Bristow Ent Fin Ch9

Bristow Ent Fin Ch9 - Entrepreneurial Finance For New and...

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Entrepreneurial Finance For New and Emerging Businesses Special Edition James McNeill Stancill © 2008 James McN. Stancill - All Rights Reserved
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Chapter 9 LONG TERM FINANCING: SWEETENERS AND INNOVATIONS
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3 History of bonds in the USA Collateral trust bonds - forerunner of CMOs At first, only secured (mortgage) bonds Guaranteed bonds Debenture bonds in late 1920’s The low point - 1934 Lessons from the Great Depression: Required sinking funds; “Best efforts” stock offerings Income bonds: To keep bankrupt firms from going bankrupt again. LONG TERM FINANCING
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4 Post World War II Opening up of capital markets Breaking up “monopolies” for bond issuance Popularization of the stock markets Need to use “Sweeteners” on bonds Advent of convertibles, later bonds with warrants LONG TERM FINANCING
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5 What is a “convertible bond” ? convertible into common stock at a certain price any time after issue at election of bond holder . Conversion price: usually ≈ 115% of stock price Call date : usually deferred for 3-5 years Sinking fund required : usually deferred 3-5 yrs If S. F. deferred, bond is an “interest only” loan Thought to be “cheap way” to issue stock May result in complex capital structure LONG TERM FINANCING:   CONVERTIBLE BONDS
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6 What is a “warrant” ? Warrant is right to buy a share of stock by a certain date at a certain price. Two types: Detachable and Non-detachable. Term: from 3 to 10 years; (usually 5-8 years). Exercise price of warrant: 115% of stock price No. of warrants : Expected drop in price of bonds Expected price of warrants Where the Expected price of warrants 40% stock price LONG TERM FINANCING:  BONDS WITH WARRANTS
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7 Expected drop in price of bond: Price of bond will be a function of the coupon rate of interest and the time to maturity relative to the “Yield To Maturity” that the bond should have according to its “Risk class” - the bond’s rating, e.g., “Ba.” Example: Bond has a 6.5% coupon; but Grade Ba bonds should have a 9.6% YTM. Bond will have to drop in price enough to give buyer a YTM of 9.6% . This may be, e.g., to $80 (meaning $800.) LONG TERM FINANCING:  BONDS WITH WARRANTS   (continued)
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8 If there are “stock equivalents” outstanding , firms must report their earnings as “Basic” and “Diluted” . Collectively, reporting agencies are now
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Bristow Ent Fin Ch9 - Entrepreneurial Finance For New and...

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