Chapter 12 - Sources Of Finance - Debt Flashcards
Debt options for unquoted company
Only option is loan term loan from bank / rich relatives
What debt options for quoted company
Long term loan from bank (though limited amount you can borrow)
Issue “trading debt”
What is trading debt ?
Trading debt are debentures/loan stocks/bonds
Suppose a company wanted to raise £500k what they can do with traded debt, rather than go to one lender they advertise they want to borrow money to the public.
They do it in units, usually $100 units so if want to borrow 500k @5% repayable in 10 years time then they advertise this. If I can afford to buy $500 then I buy 5 units. I get a certificate also. It’s just like subscribing for shares and instead of a dividend you get interest instead.
Reason it’s call traded debt, if I want the money bank in 5 years rather than wait til the 10 year mark, these are traded on the stock exchange.
How does trading debt look on the stock exhange
“10% debenture 2025 quoted at 96 p.c”
The nominal value (original value) was £100 however it is valued on the stock exchange is £96
The p.c refers to per cent
The 10% is the interest rate on the nominal so whatever the price is on the stock exchange, the interest is fixed at 10% of the original £100. Also called the coupon rate
The 2025 is the date of repayment
Why does market value change on debentures ?
When I first lent the money 10% was a good rate of return. However since then, interest rates have changed, but maybe today banks are paying 12% interest so why would somebody buy it at same £100 nominal price.
So if somebody buys for £80 and still getting the fixed 10% @ £100 then in theory they would be getting 10/80 100 = 12.5% interest
Another option is convertible debt. When it comes time for repayment/redemption we give the investors the choice of either receiving
a) take cash
b) take fixed number of shares in the company
Suppose the company issues 4% bonds, convertible in 5 years time to 20 shares in company. So for each unit we get £4 per year in interest, when it comes time for repayment, we get a letter with the choice. Depends on what is better take the £100 or the 20 shares
What rate of interest does a company offer ?
Should be more than what a bank would offer to save money but often this is higher than a company may like so what they may do is offer a lesser interest with a promise to pay at a premium
Let’s say it’s 5% loan stock, repayable in 10 years time at a premium of 10%. This means that for every unit (£100) there will be interest each year of 5% per annum but the repayment would not be at nominal value but instead at £110
What is a warrant
When the investor gets a certificate off debt they have a warrant attached
It entitles the holder to buy shares in a company, at a fixed price on a fixed future date
For example the company might issue 6% bonds payable in 2024 with a warrant that entitles them 20 share at a fixed price of £2 per share in let’s say 2022. The current share price is £1.50.
They don’t have to buy them
What is the coupon rate
It is the interest on the nominal rate
What is the interest yield ?
If a company as a coupon rate for 8% and current rate is £80 then the interest yield is 10% (8/80)
What is the redemption yield
Imagine a debenture is 8% coupon rate at £80 with a premium repayable of 10% well the interest yield is 10% however the redemption yield is greater as we are actually getting back £110 and not the unit price of £100
What is crowd funding
Is not a source of debt finance
New company needs funding to start. Give new idea and people give you money. It’s not debt because it’s not repayable
The person gets something in return, like a discount on the product being produced
What is peer to peer funding
It is a source of finance
Cuts out the middle man of the bank and get better interest than what bank offers
Let’s say bank offers savers 3% and want bank want borrowers to pay 6% well with this it may be 5% so both win
What are preference shares ?
These are shares with a fixed rate of dividend having a prior claim on profits abatible for distribution
Although legally equity, these are often treated as debt because they carry a fixed rate of dividend
