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The document provides an overview of long-term financing, detailing the features of common and preferred stock, including voting rights and dividend payments. It contrasts debt and equity financing, explaining the implications of each on ownership, tax treatment, and bankruptcy risk. Additionally, it discusses various bond types, bank loans, and recent trends in capital structure, emphasizing the preference for internally generated cash flow as a financing source.

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Nhi Nguyen
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8 views6 pages

Long

The document provides an overview of long-term financing, detailing the features of common and preferred stock, including voting rights and dividend payments. It contrasts debt and equity financing, explaining the implications of each on ownership, tax treatment, and bankruptcy risk. Additionally, it discusses various bond types, bank loans, and recent trends in capital structure, emphasizing the preference for internally generated cash flow as a financing source.

Uploaded by

Nhi Nguyen
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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• Long-Term Financing: An Introduction

• Features of Common Stock

• Voting rights (Cumulative vs. Straight)

• Proxy voting

• Classes of stock

• Other rights

• Share proportionally in declared dividends

• Share proportionally in remaining assets during liquidation

• Preemptive right – first shot at new stock issue to maintain proportional


ownership if desired

• Features of Preferred Stock

• Dividends

• Stated dividend must be paid before dividends can be paid to common


stockholders

• Dividends are not a liability of the firm, and preferred dividends can be
deferred indefinitely

• Most preferred dividends are cumulative – any missed preferred dividends


have to be paid before common dividends can be paid

• Preferred stock generally does not carry voting rights

• Debt versus Equity


• Debt

• Not an ownership interest

• Creditors do not have voting rights

• Interest is considered a cost of doing business and is tax deductible

• Creditors have legal recourse if interest or principal payments are missed

• Excess debt can lead to financial distress and bankruptcy

• Equity

• Ownership interest

• Common stockholders vote for the board of directors and other issues

• Dividends are not considered a cost of doing business and are not tax deductible

• Dividends are not a liability of the firm, and stockholders have no legal recourse if
dividends are not paid

• An all-equity firm cannot go bankrupt

• The Bond Indenture

• Contract between the company and the bondholders that includes:

• The basic terms of the bonds

• The total amount of bonds issued

• A description of property used as security, if applicable

• Sinking fund provisions


• Call provisions

• Details of protective covenants

• Bond Classifications

• Registered vs. Bearer Forms

• Security

• Collateral – secured by financial securities

• Mortgage – secured by real property, normally land or buildings

• Debentures – unsecured

• Notes – unsecured debt with original maturity less than 10 years

• Seniority

• Required Yields

• The coupon rate depends on the risk characteristics of the bond when issued

• Which bonds will have the higher coupon, all else equal?

• Secured debt versus a debenture

• Subordinated debenture versus senior debt

• A bond with a sinking fund versus one without

• A callable bond versus a non-callable bond

• Zero-Coupon Bonds

• Make no periodic interest payments (coupon rate = 0%)


• The entire yield to maturity comes from the difference between the purchase
price and the par value

• Cannot sell for more than par value

• Sometimes called zeroes, deep discount bonds, or original issue discount


bonds (OIDs)

• Treasury Bills and principal-only Treasury strips are good examples of


zeroes

• Floating Rate Bonds

• Coupon rate floats depending on some index value

• Examples – adjustable-rate mortgages and inflation-linked Treasuries

• There is less price risk with floating rate bonds

• The coupon floats, so it is less likely to differ substantially from the yield to maturity

• Coupons may have a “collar” – the rate cannot go above a specified


“ceiling” or below a specified “floor”

• Other Bond Types

• Income bonds

• Convertible bonds

• Put bonds

• There are many other types of provisions that can be added to a bond, and
many bonds have several provisions – it is important to recognize how these
provisions affect required returns
• Bank Loans

• Lines of Credit

• Provide a maximum amount the bank is willing to lend

• If guaranteed, referred to as a revolving line of credit

• Syndicated Loan

• Very large banks frequently have more demand for loans than they have supply

• Small regional banks are often in the opposite situation

• As a result, a very large bank may arrange a loan with a firm or country and then sell
portions of the loan to a syndicate of other banks

• A syndicated loan may be publicly traded

• International Bonds

• Eurobonds: bonds denominated in a particular currency and issued


simultaneously in the bond markets of several countries

• Foreign bonds: bonds issued in another nation’s capital market by a foreign


borrower

• Patterns of Financing

• Internally generated cash flow dominates as a source of financing

• This preference has increased through time

• Net stock buybacks accelerated in 2002-2007 in the U.S.

• Declined in 2008, likely as a result of the financial crisis

• The Long-Term Financial Deficit


• Recent Trends in Capital Structure

• Which are best: book or market values?

• In general, financial economists prefer market values

• However, many corporate treasurers may find book values more appealing due to the
volatility of market values

• Whether we use book or market values, debt ratios for U.S. non-financial
firms have been below 50 percent of total financing

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