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Lecture 5

MGTA05H3 Lecture Notes - Lecture 5: Foreign Exchange Risk, Debenture


Department
Management (MGT)
Course Code
MGTA05H3
Professor
H Laurence
Lecture
5

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Corporate Finance: Lecture Five Part Two
How does Debt Financing Work?
A bond or debenture is evidence of a loan
The corporation agrees to pay back the loan at some time, with interest
How Does Debt Financing Work?
How is the interest rate set?
Risk of default
Risk of changing interest rates
Risk the bond will not be saleable
Supply risk – will more be issued?
Inflation risk
Currency risk
How Does Debt Financing Work?
How is the risk handled?
Personal covenant to repay the debt
Security – assets are given as collateral for the loan. If the loan is not
repaid, the creditor can seize the collateral and sell it
Guarantee – someone else agrees to pay the debt if the original debtor
cannot pay
Debt and Equity Financing
Equity financing
No interest is payable and dividends are discretionary, so no requirement
to make any payments
Balance sheet improves with issue of equity financing, so you may be able
to borrow more for the short term
Dividends are paid only from profits, so any claim is secondary to bond
claims
Problems with Debt and Equity
Debt
Interest and principal must be repaid
Banks often put restrictions on the business, and monitor the balance sheet
Equity
Issuing equity may be very expensive
Issuing equity means giving up some control
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