Download Chapter 9 - McGraw Hill Higher Education

Chapter 9
Sources of Short-Term
Debt
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–1
Learning Objectives
•
Identify the main forms of short-term borrowing
by Australian companies.
•
Understand the characteristics of trade credit
and calculate the implied interest rate.
•
Understand the main forms of bank lending
and appreciate when each may be suitable
to a borrower’s needs.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–2
Learning Objectives (cont.)
•
Understand debtor finance, inventory loans
and bridging finance, and be able to
distinguish between them.
•
Understand the basic features of the interbank
cash market.
•
Understand the process of using promissory
notes and bills of exchange to raise funds.
•
Calculate prices and yields for promissory
notes and bills of exchange.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–3
Introduction
•
‘Short-term debt’ is defined as debt due for
repayment within a period of 12 months.
•
The major short-term borrowing choices available
to Australian companies are:
–
Trade credit.
–
Borrowing from banks and other financial institutions.
–
Issuing short-term marketable debt securities such
as promissory notes and bills of exchange.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–4
Trade Credit
•
When companies sell goods or services to
other businesses ‘on credit’.
•
Usually, the seller allows the purchaser
several weeks to pay.
•
Thus, trade credit is, in effect, a form of
short-term debt in which the seller lends
the purchase price to the purchaser.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–5
Borrowing from Banks and Other
Financial Institutions
•
Bank overdraft
–
An overdraft permits a company to run its current
(cheque) account into deficit up to an agreed limit.
–
The cost of a bank overdraft includes the interest
cost and fees.
–
The interest rate charged is usually at a margin above
an indicator rate, published regularly by the bank, and
only on the amount by which the account is overdrawn.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–6
Borrowing From Banks and Other
Financial Institutions (cont.)
•
Debtor financing
–
Debtor finance allows a company to raise funds by
selling its accounts receivable on a continuing basis
to a financier (called a discounter), who is then
responsible for managing the sales ledger and
collecting the debts.
–
The discounter earns a return by discounting the
value of the receivable and charging a fee.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–7
Borrowing From Banks and Other
Financial Institutions (cont.)
•
Debtor finance with recourse
–
•
Debtor finance without recourse
–
•
Agreement in which the discounter is reimbursed
by the selling company if the debtor defaults.
Agreement in which the discounter is not reimbursed
by the selling company if the debtor defaults.
Invoice discounting
–
A discounting agreement in which the debtors of the
company seeking finance are unaware of the existence
of the discounting agreement.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–8
Borrowing From Banks and Other
Financial Institutions (cont.)
•
•
Inventory loans
–
Known as floor-plan or wholesale finance.
–
A loan, usually made by a wholesaler to a retailer,
that finances an inventory of durable goods, such
as motor vehicles.
Bridging finance
–
A short-term loan, usually in the form of a mortgage,
to cover a need normally arising from timing differences
between two or more transactions.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–9
Interbank Deposits
•
Interbank market is a loan market that operates
between banks that lend to each other overnight.
•
Facilitated by exchange settlement accounts that
all banks hold with RBA.
•
These funds can be lent to (borrowed from)
another bank at the interbank cash rate.
–
‘Interbank cash rate’ is the rate changed on overnight
interbank loans which is closely tied to the RBA’s cash
rate.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–10
Short-Term Marketable Debt
•
Companies can obtain short-term debt funding by
issuing (selling) securities such as promissory
notes and bills of exchange.
•
The securities are a promise to pay a sum of
money on a future date.
•
These are generally discount securities.
•
A secondary market exists for the exchange of
such securities.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–11
Promissory Notes
•
A promise to pay a stated sum of money on a stated
future date.
•
Also known as ‘one-name paper’ and ‘commercial
paper’.
•
Face value
–
•
Sum promised to be paid in the future on the debt security.
Discounter
–
Purchaser of a short-term debt security such as a
promissory note or a bill of exchange.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–12
Promissory Notes (cont.)
•
To calculate the price P of a promissory note:
F
P
1  r d 365
where :
F  face value (future sum payable)
r  yield per annum on a simple interest basis
d  number of days to maturity
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–13
Promissory Notes (cont.)
Example 9.2:
• 90-day promissory note, $500k face value, and
a yield of 4.926% p.a. What is the price?
F
P
1  r d 365
$500 000

