Let’s talk about activities like debt issuance in the firm. Well one may not be aware of the fact that debt issuing is more common than that of equity. The only time when both debt and equity will become common is the context of acquisition. In general, large firm which are traded publicly are suggested to finance themselves in by debt offerings or earnings of retained. At the end, investment banks and firms, only make profits and better business from debt offerings.
21.5 A DOES FAIR PRICING IMPLY IRRELEVANCE?
Well we have discussed earlier in another chapter on how to think about the availability of the bonds which are present in different flavors which included various features along with variables associated with the same. Some of them are:
- Seniority
- Covenants
- Conversion
- Putability
- Duration
- Security
- Collateral
- Callability
- Maturity
- Floating/fixed
And many more…
And it was very well explained by considering the example of IBMs structure of debt. We have understood the basic quote to understand choose the best financing methods, which is: “What you pay for is what you get!” considering an example of the CFO when he has to do decide on whether to give more rights to the bond buyers or not? Well if you give more rights, you will pay lower interest and vice versa. Under such a case, a discussion with your managers will be really helpful as they are aware of the rates on interest and their fluctuation.
But here you need to understand that fair pricing will not always lead to value adding securities of debt which might seem most appropriate for your company. Understand the same with an example of feature bond stating the shutting down of the factories if the super bowl is won by AFC team. Although you might get a good price on these securities but they are not suitable to increase the marvel of the firm. So basically, you must choose to offer those bonds with features perfectly suiting for your firm and ethics.
21.5 B Assembling the Building Blocks of a Bond Offering
You might have enjoyed the features of bond and their approach separately. Let’s talk about the whole thing together now! So the question here is: what is the procedure of borrowing money of the corporations which are large and traded publicly. The most common answer to the same is obtaining the facility of bank credit and issuing of multiple bonds. But they should happen at the same time. Well, there are two sections in the package of financing:
- The revolver: it is known as the credit line of the company on the basis of which the firm will pay or borrow in the money again, if they want. But it is only possible till the date of termination or maturity. Talking about the bank here, they receive fee for the portion of revolver against their offering of line of credit.
- The term Debt: Basically this is divided into slices (or tranches) to make a proper structure. Please note that date of maturity as well as schedule of principal payment is entirely different from each one of the tranches. Tranche X will have the access to amortize right away which means he will have the maturity term as the shortest. The term loan by Tranche Y will amortize after the term loan of Tranche X but before the term loan of tranche Z. And the cycle continues!
Considering Tranche X and revolver, we will notice that they both will share the share rate of interest on the London Interbank Offer Rate (LIBOR) and will they marketed and known as package. Tranche Y and Z, on the other hand, will receive the wider spread over LIBOR in order to compensate the creditors.
Now the question here is who is going to sell such instruments? If the request of the bond to be issues is larger: A lead investment bank will undergo discussion about the larger part of the corporate bond with the other bankers in order to lead a successful and easier bond placing. Well, such a deal is always available on the market by the primary investment banker. But the catch here is that they are labeled or priced as per the interest rate which can clear the market.
Now the next question here is in the cycle of these instruments of multiple loans, who are the potential investors? The first package that we discussed about before which includes revolver and tranche X are generally purchased by the banks which are commercial. Well, it is noticed that the market of other tranches which are subsequent are comparatively liquefied and thus, they are purchased by hedge fund, mutual funds, commercial banks and the similar segment.
Talking about how do smaller companies borrows the money? They generally contact the primary investment banker. But if the company is too small, they will contact the regional bank in the area. These structures are simpler which includes Tranche X and revolver and in some cases, its only revolver. Talking about the price, the premium amount and the interest rate is generally discussed and decided between the lender and borrower.
21.5 C Post-Issue Placement and Bond Liquidity
If the potential investors are allocated with better information and also with the power of liquidating the assigned investment, the issuers in this case can receive the finances at a very low costing. Talking about the securities related to equities, they are available for buy and sell on the stock market once the primary offering is placed.
Talking about the stock exchanges, NASDAQ and NYSE are known as the two most popular in the same. At the time of trading, the market is not really liquefied but rather the bonds are said to be available from trading over the counter which means that large investors will do the trading on their desks with the banker. Well, under such a case, the disclosure of the transacted price is not allowed since exchanges are not really the part of such transactions.
21.5 D Coercive Bond Exchange Offers
Most of the bonds which include the provisions of contract are eligible for changes as well. But one must note that provisions likes this are generally hard to evoke but not in the case of distress of financials by that’s why the firms must deal with the covenants which is written up front.
But shares are two mechanisms which are allow the creditors for the changes to appear in the terms which are shared by the bondholders.
- First mechanism is served by the term bankruptcy which the terms are changes by the judge.
Second is served by the term “exchanges offer”. But these offers are generally not realized as creditors aim to protect themselves.
Links of Previous Main Topic:-
- Introduction of corporate finance
- The time value of money and net present value
- Stock and bond valuation annuities and perpetuities
- A first encounter with capital budgeting rules
- Working with time varying rates of return
- Uncertainty default and risk
- Risk and return risk aversion in a perfect market
- Investor choice risk and reward
- The capital asset pricing model
- Market imperfections
- Perfect and efficient markets and classical and behavioral finance
- Capital budgeting applications and pitfalls
- From financial statements to economic cash flows
- Valuation comparables financial ratios
- Corporate claims
- Capital structure and capital budgeting in a perfect market
- Capital structure dynamics firm scale
- Theories of capital structure levels changes and issuing activity
Links of Next Financial Accounting Topics:-
- Seasoned equity offerings
- Initial public offerings ipos
- Raising funds through other claims and means
- The capital market response to issue and dividend announcements
- For value financial structure and corporate strategy analysis
- Capital structure dynamics firm scale
- Capital structure patterns in the united states
- Investment banking and mergers and acquisitions
- Corporate governance
- International finance
