S2 - debt finance Flashcards
what are fundamental features of debt finance
has to be repaid
Generally less expensive than equity
Cost of raising funds
Annual return required to attract investors
Tax deductibility of interest - fixed ratio rule limits the amount of interest expense that a worldwide group can deduct
lenders do not generally share in the value created by an extraordinarily successful business
Absense of voting power
why are bank loans attractive
administrative and legal costs are low
Quick
Flexibility
Available to small firms
why are costs considered when borrowing
arrangement fee
Interest rate can be wither fixed or floating
If it is floating then the rate will generally be certain percentage points above the banks base rate of LIBOR
Floating rate borrowings have advantages
If interest rates fall the cost of the loan falls
Fixed rates are usually above floating rates
Returns on the firms assets may go up at times of higher interest rates
Disadvantages
Firms may be caught out by a rise in interest rates
Uncertainty about the precise cash
what are the fundamental features of debt finance
has to be repaid
Generally less expensive than equity
Cost of raising funds
Annual return required to attract investors
Tax deductibility of interest - fixed ratio rule limits the amount of interest expense that a worldwide group can deduct
lenders do not generally share in the value created by an extraordinarily successful business
Absense of voting power
why are bank loans attractive
administrative and legal costs are low
Quick
Flexibility
Available to small firms
why are costs considered when borrowing
arrangement fee
Interest rate can be wither fixed or floating
If it is floating then the rate will generally be certain percentage points above the banks base rate of LIBOR
Floating rate borrowings have advantages
If interest rates fall the cost of the loan falls
Fixed rates are usually above floating rates
Returns on the firms assets may go up at times of higher interest rates
Disadvantages
Firms may be caught out by a rise in interest rates
Uncertainty about the precise cash
why is security considered when borrowing
banks concerned about the borrowers competence and honesty
Companies may overcome bank uncertainty to some degree by providing as much information as possible
Collateral
Loan covenants place restrictions on managerial action
Personal guarantees of directors
Key to this is asymmetric information
One party in the negotiation is ignorant of or cannot observe some of the information which is essential to the contracting and decision making process
what are corporate bonds
a bond is a long term contract in which the bondholders lend money to a company
Company promises to pay the bond owners pre determined payments usually a series of coupons until the bond matures
At maturity the bondholder receives a specified principal sum called the par value of the bind
These negotiable instruments come in a variety of forms
Secured
Unsecured
Straight
Coupons every three months
Zero coupon
Floating rate or variable rate
Linked to wide variety of economic events or investment interests including moral money green investing
what are green bonds and sustainably linked bonds
green bond principles
Set of principles which a consortium of major 15 banks
Use of proceeds
Process for project evaluation and selection
Management of proceeds
Reporting
This period of voluntary practice has been under sustained regulatory scrutiny of late and probably will not last due to a series of greenwashing scandals in which investors have been somewhat shocked at what some of their green investment monies have been used for
what are trust deeds and covenants
trustees ensure compliance with the contract
Affirmative covenants
Negative covenants
Limits on further debt issuance
Dividend level
Limits on the disposal of assets
Financial ratios
what are debt repayments
usually paid entirely at maturity
Can be repaid before the final redemption date if a call provision is written into documents
Sinking fund - company pays into the fund and would increase until it could redeem all outstanding bonds
Could be a range of dates for redemption
Issuing firm can also buy the outstanding bonds with a firm able to purchase bonds on the open market
what are credit ratings
debt rating depends on likelihood of payments of interest and capital not being paid
Extent to which the lender is protected in the event of a default
Investment grade - many institutional investors are permitted to invest in investment grade bonds only
Specific loan is rated rather than the borrower
what are syndicated loans
syndicated market is usually only available for loans of more than £50m - a few banks contribute a portion of the overall loan
Lead manager arranging banks
Handful of other banks to co manage the loan
Syndicate group
Managing bank also underwrites much of the loan
Syndicated loans are available at short notice and can be provided discreetly
Generally floating benchmark interest rate
Generally offer lower returns than bond
Fees - management fees, loan commitment fees and underwriting fees for guaranteeing the availability of funds, agents fee
Loans carry covenants similar to those on bound agreements
Draw down schedule - grace periods
