CH10+solutions - Chapter 10 Medium- to long-term debt The...

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Chapter 10 Medium- to long-term debt The financial system provides corporations with a wide range of medium- to long-term loan and debt facilities. These facilities allow a corporation to diversify its funding sources and match its cash-flow requirements. The sources of medium- to long-term debt may be intermediated finance provided by financial institutions or it may be direct finance obtained from either the domestic markets or the international capital markets. A common form of intermediated debt is the term loan or fully drawn advance. The main providers of term loans are the commercial banks. However, investment banks, merchant banks, finance companies, insurance offices and credit unions also provide term loans to the business sector. The structures of term loans vary considerably. The loans may be: interest-only repayment loans, with the principal repaid in full at maturity credit foncier loans, with payments amortised over the period of the loan loans with reduced payment or deferred payment schedules for a specified period before loan instalments commence. A common practice is to price a variable rate loan at a margin above an indicator interest rate. The margin will reflect the level of credit risk of the borrower. During the term of the loan, the interest rate will be periodically reset in relation to changes in the specified indicator rate, such as USCP, LIBOR, SIBOR, BBSW or the bank’s own prime rate. Reuters publishes the indicator rates daily. A range of fees are typically applied, including an establishment fee, a service fee and a commitment fee. A term loan lender will often seek to protect its total financial risk exposure to a borrower by including debt covenants in a loan contract. These restrict the business and financial activities of the borrower. For example a negative covenant may restrict further borrowing by the company, and a positive covenant may require the company to submit audited financial statements to the lender. Another form of loan is one that is secured by the lender (the mortgagee) taking a mortgage over the property being acquired by the borrower (the mortgagor). The secure nature of mortgage finance lending (coupled with the option of mortgage insurance) and the development of securitisation and the issue of mortgage-backed assets have made mortgage finance widely available. If the mortgagor (borrower) defaults on loan repayments, the lender is entitled to take possession of the property and sell it in order to recover the amounts outstanding. The formula for calculating the instalment on a term loan and a mortgage loan is: The corporate bond markets are direct-finance capital markets and have experienced an increase in prominence in both the domestic markets and the international markets. The instruments issued in the market include debentures, unsecured notes and subordinated debt. Each of the instruments has in common a contract between the borrower and the lender that prescribes that the lender will
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This note was uploaded on 10/29/2010 for the course FINS 1612 taught by Professor Nice during the Three '10 term at University of New South Wales.

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CH10+solutions - Chapter 10 Medium- to long-term debt The...

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