Long-termdebt - Medium to Long-term Debt 10-1 Identify the...

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Medium- to Long-term Debt 10-1
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Identify the types of medium- to long-term debt instruments in the market Describe the main features of these facilities Identify the financial institutions and parties involved in the provision of these facilities Undertake calculations related to the pricing of these debt instruments Discuss the availability and appropriateness of these debt instruments for business 10- 2
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10.1 Term Loans or Fully Drawn Advances 10.2 Mortgage Finance 10.3 Debentures, Unsecured Notes and Subordinated Debt 10.4 Calculations: Fixed-interest Securities 10.5 Leasing 10.6 Summary 10- 3
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Term loan A loan advanced for a specific period (3 to 15 years), usually for a known purpose, e.g purchasing land, premises, plant and equipment Secured by mortgage over asset purchased or other assets of the firm Fully drawn advance A term loan where the full amount is provided at the start of the loan 10- 4
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Provided by Mainly commercial banks and finance companies To a lesser degree, investment and merchant banks, insurance offices and credit unions 10- 5
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Term loan structures Interest only during term of loan and principal repayment on maturity Amortised loan Periodic loan instalments consisting of interest due and reduction of principal Deferred repayment loan Loan instalments commence after a specified period related to project cash flows and the debt is amortised over the remaining term of the loan 10- 6
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Term loan structures (cont.) Interest may be fixed (for a specified period of time, e.g. 2 years) or variable Interest rate charged on term loan is based on: An indicator rate (e.g. BBSW or a bank’s own prime lending rate) and is also influenced by Credit risk of borrower—risk that borrower may default on loan commitment, giving rise to a risk premium Term of the loan—usually longer-term attracts a higher interest rate (liquidity) Repayment schedule—frequency of loan repayments (e.g. monthly or quarterly) and form of the repayment (e.g. amortised or interest-only loan) 10- 7
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Term loan structures (cont.) Other fees include Establishment fee: reflects the costs for the bank associated with the loan application and documents Service fee: represents the ongoing administrative costs incurred by the bank in maintaining the loan account. Commitment fee: will usually be applied by the bank to bu Line fee Bill option clause fee 10- 8
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Loan covenants Restrict the business and financial activities of the borrowing firm Positive covenant what the company can do Requires borrower to take prescribed actions, e.g. maintain a minimum level of working capital Negative covenant what the company cant do Restricts the activities and financial structure of borrower, e.g. maximum D/E ratio, minimum working-capital ratio, unaudited periodic financial statements Breach of covenant results in default of the loan contract, entitling lender to act 10- 9
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