Financial instruments Flashcards
Loan capital .
is a method of raising funds from investors by issuing debt instruments.
1.1. Loan capital is issued to investors who receive interest payments and a return of capital in return
how is Interest and capital calculated loan capital
Interest and capital payments are specified at the outset or calculated through a formula.
Loan capital
is often referred to as bonds or bills.
Loan capital may be listed on a__________
stock exchange.
. Holders of loan capital are
. Holders of loan capital are creditors of the company and do not have voting rights.
state Features of loan capital
Features of loan capital include nominal value, interest payments as a proportion of the par value, issue price, redemption at par, and market price fluctuations.
state Features of loan capital
Features of loan capital include nominal value, interest payments as a proportion of the par value, issue price, redemption at par, and market price fluctuations.
Most loan capital is redeemed at _______after a set date.
Most loan capital is redeemed at par after a set date.
Variations in loan capital include
capital repayment at the company’s option, variable rate issues, index-linked bonds, stepped bonds, call option, put option, and sinking funds.
The rights of bondholders are set out in a
loan agreement drawn up when the loan is issued, and a trustee is appointed to act on behalf of the loan stockholders.
loan capital benefits
Loan capital is a significant source of finance for UK listed companies.
2.1. Companies often raise more finance each year by borrowing from investors by issuing loan capital than by issuing shares.
Long-term loan capital instruments are often referred to as________and short-term instruments as _______.
Long-term loan capital instruments are often referred to as “bonds” or “corporate bonds”, and short-term instruments as “bills”.
Loan capital is a cost to the company, not a distribution of profits, true or false
Loan capital is a cost to the company, not a distribution of profits, and holders of loan capital rank equally with, or above other creditors on a winding-up.
The price of a bond is fixed true or false
The price of a bond varies with supply and demand for the bonds, and there is a see-saw relationship between interest rates and the price of a bond.
Loan capital variations include
capital repayment at the company’s option, variable rate issues, index-linked bonds, stepped bonds, call option, put option, and sinking funds.
is Loan capital different from shares explain
Loan capital is different from shares as shareholders receive dividends at the discretion of the company’s directors, whereas holders of loan capital receive specified interest payments and a return of capital.
Question 4.1
What is the total amount of cash you would receive if you purchased £200 nominal of a
6% government bond redeeming on 31 December 2025, and purchased on 1 January
2015?
Solution 4.1
In each of the years 2015 to 2025 inclusive, you would receive 6% of £200 = £12. This
would normally be paid in two semi-annual payments of £6. This amounts to £132. At
the maturity of the bond you would get £200 back in addition to the final coupon
payment we have included above. Total cash received = £332
Question 4.2
Suppose interest rates rise in the economy, what would happen to the demand for a
fixed-coupon bond and hence what would happen to the price of the bond?
Solution 4.2
If interest rates rise general in the economy, the fixed interest on the bond compares
unfavourably with that received elsewhere. The demand for such bonds will therefore
fall and the price will fall. As the price falls, the fixed interest becomes a higher
percentage of the market price and the capital gain (if any) on redemption increases
until equilibrium is restored.
What details might you expect to find in the trust deed of a bond issued by a company?
Solution 4.3
Typical issues covered in a trust deed:
Description of any assets of the company that might be set aside to cover the
particular loan in the event that the company winds up.
Details of exactly how the assets should be used to repay the bondholders in the
event of a winding-up and how surplus cash should be treated.
The rights of the company to issue further bonds that rank above or alongside
this particular issue.
Covenants that describe how much the company’s profit must remain above the
amount of the interest payments on the bond. This is a form of protection for
bondholders to ensure that their interest payments are easily met by the company
in future.
Arrangements for changing the trustees.
A description of circumstances under which bondholders must be consulted. For
example if covenants are breached or about to be breached.
What details might you expect to find in the trust deed of a bond issued by a company?
Solution 4.3
Typical issues covered in a trust deed:
Description of any assets of the company that might be set aside to cover the
particular loan in the event that the company winds up.
Details of exactly how the assets should be used to repay the bondholders in the
event of a winding-up and how surplus cash should be treated.
The rights of the company to issue further bonds that rank above or alongside
this particular issue.
Covenants that describe how much the company’s profit must remain above the
amount of the interest payments on the bond. This is a form of protection for
bondholders to ensure that their interest payments are easily met by the company
in future.
Arrangements for changing the trustees.
A description of circumstances under which bondholders must be consulted. For
example if covenants are breached or about to be breached.
what are Debentures stocks
are loans secured by some or all of a company’s assets, and the stockholders have various actions available to them in case the company fails to make one of the coupon payments or the capital repayment.
two types of Debentures
Debentures come in two types: Mortgage debenture (fixed charge) and Floating charge debenture.
whats a fixed charge debenture
A fixed charge means that specific secured assets are mentioned in the legal documentation for the mortgage debenture, and the company can sell or make significant alterations to the secured asset only with the mortgage debenture holders’ permission.
whats A floating charge debenture
A floating charge debenture allows the company to change the secured assets in the normal course of business, but if the company fails to make an interest or capital payment, the debenture holders can apply to the courts to make the floating charge become a fixed charge, which is called “crystallising.”
