Sources of Finance Flashcards
What is an overdraft?
Bank grants an overdraft facility (usually for a fee)
Why are overdrafts the most important source of short-term finance?
Can be arranged relatively quickly and offer a level of flexibility
Are overdrafts repayable on demand?
Yes
What is a short-term loan?
Drawn in full at the beginning of the loan period and repaid at a specified time or in defined instalments
What happens once a short-term loan is agreed?
The term of the loan must be adhered to, provided that the customer does not fall behind with their repayments
Is a short-term loan repayable on demand?
NO
What is trade credit?
Current assets may be purchased on credit. This represents an interest-free short-term loan
What is important to take into account for trade credit?
The loss of discounts suppliers may offer for early payment
Delays in payment and trade credit?
Worsens a company’s credit rating and additional credit may become difficult to obtain
What is a short-term lease?
An alternative to buying an asset outright
Why is short-term finance riskier?
May be more expensive at the point it is being reviewed. Therefore, it is more liekly that long-term finance is required over a longer time period
Where there’s a long-term investment being considered by a firm?
A strong argument for matching the term of investment to term of long-term finance
Why match term of investment to term of long-term finance
Returns being generated by investment may be required to repay debt
What happens when there’s a loan whose maturity date was longer than the term of investment?
Expose the company to a potentially unnecessarily long period over which interest repayments must be made
What is needed when obtaining a bank loan?
Present a convincing business plan
Provide security by either fixed/floating charge against firm’s asset or personal collateral
What is a loan covenant?
If borrower does not act in accordance with covenant, loan is in default and bank can demand repayment. Terms must be complied with
Features of loan notes?
Coupon rate
Marketable
Redeemable
Secured
What is a coupon rate?
Fixed at time of issue will be set according to prevailing market conditions given the credit rating of company issuing the debt
What is marketable?
Ability to sell debt means investors accept a lower return compared to cost of a bank loan
What is redeemable?
Loan notes are normally redeemable
What is meant by an irredeemable loan note?
Called perpetual bonds often issued by banks
What is meant by unsecured loan note?
Likely to carry debt covenants. Investors are likely to get higher yield as there’s higher risk
What is a convertible loan note?
Gives loan holders the right to conver their loan notes at a specified future date into new equity shares of the company at a conversion rate also specified when loan notes are issued
What is the possibility of convertible loan note holders bable to sell these shares at a favourable price?
Means the coupon rate of interest is often considerably lower than on similar conventional loan notes
If the loan note holders choose not to convert their loan notes into shares?
Loan notes are redeemed at maturity
What is the conversion value?
The current market value of ordinary shares in which a loan note may be converted
What will the conversion value be?
Below the value of the loan note at date of issue but not expected to increase as date for conversion approaches
Assumption of conversion value?
A company’s shares ought to increase in market value over time
Aim of a company and loan note premiums?
Aim to issue loan notes with greatest possible conversion premium, means that for amount of capital raised it will have to issue lowest number of new ordinary shares
How will premium on loan notes be accepted by investors?
Depends on company’s growth potential and prospects for a sizeable increase in share price
