Long term financing
Chapter 12: 2,5,8,13,15
Chapter 13: 6,8,16,23
Chapter 14: 1,3,9,11
Chapter 20: 6,12,16
Characteristics of stock vs. debt
• Debt vs. Equity
– Residual claim?
– Payments are tax deductible?
– Finite life?
– Voting rights?
• Hybrid securities (preferred)
Characteristics of debt securities
•
•
•
•
•
Security
Seniority
Callable
Convertible
Covenants
• Credit rating
Example: Estimating debt ratios (MV)
with complex capital structures
Kmart is trying to estimate its debt ratio. It has 1
million shares outstanding, trading at $50 per
share, and $250 million in straight debt
outstanding (with a yield ot maturity of 9%). It
also has two other securities outstanding:
1) it has 200,000 warrants outstanding, conferring
on ints holders the right to buy stock at $65 per
share. These warrants are trading at $12 each.
2) It also has 10,000 20-year convertible bonds
outstanding, with a coupon rate of 6% and 10
years to maturity. These bonds trade at par.
Estimate the debt ratio in market value terms.
Example: Value of convertible
bonds
• At the end of 2003, GM had an 8.25%
convertible bond, coming due in the year
2011, which was trading at $1400. It also
had straight bonds, with the same
maturity, trading in December 2003 at a
yield of 8.4%. What is the value of the
conversion option?
Corporate bond yield spreads
Rating:
Aaa/AAA
Aa2/AA
A2/A
Baa2/BBB
Ba2/BB
B2/B
Caa/CCC
1 yr
9
39
89
109
320
465
755
2 yr
13
41
108
126
340
485
765
3 yr
16
43
110
131
350
495
775
5 yr
31
64
118
151
380
520
840
7 yr 10 yr 30 yr
52
70
84
81
94
116
126
146
162
168
187
202
400
425
475
555
580
630
890
945
985