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What is the advantage of bond financing for a company?

Essay Bonds.

Companies finance most of their activities by way of internally generated cash flows. Companies now issue their own bonds rather than borrow from banks, because this is often cheaper: the market may be a better judge of the firm's creditworthiness than a bank. It may lend money at a lower interest rate. This is evidently not a good thing for the banks, because the banks are forced to give a large amount of money a little unreliable company.

Bond-issuing companies are rated by private ratings companies and given an 'investment grade' according to their financial situation and performance. Higher rating is very important because, the higher rating, the lower the interest rate at which a company can borrow.

Bonds are securities issued by companies, governments and financial institutions when they need to borrow money. They usually pay a fixed rate of interest and are repaid after a fixed period, known as their maturity, for example five, seven, or ten years. Bonds are very liquid. They can be sold on the secondary market until they mature. But of course, the price might have changed, because of changes in interest rates. For example, no-one will pay the full price for a 6% bond if new bonds are paying 10%. A bond's yield is its coupon payment expressed as a percentage of its price on the secondary market, so the yield changes if you buy or sell above or below par. And the opposite, a bond whose market value is higher than its face value, is above par. The coupon, the amount of interest a bond pays, remains the same. But the yield will change. Bond-issuing companies are given an investment grade by private ratings companies such as Standard 6k Poors, according to their financial situation and performance. Gilts are the name they use in Britain for long-term government bonds - gilts or gilt-edged securities. In the States they call them Treasury Bonds.

 

As a certificate of certifying debt relationship, the bonds have some face element:

- Face Value, that is money type and money value;

- Tender Term, that is maturity the date of paying off principal and interest;

- Interest Rate, that is ratio annual interest rate percentages;

- Issuer Name, that is main body of debtor.

There are some qualities and characteristics of Bonds:

There are certainly qualities and characteristics of bonds. First of all, bonds belong to marketable securities. This means that bonds are liquid and can be traded on the secondary market. Then, bonds are kind a fictitious capital and are expression of creditors right. This means, that a debtor must pay back the principle and interest, when the turn is due, that is when it maturities. Thus, bonds can bring certain benefit for investors. And at last, bonds are relatively saved because they carry a moderate degree of risk.

Advantage of a bond as a bearer certificate.

A company before paying tax, should pay bond interest, even the reason profits from which to deduct it, when the debt matures you have to pay principal. Thus, companies have a debt-equity ratio that is determined by balancing tax savings against the risk of being declared bankrupt by creditors.



There are many types of bonds and many criteria to their classification:

1. First of all, the nature of the issuer

Government bonds are issued by governments

Finance bonds are issued by banks.

Company bonds are issued by shareholding companies.

 

2. By interest charge method

Simple mean that the interest is calculated and paid on the principle alone.

Compound is calculated on both the principle and its accreted interest

A discount is a bond that is issued and currently traded for less than its face value in the secondary market.

Accumulative mean that bond accumulates, but is not paid until maturity. It is paid together with a principal.

 

3. To the forms of bonds we may distinguish:

Physical bondis a kind of bond with physical face of standard format.

Certificate bond refers to payment receiving certificate after debtors purchase the bonds.

Andbooked bond means the bond value is record in the computer book instead of physical notes.

5. By forms of holders there are:

Registered bonds mean that the names and addresses of the bonds holders are entered in a register.

Bearer bondsmean that the right to such securities passes to another person by delivery.

 

6. According to the interest rate there are fixed rate, floating rate notes and zero.

Floating rate notes pay out variable coupon interest payments at each period (monthly or annually). The amount of this payment is determined by the current market interest rate.

Zero coupon bonds don't pay out coupon interest payments, but are issued at a considerable discount and are sold for very cheap.

 

There are some another kind of bonds: convertible bonds and junk bonds

A convertible bond is exchangeable for equity or stock.

Junk bonds high yield securities issued by companies with a very high risk of default.

 

7. According to the function and term maturity there are long-term and short-term bonds.

Long-term securities: government bonds (more than 10 years).

Middle-term this are debt securities with maturity from 1 to 10 years.

Short-term bonds are sold and bought by GB and US central banks as a way of regulating money supply when maturity less than 1 year.

