Download Taking Loans and Issuing Bonds

Raising Money to
Grow a Business
Lesson 1
Taking Loans and Issuing Bonds
How Companies Expand
Aim:
 What are the pros and cons of borrowing the
money you need to grow your business?
Do Now:
 From your experience hearing about loans
people take to buy homes and cars, identify
the essential elements of every loan.
How Companies Expand
 Do Now answers:
1. The dollar amount borrowed.
2. The annual interest rate applied to
the borrowed money.
3. The amount of time, usually in years
or months, the borrower has to pay it
back.
Frizzle, Inc.
 Ice cream and restaurant.
 Opening new Frizzle’s around the world for the past five
years.
 One of the most popular ice cream restaurants in the
United States and Europe.
 20% market share.
 25,000 employees in multiple locations in the United States
and Europe.
 Headquartered in New York, NY.
 Looking to expand to China or Russia.
 Needs $500 million in order to expand.
 Financial statements indicate a healthy, profitable company.
Frizzle, Inc.
Frizzle, Inc. has 2 choices to borrow money
Frizzle, Inc.
Borrow money
from a bank
Issue Bonds
Borrowing from a Bank
Company can take a loan from a
bank in order to get the capital (ie: cash to use
for a long while) it needs
 Similar to an individual
borrowing money
 Must be paid back in a
certain time by a specified
date with interest
Borrowing from a Bank
Advantages
Disadvantages
 May be able to secure loan
quickly
 Owners don’t give up
control
 Less restrictions on what
the money can be used for
 May be more expensive and
have to pay a higher rate of
interest (than the other form
of borrowing, a bond)
 Potential prepayment penalty
 Could decrease cash flow if
repayment starts right away
Borrowing with Bonds
 What is a bond?
 A document (ie: security) that
represents an amount of money
(usually $1,000), which is clearly
printed on the bond (ie: Principal)
 For each $1,000 an investor wants
to lend to a governent or business,
it receives one bond
 Lender/Bondholder – We say the investor “buys” the bond
because he or she pays (the Principal $ amount) for it.
 Issuer – The company or government that borrows the
money. It has this name because it issues the bonds!
Bonds
Lender
Issuer
The issuer is repaying the lender’s/bondholder’s
original investment (Principal) when the term of
the bond is due. This date, also printed on the
bond, is called the Maturity Date)
Bonds
In the days before computers, the
bond was issued with coupons.
Every six months, one would be
torn off and turned in to receive
interest. The coupons went away,
but we continue to call the interest
rate the coupon rate, and the
payment itself the coupon payment.
The issuer pays interest to the bondholder during
the term of the bond. The coupon payments end
when the bond reaches maturity.
Bonds
 Principal (aka “Face Value”): The original investment is
repaid when the bond matures.
 Maturity Date: Predetermined date in the future when
the bond matures and the lender/bondholder receives
the principal investment.
 Coupon Rate (%): The interest that the
lender/bondholder receives.
 Coupon Payment ($): A dollar amount that is paid to the
lender/bondholder regularly until the bond matures
(payment is based on the Coupon Rate and Principal)
Bonds
 Cash Flows of a Bond
Coupon
Payment
0
Coupon
Payment
1
Coupon
Payment
2
+ Coupon
Payment
Coupon
Payment
3
Year
Principal
4
5
Maturity
Bonds
Credit risk is the chance that a bond issuer will fail to
repay the principal and interest on the specified date
Coupon
Payment
0
Coupon
Payment
1
Coupon
Payment
2
Coupon
Payment
3
Year
4
5
Rating Process For Bonds
 To assess a company’s risk of failing, bond investors
turn to the following three credit ratings agencies:
 Ratings are based on whether or not the issuer will be able to
make their principal and interest payments, to the bond
holder, on time
A “AAA” high grade bond offers more
security but a lower yield than a “C” bond
A “C” bond is more risky
but has a higher yield
STRONGEST
NON-INVESTMENT
GRADE
INVESTMENT
GRADE
CREDIT RATINGS*
WEAKEST
MOODY’S
STANDARD & POOR’S
FITCH
Aaa
AAA
AAA
Aa
AA
AA
A
A
A
Baa
BBB
BBB
Ba
BB
BB
B
B
B
Caa
CCC
CCC
Ca
CC
CC
C
C
C
C
D
D
*These credit ratings are reflective of obligations with long-term maturities.
Maturity
Date
Face
Value
(Prin.)
Bonds
Coupon
Payment
Coupon
Rate
Issuing a Bond
(vs. Borrowing From a Bank)
Advantages
Disadvantages
 Company can borrow at a
lower interest rate than they
would have to pay the bank
 Company will be able to
raise a large sum of money
from the large community of
bond investors
 Company may have
difficulty issuing bonds if
they are experiencing
financial difficulties within
their company
 Company may not be large
enough to issue bonds
Lesson Summary
1. What are the two choices corporations have if
they want to borrow money?
2. What are the relative pros and cons of each?
3. What are the major elements of a bond?
4. Identify the three big bond ratings agencies
5. What are the highest and lowest available
ratings?
6. What are the pros and cons of borrowing the
money you need to grow your business?
Web Challenge #1
Q: The Federal Reserve has tried to keep down
the interest rate at which people and
corporations can borrow money. Will this cause
there to be more or less money borrowed?
•
A: It will encourage more borrowing because
low rates means less interest costs.
•
Challenge: Find corporations that have issued
bonds because it’s just cheap to borrow and
they want to lock in a low rate. Hint: Look for the
explanation that the money will be used for
“general corporate purposes”.
Web Challenge #2
• Challenge: Not any company can walk
into a bank and get a loan. Research
the characteristics a business must
have to qualify for a bank loan.
Prepare a checklist of five to 10
requirements. Indicate the most
challenging one, explaining why. (Hint:
the evaluation by the bank is formally
called “underwriting”.)
Web Challenge #3
Q: The Small Business Administration is a
government department that was created to
help small businesses, including providing
loans to them.
•
•
Challenge 3a: Visit sba.gov. Identify three
ways that it can help a small business.
Challenge 3b: Prepare one argument for
and one against having the government
loan money to businesses. After all, who
loses if the business fails and can’t repay
the loan?