Download DEBT FINANCING

Chapter 11
Sources of Long-Term
Finance: 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
11–1
Learning Objectives
•
Explain the general characteristics of
long-term debt.
•
Identify and explain the features of the main
types of long-term loans.
•
Identify and explain the features of the main
types of marketable long-term debt 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
11–2
Learning Objectives (cont.)
•
Identify and explain the main features of
project finance.
•
Understand the role of interest rate swaps
in managing debt.
•
Identify and explain the features of securities that
have the characteristics of both debt and equity.
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
11–3
Introduction
•
‘Long-term debt’ is debt with a term to maturity
greater than 12 months.
•
Long-term debt typically comprises more than half
of the total debt of listed Australian companies.
•
Two broad types of long-term debt:
–
Loans from banks and other financial intermediaries.
–
Funds raised by issuing marketable debt securities
such as corporate bonds.
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
11–4
General Characteristics of Long-Term
Debt
•
Debt — contract where borrower promises
to pay future cash flows to lender.
•
Debt contract specifies the size and timing of
interest payments and how they are calculated.
•
May specify if there are assets pledged as
security, if debt is transferable, any other
restrictions on and rights of the parties.
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
11–5
General Characteristics of Long-Term
Debt (cont.)
•
Secured
–
•
Lender has claims against the borrower and
against assets of the borrower.
Unsecured
–
Lender has a claim against the borrower, but no claim
to any particular property owned by 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
11–6
General Characteristics of Long-Term
Debt (cont.)
•
Marketable
–
•
Securities such as notes, bonds or debentures that
are issued direct to investors and can then be traded
in a secondary market.
Non-marketable
–
Loans arranged privately between two parties.
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
11–7
General Characteristics of Long-Term
Debt (cont.)
•
•
Interest cost of debt
–
Fixed versus variable — if variable, typically some benchmark
rate (cash rate) plus a premium dependant on risk of borrower.
–
Higher for subordinated debt — lowest ranking debt in event
of company being wound up.
Effect of debt on risk
Financial risk — risk attributable to the use of debt as
a source of finance.
– Financial risk effects:
–

leverage effect
 financial distress effect
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
11–8
General Characteristics of Long-Term
Debt (cont.)
•
Effect of debt on control
–
Lenders have no voting rights.
–
However, lenders have a large degree of potential
control if the company breaches the loan agreement.
–
To protect their assets, creditors can take control of
loan security, appoint administrators, move for
receivership or liquidation.
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
11–9
General Characteristics of Long-Term
Debt (cont.)
•
Security for debt
–
Legal ownership — a bank or other financier can
purchase asset and lend it to a business.
This form of debt finance is called ‘leasing’.
 Financier has legal ownership of asset, providing
some greater security.

–
Fixed charge — lender has a charge over specific
asset or group of assets.

–
Restricts borrowers ability to deal in these assets.
Floating charge — lender has a charge over a class
of assets such as inventory.

Borrower can deal in the asset.
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
11–10
General Characteristics of Long-Term
Debt (cont.)
•
Security for debt (cont.)
–
Restrictive covenants — rather than requiring security or
a charge, place some financial or accounting restriction
on the borrower to ensure ability to service debt.

Typically used with larger loans to listed companies and
marketable security issues.
–
Negative pledge — borrower undertakes not to pledge
existing or future assets of the company to anyone else
without the consent of the lender.
–
Guarantee — promise from a third party to cover debt
obligation in event of default.

Typically, a parent company may guarantee a loan for
a subsidiary.
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
11–11
Long-Term Loans
•
Australian companies obtain long-term debt finance largely
by loans, rather than by issuing their own debt securities.
•
Important features of term loans:
–
•
Loan is for a fixed period
Other features that may be fixed include:
–
The amount borrowed
– The interest rate
– The repayments
•
In many respects, a term loan resembles a mortgage
loan used to purchase real estate.
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
11–12
Long-Term Loans (cont.)
