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: 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 30 yrAaa/AAA 9 13 16 31 52 70 84Aa2/AA 39 41 43 64 81 94 116A2/A 89 108 110 118 126 146 162Baa2/BBB 109 126 131 151 168 187 202Ba2/BB 320 340 350 380 400 425 475B2/B 465 485 495 520 555 580 630Caa/CCC 755 765 775 840 890 945 985