Chapter 15

Long-Term Financing: An Introduction

McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. 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 Long-Term Syndicated Bank Loans
15.5 International Bonds

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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

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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

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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

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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.”

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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.
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Securitized Bonds
 Also called asset-backed bonds
 Bondholders receive interest and principal
payments from a specific asset rather than a
specific company or government
 Mortgage backed securities are the best-known
type of securitized bond, but others include
 Car loans
 Credit cards

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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 nation’s 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, typically between 70 and 90%.
 Firms usually spend more than they generate
internally—the deficit is financed by new sales of
debt and equity.
 Net new issues of equity are dwarfed by new sales of
debt.

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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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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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