FINANCE IN A CANADIAN FINANCE IN A CANADIAN SETTING SETTING Sixth Canadian Edition Sixth Canadian Edition Lusztig, Cleary, Lusztig, Cleary, Schwab Schwab
Jan 03, 2016
FINANCE IN A FINANCE IN A CANADIAN SETTINGCANADIAN SETTING
Sixth Canadian EditionSixth Canadian Edition
Lusztig, Cleary, Lusztig, Cleary, SchwabSchwab
CHAPTER CHAPTER
TWENTY-FOURTWENTY-FOUR
Short-Term Financing Short-Term Financing OptionsOptions
Learning ObjectivesLearning Objectives
1. Discuss the different sources of short-term 1. Discuss the different sources of short-term and intermediate-term loans.and intermediate-term loans.
2. Identify five common features of term 2. Identify five common features of term loans.loans.
3. Discuss the reason for hedging through 3. Discuss the reason for hedging through forward or futures contracts or options.forward or futures contracts or options.
4. Compare the informal and formal types of 4. Compare the informal and formal types of trade credit.trade credit.
5. Explain the role of the venture capital firm.5. Explain the role of the venture capital firm.
IntroductionIntroduction
In this chapter we discuss short and intermediate-In this chapter we discuss short and intermediate-term financingterm financing
Short-term funds are appropriate for the financing Short-term funds are appropriate for the financing of receivables and inventoriesof receivables and inventories
Intermediate-term financing is useful when funding Intermediate-term financing is useful when funding must be committed for extended periodsmust be committed for extended periods The most common intermediate term The most common intermediate term financing is financing is
term loansterm loans Term loanTerm loan – a loan that has a specified maturity and – a loan that has a specified maturity and
cannot be called as long as the borrower complies cannot be called as long as the borrower complies with the conditions of the loanwith the conditions of the loan
Bank LoansBank Loans
Canadian BanksCanadian Banks operate a national system of branch bankingoperate a national system of branch banking maintain a balanced portfolio of loansmaintain a balanced portfolio of loans most short-term loans for business are in the most short-term loans for business are in the
form of lines of credit secured by inventories form of lines of credit secured by inventories and receivablesand receivables
Line of creditLine of credit – an open lending arrangement – an open lending arrangement with a stated maximum that a bank may be with a stated maximum that a bank may be willing to lend a customer for a set period of willing to lend a customer for a set period of timetime
Bank LoansBank Loans Advantages of line of credit include:Advantages of line of credit include:
firms know how much bank credit can be expectedfirms know how much bank credit can be expected borrowing is limited to amounts actually neededborrowing is limited to amounts actually needed the bank’s credit manager can make instant the bank’s credit manager can make instant
advances up to the maximum amount approved advances up to the maximum amount approved without additional applicationswithout additional applications
Rate of interest on bank loans is expressed as a Rate of interest on bank loans is expressed as a percentage above primepercentage above prime prime loan rateprime loan rate – the interest rate banks charge – the interest rate banks charge
their most credit-worthy borrowerstheir most credit-worthy borrowers
Bank LoansBank Loans
A large portion of business loans are A large portion of business loans are secured by pledged assets secured by pledged assets (equipment, property)(equipment, property)
Term loans Term loans are secured by collateralare secured by collateral collateral exceeds the amount of a loan collateral exceeds the amount of a loan
by a marginby a margin interest rates are often variable and tied interest rates are often variable and tied
to the prime rateto the prime rate
Other PrivateOther Private Financial Institutions Financial Institutions
Trust CompaniesTrust Companies most operate as subsidiaries of the major most operate as subsidiaries of the major
charter bankscharter banks offer many of the same services as banks offer many of the same services as banks
plus estate management, pension plans, and plus estate management, pension plans, and other trust fundsother trust funds
Caisse PopulairesCaisse Populaires and Credit Unions and Credit Unions are savings and credit co-operativesare savings and credit co-operatives have different policies regarding asset have different policies regarding asset
managementmanagement
The Money MarketsThe Money Markets
Money marketsMoney markets –– consist of the places and consist of the places and institutions in which debt instruments with institutions in which debt instruments with relatively short maturities (under 3 years) are relatively short maturities (under 3 years) are tradedtraded
