Question

What long term debt instruments docorporations use?

How can leasing be a type of long term financing?

What are the differences between financing with common stock and preferred stock

Answer 1

1 . Debt instruments provide fixed and higher returns, thus giving them an edge over bank fixed deposits. The duration of debt instruments can either be long-term or short-term. Funds raised through short-term debt instruments are to be repaid within a year.However, long-term debt instruments are the ones that are paid over a year or more. Credit card bills and treasury notes are examples of short-term debt whereas long-term loans and mortgages form part of long-term debt instruments.

1. Debentures
Debentures are not backed by any security. They are issued by the company to raise medium and long term funds. They form the part of the capital structure of the company, reflect on the balance sheet but are not clubbed with the share capital.
2. Bonds
Bonds on the other hands are issued generally by the government, central bank or large companies are backed by a security. Bonds also ensure payment of fixed interest rates to the lenders of the money. On maturity of the bond, the principal amount is paid back. Bonds essentially work the way loans do.
3. Mortgage
A mortgage is a loan against a residential property. It is secured by an associated property. In a case of failure of payment, the property can be seized and sold to recover the loaned amount.
4. Treasury Bills
Treasury bills are short-term debt instruments that mature within a year. They can be redeemed only at maturity. They are sold at a discount if sold before maturity.

2 . A lease for longer than one, five or 10 years, depending on the specific asset being leased. For example, commercial property usually has long-term leases for five or more years, while residential property often carries long-term leases for more than one year. A long-term lease locks in the price one pays for the asset, which is usually advantageous because prices often trend upward. However, long-term leases offer little flexibility. For example, one may have to pay significant penalties if one cancels a long-term lease.

3 . Financing with common stock :

Equity Financing Via Common Stock:
With equity financing via common stock, you reduce your ownership percentage in your company through the sale of common stock to one or more individuals or entities in exchange for a specified amount of money. These company stock purchasers could be active participants in the business as would occur if you brought in a business "partner" or a hands-on angel investor. Alternatively, the purchasers could be passive investors. Regardless of their level of activity, common stock buyers take on the company risk because they believe the potential upside far outweighs the downside.

No Mandatory Payments:
One of the biggest advantages of common stock from the issuing company's perspective is the absence of required payments. Debt financing requires a business to make interest and principal payments on a specified schedule. Common stock has no such requirements. When a company has significant start-up or expansion costs, an equity investment contributes necessary capital and allows the company to use all its available free cash flow to grow. Companies do pay distributions or dividends to common stockholders, but only if the company is profitable. In addition, companies can specify above what level of profitability any distributions will be made.

Limited Operating History is OK:
When purchasing common stock, investors focus more on the founders and management team, the company's strategy and the management team's perceived ability to execute. Investors -- friends and family, angels, venture capitalists and private equity investors -- purchase common stock primarily because they believe in the management team. These investors look at the passion with which the team conveys its story and the level of knowledge the team has about the business and the market. If management can credibly explain mediocre past performance and how they are re-positioning the company for growth, investors may discount the previous operating history.

Investor Perspective:
Some individuals and entities like to invest in common stock of private companies because they believe the business will grow in size and profitability and wish to participate in that growth. For example, say your company is valued at $200,000 when you sell common stock to investors. Four years later, your company's value has increased to $2 million. That investor's common stock, assuming no dilution, has grown ten-fold, or 1,000 percent. The opportunity to experience such a large return appeals to common stock investors.

Financing with preffprefe stock :

Unattractive to Investors:
Selling investors preferred shares isn't always easy. For several reasons, investors often don't find these offerings very attractive. Their dividends aren't legally enforceable. In an insolvency, preferred shareholders come after bondholders. Unlike bonds, preferreds either have no fixed maturity dates or have maturity dates in the far future -- usually 30 years. Because preferred shares can't be retired in the short term, but can only be resold into the market, they do share one characteristic with longterm bonds: high volatility. Worse, they often come with a one-sided maturity agreement, where the buyer has to wait many years to get back his investment at par value -- the issuing price --while the company has a right to buy back the shares at the current market price. This usually occurs when the market price is significantly below the issue price.

Expensive Way to Finance:
Because preferred shares have known disadvantages for investors, companies almost always offer high interest rates to sell them. In the first half of 2013, long-term investment grade corporate bonds had interests rate slightly above 2.5 percent. During the same period, preferred shares of Fortune 100 companies (the largest, presumably most stable U.S. corporations) had yields of more than 6 percent.

Appearance of Weakness:
The difference between bond rates and preferred rates has an unfortunate implication, that the reason a company is rising capital with preferreds despite the cost disadvantage may be because that's the only way it can raise money. The one big advantage of preferreds for companies that have weak capital positions is that issuing preferreds, unlike issuing bonds, doesn't increased the indebtedness of the company on its books. This "advantage" however, because it is widely known, can lead investors to the perception that issuing preferreds is a sign of weakness. Whether this is true or not, unless the company's financial strength is very well-known, issuing preferreds may lower the price of its common shares.

Exceptions:
For some companies, despite the disadvantages, offsetting advantages make preferreds a good way to raise money. This is particularly true for large U.S. corporations, which can use preferreds for special projects without arousing a suspicion of financial weakness among its investors, then retire them when the capital investment on the project generates enough revenue. Utilities also like them because, as Mark Koba explains in a CNBC article, "preferred stock dividends are treated like an expense for rate-making purposes," which allows them to pass the entire dividend cost onto their customers.

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