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Flashcards in Study Unit 7 Deck (35)
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1

Indenture

document that states terms of bond agreement
may require issuer to establish and maintain bond sinking fund
-objectives of pmts into fund is to segregate and accumulate assets to pay bond principal at maturity

2

Advantages and disadvantages of bond to issuer

Advantages
interest paid on debt is deductible
maintain ctrl of firm

Disadvantages
pmt of interest and debt are legal obligations; if not enough cash flow to pay could become insolvent
legal req raises firm's risk level; s/h demand higher cap rates on r/e, decreasing mkt price of stock
require collateral (restricts assets)
debt financing limited; cost of debt may rise rapidly

3

Maturity Pattern Bonds

term- single maturity date at end of term
serial- matures in stated amnt at regular intervals

4

Valuation Bonds

Variable (floating) rate- pay interest based on mkt conditions
zero-coupon or deep discount - no stated rate of interest, no periodic cash pmt, interest is the bond's discount
commodity backed- payable at prices related to a commodity (i.e. gold)

5

Redemption Provisions

Callable- able of issuer to repurchase at specific price before maturity (good when interest rates fall b/c issuer an replace high interest debt with lower interest rate); pay higher yield than non callable

Convertible-convert into equity security of issuer

6

Call provisions

provisions on a bond allowing issuer to repurchase and retire bonds early

7

Value proposition of callable bonds

favorable for issuer b/c can retire & pay debt earlier
-no more interest pmts

unfavorable for investor bc amnt rec'd when not retired is more than premium company pay to retire

8

Securitization

Mtg bonds- backed by assets (real estate)
Debentures- backed by borrower's general credit not specific collateral

9

Ownership

Registered bonds- issued in name of holder; only holder receives interest and principal pmts

bearer bonds- not individually registered; interest and principal paid to whomever presents bond

10

Priority

Subordinated debentures- junior securities with claims inferior to sr bonds

11

Repayment provisions

income bonds- pay interest contingent on issuer's profitability
revenue bonds- issued by govt and payable from specific revenue sources

12

Bond discount vs premium

discount- stated rate (coupon) mkt rate
-investor pay more bc interest pmts are higher than available for mkt

13

Leverage

relative amnt of FC in firm's overall cost structure
-creates risk bc FC must be covered regardless of sales level

14

Operating Leverage

firms' cost of operating are fixed rather than variable
degree of op leverage (DOL) measures effect given level of fixed operating costs has on firm earnings

DOL=% change in earnings before interest & taxes (EBIT)/% change in sales
-help find best level of operating leverage to maximize EBIT
-firm w/ high FC more risky than firm w/ more VC

15

Financial leverage

degree of debt (fixed financial costs) in the financial structure
degree of financial leverage (DFL)
DFL=% change in EPS/ % change in EBIT

high % of fixed financial costs, firm takes more risk to increase its EPS

16

Degree of total (combined) leverage

DTL= DOL * DFL
high DTL has higher return for investors, but is more risky

17

Disadvantages of issuers of common stock

cash dividends aren't tax deductibe; paid out of after tax profits
new c/s sales dilute EPS to existing s/h
underwriting costs higher
too much equity raises avg cost of capital above optimal level

18

Preemptive rights

common shareholder have right to purchase adtl stock issuance in proportion to current ownership %

19

Dividend payout model for constant dividend

Price per share now = divident per share (constant)/req rate of return

P(0)=D/r

when dividend is constant & expected to be paid continuousy

20

Constant growth model

dividend discount model
P(0)=D(0) (1+g) / r-g
P(0)=D(1)/r-g

21

preferred stock

hybrid of debt & equity; has fixed charge, pmts not obligation

22

Advantages of issuers of preferred stock

builds creditworthiness (form of equity)
control held by common s/h (no voting rights)
superior earning of firm reserved for common s/h
doesn't req periodic pmts; failure to pay doesn't lead to bankruptcy

23

Disadvantages to issuers of preferred stock

cash dividend aren't tax deductible
during rough economy, accumulated unpaid div create managerial and financial problems

24

Future dividends of preferred stock

D=par value of preferred * preferred div rate
preferred stock price P(p)
P(p)= D(p)/r

25

IPO (advantages & disadvantages)

advantage
-raise $
-establish value in mkt
-increase liquidity of firm's stock

disadvantage
-cost of reporting req
-access to firm's operating data by competitors
-access to net worth by s/h
-limitation on self-dealing by corporate insiders
-pressure from outside s/h for earnings growth
-stock prices don't accurately reflect NW
-loss of control by mgt
-increased s/h service costs

26

Types of leases

sale leaseback- alternative for raising capital; allow firms to acquire capital from sale of asset while retaining use

service or operating- both financing and maint services

financial- don't provide maint, noncancelable and fully amortize cost of lease over term of basic lease contract (installment purchases)

27

Capital lease

essentially the purchase of an asset
4 part test (meet at least 1)
-Bargain purchase option
-Lease term is at least 7% of useful economic life
-Title transfered at end of lease
-Minimum lease pmt (PV MLP =90% or more of FV of leased property)

28

Operating lease

off B/S
rental contract
no entry recorded, expense as incurred

29

Cost of capital used to discount FCF of LT projects

investments w/ RoR higher than cost of capital increase the value of the firm (s/h wealth)

30

Risk for Investors

firm not legally obligated to pay return
if firm liquidates, creditors have priority