Long-Term Debt Financing – financing with
maturity of more than 5 years
- Used to finance long-lived assets
- More capital intensive = rely on long term
debt and equity
Capital Structure – business’ mix of long-
term fund
- Ideal capital structure: maximizes the total
value of business and minimizes the
overall capital costs
Types of Long-term Debt
. Mortgages - notes payable that are
secured by real estates and that require
periodic payments
̶ Issued to finance purchase of assets,
construction of plants and modernization
of facilities
̶ May be obtained from a bank, life
insurance companies or other financial
institution
̶ Easier to obtain for multiple-use real
assets than for single-use real assets
̶ Two Types:
a. Senior Mortgages – first claim on
assets and earnings
b. Junior Mortgages – subordinate
liens
̶ May have:
a. Closed End Provision – prevents the
business from issuing additional debt
of the same priority
b. Open End Provision – business scan
issue additional first-mortgage bonds
against the property
̶ Advantages:
i. Favorable interest rates
ii. Fewer financing restrictions than
bonds
iii. Extended maturity dates for loan
repayment
iv. Easy availability
b. Bonds – certificate indicating that the
business shas borrowed money and agrees
to repay it
̶ Indenture – written agreement
describing the feature of the bond
̶ Contract between business,
bondholder and trustee (makes sure
the business meets the term of the
bond contract)
̶ Violated provision = bonds are in
default
̶ May also have *negative pledge
clause [*precludes the issuance of new
debt that takes the priority over existing
debt in the event of liquidation ]
̶ Bond prices and market interest rates
are inversely related
̶ Nominal Interest Rate – interest
payment to bondholders
̶ Likely to be sold in discount when the
interest rate on the bond is below
prevailing market interest rate (issue
price is risky or with long maturity
period)
̶ Bond issue cost are tax deductible
̶ Types:
a. Debentures – unsecured (no
collateral) debt
̶ Can only be issued by large,
financially strong companies
b. Junk Bonds – debentures of large
companies with no good credit rating
̶ For small companies with
unproven track records
c. Subordinate Debentures – claims
of holder are subordinate to those of
senior creditors
̶ Paid off after short-term debt
d. Mortgage Bonds – secure by real
estates
̶ There may be several mortgages for
the same property
e. Collateral Trust Bonds – collateral
is the business’ security investment in
other companies held by trustee for
safekeeping
f. Convertible Bonds – may be
converted to shares at a later date
based on a specified conversion ratio
̶ Typically in the form of
subordinated debentures
̶ More marketable and are typically
issued at a lower interest rate than
regular bonds
̶ A *quasi security [*market value is
ties to td value if converted to share
rather than as a bond]
g. Income Bonds – pays interest only if
the business makes profit
̶ Interest may be cumulative or
noncumulative
̶ Appropriate for companies with
large fluctuations in earnings or for
emerging companies that expect
low earnings in early years
h. Guaranteed Bonds – debt issued by
one party and guaranteed by another
i. Serial Bonds – issued with different
maturities available
̶ Schedule is prepared to show the
yields, interest rates and prices for
each maturity
 ̶ Interest rates on shorter Call Premium – call price exceeds the face
maturities is lower than longer value
maturities - Usually equal to one year’s interest if the
j. Deep Discount Bond – have low bond is called in the first year
interest rates and are issued at a - Declines at the constant rate each year
substantial discount from face value Bond with a Call Provision – has a lower
̶ Return comes primarily from offering price and is issued at interest rate
appreciation in price rather than higher than without call provision
interest payments * Extinguishment of debt results in an
̶ Volatile in price ordinary gain or loss to the issuing business
k. Zero Coupon Bonds – do not pay Sinking Funds – business puts aside money
interest with which to buy and retire part of a bond
̶ Return is in the form of issue each year
appreciation of price - If sinking fund is not made, the bond issue
̶ Lower interest may be available may be in default
because they cannot be called * If interest rates increase, bond price will
l. Variable-Rate Bond – adjusted decrease and open market options should be
periodically to reflect changes in employed
money market conditions * If interest decreases, bond price will
̶ Popular when future interest rates increase, thus calling the bonds less costly
and inflation are uncertain
m. Eurobonds – issued outside the
country in whose currency the bonds
are dominated
̶ Typically in bearer form
̶ Has coupons attached
̶ Can only be issued by high-quality
borrowers
n. Inflation-linked Bonds – have
coupons that are adjusted according
to inflation rate
o. Catastrophe (Cat) Bonds – issued
mostly by insurance companies to
cover extraordinary losses
p. Put Bonds – allow holder to force the
issuer to buy back the bonds at stated
price
Bond Ratings – influence marketability and
the cost associated with bond issue
- Inverse relationship between the quality of
bond and its yield: low quality has higher
yield
Project Financing – tied to particular
projects and may be suitable for large,
contained undertaking (joint ventures)
* If your business is experiencing financial
difficulty, it may wish to refinance short term
debt on a long-term basis
* Threat of financial distress or even
bankruptcy is the ultimate limitation on
leverage
Bond Refunding – companies may refund
bonds before maturity either by:
o Issuing a serial bond – refund the debt
over life of the issue
o Exercising a call privilege – enables
the business to retire it before expiration
date