2. • Principle sources of LT capital available
to companies – debt and equity
• Consider risk and return aspects of each
type of finance from the viewpoint of the
company raising money
• Investors attitude towards risk to
different types of finance are critical in
determining whether or not a particular
method of finance could be used
3. DEBENTURES
Debentures are loan stock (corporate bonds)
which are secured on some or all of the assets
of a company
TYPES OF DEBENTURES
MORTGAGE DEBENTURES – a fixed charge
means that there are specific secured assets
mentioned in the legal documentation
Changes to secured assets can only be made
with the permission of debenture holders
4. FLOATING CHARGE DEBENTURES – company can
change secured assets, as long as they are replaced
by equally quality assets
Characteristics:
Default on capital and interest payments
Interest payments are tax deductible
Interest payments have to be made irrespective of company’s
profitability or cash position
Have a fixed redemption date and carry a fixed
rate of interest
5. RISK - risk of default and secured asset’s
value not enough to cover the loan. The rights
of debenture holders are overseen by a trustee
RETURN – carry risk and not always
marketable, reflected in yield and trade at
yields above government bonds
MARKETABILITY - worse than government
bonds and trade at bigger spreads between
selling and buying prices
6. No specific security for the loan
If issuer default, only remedy is to sue the
issuer
Ranked equally with other creditors of the
issuing company
Appointment of a trustee, that design deed to
reduce risk for example restricts further
borrowing
Unsecured loan stock is dependent upon
continuing profitability of issuing company
7. RISK – no security ( rights are set out in trust
deed) but more secured than ordinary shares
RETURN – yields are higher than debentures
and government stock to compensate for
poorer marketability and higher risk
MARKETABILITY – similar to debentures
but much worse than government stock. The
issuer’s size and “standing” in market
determines the marketability.
8. Traditionally a company would issue loan
capital within the tax and legal framework of
its own country. It is now also possible to
borrow in another country
Foreign bonds can be issued by international
borrowers and sold to investors in countries
with currencies other than the currency in
which the bonds are denominated.
9. Example:
Bulldogs – overseas borrowers (USA) issue
sterling-denominated bonds in the UK
market
Yankee bonds – UK firms issue dollar-
denominated bonds in the US market
Foreign bond issues give borrowers access to
investors of other countries
10. Eurobonds go one stage further:
A Eurobond is issued in the Euro-market and
is marketed internationally, mainly by the
London branches of international banks
o AN ISSUE OF EUROBONDS ENTAILS AN
ARRANGEMENT WITH INVESTMENT
BANKS FOR LOAN CAPITAL TO BE ISSUED
WITHOUT IT BECOMING UNDER THE
LEGAL OR TAX JURISDICTION OF ANY
COUNTRY
11. o THE MARKET FOR THIS TYPE OF LOAN
CAPITAL IS KNOWN AS THE “EURO-
MARKET” (EUROPE AND LUXEMBURG
ARE THE MAIN CENTRES OF TRADING)
12. CHARACTERISTICS:
Usually unsecured
Can be issued in almost any currency including the euro
Usually redeemed at par on settlement date with a fixed
coupon rate during the bond’s term
Interest payments (coupon payments) are made annually
Usually “bearer” form – claim through paying agency
Issued free from national regulations and not fully within
the legal control of any government, many innovative types
have been issued
Underwritten by an international syndicate of banks
13. MAIN INVESTMENT CHARACTERISTICS:
RISK – no security and very dependent on the
profitability of issuing firm- more riskier than
unsecured loans
RETURN – depends upon issuer and issue size.
Inflation will affect the real return. Similar to the
yield on an unsecured loan. Traditionally issued
by very secured borrowers
MARKETABILITY – better than unsecured loans
and debentures but not as good as government
bonds
14. Are medium term debt instruments issued in
the market (Euro market) who’s interest
payments float with short-term rates, possibly
with a stipulated minimum rate (interest-rate
floor)
Most investor’s savings earn a variable rate of
interest
15. WWW.BONDEXCHANGE.CO.ZA
Turnover of bonds is an indication of
liquidity and is measured through the “turn-
over-ratio” (total value of bonds traded in a
specific time divided by the total value of
bonds outstanding)
Market for government bond
Kind of bonds issued in SA
Primary market and issuing procedures
Secondary market for bonds
Other issuers of bonds
16. The primary way SA companies are financed
Shareholders are the owners of the business
(voting rights)
They receive dividend payments
Dividends are paid net of tax
They have a residual claim
Ordinary shareholders are the lowest ranking
form (in terms of unwinding) of finance
issued by companies
17. Ordinary shareholders are irredeemable (no
fixed date when company has to repay the
share capital)
Accounts of a company shows the nominal
value (par value) of the issued capital
The Memorandum of Associations set out the
total value of authorised share capital
The low ranking of shares in terms of
payment of dividends and upon unwinding
makes this a risky investment
18. Shareholders have the right to residual profit
and assets
Attend annual meetings
Vote to appoint directors
Vote on dividend payments
Vote to change the company’s borrowing
power
Approve the annual financial reports
Issued share capital cannot be greater than
authorised capital
19. Characteristics Debt Equity
Management No Yes
Claims on income Senior to equity Subordinate to debt
residual claims
Maturity Stated Permanent
Tax Interest deduction No deduction
20. Capital Asset Pricing Theory (risk and return)
Relation between risk and return
Rational investor - higher risk higher
required return
Price determined where expected return at
that price gives a return at least as high as the
required return
Expected return will be influenced by:
Income or dividend yield and
Capital growth
21.