Since 1954 governments and corporations have Since 1954 governments and corporations have used money markets to obtain short-term used money markets to obtain short-term financingfinancing
Money markets instruments sell at a discount from Money markets instruments sell at a discount from face value and investors realize a return at face value and investors realize a return at maturity when the borrower redeems at face valuematurity when the borrower redeems at face value
Money MarketsMoney Markets
Commercial PaperCommercial Paper
Commercial paperCommercial paper Commercial paperCommercial paper –– consists of short-term promissory consists of short-term promissory
notes issued by major corporations that are well known notes issued by major corporations that are well known to investors and have excellent credit historyto investors and have excellent credit history
Issued in denominations > $100,000Issued in denominations > $100,000 Unsecured with maturities of 60, 90, and 120 daysUnsecured with maturities of 60, 90, and 120 days Not subject to scrutiny of the provincial securities Not subject to scrutiny of the provincial securities
commission the way long-term debt and equity issues commission the way long-term debt and equity issues areare
Rating agencies publish reports on the quality of Rating agencies publish reports on the quality of commercial papercommercial paper
Commercial PaperCommercial Paper
Bankers AcceptancesBankers Acceptances
Bankers acceptancesBankers acceptances Bankers acceptancesBankers acceptances –– drafts or orders to pay, drafts or orders to pay,
drawn on a chartered bank by the firm seeking drawn on a chartered bank by the firm seeking fundsfunds
are short-term debt instruments similar to are short-term debt instruments similar to commercial paper guaranteed by the bankcommercial paper guaranteed by the bank
virtually default-freevirtually default-free issued in multiples of $500,000issued in multiples of $500,000 issued for periods between 30 and 90 daysissued for periods between 30 and 90 days banks charge an acceptance fee between 1/2 to 1 banks charge an acceptance fee between 1/2 to 1
percent of face value to the firm seeking fundspercent of face value to the firm seeking funds
Securities Issued by Securities Issued by Banks and Trust Banks and Trust
CompaniesCompanies Certificates of deposit (CDs)Certificates of deposit (CDs) –– are non- are non-
redeemable, registered, transferable, interest-redeemable, registered, transferable, interest-bearing notes with maturities between one and bearing notes with maturities between one and six yearssix years
Deposit receiptsDeposit receipts –– are transferable term are transferable term deposits with maturities of between 30 and 364 deposits with maturities of between 30 and 364 days that can be cashed in at any time subject days that can be cashed in at any time subject to an interest penaltyto an interest penalty
Bearer depositBearer deposit –– are issues exceeding $100,000 are issues exceeding $100,000 for fixed maturities of up to seven yearsfor fixed maturities of up to seven years
FactoringFactoring
Factors are firms that provide financing Factors are firms that provide financing to businesses by purchasing their to businesses by purchasing their accounts receivableaccounts receivable
Factors can provide three services:Factors can provide three services:1. taking over credit screening and 1. taking over credit screening and
collectionscollections
2. assuming the risk of bad debt2. assuming the risk of bad debt
3. financing by advancing funds that 3. financing by advancing funds that would otherwise be collected laterwould otherwise be collected later
Trade CreditTrade Credit
Trade creditTrade credit – is the financing suppliers – is the financing suppliers extend by allowing customers to pay for extend by allowing customers to pay for goods or services sometime after deliverygoods or services sometime after delivery
Reasons for the wide use of trade credit Reasons for the wide use of trade credit include:include: convenience to both suppliers and purchasers convenience to both suppliers and purchasers there are no negotiations to be entered into there are no negotiations to be entered into
or detailed forms to be filled outor detailed forms to be filled out
Trade CreditTrade Credit Major types of trade credit include:Major types of trade credit include:
Open accountOpen account –– where the seller accepts the account and where the seller accepts the account and fills the buyer’s order and sends out an invoicefills the buyer’s order and sends out an invoice
Open accounts also extended under selling terms classified Open accounts also extended under selling terms classified by the timing of called-for payments which include:by the timing of called-for payments which include:
cash before delivery (CBD)cash before delivery (CBD) cash on delivery (COD)cash on delivery (COD)
