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32 Cards in this Set
- Front
- Back
debt financing
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borrowing money (liabilities)
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equity financing
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obtaining additional investment from stockholders (stockholders' equity)
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Why choose debt financing over equity financing?
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Debt financing = interest expense incurred is tax deductible
Dividends paid to shareholders is NOT tax deductible (dividends aren't an expense) |
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capital structure
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mixture of liabilities and stockholders' equity that a business uses
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3 primary sources of long-term debt financing:
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bonds, notes, and leases
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bond
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- most common form of corporate debt
- a formal debt instrument that obligates the borrower to repay a stated amount (aka principal or face amount), at a specified maturity date - interest is paid back to borrower - easy to distribute -> provide most access to cash - intangible asset |
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Security
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negotiable instrument representing financial value
- 2 types: debt and equity - i.e. stocks, bonds, notes |
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How are bonds distributed?
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Bonds are underwritten (aka sold) by investment houses to an issuing company (the borrower)
- i.e. Citigroup, JPMorgan Chase, Merrill Lynch |
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Private placement
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Issuing company chooses to sell the debt securities directly to a single investor (i.e. individual like me, large investment fund or insurance company)
- keeps costs (actg, registration, printing, legal, etc) down |
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Why are issue costs lower with private placement?
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Privately placed securities aren't subject to the costly and lengthy process of registering with the SEC that is required of all public offerings
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bond indenture
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contract between a firm issuing bonds to borrow money (the issuer) and the investors (people who purchase bonds as investments)
- specify: interest rate, maturity date, convertability |
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Secured vs. unsecured bond
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- secured bonds = supported by specific assets the issuer has pledged as collateral (borrower's pledge to lender to secure
repayment of a loan) VS. - unsecured bonds = aka debentures; aren't backed by a specific asset (collateral); secured by "faith"; more common |
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sinking fund
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designated fund to which an organization makes payments each year over the life of its outstanding debt
- way to ensure that sufficient funds are available to pay a large sum over an extended period of time - an investment used to set aside money to pay the outstanding debt as it becomes due |
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term bonds
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require payment of the full principal amount of the bond at a single maturity date; more common
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serial bond
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requires payments in installments over a series of years
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borrower (issuer)
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issuing company (i.e. JP Morgan)
- eventually a corporation, insurance company, or individual might be issued a bond by the issuing company -owes the holders a debt - pays them interest |
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callable bonds
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aka redeemable; allows the borrower to repay the bonds early before their scheduled maturity date at price (stated in the bond contract; exceeds the bond's face amount)
- occurs when interest rates go down - protects the borrower from decreasing interest rates - more common - implies company has capital to pay it off |
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convertible bonds
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allow the lender (or investor) to convert each bond into a specified number of shares of common stock
- sell at a higher price, lower interest rates |
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How to price a bond (3 ways):
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present value of the face value + present value of periodic interest
- can be issued at: 1) face value (aka principle, par, stated value): market interest % = corporate bond %; combo of pricing lump sum and annuity 2) discount = corporation receives less cash than face value of bond; occurs when market interest % > corporate interest % 3) premium = corp receives more cash than face of bond; market int % < corp int % |
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market interest rate
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true interest rate used by investors to value a company's bond issue
- higher the market interest rate = lower bond issue price - will be higher for high risk companies |
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stated interest rate
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rate quoted in the bond contract used to calculate the cash payments for interest
- never changes (stated in bond indenture) |
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periods to maturity
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number of years to maturity X # of interest payments per year
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carrying value
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= book value; the value of the asset recorded on the balance sheet
- amount owed during a certain period |
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Journal entry for issuance of bonds
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- debit cash
- credit bonds payable at first semi-annual interest payment: - debit interest expense - credit cash - the carrying value will increase from the amount original borrowed to the amount at maturity (i.e. market interest rate causes bond to be less than issue price) |
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calculation for interest expense:
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carrying value (amount owed during that period) X market rate (semi-annual or annual)
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calculation for cash paid for interest:
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face amount X stated rate (semi-annual or annual) X time
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What does an amortization schedule for bonds show?
- at premium - at discount |
- at premium = shows decreases in carrying value from higher carrying value down to original face value
- at discount = shows increase in carrying value from lower carrying value up to original face value |
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retirement of bonds
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When the issuing corporation buys back its bonds from the investors
- can occur at maturity of bond or prior (prior occurs more often; feature of callable bond) |
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long-term notes payable
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each installment payment includes: amount that represents interest, amount that represents reduction of outstanding loan balance
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lease
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contractual agreement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specific period of time
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operating leases vs. capital leases
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- operating = like a rental
- capital = occurs when a lessee buys an asset and borrows the money through a lease to pay for the asset (4 year lease for a car - ownership is transferred at the end of the lease term) |
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When you're recognized as high risk...
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Market will call for a higher rate (stated or not)
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