Longterm Sources of Funds

8/13/2019 Longterm Sources of Funds

1/23

LONG-TERM SOURCESOF FUNDS

Debt, Preferred, and CommonStock


2/23


3/23

Trustee: A person or institution

designated by a bond issuer as theofficial representative of bondholders.Typically, a bank serves as trustee.Indenture: The legal agreementbetween the corporation issuing bondsand bondholders, establishing the termsof bond issue and naming the trustee.

Bond Ratings: Where creditworthinessis often judged by investment ratingagencies. Opinions are given in theform of letter grades.


4/23


5/23

INCOME BONDS

Bond where payment of interest iscontingent on sufficient earnings of thefirm.

If firm generates earnings in future, itwill have to pay the cumulative interestto the extent that earnings permit.Cumulative obligation limited to 3 years.


6/23

JUNK BONDS

A high-risk, high-yield (often unsecured)bond rated below investment grade.MORTGAGE BONDS

A bond issue secured by a mortgage onthe issuers property fixed assets.If the corporation defaults, the trusteehas the power to foreclose .In a foreclosure, trustee takes over theproperty and sells it. The proceeds arepaid to the bondholders.


7/23

EQUIPMENT TRUST CERTIFICATES

A security, usually issued by atransportation company, that is used tofinance new equipment.For example, the railways arranges witha trustee to purchase equipment from amanufacturer.When the equipment is delivered, theETCs are sold to investors. Theproceeds of this sale, together withdown payment by railways, are used topay the manufacturer.


8/23

ASSET SECURITIZATIONProcess of taking a cash-flow producing asset,packaging it into a pool of similar assets, and thenissuing securities backed by the asset pool.For example, if a firm needs cash but doesnthave a high enough credit rating to make a bondissue economical.So it picks assets to package, removes them fromits balance sheet, and sells them to a SPV. In thisway, if the firm ever went bankrupt, its creditorscouldnt seize the packaged assets. The SPV, in turn, raises money by sellingsecurities backed by the assets just purchasedfrom the firm.


9/23

Retirement of Bonds

The retirement (repayment) of bondsmay be accomplished in a number ofdifferent ways.By making single-sum payment atmaturity.By conversion if bonds are convertible.By calling the bonds (subject to callfeature).By periodic repayment (sinking funds).


10/23

Preferred StockIs a hybrid form of financing, combiningfeatures of debt and common stock.Such stockholders, in the event of

liquidation, have claim on assets after thecreditors but before the commonstockholders.This claim is restricted to par value of thestock.


11/23

VOTING RIGHTS (Special Situations)

Because of their prior claim on assetsand income, PSs are not normally givenvoice in management.Under such circumstances PSs wouldbe entitled to elect a specific number ofdirectors.


12/23

Common Stock

The common stockholders of a companyare its ultimate owners.Collectively, they own the company andassume the ultimate risk associated withownership.Their liability, however, is restricted to theamount of their investment.

They have a residual claim on the assets.CS has no maturity date. But can liquidateby selling their stocks in the secondary

market.


13/23

Features AUTHORIZED, ISSUED, & OUTSTANDING

The corporate charter specifies the numberof authorized shares of CS.When authorized shares are sold, they

become issued shares .The number of shares issued and actuallyheld by the public refers to outstandingshares .The company can buy back part of its issuedstock and hold it as treasury stock .


14/23

PAR VALUE

A share of CS can be authorized eitherwith or without par value. The par value ofCS is merely a recorded figure in thecorporate charter and is of little economicsignificance.CS that is authorized without par value(no-par stock) is carried on the books at

the original market price or at someassigned (or stated) value . Assigned value refers to a no-par CSusually far below the actual issuing price.


15/23

BOOK VALUE & LIQUIDATING VALUEThe BV per share is the shareholdersequity total assets minus liabilities.Often assets are sold for less than their

book values, particularly whenliquidating costs are involved. For thecompany involved, LV may be higherthan the BV.


16/23

MARKET VALUEMV per share is the current price at whichthe stock is traded.MV of a common stock is a function of thecurrent and expected future dividends and

the perceived risk of the stock on the partof investors.Typically, shares of a newer company aretraded in the OTC market, where one ormore security dealers maintain aninventory in the common stock and buy &sell it at the bid and ask prices that they

quote.


17/23

VOTING RIGHTSEntitled to elect board of directors.Usually exercise indirect control throughthe BODs they elect.When goals differ (mgt. V/s shrholders),the shareholders can effectmanagement through the BODs.Voting can be done either in person orby proxy at the annual meetings.


18/23

Proxy refers to a legal document givingone person the authority to act foranother. In business, in generally refersto the instructions given by a

shareholder with regard to voting sharesof common stock.BODs are elected under a majority-rule

voting system.These depend on the corporate charter.


19/23

Majority-Rule System

Stockholders have one vote for eachshare of stock that they own, and theymust vote for each director position that

is open. A stockholder who owns 100 shares willbe able to cast 100 votes for eachdirectors position open. Management can select entire BODs ifit can obtain proxies for over 50% ofshares voted.


20/23

Cumulative Voting System

A stockholder is able to accumulatevotes and cast them for less than thetotal number of directors being elected.The total number of votes for eachstockholder is equal to the number ofshares owned times the number ofdirectors being elected.

A stockholder who owns 100 sharesand 12 directors are to be elected, then100 x 12 = 1200 votes may be cast forone director.


21/23


22/23

Features of Term Loans

Currency: Given domestic currency andforeign currency term loans.Security: Term loans typically represent

secured borrowing.Interest payment & Principal repayment: They are definite obligations that arepayable irrespective of the financialsituation of the firm.


23/23

Comparative Picture

Cost Dilution of Control Risk Restraint on MF

Equity high yes nil noRE high no nil noPreference high no neg. noTerm Loan low no high moderateDebentures low no high some

MF = Managerial Freedom

Longterm Sources of Funds

Documents

Transcript of Longterm Sources of Funds