 

The reasons for government to issue bonds.

Governments are issue bonds when public spending exceeds receipts from income tax. Long-term government bonds are known as gilt-edged securities or simply gilts. The British and American central banks also sell and buy short-term Treasury Bills as a way of regulating the money supply. To reduce the money supply, they sell these bills to commercial banks, and withdraw the cash received from circulation; to increase the money supply they buy them back this Treasury Bills back.

 

Most bonds are bearer certificates, so after being issued, they can be traded on the secondary bond market until they mature. As we have already said bonds are liquid. Their price on the secondary market fluctuates according to changes in interest rates.

If interest rate rise .

The majority of bonds on the secondary market can be traded either above or below par.

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Its difference from a share. Bonds:

- generally pay a fixed rate of interest

- are repaid at a fixed date

Stocks:

-the income from stocks depends on the companys performance

-dont have maturity date

If companies need more money they can sell shares or borrow by issuing bonds.

More companies issue their own bonds rather than borrow from banks, because it is cheaper.

Buy and hold is an investment strategy where an investor buys stocks and holds them for a long time.

In the long run financial markets give a good rate of return despite some volatility

 

Rating companies

Bond-issuing companies are rated by private rating companies, and given an 'investment grade' according to their financial situation and performance, AAA being the best, and C the worst, i.e. nearly bankrupt.

High rating is important for a company because the higher the rating , the lower the interest rate.

 

What is a coupon?

A bond's yield at any particular time is thus its coupon(the amount of interest it pays) expressed as a percentage of its price on the secondary market.

Total income is the sum of the bond interest payments (coupons) and the size of the discount at purchase. Total income on the bond is the sum of paid percent (coupons) and the amount of discount upon purchase

What is the advantage of bond financing for a company?

The main advantage of debt financing over equity financing for companies is that bond interest is tax deductible. I mean to say, a company deducts its interest payments from its profits before paying tax, while dividends are paid out of already-taxed profits. On the one hand its usually considered to be a sign of good health and anticipated higher future profits if a company borrows. On the other hand, increasing debt increases financial risk: bond interest has to be paid, whereas companies are not obliged to pay dividends or repay share capital. Thus companies have a debt-equity ratio that is determined by balancing tax savings against the risk of being declared bankrupt by creditors.

Governments issue bonds when public spending exceeds receipts, for example, from income tax. Long-term government bonds are called gilt-edged securities - gilts, in Britain, and Treasury Bonds in the US. The British and American central banks also sell and buy short-term (three month) Treasury Bills as a way of regulating the money supply. To reduce the money supply, they sell these bills to commercial banks, and withdraw the cash received from circulation; to increase the money supply they buy this Treasury Bills back.

 

Trading in bond market.

When businesses, units of government or individuals cannot get revenue from sales they can turn to either debt financing or equity financing.

Government can't issue stocks, when it needs money they borrow by issuing bonds.

A bond is an instrument in which the issuer promises to repay to the lender the amount borrowed plus interest over some specified period of time. One of the most important characteristics of a bond is the nature of its issuer. Issuers include federal governments and their agencies, supranational, municipal governments, and nonfinancial and financial corporations.

There is no uniform system for classifying the global bond markets. From the perspective of a given country, the global bond market can be classified into two markets: an internal bond market and an external bond market. The internal bond market is also called the national bond market. It can be decomposed into two parts: the domestic bond market and the foreign bond market.

The domestic bond market is where issuers domiciled in the country issue bonds and where those bonds are subsequently traded. The foreign bond market of a country is where bonds of issuers not domiciled in the country are issued and traded.

Bonds there are traded in the foreign bond market have nicknamed Yankee bonds Samurai bonds, bulldog bonds, Rembrandt bonds and matador bonds.

The external bond market, also called the international bond market, offshore bond market and the Eurobond Market. The international bond market includes bonds with several distinguishing features: 1) they are underwritten by an international syndicate, 2) they are offered simultaneously to investors in a number of countries, 3) they are issued outside the jurisdiction of any single country, and 4) they are in unregistered form. The Eurobond Market is divided into different submarkets depending on the currency.


Date: 2016-01-05; view: 180


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