Lecture8 - raising capital debt equity covenants

G ar inventory the borrower promises to pay a pre

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Unformatted text preview: financing of short-term liabilities (e.g., AR, inventory). The borrower promises to pay a pre-specified amount to the lender at some future date (one to six months). Cheap, as it does not require registration with OSC/SEC. registration Corporate bonds: tradable fixed-income securities – Covenants – Options (e.g., callable, putable, convertible, etc.) – Cash-flow pattern – Maturity – Price – Rating 6 Corporate Bonds-Covenants When debt is risky, shareholders may take actions that When increase the value of equity but reduce the value of the debt increase We refer to these as shareholder-bondholder conflicts We shareholder-bondholder Since lenders are rational, they anticipate that issuing firms Since may take actions that hurt bond prices, and thus pay lower prices when debt is issued prices Thus, firms suffer agency costs of debt finance Thus, agency To reduce financing costs, firms write contracts that mitigate To the shareholder-bondholder conflict. the Bond covenants are provisions in debt contracts that restrict the firm from engaging in specified actions after the bonds are sold. They provide protection for lenders. are 7 Corporate Bonds-Covenants Debt covenants carry costs to the firm: – They are costly to write – They may limit a firm’s flexibility to respond to They unexpected contingencies unexpected But they are also beneficial: But – By protecting bondholders from firms’ incentives By to take actions that hurt bond prices, they can reduce financing costs and increase firm value reduce Bond covenants will be used more frequently Bond when the benefits exceed their costs when 8 Corporate Bonds-Covenants Covenants specify the rights of the lender and the Covenants restrictions on the borrower restrictions Asset covenants govern the firm’s acquisition, use, maintenance, and disposition of assets (also mergers) maintenance, Dividend covenants restrict the payment of dividends Financing covenants restrictions on additional debt issues and its priority in liquidation issues Covenants modifying the pattern of payoffs to Covenants bondholders – bond options bondhold...
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