Debt V Equity

Debt Financing

Commercial Banks offer:

Line of Credit-an informal, short term loan arrangement where the bank authorizes the loan amount, but not the interest rate. No upfront cost to the borrower.

Loan Commitment - requires the bank to lend up to a maximum, prespecified loan amount at a prespecified rate, upfront cost-don't have to pay if you borrow.

2 types: Revolver-borrow, repay, borrow, repay
Non-revolving loan commitment -takedown, take the loan up only once.

Interest Rates
Fixed-most loans historically-prescribed rate that endures
Floating-attached to an external interest rate

Compound interest-interest is paid on the interest.
Zero coupons-sold at a deep discount, no payments, at maturity you receive all the interest + amount.

Need to attach Floating Rates to something. (ex:Fed Funds Rate, LIBOR, Commercial Paper rate, Prime Rate)


Covenants-specify what a borrower must do, govern how firms use assets, pay dividences, maintain financial ratios, or secure additional financing, if any of the bond covenants are violated it is in default.

Options-call (issuing company can call it back ex: interest rates drop and can re-issue at a lower rate), put (allows borrower to get money back under certain provisions)

Cash flows-Fixed or floating
Price-the amount at which a bond sells, actual price is usually above (premium) or below (discount), rarely at face value (par)

Yield to Maturity -equates the market price w/ future cash flows.

Conversion Price = Face Value / Equivalent # of Shares

Conversion Value = # of Shares * Market Price

Conversion Premium = (Bond Equivalent Value - Stock Value) / Stock Value

Bonds, Bills, Notes:
Bonds-over 10 years
Bills-Less than 1 year
Notes-In between

Equity Financing

Common Stock
Class A -dividend protection, more dividends, gets one vote per share.
Class B - voting control preferences, multiple votes per share.

Preferred Stock
-Cumulative-if a dividend is missed, it accumulates and is owed.
-Participating -Adjustable rate, rate will go up
-Convertible-may be exchanged for common stock

Market Efficiency:
Information-what information is incorporated into the stock price:
Weak- technical analysis, trends, history
Semi-strong - all publicly available information
Strong - even information that only insiders know is incorporated into the stock

Going Public allows firms to obtain capital, offers liquidity and diversification for owners as well as performance assessment to managers, and increases credibility. However, it is costly, can lead to difficulty with shareholders, and competitors have access to a firm's information.

Book Building - Pricing method-syndicate w/ a price, but allow it to go up or down as see fit with responses.

Fixed Pricing Method-set a price and proportionally divy it up.

An IPO may be underpriced because it is easier for the underwriter to sell.