•
Choices in taking long-term loans
–
Typically, a minimum amount is specified by the lender,
while the maximum depends on the borrowers debt
capacity and ability to repay.
–
Lender will specify minimum and maximum terms, while
the borrower would choose the actual term.
–
Interest rates can be fixed or variable — variable rates
will be tied to the yield on government bonds.
–
Interest rates will also vary, depending on security on
the loan and type of asset used as security.
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
11–13
Long-Term Loans (cont.)
•
Choices in taking long-term loans (cont.)
–
Credit foncier loan — type of loan that involves regular
repayments which include ‘principal and interest’.
–
Alternative payment arrangements, ‘principal plus
interest’, ‘interest only’ and ‘interest only in advance’.
–
Frequency of repayment can vary from weekly to yearly
— in the case of infrequent payments, interest payments
may be arranged more frequently.
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
11–14
Long-Term Loans (cont.)
•
Variable-rate term loans
–
If a borrower chooses a variable interest rate, there
is considerable flexibility for the amount borrowed
and repayment pattern.
–
Variable-rate loan is flexible in that it can be repaid early
without penalty and a redraw facility may be available.
–
Possible to convert to fixed rate loan without penalty.
–
Capped option — rate can rise but not above some
agreed cap.
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
11–15
Long-Term Loans (cont.)
•
Fixed-rate term loans
–
Borrower chooses to pay an agreed fixed interest rate for a
period of at least 1 year. The maximum varies from 5 –10 years.
–
Fixed-rate loan loses some of the flexibility of
variable-interest-rate loan.
–
Progressive draw down is not allowed — you borrow and
pay interest on the full amount from day 1.
–
Repayment patterns are flexible but, once determined,
cannot be varied during the fixed-rate period.
–
May be able to make special repayments or repay in full
before end of term but there usually is an administration fee
and an early repayment adjustment.
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
11–16
Long-Term Loans (cont.)
•
Other features of term loans
–
In addition to interest, there may be loan establishment
and periodic loan service fees.
–
Bank may not wish to lend the whole amount a single
borrower seeks for risk-management reasons.
–
This can be overcome through a syndicated loan.
–
A number of banks join together to provide what
is in effect a term loan, with each lender having
identical rights.
–
A way to spread the credit risk without having several
loans and worrying about subordination of 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
11–17
Long-Term Loans (cont.)
•
•
Eurocurrency loans
–
Loans that are normally denominated in a foreign
currency and sourced overseas.
–
Reasons for Eurocurrency loans include diversification
of funding sources and exposure to more than one
currency.
Why do businesses use term loans?
–
Loans from financial intermediaries are preferred
where borrowing is small, with direct finance being
more competitive as the size of the loan increases.
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
11–18
Long-Term Loans (cont.)
•
Why do businesses use term loans? (cont.)
–
Low transaction costs of term loans — better for
small amounts.
–
Issue of marketable securities has strict disclosure
requirements, while a term loan does not require
such public disclosure.
–
Term-loan repayments are much more flexible, with
banks willing to renegotiate repayment patterns.
–
Debt securities may need to be rated by a rating
agency — not feasible for small borrowers (costs:
financial and public disclosure).
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
11–19
Marketable Long-Term Debt
•
Most long-term debt securities are issued
by governments and financial institutions.
•
Long-term debt issues are important means for
Australian borrowers to raise funds from overseas.
•
Main domestic issuers of long-term debt securities
are financial institutions.
•
Domestic public issues of long-term debt securities
by non-financial corporations are a small, but
growing, proportion of long-term debt issues.
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
11–20
Marketable Long-Term Debt (cont.)
•
•
Debentures
–
Fixed charge / floating charge.
–
Coupon rate is a function of general interest rates at
time of issue and riskiness of issuer.
–
Need for a trust deed.
In the Australian market:
–
Usually secured, long-term, fixed-interest securities
that are issued for fixed periods but can be sold by
the investor if required.
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
11–21
Marketable Long-Term Debt (cont.)
