Question

1. Explain 3 advantages of taking a long term debt for an organization.

2. Explain 3 disadvantages of taking a long term debt for an organization.

(Make sure your responses include the significance of "debt to asset ratio")

3. Research any bonds issued by a local government body in your community / state.

a) Identify the bond issuer, the purpose of the bond, the total amount being raised.

b)What is the yield of this bond?

c) When is the maturity date of this bond?

d) What is the rating of this bond? What does this rating mean?

c) What are 3 benefits of investing in this bond?

d) What are 3 drawbacks of investing in this bond?

e) Would you personally buy this bond? Why or why not?

This discussion post is worth 50 points.

Answer 1

ong-term debt is financing used by a company with payback periods ranging anywhere from one to 30 years

While you would generally prefer to have little to no debt, carrying loan balances offers your small business some distinct advantages relative to alternatives such as limited growth or equity financing.

Immediate Growth

Long-term debt is usually tied to large up-front payouts used for major purchases and acquisitions. Normally, companies use major loans to buy new buildings or equipment, or to invest in product research and development, or to acquire another company. The financing allows you to invest in these growth-oriented purchases that you would otherwise have to wait years for by slowly saving profits over time.

Cost Advantages

Long-term debt financing usually has some financial benefits relative to short-term debt. Interest rates are normally lower because long-term loans are usually secured with property. If you buy a building, for instance, your building loan is secured by the property. While this exposes your purchase to repossession, it lowers the bank's risk and makes it more willing to offer a more attractive interest rate than for an unsecured loan. Over time, this makes for a lower cost of borrowing than unsecured short-term loans with higher rates.

Small Installments

Long-term debt financing usually means smaller monthly installments than short-term credit accounts. Your amounts toward principal and interest are lower the longer your repayment period is spread out. By repaying the loan over a lengthy period, your monthly cash flow is less affected than it would be on a short-term debt with larger payments. This enables you to more easily meet other expense obligations and pocket earnings.

Disadvantages Of Long-Term Debt Financing

Long-term debt financing has some disadvantages from firm's viewpoint as follows:

1. Interest on debt is permanent burden to the company. Company has to pay the interest to bondholders or creditors at fixed rate whether it earns profit or not. It is legally liable to pay interest on debt.

2. Debt usually has a fixed maturity date. Therefore, the financial officer must make provision for repayment of debt.

3. Debt is the most risky source of long-term financing. Company must pay interest and principal at specified time. Non-payment of interest and principal on time take the company into bankruptcy.

A bond, also known as a fixed-income security, is a debt instrument created for the purpose of raising capital. They are essentially loan agreements between the bond issuer and an investor, in which the bond issuer is obligated to pay a specified amount of money at specified future dates.

When an investor purchases a bond, they are "loaning" that money (called the principal) to the bond issuer, which is usually raising money for some project. When the bond matures, the issuer repays the principal to the investor. In most cases, the investor will receive regular interest payments from the issuer until the bond matures.

Different types of bonds offer investors different options. For example, there are bonds that can be redeemed prior to their specified maturity date, and bonds that can be exchanged for shares of a company. Other bonds have different levels of risk, which can be determined by its credit rating.

Bond rating agencies like Moody's and Standard & Poor's (S&P) provide a service to investors by grading fixed income securities based on current research. The rating system indicates the likelihood that the issuer will default either on interest or capital payments.

Bonds are often referred to as fixed-income securities because the lender can anticipate the exact amount of cash they will have received if a bond is held until maturity. For example, say you buy a corporate bond with a face value of $1,000, a coupon of 5% paid annually, and a maturity of 10 years. This tells you that you will receive a total of $50 ($1,000 x 0.05) of interest per year for the next 10 years (because most corporate bonds pay interest semi-annually by convention. You'd then receive two payments of $25 a year for 10 years. When the bond matures in a decade, you'd then get your $1,000 back.

Advantages

Bonds offer safety of principal and periodic interest income, which is the product of the stated interest rate or coupon rate and the principal or face value of the bond. Bonds are ideal investments for retirees who depend on the interest income for their living expenses and who cannot afford to lose any of their savings. Bond prices sometimes benefit from safe-haven buying, which occurs when investors move funds from volatile stock markets to the relative safety of bonds. You can buy bonds directly through your broker or indirectly through bond mutual funds. You can also buy U.S. Treasury bonds directly from the department's TreasuryDirect website.

Disadvantages

The disadvantages of bonds include rising interest rates, market volatility and credit risk. Bond prices rise when rates fall and fall when rates rise. Your bond portfolio could suffer market price losses in a rising rate environment. Bond market volatility could affect the prices of individual bonds, regardless of the issuers' underlying fundamentals. Credit risk means that issuers could default on their interest and principal repayment obligations if they run into cash-flow problems. Some bonds have call provisions, which give issuers the right to buy them back before maturity. Issuers are more likely to exercise their early-redemption rights when interest rates are falling, so you then might have to reinvest the principal at lower rates.

What Are the Risks?

There are numerous risks involved with bonds as well as several management tools to assess, analyze, and ultimately help investors manage the risks they take on as they invest in bonds. Some specific types of risk of primary concern to investors in corporate bonds are: inflation risk, interest rate risk, liquidity risk, and credit risk.

Can the Issuer Purchase the Bonds Back Before Maturity?

Investors must consider another significant risk factor with bonds: the chance it is called or bought back before its maturity date. Commonly referred to as the bond’s “call risk,” this refers to the chance that the issuer may redeem the bond at an early date in response to rising market prices or falling interest rates. It’s vital, therefore, to determine whether a bond has a call date before its maturity and how likely an issuer is to make good on that call.

Are the Interest Payments Made at a Fixed or Floating Rate?

It is also important for an investor to determine whether a bond’s coupon is fixed or floating rate. Fixed coupons offer a set percentage of the face value in interest payments. Floating rate bonds, on the other hand, have their coupon rate set by movements in the market’s benchmark rates. For U.S. issuers, this benchmark is determined by the US Treasury rate, LIBOR, or the prime rate/fed funds. Most floating rate bonds are issued with 2- to 5-year maturities, and usually by governments, banks, and other financial institutions. A bond’s prospectus should fully educate buyers on the floating rate, including when the rate is calculated.

Can the Bond`s Issuer Cover Its Debt Obligations?

Keep in mind that companies issue bonds as a way to attract loans, so bond purchasers are lending their funds to the issuer. Therefore, just like they would when assessing anyone they offer a loan to, investors should make sure that the issuer is prepared to make good on the payments and principal promised at maturity of any bond they purchase. This isn’t simple, as it requires constant monitoring as well as an in-depth analysis by qualified professionals. The sheer volume of data, risk factors, and analyses can be overwhelming. However, focusing on the most important financial metrics may make this a bit easier to do.

How Are the Bonds Secured?

One of the most important things is to determine whether or not you are likely to receive your money back (or part of your money back) in the event that an issuer goes into default or becomes insolvent. Typically, investors will do this both through the determination of two figures: (1) loss given default (LGD) and (2) the recovery rate. Additionally, besides knowing whether or not a bond is secured, it is important to know where it ranks in seniority for other secured bonds in terms of pay out during insolvency .

The Bottom Line

Investing in bonds requires a profound analysis as well as a considerate deliberation. The seven questions above include merely a few of the vital issues which require in-depth consideration. Moreover, it is important to understand that these issues do not only require attention before the actual investment. During the investment period, ongoing monitoring is also essential.