Sources of Long-term Financing - Sources of Long-Term...

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Sources of Long-Term Financing 1. Warrants – long-term options that give holders the right to buy common stock in the future at a specific price. If the market price goes up, the holders of warrants will exercise their rights to buy stock at the special price. If the market priced does not exceed the exercise price, the warrants will lapse. - A major use of warrants in financing is to lower the cost of debt. Issuers of debt sometimes attach stock purchase warrants to debt instruments as an inducement to investors. The investor then has the security of fixed-return debt plus the possibility for large gains if stock prices increase significantly. If warrants are attached, debt can sell at an interest rate slightly lower than the market rate. - The exercise of warrants results in inflows of additional capital to the firm and the issuance of stock. - Bonds that are issued with warrants remain outstanding after the bondholder exercises the right to become a common shareholder, but convertible bonds do not. 2. Preferred shareholders have preference over common shareholders with respect to dividend and liquidation rights, but payment of preferred dividends, unlike bond interest, is not mandatory. In exchange for these preferences, the preferred shareholders give up the right to vote. Consequently, preferred stock is a hybrid of debt and equity. 3. Serial bonds have staggered maturities, that is, they mature over a period (series) of years. Thus investors can choose the maturity date that suits their financial needs. For example, an investor who will have a child starting college in 16 years can choose bonds that mature in 16 years. 4. Discount bonds - The coupon rate on discount bonds is below the market rate on bonds of similar risk and maturity. - The market value of the bond rises between the issue date and the maturity date. 5. Debentures are unsecured bonds. Although no assets are mortgaged as security for the bonds, debentures are secured by the full faith and credit of the issuing firm.
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6. Short-term securities are less likely than long-term securities to fluctuate in value because of changes in the general level of interest rates. Similarly, short-term credit typically has lower interest rates and is more readily available than long-term credit. - A firm would generally choose to finance temporary assets with short-term debt because matching the maturities of assets and liabilities reduces risk.
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