Answer 25

(tier 1 capital + tier 2 capital) / risk weighted assets

Question 26

how do you improve capital adequacy ratio

Answer 26

raise capital, decrease risk weighted assets

Question 27

what is the issue with banks raising capital

Answer 27

costly, reduces ROE for existing shareholders

Question 28

what is the issue with banks decreasing risk weighted assets

Answer 28

gives fewer loans, restricting business

Question 29

what is the best way to reduce risk weighted assets

Answer 29

securitization

Question 30

what are syndicated loans

Answer 30

loans granted by group of banks (syndicate)

Question 31

why do syndicated loans exist

Answer 31

1) some loans are too big/too much exposure
2) banks receive commissions
3) diversification

Question 32

what is project finance

Answer 32

financing specific project, not full company

Question 33

what is the risk with project finance

Answer 33

cash flows generated by project are the only guarantee lenders have

Question 34

what is a positive covenant

Answer 34

behaviour required

Question 35

what is negative covenant

Answer 35

prohibited behaviour

Question 36

financial covenant

Answer 36

ratio that needs to be maintained

Question 37

what happens if project finance defaults

Answer 37

bank cannot seize other assets from company

Question 38

benefits from project finance

Answer 38

initiative stays off balance sheet, formal life occurs within confines of SPV

Question 39

EPC contract

Answer 39

engineering, procurement and construction contract eliminates operational risk of construction, assigning it to contractor

Question 40

What is the main advantage of bond financing compared to bank financing?

Answer 40

pricing