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Corporate Finance Thirteenth Edition

Stephen A. Ross / Randolph W. Westerfield / Jeffrey F. Jaffe /
Bradford D. Jordan

Chapter 15

Long-Term Financing

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 Key Concepts and Skills
• Describe the basic features of common and preferred
stock.
• Understand the different types of bonds and how bond
characteristics impact the required yield.

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 Chapter Outline
15.1 Some Features of Common and Preferred Stock
15.2 Corporate Long-Term Debt
15.3 Some Different Types of Bonds
15.4 Bank Loans
15.5 International Bonds
15.6 Patterns of Financing

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 15.1 Features of Common Stock
Voting rights (cumulative vs. straight)
Proxy voting.
Classes of stock.
Other rights.
• Share proportionally in declared dividends.
• Share proportionally in remaining assets during liquidation.
• Preemptive right – the right to purchase new stock issued,
so as to maintain proportional ownership.
Dividends.

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 15.1 Features of Preferred Stock
Dividends
• Stated dividend must be paid before dividends can be paid
to common stockholders.
• Dividends are not a liability of the firm, and preferred
dividends can be deferred indefinitely.
• Most preferred dividends are cumulative – any missed
preferred dividends have to be paid before common
dividends can be paid.
Preferred stock generally does not carry voting rights.

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 15.2 Corporate Long-Term Debt
Debt Equity
• Not an ownership interest. • Ownership interest.
• Creditors do not have voting • Common stockholders vote for
rights. the board of directors and other
issues.
• Interest is considered a cost of
doing business and is tax • Dividends are not considered a
deductible. cost of doing business and are
not tax deductible.
• Creditors have legal recourse if
interest or principal payments • Dividends are not a liability of
are missed. the firm, and stockholders have
no legal recourse if dividends
• Excess debt can lead to
are not paid.
financial distress and
bankruptcy.

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 The Bond Indenture
Contract between the company and the bondholders that
includes:
• The basic terms of the bonds.
• The total amount of bonds issued.
• A description of property used as security, if applicable.
• Sinking fund provisions.
• Call provisions.
• Details of protective covenants.

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 Bond Classifications
Registered vs. bearer forms
Security
• Collateral – secured by financial securities.
• Mortgage – secured by real property, normally land or
buildings.
• Debentures – unsecured.
• Notes – unsecured debt with original maturity less than 10
years.

Seniority

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 Required Yields
The coupon rate depends on the risk characteristics of the
bond when issued.
Which bonds will have the higher coupon, all else equal?
• Secured debt versus a debenture.
• Subordinated debenture versus senior debt.
• A bond with a sinking fund versus one without.
• A callable bond versus a noncallable bond.

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 15.3 Some Different Types of Bonds
• Zero coupon bonds.
• Plain vanilla bonds (conventional bonds)
• Floating-rate bonds.
• Income bonds.
• Convertible bonds.
• Put bonds.

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 Zero Coupon Bonds 1

Make no periodic interest payments (coupon rate = 0%)

The entire yield to maturity comes from the difference
between the purchase price and the par value.
Cannot sell for more than par value
Sometimes called zeroes, deep discount bonds, or original
issue discount bonds (OIDs).
Treasury Bills and principal-only Treasury strips are good
examples of zeroes.

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 Floating-Rate Bonds
Coupon rate floats depending on some index value
Examples: adjustable to Treasury bill interest rate or 30-year
Treasury bond rate
There is less price risk with floating rate bonds.
• The coupon floats, so it is less likely to differ substantially
from the yield to maturity.
Coupons may have a “collar” – the rate cannot go above a
specified “ceiling” or below a specified “floor.”

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 Other Bond Types
Income bonds: similar to conventional bonds, except that
coupon payments are dependent on company income.
Convertible bonds: can be swapped for a fixed number of
shares of stock anytime before maturity at the holder's
option.
Put bonds: allow the holder to force the issuer to buy the
bond back at a stated price.
There are many other types of provisions that can be added
to a bond, and many bonds have several provisions. It is
important to recognize how these provisions affect required
returns.

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 15.4 Bank Loans
Lines of Credit
• Provide a maximum amount the bank is willing to lend.
• If guaranteed, referred to as a revolving line of credit.

Syndicated Loan
• A large bank may arrange a loan with a firm or country and
then sell portions of the loan to a syndicate of other banks.
• With a syndicated loan, each bank has a separate loan
agreement with the borrowers. Syndicated loans also
benefit banks by allowing them to spread the risk of each
loan across several banks.

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 15.5 International Bonds
Eurobonds: bonds denominated in a particular currency and
issued simultaneously in the bond markets of several
countries
Foreign bonds: bonds issued in another nation’s capital
market by a foreign borrower
• Yankee bonds (US).
• Samurai bonds (Japan).
• Rembrandt bonds (the Netherlands).
• Bulldog bonds (Great Britain).
• dim sum bonds (Chinese yuan-denominated bonds issued
in Hong Kong).

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 15.6 Patterns of Financing
Internally generated cash flow dominates as a source of
financing.
• This preference has increased through time.

Net stock buybacks accelerated in 2002 to 2007.

• Declined in 2008, likely as a result of the financial crisis.
• Increased again following the recovery (2010 and after).

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 The Long-Term Financial Deficit

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 Quick Quiz
Describe the basic characteristics of common and preferred
stock.
Differentiate between cumulative voting and straight voting.
Identify the rights of shareholders and bondholders.
How would the following characteristics impact the yield on a
bond:
• Call provision.
• Sinking fund.

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