Long Term Funding

Question 1

7 Core considerations in LTF

Answer 1

1. How much to raise?
2. What form?
3. What maturity?
4. What interest rate?
5. Currency mix?
6. Risk?
7. What interest rate (Price of money)

Question 2

Pecking order of choice

Answer 2

1. Retained earnings
2. Debt
3. Equity

Question 3

Myers 1984 Capital Structure Puzzle

Answer 3

“We don’t know”
2 choices: Static tradeoff v.

Modified pecking order:

1. Avoid having to finance investment via stock/securities b/c risk
2. Set target dividend payout ratios /
3. Cover normal investment outlays with new borrowing safe
4. sticky dividend payout ratio means firm will exhaust ability to issue safe debt. Turn to risky debt/convertibles before stock

Question 4

Modigliani-miller theorem

Answer 4

Absense of taxes, bankruptcy costs, agency costs and asymmetric info in an efficient market firm value unaffected by financing

Capital structure irrelevance principle

Question 5

3 points of equity

Answer 5

Shareholders own the company
vote at AGM
Dividends and capital growth give return

Question 6

What is debt

• Cash flows
• Value

Answer 6

Loan to company that pays interest. Can be loans, bonds or debentures. May be redeemable, irredeemable or convertible.

Question 7

Convertible debt issue

Answer 7

Into equity

Question 8

8 Characteristics of bonds
Def
Collateral
Issuing body
Risk
Priority
Interest
Payment structure
Convertibility

Answer 8

• 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

Question 9

8 characteristics of debentures
Def
Collateral
Issuing body
Risk
Priority
Interest
Payment structure
Convertibility

Answer 9

• Instrument for LT finance
• Secured or unsecured (often not)
• Private companies
• High risk
• Priority after bondholders
• High interest
• Periodical payment
• Convertible to equity

Question 10

6 things that impact interest rate of debt

Answer 10

• Risk
• Expectations
• Supply and demand
• Maturity
• Liquidity
• Inflation (due to impact on base rate)

Question 11

Interest rates fall, bond prices…

Interst rates rise, bond prices…

Answer 11

Rates fall, bond prices up

Rates rise, bond prices fall

Question 12

Difference between coupon and yield

Yield formula

Answer 12

Coupon fixed
Yield varies

Yield effectively interst rate
Bond yield = coupon / price * 100 –> return to investor as an annual %

Question 13

YTM formula

Answer 13

Return if held until maturity

=(Coupon + ((Face value - price)/years to maturity) / ((face value + price)*.5)

Question 14

Two items on yield curve

Answer 14

Yield and years until maturity

Slopes up then flattens.

Question 15

Expectations theory

Answer 15

Expectations around future interest rates / people expect them to rise in future

Question 16

Liquidity preference theory / liquidity premium theory

Answer 16

Investors prefer cash in hand. If more attrative bond issued must sell current at discounted rate

Question 17

Market segmentation theory

Answer 17

Many investors all have differing needs

Question 18

Yield spread definition

Decrease shows…
Flat shows…

Answer 18

2 year v 10 year difference

Decrease may be sign of recession
Flat curve shows high perceived ST risk

Question 19

Time to redemption implications

Answer 19

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.

Question 20

3 Types of matching in funding

Answer 20

1. Maturity matching - length of borrowing matched to asset
2. Working capital - ST with ST funding
3. NCAs - LT so fund with LT

Question 21

8 sources of LT funding (3 equity based, 5 debt based)

Answer 21

1. Equity
2. Going public
3. Rights issue
4. Bonds, loan stock, notes
5. Debentures
6. Corporate bond
7. Convertibles
8. Other bonds

Question 22

Equity

Answer 22

ORDS, preference shares and reserves (retained earnings)

Question 23

Going public

LSE IPOs in 2017

Answer 23

Issue shares via a stock exchange
Brings huge ongoing obligations

106 IPOs on LSE in 2017 raising £15B - avg of £142M per IPO

Question 24

Rights issue

Answer 24

Existing shareholders have preemption rights
Subscribe to new rights
Avoids dilution of ownership
Discount

Negative signal to market if not taken up

Question 25

Bonds, loan stock, ntoes

Verizon

Answer 25

Promise to pay. Provide nominal value, redemption value and date + coupon

Verizon largest ever at $49B

Question 26

Debentures

Answer 26

Acknowledgement of indebtedless

Usually secured on assets

Question 27

Bond ratings

Agencies in US and Europe

Answer 27

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.

Question 28

Bond ratings

Agencies in US and Europe

Answer 28

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.

Question 29

Convertibles

Answer 29

Debt which carries right to convert to ord share
Hybrid
Lower coupon due to equity
Investor can harness growth
e.g. Mezzanine capital

Question 30

3 Other bond types

Answer 30

Foreign bonds
Eurobonds - different than issuer currency
Green bonds - for green activity

EY 2018 like green investment