Ch 4 - Long-term finance Flashcards
Loan capital (debt)
-raise money from investors via LC
-in return, co. will pay the investor a stream of interest payments + eventual return of capital (both are specified at the outset)
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LT = corporate bonds, ST= bills
(Issues of LC may be listed on SE)
[Holders of LC are creditors & don’t have voting rights]
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rights of holders of LC will be set out in a loan agreement drawn up when the loan is issues. Trustee normally acts on behalf of LS holders -> legal docs set out obligations of issuing company to loan stock holders = trust deed
Features of LC
-conventional to refer to LC in units of 100 pounds nominal (par value)
-express interest payments as a proportion of the par value
-normal to issue LC at price close to just below par
-almost all LC is redeemed at par
-price of a bond varies with S+D
-inverse relationship between interest rates & bond prices
LC variations
capital repayment, variable rate issues, ILB, stepped bonds, call & put option
Types of Loan Capital
1) Debentures
2) Unsecured loan stocks (ULS)
3) Subordinated debt
4) Eurobond LC
5) Floating-rate notes (FRN)
6) Asset-backed securities
7)Covered bonds
Debenture stocks
def: loans which are secured on some or all assets of the company
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if the company fails to make one of the coupon payments or capital repayment, actions such as the ffg are available:
>appoint a receiver to intercept income from secured assets
>take possession of the secured asset to sell it in order to meet their debt (foreclosure)
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2 types = MORTGAGE (fixed charged)
»_space; specific secured assets mentioned in the legal docs for the debenture
& FLOATING charge
»_space; company can change the secured assets in normal course of business
[crystallising = when a company fails to make interest or capital payment, the debenture holders can apply to the courts to convert the floating to a fixed charge]
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used to raise large amount of funds -> redemption date + fixed rate of interest so that borrower has known debt servicing commitment.
**interest payments are tax deductible
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RISK = payments are a legal obligation & LC holders get paid in full upon winding-up before SH’s
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RETURN= carry the risk that coupon payments or capital repayment may not be made, but stockholders have security in terms of secured assets
[value of all payments - capital & interest - may be eroded by inflation, not readily marketable ->reflected in return]
Unsecured loan stocks (ULS)
there’s no specific security for the loan (if company defaults, LS holders’ only remedy is to sue the co.
>ranks after debenture
>other creditors rank equally with ULS
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RISK=there’s no security for the loan, but payments are a legal obligation
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RETURN=GRY higher than debenture to compensate for poorer marketability & greater risk
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MARKETABILITY= worse than gov bonds (All restrictions & appointment of trustee are found in the trust deed)
Subordinated debt
def: debt over which senior debt takes priority
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in the event of default, ranks below general creditors but ahead of preference & OSH’s. (holds a junior debt & is paid after all senior debt holders are satisfied)
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rating & terms of which it’s issued will reflect the lower level of security
Eurobond LC
form of ULS that is issued outside the legal & tax jurisdiction of any country. It is a bearer document (in order to claim interest- holders must cut out coupons from certificates & send them to co.), paying interest normally once a year. Interest is paid gross and may pay a variable rate of interest, in which case it is known as a FRN.
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normally in Euros’
>trading occurs through banks rather than through S.E
> used to raise large sums ($75m or >)
>key difference between Eurobond & ULS = marketability
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RISK = no security, don’t always place restrictions on issuing company’s future borrowing powers
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RETURN= GRY depends on issuer & issue size. inflation will affect real return achieved
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more MARKETABLE because trading through banks (subject to less regulation & issued with either fixed or FR)
Floating-rate notes (FRN)
medium-term debt securities issued in the Euro market whose interest payments ‘float’ with ST interest rates, possibly with a stipulated minimum rate (interest-rate floor)
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issuer doesn’t need to estimate the likely levels of future inflation & interest rates, and lender doesn’t require an IRP
Asset-backed securities (ABSs)
def: bond secured on a pool of ring-fenced assets (mortgages, credit card debt, car loans, or almost any other type of asset)
»investors are repaid through interest & capital payments made from the pool of assets
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security depends on quality of assets in the pool & investors can claim the assets in the event that ABS defaults
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no claim on the co. itself, only the ring-fenced assets
>typically tranched into bonds with different credit ratings (with different levels of risk & yields)
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gives investor access to lending assets, w/o having to issue their own loans
»credit risk reduced by diversification
(e.g of ABS includes CDOs - Collateralised debt obligations)
Covered bonds
bonds issued by banks or building societies with ring-fenced pools of assets that will repay investors if the issuing institution fail.
>ring-fenced assets continue to be legally owned by issuing banks or building societies unless they fail
Ordinary shares (OS) ‘equities’
def: gives rights to a share of the residual profits of the company, & to the residual value if the company is wound up, together with voting rights & various other rights
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SH are the owners of the business & have rights at meetings in proportion to the # of shares held
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receive dividends from co’s profits ->not a legal obligation, paid at discretion of directors (tax paid first)
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lowest ranking form of finance issued by companies (upon winding-up, they rank after all creditors.
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upside of residual nature is no upper limit on size of residual profits & no upper limits on returns earned as dividends
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almost irredeemable -> no fixed date when company has to repay capital
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all shares have a ‘par’ or ‘nominal’ value
>co’s docs will set out the total nominal value of authorised share capital
>issued SC cannot be > authorised SC
Give some variations of basic ordinary shares
-‘deferred’ shares
-redeemable OS
-non-voting shares
-shares with multiple voting rights
-‘golden’ shares in newly privatised industries
Theory of risk & expected return
Any rational investor making an investment decision will first decide what return they require from a particular investment.
(the riskier the investment, the more return he/she will require)
Describe characteristics (investment) of OS
RISK -> rank last, hence require high return (uncertain & volatile future income stream & capital return when wound-up)
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RETURN -> high, to compensate for high risk. (Initial running yield is low but should increase with inflation & real growth in co’s earnings)»_space; very good over LT (highest among other asset classes)» highly volatile
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MARKETABILITY -> varies with size of co (normally better than LC)
