Question

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1. Why bonds?, bond issuance (bond offering) versus stock issuance from a corporate perspective in terms of capital need. In other words, what are some of pros and cons of this two pathways of corporate financing options? One, through "Debt Financing" (long term liability section in financial reporting, ch.14) as opposed "Equity Financing" (ch.13 paid-in-capital of equity section of financial reporting)? Please also think about the related concept of "Financial Leverage". Please discuss ups/downs (pros and cons) between the two capital raising/structure.

2. Now everything said and done with bonds, what is then difference between bonds and loans(bonds vs. loans as long-term debt)? Please discuss as many difference as you think of, from a corporation perspective as well as from an investor/lender perspective.

Answer 1

Answer -

1. Bonds - Bonds are basically debt obligations which company issues. They have to be treated as loan and the company needs to pay in future. Also, interest is paid to the bond holders.

Basically the corporates follow 2 types of financing - Equity financing and Debt financing. Both have its own pros and cons.

	DEBT FINANCING	EQUITY FINANCING
1	Here, the company raises money from public by issuing loans and debentures.	Here, the company raises money from public by issuing equity and preference shares
2	Here, the company pays interest	Here, the company pays dicidend to the share holders
	Pros	Pros
1	The bond holders do not become the owner of the company. They are just like creditors	When there are losses, company need not pay to the share holders
2	Even when there are huge profits, the company only needs to pay a fixed interest and can keep the balance with the company otself	The company need not repay the shareholders till the time of liquidation. Thus, they need not worry about repayment of money.
3	The company can keep the creditors out of the business and can independently take decisions
	Cons	Cons
1	The company needs to pay the bond holders even when there are losses	The shareholders become the owners of the company and they have right to vote
2	Bonds are only for fixed period and hence the company should be repaying the debt amount else will go into liquidation	They participate in the decision making of the company

FINANCIAL LEVERAGE -

Basically, financial leverage means the ability of a firm to use its interest payments to magnify its operating profits. In simple words, the company uses borrowed capital for an investment, expecting the profits made to be greater than the interest payable. As mentioned above, when a company uses debt financing, it has to pay only a fixed interest even if it earns more profits. Thus, company can keep those profits for itself and use for its growth.

Hence, financial leverage occurs when a company has debt content in its capital structure and fixed financial charges i.e. interest on debentures, bonds, etc.

Conclusion - More amount of loans may put company to a risk because irrespective of profit or loss the company has to pay interest in case of debt financing. If the company faces losses, the interest payment may become a burden for it. so, an ideal financing option for a company is to have both debt and equity financing in its capital structure so that the company can enjoy the benefits of both the types.

2.Below are the following differences between bonds and loans

BONDS	LOANS
Here, the company issues some securities known as bonds to the public and raises money.	Here, the company raises money through a bank. This is called a loan
The company keeps paying interest and will have to repay the amount at maturity. This feature is same for both bonds and loans	The company keeps paying interest and will have to repay the amount at maturity. This feature is same for both bonds and loans
From Corporate Perspective
Pros	Pros
Advantage of bond is that the long term interest rate of bonds is lower than the rate a bank would charge	Generally loans can be modified or restructured to the benefit of the borrowing party
Also, it is more flexible for a company in case of bonds to use the money in whichever way they want.	Easy to get a bank loan when compared to the big process of issuing bonds
	Cost involved in getting bank loan is significantly less when compared to that of bonds
Cons	Cons
Bonds cannot be restructed and mostly the company is committed to fixed payment schedule and mandtory payment on maturity	The bank rates are higher than the bond interest rates
A big process involved to issue bonds when compared to taking bank loans	Less flexibility of usage of loan amount when compared to bonds
Bonds issue is comparatively costlier than obtaining loans
From Investor Perspective
An investor purchases bonds when he has to do some good investments and earn interest income on them	When a bank gives loans, it also does it as an investment, ie it earns from the interest income from the loan given.