Chapter 15

Long-Term Financing: An Introduction

Copyright 2015 by the McGraw-Hill Education (Asia). All rights reserved.

Key Concepts and Skills
Describe the basic features of common and
preferred stock.
Understand the different types of bonds and
how bond characteristics impact the required
yield.

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Chapter Outline
15.1 Some Features of Common and Preferred
Stock
15.2 Corporate Long-Term Debt
15.3 Some Different Types of Bonds
15.4 Bank Loans
15.5 International Bonds
15.6 Patterns of Financing
15.7 Recent Trends in Capital Structure
15-2
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
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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.
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Debt versus Equity
Debt Equity
Not an ownership interest Ownership interest
Creditors do not have voting Common stockholders vote
rights
for the board of directors and
Interest is considered a cost of other issues
doing business and is tax
deductible Dividends are not considered
Creditors have legal recourse a cost of doing business and
if interest or principal are not tax deductible
payments are missed Dividends are not a liability of
Excess debt can lead to the firm, and stockholders
financial distress and have no legal recourse if
bankruptcy dividends are not paid
An all-equity firm cannot go
bankrupt
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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
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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
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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

15-8
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
15-9
Pure Discount Bonds
Information needed for valuing pure discount bonds:
Time to maturity (T) = Maturity date - todays date
Face value (F)
Discount rate (r)

$0 $0 $0 $F

0 1 2 T 1 T

Present value of a pure discount bond at time 0:

F
PV
(1 r ) T
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Pure Discount Bonds: Example
Find the value of a 30-year zero-coupon bond
with a $1,000 par value and a YTM of 6%.
$0 $0 $0 $1,000

0 1 2 29 30

F $1,000
PV $174.11
(1 r ) T
(1.06) 30

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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.

15-12
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.
15-13
15.4 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
Large money-center banks frequently have more demand
for loans than they have supply.
Small regional banks are often in the opposite situation.
As a result, a lager money center 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.
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15.5 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 nations capital
market by a foreign borrower

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15.6 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

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The Long-Term Financial Deficit
Uses of Cash Flow Sources of Cash Flow
(100%) (100%)

Capital Internal cash

spending flow (retained
80% earnings plus Internal
depreciation) cash flow
80%
Financial
deficit
Net
working
capital plus Long-term External
other uses debt and cash flow
20% equity 20%
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15.7 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.

15-18
Quick Quiz
Describe the basic characteristics of common
and preferred stock.
Differentiate between cumulative voting and
straight voting.
Identify the rights of shareholders and
bondholders.
How would the following characteristics
impact the yield on a bond:
Callable
Sinking Fund
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