1  0.0492690 365
$500 000

1.012146301
 $493 999.73
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–14
Promissory Notes (cont.)
•
A promissory note can be underwritten, banks and
other financial institutions are usually involved.
•
To facilitate trading it is usual for promissory note
issues to have a credit rating from a ratings agency.
•
For example, Moody’s Investors Service assigned
a long- and short-term rating to a WMC Resources
$500m promissory note program.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–15
Bills of Exchange
 A marketable short-term debt security in which one
party (the drawer) directs another party ( the acceptor)
to pay a stated sum on a stated future date.
Drawer
has bill accepted by
Acceptor
Then the drawer has
the bill discounted by
Discounter
The discounter lends the drawer an amount
of money in exchange for the bill
Figure 9.1
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–16
Bills of Exchange (cont.)
•
A company will struggle to issue and sell a
promissory note if it does not have a credit
rating from a ratings agency.
•
This is one of the reasons that bills of exchange
have been developed — in order to enable an
unrated entity to borrow by issuing marketable
securities.
•
In addition to the issuer of the bill, there is an
acceptor who promises to redeem the bill in
the event that the issuer defaults.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–17
Bills of Exchange (cont.)
•
The face value is paid to whoever holds the bill
on the maturity date.
•
The discounter has the choice of either holding
the bill until maturity, when payment will be
received from the acceptor, or selling
(rediscounting) the bill.
•
However, if the bill is sold, the seller normally
endorses the bill at the time of sale, creating
a chain of protection for the bill holder.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–18
Bills of Exchange (cont.)
•
Endorsement:
–
Acceptance by the seller of a bill in the secondary market,
of responsibility to pay the face value if there is default by
the acceptor, drawer and earlier endorsers.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–19
Bills of Exchange (cont.)
•
Normal process of repayment
Current
Holder
approaches the
acceptor for repayment
Initially the acceptor pays
the holder the face value
of the bill
approaches the
Acceptor
drawer for
recompense
Drawer
The drawer reimburses the
acceptor for this payment
to the holder
Figure 9.2
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–20
Bills of Exchange (cont.)
•
Bank accepted bills
–
•
Bills of exchange that have been accepted or endorsed
by a bank.
Non-bank bills
–
Any bill of exchange that has been neither accepted
nor endorsed by a bank.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–21
Bills of Exchange (cont.)
•
Bill facilities
–
Bill discount facility

–
Agreement in which one entity (normally a bank)
undertakes to discount (buy) bills of exchange drawn
by another entity (the borrower).
Bill acceptance facility

Agreement in which one entity (normally a bank)
undertakes to accept bills of exchange drawn by
another entity (the borrower).
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–22
Bills of Exchange (cont.)
•
Fully drawn bill facility
–
•
Bill facility in which the borrower must issue bills so
that the full agreed amount is borrowed for the period
of the facility.
Revolving credit bill facility
–
Bill facility in which the borrower can issue bills
as required, up to the agreed limit.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–23
Summary
•
Various sources of short-term finance are
available to companies.
•
The simplest is trade credit; however,
cash discounts are forgone.
•
Banks and other financial institutions offer
a range of short-term finance:
–
Banks offer overdrafts, which are a common and
flexible form of short-term finance.
–
More specialised forms of finance include debtor
finance, inventory loans and bridging finance.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–24
Summary (cont.)
•
A company can issue short-term marketable debt
such as promissory notes and bills of exchange.
–
Promise to pay face value at a future date and sold at
a discount to face value.
•
Promissory note, promise/guarantee made only
by issuer of note.
•
Bill of exchange, there is an acceptor who
guarantees the loan.
•
Secondary market for these debt instruments
exists.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
9–25