Long Term Funding Flashcards
7 Core considerations in LTF
- How much to raise?
- What form?
- What maturity?
- What interest rate?
- Currency mix?
- Risk?
- What interest rate (Price of money)
Pecking order of choice
- Retained earnings
- Debt
- Equity
Myers 1984 Capital Structure Puzzle
“We don’t know”
2 choices: Static tradeoff v.
Modified pecking order:
- Avoid having to finance investment via stock/securities b/c risk
- Set target dividend payout ratios /
- Cover normal investment outlays with new borrowing safe
- sticky dividend payout ratio means firm will exhaust ability to issue safe debt. Turn to risky debt/convertibles before stock
Modigliani-miller theorem
Absense of taxes, bankruptcy costs, agency costs and asymmetric info in an efficient market firm value unaffected by financing
Capital structure irrelevance principle
3 points of equity
Shareholders own the company
vote at AGM
Dividends and capital growth give return
What is debt
- Cash flows
- Value
Loan to company that pays interest. Can be loans, bonds or debentures. May be redeemable, irredeemable or convertible.
Convertible debt issue
Into equity
8 Characteristics of bonds Def Collateral Issuing body Risk Priority Interest Payment structure Convertibility
- Financial instrument which highlights debt taken by issuer to holders
- Secured by collateral
- Issued by financial institutions, corporations, govt agencies etc.
- Low risk
- First priority at liquidation
- Low interest depending on body stability
- Accured payment
- Not convertible
8 characteristics of debentures Def Collateral Issuing body Risk Priority Interest Payment structure Convertibility
- Instrument for LT finance
- Secured or unsecured (often not)
- Private companies
- High risk
- Priority after bondholders
- High interest
- Periodical payment
- Convertible to equity
6 things that impact interest rate of debt
- Risk
- Expectations
- Supply and demand
- Maturity
- Liquidity
- Inflation (due to impact on base rate)
Interest rates fall, bond prices…
Interst rates rise, bond prices…
Rates fall, bond prices up
Rates rise, bond prices fall
Difference between coupon and yield
Yield formula
Coupon fixed
Yield varies
Yield effectively interst rate
Bond yield = coupon / price * 100 –> return to investor as an annual %
YTM formula
Return if held until maturity
=(Coupon + ((Face value - price)/years to maturity) / ((face value + price)*.5)
Two items on yield curve
Yield and years until maturity
Slopes up then flattens.
Expectations theory
Expectations around future interest rates / people expect them to rise in future
Liquidity preference theory / liquidity premium theory
Investors prefer cash in hand. If more attrative bond issued must sell current at discounted rate
Market segmentation theory
Many investors all have differing needs
Yield spread definition
Decrease shows…
Flat shows…
2 year v 10 year difference
Decrease may be sign of recession
Flat curve shows high perceived ST risk
Time to redemption implications
If closer to redemption price moves closer to redemption value (par). Price becomes less sensitive. Explains different price sensitivity to changes of LT and ST bonds.
3 Types of matching in funding
- Maturity matching - length of borrowing matched to asset
- Working capital - ST with ST funding
- NCAs - LT so fund with LT
8 sources of LT funding (3 equity based, 5 debt based)
- Equity
- Going public
- Rights issue
- Bonds, loan stock, notes
- Debentures
- Corporate bond
- Convertibles
- Other bonds
Equity
ORDS, preference shares and reserves (retained earnings)
Going public
LSE IPOs in 2017
Issue shares via a stock exchange
Brings huge ongoing obligations
106 IPOs on LSE in 2017 raising £15B - avg of £142M per IPO
Rights issue
Existing shareholders have preemption rights
Subscribe to new rights
Avoids dilution of ownership
Discount
Negative signal to market if not taken up
Bonds, loan stock, ntoes
Verizon
Promise to pay. Provide nominal value, redemption value and date + coupon
Verizon largest ever at $49B
Debentures
Acknowledgement of indebtedless
Usually secured on assets
Bond ratings
Agencies in US and Europe
AAA best quality low risk
BB non-investment grade
B highly speculative, low risk
Lilihood to pay back
S&P and Moody’s in U.S. Fitch in U.S. and UK
Based on liklihood of inability to pay. When investing treasurer must pick inv grade.
Bond ratings
Agencies in US and Europe
AAA best quality low risk
BB non-investment grade
B highly speculative, low risk
Lilihood to pay back
S&P and Moody’s in U.S. Fitch in U.S. and UK
Based on liklihood of inability to pay. When investing treasurer must pick inv grade.
Convertibles
Debt which carries right to convert to ord share Hybrid Lower coupon due to equity Investor can harness growth e.g. Mezzanine capital
3 Other bond types
Foreign bonds
Eurobonds - different than issuer currency
Green bonds - for green activity
EY 2018 like green investment
