Secured debt

An originator with 100 million of imsecured debt, bearing an interest rate of X percent, plans to repay 50 million of this unsecured debt with the proceeds of a new 50 million issuance of secured debt. The principle of exposure conservation states that the interest rate on the secured debt will be reduced to X-Y percent, but this reduction in rate will be matched by an interest rate increase on the remaining unsecured debt to X+Y percent. This analysis assumes that the unsecured creditors are free to adjust to a market rate. Therefore, according to the theory, the originator makes no net gain from granting security. 

If this originator repaid the 50 million of the unsecured debt from the proceeds of a securitization, instead of from the issuance of secured debt, the interest rate on the remaining unsecured debt would again rise to X+Y percent. However,... 

That the next, and all future representatives shall exactly keep the public faith and give full satisfaction for all securities, debts, arrears or damages (justly chargeable) out of the public treasury and shall confirm and make good all just public purchases and contracts that have been or shall be made save that the next Representative may confirm or make null in part or in whole, all gifts of lands, monies, offices, or otherwise made by the present parliament to any member of the House of Commons or to any of the Lords or to any of the attendants of either of them. 

If the company has issued secured debt, this will rank above senior and subordinated unsecured debt. 

Debt management ratios, also known as leverage ratios, show the extent to which a company is financed with debt. Companies that are financed with debt, rather than equity, must pay principal and interest on the debt at regular time periods. If they are unable to pay back these loans on time, creditors can force the firm to accelerate repayment or force it into bankruptcy. In many instances, loan covenants require companies to maintain certain ratio targets or go into default of the loan. Most long-term debt obligations contain covenants related to secured debt levels. 

Debt Financing In practice, debt financing covers a variety of fixed-income securities, both long-term and short-term. The most common forms of long-term debt are bonds, mortgages, and debentures. 

A financial analyst looking at a company from a potential common stockholders point of view is hkely to classify preferred stock as debt. In contrast, bondholders and general creditors are likely to regard preferred stock as additional eqmty. Since preferred stock is a hybrid type of security, it may be issued by a company whose management is divided over the question of whether to use equity or debt to finance additional assets. However, preferred stock does have the disadvantage that the dividends are not allowed as a tax-deductible expense. 

Liquidity ratios are a measure of a company s ability to pay its shortterm debts. Current ratio is obtained by dividing the current assets by the current liabilities. Depending on the economic climate, this ratio is 1.5 to 2.0 for the chemical process industries, but some companies operate closer to 1.0. The quick ratio is another measure of liquidity and is cash plus marketable securities divided by the current liabilities and is slightly greater than 1.0. 

The accounting definition of woridng capital is total current assets minus total current liabilities. This information can be found from the balance sheet. Current assets consist chiefly of cash, marketable securities, accounts receivable, and inventories current liabilities include accounts payable, short-term debts, and the part of the long-term debt currently due. The accounting definition is in terms of the entire company. 

Net worth statements have common categories of assets and debts. Debts are generally divided into two categories secured and unsecured. Assets are generally divided into the following categories ... 

Bond A long-term debt-type of security generally issued by corporations or governments to generate cash. The coupon rate is the interest rate paid to the bondholder. The maturity date is when the face value of the bond will be paid to the bondholder. 

Only the most liquid of assets are included in this ratio, and the best ratio is usually 1 1, but this varies with the industry concerned. Table 9.12 calculates the acid-test ratio. Although the Blue company has a better current ratio than the Gold company, it does not have a better acid-test ratio, and, therefore, may have to sell its inventory at discounted prices in order to raise cash for current debt that is due. The Gold company, which did not have a favorable current ratio, does have an acceptable acid-test ratio because most of its current assets are in cash, accounts receivable, and marketable securities. 

Most debt capital is raised by issuing long-term bonds. A mortgage is a bond that is backed by pledging a specific real asset as security against the loan. An unsecured bond is called a debenture. The ratio of total debt divided by total assets is known as the debt ratio (DR) or leverage of the company. 

Through the securitization process described above, the SPV raises funds by issuing securities—usually debt or debt-Uke securities—and uses the receivables purchased from the originator to repay investors in the future. The investors, therefore, are concerned only with the cash flows coming due on these receivables, and care little about the originator s financial condition. ... 

Companies whose debt securities are rated "investment grade" can usually issue securities in the capital markets at interest rates competitive with, or even lower than, other generally available sources of funds, such as bank loans. The higher the company s rating within the investment grade categories, the lower the company s cost of funds. This reduced cost is a result of the lower interest rate necessary to induce investors to buy the company s securities. ... 

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