Ch. 9 Long-term Liabilities Flashcards
Debt financing
Obtaining additional funding from lenders
- referrers to borrowing money (liabilities)
- A debt capital structure would have a higher portion of liabilities relative to stockholders’ equity
- Choosing to borrow money rather than issue additional stock is beneficial for tax purposes. Interest expense incurred when borrowing money is tax-deductible, whereas dividends paid to stockholders are not tax-deductible. (because dividends are not an expense)
Equity financing
Obtaining additional funding from stockholders.
-An equity capital structure would have fewer liabilities than stockholders’ equity
Capital structure
The mixture of liabilities and stockholders’ equity in a business.
-debt financing and equity financing
Bond
A formal debt instrument that obligates the borrower to repay a stated amount, referred to as the principal or face amount, at a specified maturity date.
-Bonds are the most common form of corporate debt.
-The borrower also agrees to pay interest over the life of the bond
-Bonds are very similar to notes. bonds, though, usually are issued to many lenders, while notes most often are issued to a single lender such as a bank.
-Traditionally, interest on bonds is paid twice a year (semiannually) on designated interest dates, beginning 6 months after the original bond issue date.
-For most large corporations, bonds are sold or UNDERWRITTEN, by investment houses.
-Other costs for the borrower: underwriting services, legal, accounting, registration, and printing.
-A bond issue, in effect, breaks down a large debt into manageable parts–usually $1,000 units.
-A bond can be:
Secured or Unsecured
Term or Serial
Callable or Convertible
Private placement
Sale of debt securities directly to a single investor. (large investment fund or an insurance company)
-keep costs down. Issue costs for private placements are lower because these bonds are not subject to the costly and lengthy process of registering with the SEC that is required of all public offerings.
Bond indenture
A contract between a firm issuing bonds and the corporations or individuals who purchase the bonds.
-The bond indenture is held by a trustee, usually a commercial bank or other financial institution to represent the rights of the bondholders.
Secured bonds
Bonds that are supported by specific assets pledged as collateral.
- Collateral: something pledge as security for repayment of a loan, to be forfeited in the event of a default.
- However, most bonds are unsecured.
Unsecured bonds
Bonds that are not supported by specific assets pledged as collateral.
- Also referred to as debentures
- These bonds are secured only y the “full faith and credit” of the borrower.
Term bonds
Bonds that require payment of the full principal amount of the bond at a single maturity date. (the end of the loan term)
-Most bonds have this characteristic.
Sinking fund
An investment fund used to set aside money to be used to pay debts as they come due.
Serial bonds
Bonds that require payment of the principal amount of the bond over a series or maturity dates.
Callable bonds
A bonds feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price.
- The call price is stated in the bond contract and usually exceeds the bond’s face amount
- A call feature helps protect the borrower against future decreases in interest rates.
- can also be called redeemable
- can happen if company issues 10% bonds but market interest rates have dropped to 6%, but your still obligated to pay 10%
- If interest rates decline, the borrower can buy back the high-interest-rate bonds at a fixed price and issue new bonds at the new, lower interest rate.
- more common than convertible bonds.
- Designed to benefit the borrower
Convertible bonds
A bond feature that allows the lender (or investor) to convert each bond into a specified number of shares of common stock.
- Designed to benefit both lender and borrower
- (ie: $1,000 convertible bond can be converted into 20 shares of common stock)
- Convertible bondholders benefit if the market price of the common stock goes above $50 per share (=$1,000 / 20 shares
- If the company’s stock price goes to $60 per share, the convertible bondholder can trade the $1,000 bond for 20 shares of stock worth $60 per share (or $1,200). Prior to conversion, the bondholder still receives interest on the convertible bond.
- The borrower also benefits: Convertible bonds sell at a higher price and require a lower interest rate than bonds without a conversion feature.
Market interest rate
Represents the true interest rate used by investors to value a bond.
- Can also be called effective interest rate or yield rate
- The market rate can be equal to, less than, or greater than the stated interest rate paid to investors.
- The market rate is determined for each bond issue by the forces of supply and demand.
- Market rates change continuously
- The market rate is not the same for all companies issuing bonds. They vary based on the default risk of the company issuing the bonds.
- The higher the market interest rate, the lower the bond issue price will be.
Stated interest rate
The rate quoted on the bond contract used to calculate the cash payments for interest.
