Wk 7 Debt and Bonds Flashcards
Debt Definition?
Amount of money an entity borrows, and which needs to be repaid as per pre-agreed terms with interest.
Examples of debt instruments?
- Overdrafts
- Trade credits
- Term loans
- Hire Purchase
- Finance lease
- Bonds
What are the three classifications of debt?
- Length (Short/ long term)
- Security (secure/ non-secure)
- Risk (regular/ sub-prime)
What are Debentures?
Bonds secured against assets
What else can the interest payments on a bond be referred to as?
Coupon payments
What criteria would a ratings agency use to rank a bond?
- Likelihood of default
- Nature and provisions of obligation
- Protection arising in event of bankruptcy
Advantages of debt?
- Cheaper than equity (investors require higher returns)
- Tax relief effects since interest payments are tax deductible
- Issuing debt does not dilute ownership
Disadvantages of debt?
- Risk of financial distress as debt comes with obligation to make payments
- Debt ‘covenants’ could restrict company’s freedom
What are the two ratios useful for measuring capital gearing?
- Capital Gearing or Debt/ Equity Ratio
- Interest cover
What is the formula for Capital Gearing or Debt/ Equity Ratio?
CG = (Long term Debt/ All finance) X 100
What is the formula for Interest Cover?
IC = (PBIT/ Total Interest Payable) X 100
Coupon Rate?
Interest offered by the bond, does not change
Discount Rate?
Applicable discount rate, adjusted for the risk (rating) associated with the bond
Annual Yield?
IRR for the cash flow associated with the bond
Face Value?
The value of the bond as per the original terms