Debentures are used to raise _______ amounts of funds and have a fixed _______ and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.
Debentures are used to raise large amounts of funds and have a fixed redemption date and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.
Debentures are used to raise _______ amounts of funds and have a fixed _______ and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.
Debentures are used to raise large amounts of funds and have a fixed redemption date and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.
Debentures carry the risk that
Debentures carry the risk that coupon payments or capital repayment may not be made, but the stockholders have security in respect of the secured assets. However, payments on debentures are a legal obligation on the company, making debentures more secure than ordinary or preference shares.
The total return on debentures will reflect
all the risks such as default risk, inflation risk, and marketability risk.
Describe marketability of debentures
Debentures may not be readily marketable, and marketability is usually worse than for government bonds, with bigger spreads between buying and selling prices, and lower volumes traded.
The existence of a fixed and/or floating charge, together with the appointment of a trustee, is designed to reduce the risk to the debenture holder,
but the security ultimately depends on the company’s continuing profitability to meet the required payments, and failing that, on the market value of the charged assets.
Unsecured loan stock
Unsecured loan stock is a loan for which there is no specific security.
If the company defaults on the loan, the only remedy for the loan stockholders is to
sue the company. In practice, this means asking the courts to wind up the company.
unsecured loan stockholders rank after debenture holders. True or false
Debenture holders have a prior claim to the assets of the company on which there is a charge. Therefore, unsecured loan stockholders rank after debenture holders.
Other creditors of the company rank equally with unsecured loan stockholders.True or False
Other creditors of the company rank equally with unsecured loan stockholders.
Some banks issue subordinated loan stock,
so the loan stockholders rank after the bank’s depositors in the event of a winding-up.
If there is insufficient money generated from the liquidation of the company’s assets to meet all claims, available money is
shared out in proportion to the amount owed.
High-ranking claimants (e.g. debenture holders) may get all their capital returned on a winding-up, while low-ranking claimants (e.g. shareholders)
may get nothing.
At the highest level of ranking where the total money available is insufficient (e.g. unsecured creditors),
a proportionate payment will be made.
Question 4.4
Why don’t companies always issue unsecured loan stocks rather than debentures?
Solution 4.4
Debentures are secured upon the assets of a company. This security means that the
company can offer a lower rate of coupon (ie interest) to investors. The company will
therefore find it cheaper to borrow using debentures than using unsecured loan stock
Corporate bonds behave much like government bonds, but there are major differences between the two types of bonds. Some of the differences are as follows:
Security: Corporate bonds are generally less secure than government bonds. The level of security varies depending on the type of security, the company that has issued it, and the term.
Marketability: Corporate bonds are much less marketable than government bonds, mainly because the sizes of issues are much smaller.
Subordinated debt rank:
Subordinated debt: In the event of default, the holder of subordinated debt ranks below the firm’s general creditors (but ahead of preference shareholders and the ordinary shareholders). The subordinated lender holds a junior debt and is paid after all senior debt holders are satisfied.
Eurobond loan capital: Eurobonds give borrowers access to international _______. A Eurobond is a bond issued in the Euromarket and is marketed internationally, mainly by the London branches of international banks.
Eurobond loan capital: Eurobonds give borrowers access to international investors. A Eurobond is a bond issued in the Euromarket and is marketed internationally, mainly by the London branches of international banks.
Eurobond issues can be made in almost any _______, and the majority of Eurobond issues are denominated in ________.
Eurobond issues can be made in almost any currency, and the majority of Eurobond issues are denominated in dollars.
Eurobond issues can be made in almost any _______, and the majority of Eurobond issues are denominated in ________.
Eurobond issues can be made in almost any currency, and the majority of Eurobond issues are denominated in dollars.
Eurobonds are “bearer form” documents, and to claim interest payments, holders must
cut out coupons from the certificates and send them to the company (or its paying agent).
Trading: Although most Eurobond issues are listed on a stock exchange (often in London), most trading in them occurs through
the banks rather than through a stock exchange.
Minimum acceptable issue: Eurobonds are used to raise large sums, and the minimum acceptable issue is $75m or more. They are not secured against the assets of
the issuing company.
Underwriting: The key difference between Eurobonds and unsecured loans is that
Eurobonds are marketed in a different way.
A Eurobond is an issue underwritten by
an international syndicate of banks and typically (but not exclusively) sold in countries other than the country of the currency in which it is denominated.
