Question

In: Finance

a) Pearson Publishing Ltd needs to borrow money for two purposes: purchase of inventory and purchase...

a) Pearson Publishing Ltd needs to borrow money for two purposes: purchase of inventory and purchase of a building to expand its business. Please advise this company on how to raise funds for these two purposes. In your discussion you need to define and distinguish between the debt markets advised.

b) Pearson decides to issue a 90-day commercial paper at a yield of 2.5% p.a. If the face value of the paper is $150,000, how much fund will Pearson be able to raise?

c) The company has decided to issue a bond at a Face Value of $1,000. The coupon rate of the bond is 8% per annum and the coupons are paid semi-annually. The bond has a term to maturity of 5 years and the yield-to-maturity is 8% per annum as well. Without calculation, briefly explain what the implied price of this bond would be?

d) If an investor bought the bond at issuance at the implied price in part c) and then sold it at $1030 after holding it for 1.5 years, what was his holding period yield per annum?

Solutions

Expert Solution

a) Following are the different sources of debt financing:

LOANS

Loans are the most common and popular mode of debt finance for a company. Businesses borrow money from commercial lenders like banks by keeping some collateral security against the loan. Loans from banks and other commercial lenders are for a fixed period and business needs to pay regular interest for it. The loans can be for short, intermediate or long-term depending upon the financial requirements of the business.

TRADE CREDIT

Trade credit is an arrangement in which the business can purchase the goods now and pay for them later. This way the business can avail debt financing for short term. Trade credit is a good mode of finance for startups as they cannot afford to obtain loans of the higher amount by placing a collateral society.

INSTALLMENT PURCHASE

Purchasing the capital goods on installment is another type of debt financing. Installment purchase comprises of buying an asset and making payment in pre-determined installments. The buyer has to mortgage its asset until full payment of installment is made. A business that has higher credit rating may not have to mortgage any asset. Banks and finance companies provide the facility of installment purchase to the business.

ASSET BASED LENDERS

Asset-based lenders are those finance companies that lend money to the business for purchasing the assets. The business in return has to pledge its assets like inventory, accounts receivables, etc. This type of debt financing is very useful for businesses that have higher inventory, account receivables, real estate or any other asset that can be pledged.

BONDS

Bonds are a source of debt capital for businesses that are well established and need funds for long-term growth of the business. The company can raise funds by selling bonds to different buyers and sharing profits on the projects for which bonds are issued.

Short term loans, trade creditn are a good source of inventory financing since inventory is financed by short term source of funding.

Whereas long term loans, installment purachase, bonds, asset based lenders are good source of financing for purachase of building.

b)  Face Value = $ 150,000

Yield =            2.5% p.a.

Time =            90 days

Now, Interest to be paid on the commercial paper is:

            $ 150,000 * 2.5% * 90

                                               365

            = $ 925

Net fund raised by Pearson = $ 150,000 - $ 925

                                                  = $ 149,075

c) Whenever the coupon rate is equal to the yield to maturity, bond will be sold at Par value.

In the given scenario, since, coupon rate and yield to maturity are same, implied price of the bond will be equal to the face value, i.e. $ 1000.

d) Holding period yield = (B1-B0) + Interest

                                                      B0

                                     = (1030-1000) + (1000*4%*3)

                                                     1000

                                     = 0.15 or 15 %

The above holding period yield is for a period of 1.5 years.

Therefore, the annual yield will be:

                                         15/1.5 = 10% p.a.

Note: Interest is calculated taking coupon rate as half (4%) since the interest is calculated semi annually for 1.5 years (3 half yearly payments)

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