liabilities management

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Powerpoint Templates Page 1 “Risk comes from not knowing what you’re doing.” -Warren Buffet

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Page 1: Liabilities management

Powerpoint Templates Page 1

“Risk comes from not knowing what

you’re doing.”

-Warren Buffet

Page 2: Liabilities management

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LONG TERM FINANCING

Liabilities Management

Page 3: Liabilities management

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Sources of Long-term Financing

Principal Sources of Funds

A. Debt Financing

Bonds

B. Equity Financing

Common Stock

Retained Earnings

C. Hybrid Financing

Preferred Stock

Lease

Convertible

Securities

Option

Warrant

Page 4: Liabilities management

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Debt Financing

Debt

financing

takes the

form of loans

that must be

repaid over

time, usually

with interest.

Page 5: Liabilities management

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What are Bonds?

Page 6: Liabilities management

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Why Issue Bonds?

1. An alternative source of income

2. Leverage - borrowing can increase

shareholder returns

3. Less frequent payment - coupons are

typically paid every three, six or twelve

months, depending on the bond.

4. Delayed principal repayment

5. Fixed interest rate

6. Flexibility

Page 7: Liabilities management

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Risk and Challenges

in Issuing Bonds 1. Financial Risk

2. Refinancing Risk

3. Large Bullet Payment

4. Administration Cost

5. Disclosure Requirements

Page 8: Liabilities management

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Are Bonds Suitable For Your

Business? 1. Good Credit Quality

2. Relatively Large Size

3. Good Financial Records

4. Public Profile

5. Relatively Stable Earnings

6. Relatively Low Debt

7. Large Borrowing Requirements

Page 9: Liabilities management

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How long must the term be?

The term of a bond depends on the reasons

for raising capital and the expected cash

flows that will be available to meet

payments.

Page 10: Liabilities management

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MATURITY

Money Market

Securities

Capital Market Securities

Stocks (Equity) Notes and Bonds

0 1 year to 10 years to 30 years to No specified

maturity maturity maturity maturity

(Intermediate-term financing)

Page 11: Liabilities management

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Primary and Secondary Market

Transfer of Funds Time Line

Primary Markets (Where new issues of financial instruments are offered for sale)

Users of Funds

(Corporations

issuing debt/equity

instruments)

Underwriting with

Investment Banks

Initial Suppliers of

Funds (Investors)

Financial Instruments flow

Funds Flow

Page 12: Liabilities management

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Primary and Secondary Market

Transfer of Funds Time Line

Secondary Markets (Where financial instruments, once issued, are traded)

Financial Markets Securities Brokers Other Suppliers of

Funds

Financial Instruments flow

Funds Flow

Page 13: Liabilities management

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Bonds (Debt Financing)

Basic Types of Bonds

1. Debenture Bonds

2. Mortgage Bonds

• Open-end

• Closed-end

3. Income Bonds

4. Serial Bonds

Page 14: Liabilities management

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Bonds (Debt Financing)

Debenture bonds – not secured with tangible assets, only by the creditworthiness

Mortgage bonds - secured by a mortgage on one or more assets

Income bonds - pays interest at a rate based on the issuer's earnings

Serials bonds - a portion of the

outstanding bonds matures at regular

intervals

Default Risk Issue Date

Maturity Coupon Rate

Call Provisions Face Value

Page 15: Liabilities management

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QUESTIONS

• Why do firms call/pay the bonds ahead of

schedule?

• What if the bond holder does not turn the

bonds in for redemption?

Page 16: Liabilities management

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Market Price of Bonds

Bond

Stated

Interest

Rate

10%

7% Premium

10% Face Value

13% Discount

Yield

Page 17: Liabilities management

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Discount

If

Effective Rate is

GREATer

Page 18: Liabilities management

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Bond Valuation Mathematics

Formula:

PV of Bond = PV of Principal + PV of Interest

Page 19: Liabilities management

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1. 15-year bonds with 13%

annual rate

PV= PV of Principal + PV of

Interest

= 239.39 + 988.79

= 1,228.18

Amortization:

Year 1: 1228.18 x 10% = 122.82

1000.00 x 13% = 130.00

Given: $1000 par value bond, 15 years Coupon rate: 13% or 7% Effective Rate: 10%

Problem:

2. 15-year bonds with 7%

annual rate

PV= PV of Principal + PV of

Interest

= 239.39 + 532.43

= 771.82

Amortization:

Year 1: 771.82 x 10% = 77.18

1000.00 x 7% = 70.00

7.18 7.18

Page 20: Liabilities management

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-

200.00

400.00

600.00

800.00

1,000.00

1,200.00

1,400.00

15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0

7%

10%

13%

Years Remaining until Maturity

Bond Value ($)

Page 21: Liabilities management

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Volatility of Bonds

Bonds currently selling at a premium has the

least volatility

The most volatile bonds are the zero-interest

bonds because all interests are paid only at

maturity

The more time until the bond matures, the

greater the bond’s volatility

Bonds volatility is lower than stocks

Page 22: Liabilities management

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Reality Check (Debt Financing)

• SMC raises $800M via overseas bond

issue, Philippine Daily Inquirer, April 19,

2013

• ALI to issue P21-B bonds, The Philippine

Star, June 20, 2013

• Globe Telecom to issue P10B worth of

bonds, June 28, 2013

Page 23: Liabilities management

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“No matter how great the talent or

efforts, some things just take time. You

can’t produce a baby in one month by

getting nine women pregnant.”

-Warren Buffet