Issues are often marketed in several countries simultaneously. Eurobonds are not fully within the legal control of any________
Issues are often marketed in several countries simultaneously. Eurobonds are not fully within the legal control of any government.
Floating-rate notes (FRNs) are
medium-term debt securities issued in the Euro market.
The interest payments on FRNs _____ with short-term interest rates.
The interest payments on FRNs “float” with short-term interest rates.
FRNs may have a stipulated minimum rate, which is commonly known as an
interest-rate floor.
An interest-rate floor ensures that the coupons on FRNs will not
fall below the minimum rate, even if the benchmark interest rate falls lower.
FRNs are attractive to investors when
interest rates are expected to rise, as the interest payments will increase.
FRNs are less attractive to investors when interest rates are expected
to fall, as the interest payments will decrease.
FRNs are less attractive to investors when interest rates are expected to fall, as the interest payments will decrease.
FRNs are less attractive to investors when interest rates are expected to fall, as the interest payments will decrease.
Companies may issue FRNs when interest rates are high, as they can still access financing while avoiding fixed interest rates that may become unaffordable during periods of high interest rates.
Companies may issue FRNs when interest rates are high, as they can still access financing while avoiding fixed interest rates that may become unaffordable during periods of high interest rates.
FRNs provide investors with some protection against interest rate risk, as their interest payments adjust to changes in the benchmark interest rate.
FRNs provide investors with some protection against interest rate risk, as their interest payments adjust to changes in the benchmark interest rate.
FRNs may offer lower yields than fixed-rate bonds with similar credit ratings, as investors pay for the flexibility provided by the floating interest rates.
FRNs may offer lower yields than fixed-rate bonds with similar credit ratings, as investors pay for the flexibility provided by the floating interest rates.
Share capital; Ordinary shares give rights to
a share of the residual profits of the company, and to the residual capital value if the company is wound up, together with voting rights and various other rights.
A company may or may not have loan capital and/or preference shares, but to exist it must have
ordinary share capital (unless it is “limited by guarantee”).
Shareholders are the _______of the business and have _____rights at meetings in proportion to the number of _______held.
Shareholders are the owners of the business and have voting rights at meetings in proportion to the number of shares held.
are “dividend” payments a legal obligation
Shareholders receive “dividend” payments made from a company’s profits, which are not a legal obligation of the company and are only paid at the discretion of the directors.
Dividends are paid net of tax with an attaching tax credit for the recipient, which is termed
“franked” investment income.
Ordinary shares are the ______ranking form of finance issued by companies and rank after all ________, including preference shareholders, on winding-up.
Ordinary shares are the lowest ranking form of finance issued by companies and rank after all creditors of the company, including preference shareholders, on winding-up.
Ordinary shares are almost always ______, meaning there is no fixed date when the company has to _______.
Ordinary shares are almost always irredeemable, meaning there is no fixed date when the company has to repay the share capital.
All shares have a “par” or
“nominal” value, often 25p, which has no relevance to the market value of the share.
Shareholders have a ________up to the fully paid value of the shares, and partly paid issues are allowed.
Shareholders have a ________up to the fully paid value of the shares, and partly paid issues are allowed.
The figure shown in the accounts for issued share capital is the
nominal value.
The total nominal value of authorized share capital is the maximum amount that the directors can issue without calling for a vote from the shareholders. The issued share capital is the nominal amount actually issued, and it cannot be greater than the authorized share capital.
The total nominal value of authorized share capital is the maximum amount that the directors can issue without calling for a vote from the shareholders. The issued share capital is the nominal amount actually issued, and it cannot be greater than the authorized share capital.
Ordinary shares give an equal right to share in residual profits, give
one vote per share, give an equal share to any assets left over following a winding-up after all other creditors have been paid, are fully paid, and give various other minor rights.
The low ranking of ordinary shares in terms of payment of dividends and upon winding-up makes ordinary shares a more
risky investment than other types of capital.
The low ranking of ordinary shares in terms of payment of dividends and upon winding-up makes ordinary shares a more
risky investment than other types of capital.
Ordinary shareholders have the right to attend and
speak at company meetings, or appoint a proxy to attend and vote on their behalf, vote to reduce dividends, appoint directors, forego the “pre-emptive” right to be offered any new shares to be issued, and change the company’s borrowing powers.
Question 4.5
What does “bearer” mean? What form will a security be if it is not “bearer”?
Solution 4.5
This means that the issuing company does not keep a register of holders, unlike share
capital and traditional loan capital. So, holding the Eurobond loan certificate is proof of
ownership. Rather like a pound note – if you lose it, you’ve lost it.
If a certificate is not bearer, it is normally “registered” which means that your name is
on a computer list somewhere, and if you lose your certificate, the registrars can issue
you with another one. Dividends can be transferred directly to your bank account.