22. RISK- uncertainty and volatility of future
income and uncertainty of capital return in
the case of bankruptcy
RETURN- high potential return for high risk.
Initial low running yield but should increase
with inflation and growth in company
earnings
MARKETABILITY- depends on the size of
the company and future profit growth but are
usually highly marketable
23. Preference shares are an equity instrument that pays
a fixed dividend and have a prior claim on the
firm’s earnings and assets in the case of liquidation
Much less important than ordinary shares
Dividends are expressed as a fixed percentage of
par-value, and paid net of tax
Do not usually carry voting rights
Have a preferential right to dividends, or return of
capital compared to ordinary shares
Do dividends have to be paid?
24. Crucial difference between preference and ordinary
shares is that preference share dividends are limited to
a set amount which is almost always paid
Preference shares can be – cumulative and
irredeemable
Preference shares may also be:
a. Non-cumulative
b. Redeemable
c. Participating
d. Convertible
25. MAIN INVESTMENT CHARACTERISTICS
RISK- ranked below loan capital and above
ordinary shares if the company is wound up –
risk is higher than holding loan stock but the
return is higher than loan stock- return is
relatively predictable but uncertainty about
return of capital in the event of winding-up
RETURN- for all investors, the expected return
on preference shares is likely to be less than on
ordinary shares because the risk of holding
preference shares is less
MARKETABILITY- similar to loan capital
26. Convertible securities are almost invariable,
unsecured loan stock (bonds) or preference shares
that converted into ordinary shares of the issuing
company
Convertible pref. shares gives the holder the
right to convert it into ordinary shares at a later
stage
A conversion feature is an option that is included
as part of a pref. share or bond issue that allows
the holder to change the security into stated
number of ordinary shares
Conversion features typically enhances the value
of the issue
27. Only difference between convertible bonds and
pref. shares:
1. Bonds part of debt
2. Pref. shares part of share capital
Conversion features provides the purchaser with
the possibility of becoming a shareholder on
favourable terms
Convertibles normally sold at a lower stated
dividend than similar non-convertible shares
Investors have the security of a fixed return on
the short-term and the possibility of sharing in
long-term capital gains!!!
28. If not converted, the security might continue as
a bond or preference share for a period of time
or might be redeemed on a prescribed basis
CONVERTION TERMS
Dates and terms are specified at the time of
issue
May be a single date
Or at the option of the holder
A specific number or conversion ratio is
specified
29. CONVERSION PREMIUM
Conversion value is measured in terms of the
market price of the ordinary share into which the
security can be converted
If market price of ordinary shares exceeds the
conversion price, the conversion value exceeds
the par value. Holders will only exercise the
option when market price > conversion price
Conversion ratio – the ratio at which a
convertible can be exchange for ordinary shares:
Can be a given number
Dividing the par value by the conversion price
30. FINANCING WITH CONVERTIBLES
A form of deferred ordinary share financing
Used as an sweetener by giving purchaser an
opportunity to share in future successes of
firm
Convertible bonds normally sold at lower
interest rates
Normally sold with fewer restrictive
covenants
Used to raise cheap funds temporarily
31. MAIN INVESTMENT CHARACTERISTICS
RISK- less volatility in price of convertible
than in price of underlying asset - security of
dividend payments is higher
RETURN- convertibles normally provide
higher income than ordinary shares but lower
than loan stock and preference shares
eventually
MARKETABILITY- useful source of finance
for many new businesses
32. ARE CALL OPTIONS WRITTEN BY A
COMPANY ON ITS OWN SHARES
The purchaser of a warrant has the right but not
the obligation to buy a fixed number of the
companies’ shares at a fixed price on a fixed date
33. When they are exercised:
Company issued more of its own shares and sell
them to the option holder at the strike price
May lead to some dilution in the value of equity
Normally added to a new issue of bonds to make
it more attractive
Also often given to investment banks as
compensation for underwriting service or used to
compensate creditors in case of bankruptcy
Warrants are not entitled to vote or receive
dividends
34. SHARE PURCHASE WARRANTS IN
SOUTH AFRICA
An important difference in terminology exists. In
South Africa the term warrant is used to describe
options on shares listed on the JSE. These options are
written by third parties on the companies’ shares and
if the option is exercised the share will be bought (call
option) by the third party. Investors can only take a
long position. The firm whose shares provide the
underlying basis for the option are not involved in the
option transaction in any way
35. Issued to senior management as part of
their remuneration package with strike
prices, (exercise prices) that are intend to
represent a performance target
