CORPORATE FINANCE :Chapter3 :Debt Valuation and Interest rate{UNIVERSITY OF CAPE TOWN} STUDY GUIDE
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Course
Corporate Finance
Institution
University Of Cape Town (UCT)
CORPORATE FINANCE :Chapter3 :Debt Valuation and Interest rate{UNIVERSITY OF CAPE TOWN} STUDY GUIDE
CORPORATE FINANCE :Chapter3 :Debt Valuation and Interest rate{UNIVERSITY OF CAPE TOWN} STUDY GUIDE
fin 3701 chapter3 debt valuation and interest rate
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University of Cape Town (UCT)
Corporate Finance
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FIN 3701- Chapter3 :Debt Valuation and
Interest
rate
“This is time to unlock your true power”
Hillary Clinton
Debt Valuation and Interest rate
In this chapter, you will learn Principles Applied in This Chapter
The features of bonds Principle 1: Money Has a Time Value.
Types of bond.
How to calculate intrinsic value of bonds. Principle 2: There is a Risk-Return Tradeoff.
Yield to Maturity, Yield to Call, Realized Yield and Current Yield.
The risks of bond investing and issuing. Principle 3: Cash Flows Are the Source of Value
4
3
Corporate Finance addresses the following 3 questions:
What long-term investments should the firm engage in? How to grow up a firm
Net
How can the firm raise money for the required investments? (Alternatives: Bonds, Stocks, PreferredIncome Stocks=what is the ap
How much short-term cash flow does a company need to pay its bills? and
DIV payout or
Share Repurchase
how to raise it
5
Use retained earnings
Make tender offers Or pay off some debt or doing nothing
Or Open market
Growth = increase the size of assets
Internal Growth vs. External growth
Borrow money from banks (private debt), Issue Bond(public debt),
Issue Common/Preferred Stocks
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1
,FIN 3701- Chapter3 :Debt Valuation and
Interest
rate
Corporate Borrowings
There are two main sources of borrowing for a corporation (External Growth):
Loan from a financial institution such as banks (known as private debt)
Bonds (known as public debt since they can be traded in public financial markets> bond markets)
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Corporate Borrowings (cont.)
Smaller firms choose to raise money from banks in the form of loans because of the high costs associated with is
Larger firms generally raise money from banks for short-term needs and depend on the bond market for long-te
8
Borrowing Money in the Private Financial Market Borrowing Money in the Private Financial Market (C
Financial Institutions are an important source of capital for
Incorporations. The loan
the private financial might loans
market, be used
aretotypically
financefloating
firm’s dr
Such loans are considered private market transactions since it only involves the two parties to the loan.
The most popular benchmark rate is the London Interbank
9
10
Borrowing Money in the Private Financial Market (Cont.)
Checkpoint
A typical floating rate loan will specify the following: STEP 1: Picture the problem
The spread or margin between the loan rate and the benchmark
We canrate expressed
envision as basis
the problem solution points.
by looking at a graph of the ceiling rate, the floor rate, a
A maximum and a minimum annual rate, to which the rate can adjust, called the ceiling and floor.
A maturity date
Collateral 2
11
, FIN 3701- Chapter3 :Debt Valuation and
Interest
12
rate
The Balance-Sheet Model of the Firm
The Capital Structure Decision (Ch. 12, 15, 18)
(Financing Decision)
Current Liabilities
Current Assets How can the
Long-Term This ch.
firm raise the money for theDebt
required investments?
Fixed Assets 1 Tangible
2 Intangible
Shareholders’ Equity
13
Features of bonds
14
What is a bond? Characteristics of Bonds
A long-term contract under which a borrower (issuer) agrees to make payments
Bonds ofcoupon
pay fixed interest(interest)
and principal, on specific
payments dates,
at fixed in
$I$I $I$I$I$I+$M
0 1 2. . . n
Source:
15
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What is a bond? (cont.) The major constituents of a bond consists of:
1. Issuer
The issuer is obligated to pay the lenders/investors periodic coupon – the issuing
payments organization
until the can beThus,
stated maturity. either a governmen
bond investor ha
The information regarding the periodic interest rates, frequency of the coupon payments, term to maturity, par
value of the bond, redemption value of the bond and any other provisions are all stated in the prospectus when a bond is issue
a.k.a. indenture 18
3
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