•
In the Australian market (cont.):
–
•
Can be issued by finance companies or by
non-financial companies.
Finance company debentures issued
continuously under a prospectus that is valid
for up to 12 months.
–
–
Interest rates can be varied (over the 12-month period)
though, once issued, the rate is fixed until maturity.
Intended to provide secure income stream and not
typically listed on ASX.
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
11–22
Marketable Long-Term Debt (cont.)
•
•
Timbercorp is a non-financial company that
issued a debenture in 2003.
Key features:
–
–
–
–
•
Issue limited to a finite amount $40m.
Open for a limited time (7 weeks).
Debentures listed on ASX.
Standardised issue — all debentures were identical in
terms of interest rate, frequency of payment and maturity.
Company issuing debentures draws up a trust
deed and appoints a trustee — specifies nature
of security and where the debt ranks in terms of
claims against company assets.
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
11–23
Marketable Long-Term Debt (cont.)
•
Unsecured notes
–
Same as debentures — unsecured creditors that
rank below secured creditors for repayment of debt.
–
Riskier than debentures.
–
Higher interest rate than debentures.
–
Unsecured but may be secured by a charge over
intangible assets — Corporations Act 2001 does
not allow use of term ‘secured’ in such cases.
–
May use term ‘bond’ to describe such securities
if they are secured by intangibles as cannot be
called ‘debenture’.
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
11–24
Marketable Long-Term Debt (cont.)
•
Corporate bonds
–
May use the term ‘bond’ as an alternative to
‘unsecured note’.
–
Corporate bond — generally long-term, fixed-interest
debt securities with coupon payments every 6 months,
issued by non-government entities in amounts of at
least $500 000 per investor.
–
Australian market has grown rapidly since 1995, $20b
on issue, to 2004 when $128b are on issue.
–
Market for offshore bonds issued by Australian
borrowers has grown rapidly.
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
11–25
Marketable Long-Term Debt (cont.)
•
Corporate bonds (cont.)
–
This may be related to higher interest rates in
Australia relative to say, US, UK and Japan.
–
Foreign bonds — bonds issued by an Australian
borrower in a foreign country and denominated in
the currency of that country.
–
Eurobonds — medium- to long-term securities sold
in countries other than the country of the currency
in which the bond is denominated.
–
Corporate bonds will typically require some sort of credit
rating to enhance their marketability and liquidity.
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
11–26
Marketable Long-Term Debt (cont.)
•
Main differences between corporate bonds and
debentures are that corporate bonds:
–
Minimum investment in corporate bonds is much larger.
–
Have less restrictive trust deeds.
–
Are placed privately with institutional investors.
–
Do not need a prospectus, if placed with institutional
investors.
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
11–27
Interest Rate Swaps
•
Agreement between two or more parties
to exchange a set of interest payments over
a specified period of time.
•
No exchange of principal is involved — only
interest payments are exchanged (that relate
to a notional principal amount).
•
The counterparty is offering a swap of variable
interest payments for fixed interest payments.
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
11–28
Interest Rate Swaps (cont.)
•
The swapping counterparty is taking on risk
and hoping that the variable rate will fall.
•
That way, the payments they receive will exceed
the payments they have to make.
•
The company doesn’t want to be exposed to
the risk of variable rate rises.
•
Attractive feature:
–
Allows many companies to borrow, at a fixed interest rate,
funds which otherwise would not be available and/or
would only be available at a higher interest 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
11–29
Example: Interest Rate Swaps
Example 11.2:
• Counterparties A and B enter into a swap agreement.
•
Notional principal of $10m with cash flows quarterly
in arrears.
•
Counterparty A agrees to pay counterparty B floating rate
payments based on the bank bill rate.
•
Counterparty B agrees to pay counterparty A fixed rate
payments at 9% p.a.
•
What are the cash flows made in the swap?
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
11–30
Example: Interest Rate Swaps (cont.)
•
Agreement entered on 1 April 2006 when the
bank bill rate was 7.6%.
