6) Debt Capital Markets Flashcards
how can a company raise funds without diluting ownership
debt
what is the benefit of equity ownership vs debt ownership
equity ownership: no interest payments
debt ownership: no dilution of ownershp
how do small and medium sized company raise debt
borrow from commercial banks
what can larger companies due to raise debt
issue bonds
what are bonds
investors lend money to borrower (company), and charges an interest rate until borrower repays money
what are the four types of bonds
1) fixed rate bonds
2) floating rate bonds
3) equity related bonds
4) asset backed securities
what are fixed interest rate bonds
pre determined rate of return, interest rate is fixed across life of bonds (typical maturity is 5/10/20 years)
what are floating rate bonds
moves across lifespan and are variable (federal interest rate +3%)
what are equity related bonds
bonds that pay interest and can be converted to equity
what are asset backed securities
different assets added to SPV (Special purpose vehicle), cash flows from assets used to repay bond owners and used as collateral
why do large coporatiions prefer bond finances instead of bank loans
bonds interest rate are cheaper than bank loan interest rate
issuing bond is less restrictive than bank loans
why would smaller firms prefer bank loans over bond financing
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
drawbacks with bond financing
1) it is difficult to deal with too many investors
2) complexity
what are the there types of fees with bond offerings
management, underwriting and selling (same as equity offering)
are bonds or equity easier to price and why
bonds, investors take comfort in credit rating industries
do banks get paid more fore equity or debt offering
equity, debt financing is easier
are debt or equity financing faster
debt
how fast is debt financing
25-35 days
explain the bond issuance process
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
what are junk/high yield bonds
debt securities of lower quality (lower probability of repaying)
how do lenders compensate for high risk borrowers
sky high interest rates
what does it mean for the economy if investments in junk bonds decrease
recession incoming
what is a securitization
group of loans/receivables grouped together in an SPV
how do financial authorities regulate a banks capital
financial authorities ask banks to maintain a specific capital adequacy ratio
how do you calculate capital adequacy ratio
(tier 1 capital + tier 2 capital) / risk weighted assets
how do you improve capital adequacy ratio
raise capital, decrease risk weighted assets
what is the issue with banks raising capital
costly, reduces ROE for existing shareholders
what is the issue with banks decreasing risk weighted assets
gives fewer loans, restricting business
what is the best way to reduce risk weighted assets
securitization
what are syndicated loans
loans granted by group of banks (syndicate)
why do syndicated loans exist
1) some loans are too big/too much exposure
2) banks receive commissions
3) diversification
what is project finance
financing specific project, not full company
what is the risk with project finance
cash flows generated by project are the only guarantee lenders have
what is a positive covenant
behaviour required
what is negative covenant
prohibited behaviour
financial covenant
ratio that needs to be maintained
what happens if project finance defaults
bank cannot seize other assets from company
benefits from project finance
initiative stays off balance sheet, formal life occurs within confines of SPV
EPC contract
engineering, procurement and construction contract eliminates operational risk of construction, assigning it to contractor
What is the main advantage of bond financing compared to bank financing?
pricing
