3-1 Explain major forms of financing and their characteristics
Businesses can finance their operations with liabilities, equity, or both.
Liability: Liability financing involves all forms of debt financing including bonds, notes, capitalized leases, and more.
Equity includes capital stock, retained earnings, and assets of the firm.
3-3 What are the major forms of financing liabilities? Which are long term and which are short term?
The major forms of financing liabilities are private and public debt and capitalized leases. Private debt includes loans from investors issuing securities, usually as bonds. Both private and public debt may be short or long term and contain various provisions in their contracts.
Leases are an indirect form of long term borrowing where firms borrow to pay for an asset.
3-4 Explain how bond discounts and premiums usually arise. Describe how they are accounted for in the balance sheet and income statement.
When the interest rate is much higher than a coupon rate, then the mirror image of the “premium” scenario unfolds. Because the market values the bond at their present value, the company gets to issue the bonds above the face value, or at a premium. These bonds are accounted for in their respective sections. They are used to show how much it would be if each of the case scenario were to arise such as: premiums, discount, fair value and par value.
Short term debt is accounted by classifying it as a current liability. This means that the company plans to pay off the debt within a year. They are made up of revolving lines of credit and Commercial Paper (along with others). These are usually required to be paid within a short fixed amount of time, thus fitting them into this category. The details of this debt are in the notes of the financial statements.
3–7. Describe the major disclosure requirements for long-term debt.
information regarding the future maturities of debt, details of contractual provisions such as collateral and covenants, unused balances in lines of credit.
Major disclosure requirements of long term debt include: a detailed break-up of outstanding and available debt, a payment schedule, the fair value of the debt
3–9. What are the various forms of protections that lenders incorporate into their debt contracts?
Seniority, collateral, and covenants.
3–10. What do we mean by seniority of debt? What consideration should an analyst keep in mind when analyzing debt seniority?
Seniority is the order in which different parties will be paid when a company is dissolved. Senior claims go before Jr claims. Seniority is predetermined by law. Existence of senior debt makes junior debt riskier, since the firm must pay off certain debts even before its...