•
Subsequently, it was:
–
–
–
8.70% — 1 July 2006
9.35% — 1 October 2006
9.25% — 1 January 2007
•
Counterparty B wants the fixed rate.
•
Counterparty A offers the fixed rate and takes
on the variable 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
11–31
Example: Interest Rate Swaps (cont.)
•
•
Payment on 1 July (for April quarter).
A pays B:
•
B pays A:
0.076  91 365  $10m  $219 287.67
0.09  91 365   $10 m  $224 383 .56
•
Net payment from B to A of $34 904.11
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–32
Example: Interest Rate Swaps (cont.)
•
•
Payment on 1 October (for July quarter).
A pays B:
•
B pays A:
0.087  92 365   $10 m  $189 479 .45
0.09  92 365   $10 m  $226 849 .32
•
Net payment from B to A of $7561.65
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
11–33
Example: Interest Rate Swaps (cont.)
•
•
•
Payment on 1 January (for October quarter).
Bank bill rate was 9.35% for this quarter.
Net payment from A to B of $8821.92.
•
Payment on 1 April (for December quarter).
• Bank bill rate was 9.25% for this quarter.
• Net payment from A to B of $6164.38.
•
Counterparty B gained in the third and fourth
quarters because the variable rate moved
above 9%.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–34
Project Finance
•
Technique that is commonly used to raise funds for
major mining and natural resource projects, infrastructure
projects such as power stations, pipelines and toll roads,
tourist resorts and other property developments.
•
Can also be used to fund acquisition of large
industrial assets.
•
Lenders rely on cash flows of a single project as
source of debt repayment.
•
Financial risk for originators of project who provide
equity finance is limited.
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
11–35
Project Finance (cont.)
Main Features of Project Finance
• No such thing as standard project finance,
though some common features are:
–
Project established as a special-purpose legal entity
whose sole business activity is the project.
–
Usually organised for a new project rather than
established business.
–
High proportion of debt finance, 70–90%, with remainder
coming from project sponsors who own project.
–
Lender’s decision based on expected cash flows
of assets.
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
11–36
Project Finance (cont.)
•
Common features of project finance (cont.):
–
Limited recourse debt — debt holders have limited claim
against equity holders (project sponsors) — usually until
project completed.
–
Main security is intangible — project company contracts,
a concession (toll roads) or rights to natural resources.
–
Project finance loans are for longer terms than normal
corporate loans — loans repaid by end of project’s life.
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Prepared by Dr Buly Cardak
11–37
Project Finance (cont.)
•
When is project finance attractive?
–
Lenders need to evaluate the terms of any project contracts
that may affect construction and operating costs.
–
Also interested in potential to shift risks onto third parties —
off-take agreements, pricing power, guaranteed price rises etc.
–
Project assessment is slow, complex and costly so lenders
charge a larger margin than on other corporate debt.
–
Project finance is viable where operating cash flows
are predictable so low risk of project allows high gearing
to be employed.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–38
Hybrid Debt–Equity Finance:
Preference Shares
•
A form of equity financing with characteristics
of debt securities.
•
Normally, holders have no voting rights.
•
Normally entitled to receive a specified fixed
return out of a firm’s net profit.
•
Rank ahead of ordinary shares with respect to
dividend payments, and usually with respect
to claims on assets in the event of a liquidation.
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Prepared by Dr Buly Cardak
11–39
Hybrid Debt–Equity Finance:
Preference Shares (cont.)
•
Cumulative or non-cumulative
–
A company that issues cumulative preference shares
is required to pay any accumulated preference
dividends before a distribution may be made
to ordinary shareholders.
–
Non-cumulative preference shares do not oblige
the company to pay any past accumulation of
unpaid preference dividends.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–40
Hybrid Debt–Equity Finance:
Preference Shares (cont.)
•
Redeemable, irredeemable, converting
or convertible:
–
Redeemable preference shares are similar to debentures,
but dividends are not deductible for income tax purposes.
