Sources of Corporate Finance: Debt Flashcards
Debt
-Borrowing from a bank creates a contract between the bank and the company.
-The principal and interest must be paid.
-Fixed interest rate: LIBOR
Floating interest rate: Premium
-The premium is dependent on the company’s credit rating and reliability.
-The debt may be secured on assets.
Bank Loan
The bank protects its position by imposing loan covenants on what the company can’t do during the contract period:
- cannot pay or set upper bounds on dividends
- cannot issue or set upper bounds on new debt
- cannot sell assets on which a loan is secured
Long term debt finance
- Fixed interest securities: loan stock and debentures
- May be convertible
- Less risky than shares
- Repaid before shareholder in the event of liquidation
- Market value depends on supply and demand in bond market
Debenture
Secured against corporate asset
- fixed charge: on specified asset. the asset cannot be disposed of while debt is outstanding.
- floating charge
Interest Payment
- Usually paid twice per year
- Must be paid
- Allow expense for tax purposes
Restrictive Covenant
- Used to protect holder and may also restrict management powers
- Intention is to protect the company’s risk profile by a potential downgrade, hence it will be less likely for the company to delay payments
- The breach of covenants can lead to early repayments
New issue of bond finance
- New bonds are issued via an investment bank in the new issues market
- Attractive bonds are often over subscribed and hence companies can increase the bonds offer if there is a lot of demand for bonds
Government Bond
- Sovereign bond markets
- Governments need to maintain a high reputation for paying their debts on time
- They are able to print more or to raise taxed to ensure they have the means to pay
Corporate Bonds
- Majority occurs in OTC
- Generally very thin secondary market
- Minimum is occasionally £1,000, more often £50,000
- Par value of one bond at £50,000 is said to have a 50,000 minimum lot or piece
Index-lined gifts
- Inflation risk
- The coupon amount, nominal value are adjusted or uplifted according to the Retail Price Index
What other other money markets?
- Interbank market
- Commercial paper
- Repurchase agreement
- Certificates of deposit
The interbank market
- A bank or other large institution which has no immediate demand for its surplus cash can place the money in the interbank market and earn interest on it
- A bank can borrow on the interbank market
- Benchmark interest rate
- LIBOR: London Interbank Offered Rate
- Only the most creditworthy borrowers can borrow at LIBOR
Commercial Payments
- Unsecured short-term instrument of debt issued primarily by corporations
- Promises to the holder a sum of money to be paid in a set of number of days
- Buyers include other corporations, insurance companies, governments, banks…
- Average maturity of about 40 days, the normal range is 30-90 days, but can be as long 270 days
- Normally issued at a discount
What is a repo?
A repo is a way of borrowing for a few days using a sale and repurchase agreement in which securities are sold for cash at an agreed price with a promise to buy back the securities at a specified (higher) price at a future date.
Repos
- Used regularly by banks and other financial institutions to borrow money from each other.
- Market is also manipulated by central bank to manage their monetary policy
- The term of repos is usually between 1 to 14 days
