Question

Company XYZ is considering using off-balance-sheet financing in order to obtain a loan from a local bank, but the company is unsure of the various forms of off-balance-sheet financing. For management, compare and contrast the various forms of off-balance-sheet financing. Give your opinion on whether or not Company XYZ should engage in off-balance-sheet financing. Provide a rationale with your response.

Explain the primary advantages and disadvantages of issuing bonds with call features to potential buyers. Suggest two (2) improvements that a company could implement in order to make bonds with call features more attractive to potential buyers.

Answer 1

There are various sources of off-balance-sheet financing. So let’s see all those sources of off-balance-sheet financing;

1. Operating lease;

This is also a source of off-balance-sheet finnacing because in this case a company can use leased asset without recording any assets and liability in the balance sheet. Hence it is a good option of off-balance-sheet financing.

2. Take-or-pay contract;

This is also a good option because under such take-or-pay contract a company or firm become able to receive supplies from their vendor. Thus this option provides a chance to company to use assets without recording it into balance sheet as assets or liability.

3. Leaseback Agreements;

This is also a type of off-balance-sheet financing. Under this option a company can sell assets to the company and that new assets can be taken on lease from that new buyer of the assets.

4. Commodity-linked bonds;

Under this case inventory purchased is financed with the help of commodity-linked bonds. So it also work as off-balance-sheet financing.

5. Sale of accounts receivables;

This is also a very popular source of off-balance-sheet financing. Under this option a company sells its’ accounts receivabels to third party and gets desired level of finance. So in this case no potential liability will be disclosed in the balance sheet.

So on the basis of above available sources for off-balance-sheet financing, it is clear that company XYZ can take help of off-balance-sheet financing because this option will help in meeting immediate financing needs without affecting items of balance sheet of the company.

Primary advantages and disadvantages of issuing bonds with call features to potential buyers;

Advantages of issuing bonds with call features;

1. Call features bonds pay higher interest rates to the buyers in compare to other types bonds.

2. Issuer of the call features bonds have sufficient flexibility, which is not possible in case of other types of bonds.

3. A company can convert its financing sources if interest rates are declined in the market. In other word we can say that in case of fall in interest rates bonds can be called back from the market to reduce over-burden of interest payment.

Disadvantages of issuing bonds with call features;

1. This types of bonds are very risky investment for the buyers because in case of fall in interest rates company can buy its bonds from the market hence in such case investors will feel unsafe.

2. In case of falling interest rate, company will buy these bonds from the market hence again company will raise finance hence it will increase costs of issue of securities.

3. Overall in case of falling interest rates company and invetsors both with suffer with various types of risks thus sometime call features bonds become very risky.

4. In case of higher interest rates investors will not be interested in making investment in these bonds.

Improvements to make callable bonds more attractive;

1. Company can make the redemption price above par so that potential investors can get more premium on the redemption of these bonds.

2. Company may offer good & attractive marginal yield on these callable bonds so that these callable bonds can be made more attractive in compare to other tyeps of bonds.