–
Irredeemable preference shares are similar to ordinary
shares.
–
Converting preference shares automatically convert
to ordinary shares at some specified time in the future.
–
Convertible preference shares can be converted
to ordinary shares at the option of the holder.
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Prepared by Dr Buly Cardak
11–41
Hybrid Debt–Equity Finance:
Preference Shares (cont.)
•
Participating or non-participating
–
A company may issue participating preference shares
that allow the holders to share in any profit earned in
excess of a certain amount.
–
These participating preference shareholders can obtain
a dividend in excess of the preference dividend rate.
–
Non-participating preference shareholders are not entitled
to a dividend in excess of the stated dividend rate.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–42
Hybrid Debt–Equity Finance:
Preference Shares (cont.)
•
•
Why issue preference shares?
Three advantages over ordinary shares and debt.
–
Non-voting — can raise capital without affecting control
of ordinary shareholders.
–
Preference shareholders cannot force a company into
liquidation — preferred over debt for this reason.
–
Easy to value as they pay a fixed dividend and
interest rates on debt are readily observable.
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Prepared by Dr Buly Cardak
11–43
Hybrid Debt–Equity Finance: Convertible
and Converting Securities
•
Convertible securities provide holder with the
right to convert into ordinary shares at some
future date or dates.
•
Typically convertible unsecured notes (debt) but
convertible preference shares have been issued.
•
Converting securities automatically change from
one form of security to another at a particular date
— converting preference share is most common.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
11–44
Hybrid Debt–Equity Finance: Convertible
and Converting Securities (cont.)
•
Convertible notes
–
A convertible note is a debt instrument issued for a
fixed term at a stated interest rate, which gives the
holder the right to convert the note into ordinary shares
at specified future dates.
–
Notes are usually issued at an interest rate that is
lower than that offered on straight debt instruments.
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11–45
Hybrid Debt–Equity Finance: Convertible
and Converting Securities (cont.)
•
In addition to the explicit conversion option,
there may be an implicit option as note holders
can normally participate in pro rata issues of
new equity.
•
For companies the attractions are:
–
–
–
–
More favourable terms than straight debt.
Maturity longer than for straight debt.
Interest is normally tax deductible.
Unsecured.
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PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
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11–46
Hybrid Debt–Equity Finance: Convertible
and Converting Securities (cont.)
•
Why issue convertible notes?
–
They may seem like a cheap debt alternative.
–
However, there is an option to acquire shares, this is
a cost to the company as well — may dilute returns to
existing shareholders.
–
Jen, Choi and Lee (1997) find that convertible
issues have less of a negative impact on the shares
of high-growth companies.
–
For these types of companies, conventional debt and
equity are expensive and unattractive — thus issue
convertible 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
11–47
Hybrid Debt–Equity Finance: Convertible
and Converting Securities (cont.)
•
Converting preference shares
–
Offer a guaranteed dividend prior to a specified
conversion date, at which time the preference shares
automatically convert to ordinary shares in the company.
–
Conversion ratio — number of ordinary shares received
by the holder of each converting preference share.
Expressed in terms of discount to market price of shares.
–
This discount means the holder is protected against a fall
in the ordinary share price prior to conversion date.
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
11–48
Summary
•
Long-term debt finance can be either:
–
–
Non-marketable — bank loans, mortgage loans from
life insurance offices and super funds.
Marketable — debentures, unsecured notes and
corporate bonds.
•
Debt with term to maturity of more than
12 months is considered long term.
•
Loans from banks and other financial
intermediaries are the most important source of
long-term debt finance for Australian companies.
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
11–49
Summary (cont.)
•
Companies can borrow by directly issuing
marketable debt securities including debentures,
unsecured notes and corporate bonds.
•
Project finance is important in Australia allowing
large natural resource and infrastructure projects
to be financed with a high proportion of debt.
•
Hybrid securities — convertible notes, convertible
and converting preference shares.
–
All pay fixed dividend (like debt) and convert into
ordinary shares at some future date.
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
11–50