Finance & Risk Q&A

Finance & Risk Q&A - BUS 101 / Prof....

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BUS 101 / Prof. Rollins CONCEPT REVIEW: FINANCING AND RISK Q. What does “financing” mean? A. The term financing means raising capital (money) to pay for something or some activity. Firms (typically through the Financial Manager) raise money for, or finance, everything from purchasing stuff, like inventory or new machinery, to expanding the business, to acquiring other firms in an acquisition or merger. Q. Okay, so how do they get “financing,” that is, where does the money come from? A. There are two ways to obtain financing: borrowing or selling shares of ownership. The former is called “debt financing,” because when you borrow you naturally incur a debt that must be paid back with interest. The other way is called “equity financing,” because raising money this way means sharing ownership (equity) with those who provide the money, i.e., the shareholders. Q. Are there different kinds of debt financing that a firm can undertake? A. Sure. A firm can either borrow the money from a financial institution, such as a bank or other lending institution, or it can borrow directly from individual investors. The first way we simply call a loan; the other way is by issuing bonds to investors. Q. When would a firm take out a bank loan (or a line of credit) and when would it issue bonds? A. Small businesses will typically borrow the money from a local bank or some other institution set up to assist small businesses, like the Small Business Administration. The larger firms, such as publicly owned corporations, borrow from a financial institution for the short term (a year or less), although some could take out a long term bank loan as well. Often, though, a big corporation will issue bonds if they decide to go the debt financing route. Q. Tell me about bonds. About the only bonds I’m familiar with are US Savings Bonds. A. At its most basic, a bond is simply a loan; that is, when you buy a bond, you are really lending money to the issuer of the bond, or the borrower. The bond is just a piece of paper given by the borrower, agreeing to pay back, on the maturity date, the face amount that you have loaned it -- with interest, of course, which is why people buy them. The issuer of a bond could be the federal government, as in the case of US Savings Bonds or Treasuries, a state or municipal bond, or it could be a corporation. Therefore, what you’re really doing when you “buy” a bond is lending the issuer money,
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Finance & Risk Q&A - BUS 101 / Prof....

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