Chapter 24 IM 10th Ed

Chapter 24 IM 10th Ed - CHAPTER 24 Term Loans and Leases...

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CHAPTER 24 Term Loans and Leases CHAPTER ORIENTATION The first section of this chapter provides an overview of the major sources of term loans and their characteristics. The second section of the chapter provides an overview of lease financing, including a discussion of leasing arrangements, the accounting treatment of financial leases, the lease versus purchase decision, and the potential benefits from leasing. CHAPTER OUTLINE I. Term loans A. In general, term loans have maturities from one to 10 years and are repaid in periodic installments over the life of the loan. Term loans are usually secured by a chattel mortgage on equipment or a mortgage on real property. The principal suppliers of term credit include commercial banks, insurance companies and, to a lesser extent, pension funds. B. The common attributes of term loans include the following: 1. The maturities of term loans are usually as follows: a. Commercial banks: 1 to 5 years. b. Insurance companies: 5 to 15 years. c. Pension funds: 5 to 15 years. 2. The collateral backing term loans: a. Shorter maturity loans are usually secured with a chattel mortgage on machinery and equipment or securities such as stocks and bonds. b. Longer maturity loans are frequently secured by mortgages on real estate. 65
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3. In addition to collateral, the lender on a term loan agreement will often require restrictive covenants that are designed to maintain the borrower's financial condition on a par with that which existed at the time the loan was made. a. Working capital restrictions involve maintaining a minimum current ratio that reflects the norm for the borrower's industry, as well as the lender's desires. b. Additional borrowing restrictions prevent the borrower from increasing the amount of debt financing outstanding without the lender's approval. c. A third covenant that is very popular requires that the borrower supply periodic financial statements to the lender. d. Term loan agreements often include a key-man provision that the borrower requires that the lender approve major personnel changes and insure the lives of "key" personnel with the lender named as the beneficiary. 4. Term loans are generally repaid in periodic installments in accordance with repayment schedules established by the lender. Each installment includes both an interest and a principal component. 5. Frequently a bank will have demand for loans that exceeds its lending capacity. In order to satisfy the demand, the bank will share the loan demand with other participating banks. The participating banks receive a certificate of participation and a commitment from the lead bank to pay a portion of the loan cash flows as they are received. 6. Eurodollar loans are intermediate term loans made by major international banks to businesses based on foreign deposits denominated in dollars. The rate of the loan is an amount greater than the London Interbank Offered Rate. The Eurodollar loan market is governed by a limited number of regulations. II.
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Chapter 24 IM 10th Ed - CHAPTER 24 Term Loans and Leases...

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