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Learning Objectives

4. Outline some of the features of innovative forms of raising long-term financing, including zero-coupon rate bonds, floating rate bonds and real return bonds. (LO4)

5. Outline the characteristics of long-term lease financing that make it an alternative form of long-term financing. (LO5)

6. Analyze a lease-versus-borrow-to-purchase decision. (LO6)

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Innovative Forms of Bond FinancingZero-Coupon Bond / Strip Bond:

– does not pay coupon (interest)– is issued at a deep discount from face value– zero-coupon bond was created when coupons stripped from a coupon

bond and were traded separately from the face value

Floating Rate Bond:– Interest/coupon rate paid on the bond changes with market conditions

Real Return Bond– principal adjusted for inflation

Revenue Bond– security based upon cash flow

Eurobond:– bond issued in a country other than the one in which currency the bond

is denominated

LO4

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Corporate Debt for the Medium Term• Term Loans

– a loan advanced against capital asset security– the length of time is 3 to 10 years– principal and interest payments are monthly or quarterly

with a balloon payment of principal at the end of the term

• Operating Loans– Generally advanced based on current asset security– Payable on demand

• Medium Term Notes (MTNs)– of 3 to maybe 10 years duration

LO4

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Corporate Debt for the Medium Term• Mortgage Financing

– a loan advanced against property– Formal appraisal of the property required– Terms of 6 months to 10 years

• Asset-Backed Securities– Current assets sold into a trust– Firm gets immediate capital in exchange for its assets– Investor receives a steady return as the receivables

are collected

LO4

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Advantages and Disadvantages of Debt

Advantages:– interest payments are tax deductible to a firm

– wise use of debt may lower a firm’s weighted average cost of capital (WACC)

– during inflation, debt is repaid with “cheaper dollars”

Disadvantages:– interest and principal must always be met when due,

regardless of a firm’s financial position

– poor use of debt may lower a firm’s stock price

– may place burdensome restrictions on the firm

LO4