Cash discounts are offered to induce customers to make Cash discounts are offered to induce customers to make prompt payments which include:prompt payments which include:
2/10 net 302/10 net 30 2/10 EOM net 302/10 EOM net 30
Federal Government Federal Government Programs and AgenciesPrograms and Agencies
Federally guaranteed loan plansFederally guaranteed loan plans The federal government guarantees The federal government guarantees
reimbursement in case of default up to an annual reimbursement in case of default up to an annual maximummaximum
Business Development Bank of Canada (BDC)Business Development Bank of Canada (BDC) Provides credit to any industrial enterprise in Provides credit to any industrial enterprise in
Canada provided that such credit would not Canada provided that such credit would not otherwise be available on reasonable terms and otherwise be available on reasonable terms and conditions conditions
For a fee the BDC will act as a guarantor for a For a fee the BDC will act as a guarantor for a client dealing with private financial institutionsclient dealing with private financial institutions
Federal Government Federal Government Programs and AgenciesPrograms and Agencies
The Export Development Corporation (EDC)The Export Development Corporation (EDC) provides insurance to Canadian firms against commercial provides insurance to Canadian firms against commercial
and political risks when dealing in foreign marketsand political risks when dealing in foreign markets offers financing services to assist exporters and to offers financing services to assist exporters and to
stimulate foreign interest in Canadian technology and stimulate foreign interest in Canadian technology and products in the form of direct loansproducts in the form of direct loans
Provincial Crown CorporationsProvincial Crown Corporations provide financial assistance designed to complement the provide financial assistance designed to complement the
lending of private institutions and the federal government lending of private institutions and the federal government to firms who otherwise would be unable to obtain funding to firms who otherwise would be unable to obtain funding under reasonable termsunder reasonable terms
Project FinancingProject Financing
Project financingProject financing obtained from private institutions and/or obtained from private institutions and/or
government agencies to fund projects involving government agencies to fund projects involving large capital expenditureslarge capital expenditures
different from traditional debt financing because different from traditional debt financing because they are supported by assets and future income they are supported by assets and future income stream of the projectstream of the project
most of the projects are financed through debtmost of the projects are financed through debt the risks of the venture are carefully assessed the risks of the venture are carefully assessed
between equity sponsors and the lendersbetween equity sponsors and the lenders
Venture CapitalVenture Capital
Venture capitalVenture capital – unsecured term funds provided to a – unsecured term funds provided to a non-public firm by an outsidernon-public firm by an outsider
Private venture capital firms and government Private venture capital firms and government agencies provide risk capital by buying common or agencies provide risk capital by buying common or preferred shares, debt, or warrants of firms seeking preferred shares, debt, or warrants of firms seeking start-up capitalstart-up capital
A venture normally terminates in one of three ways:A venture normally terminates in one of three ways:1. a successful public offering of shares1. a successful public offering of shares
2. the private sale of the investment to another party2. the private sale of the investment to another party
3. bankruptcy3. bankruptcy
SummarySummary
1. Short-term credits covers loans with 1. Short-term credits covers loans with maturities of one year or less. Primary maturities of one year or less. Primary sources of funds are banks and other financial sources of funds are banks and other financial institutions, money markets (both domestic institutions, money markets (both domestic and international), factoring, and trade credit.and international), factoring, and trade credit.
2. Intermediate-term loans mature within one to 2. Intermediate-term loans mature within one to 10 years. Sources of intermediate-term debt 10 years. Sources of intermediate-term debt may be divided into two broad categories: may be divided into two broad categories: private institutions including banks, and private institutions including banks, and government agenciesgovernment agencies..
SummarySummary
3. Most short-term bank loans are granted under lines 3. Most short-term bank loans are granted under lines of credit. They may be secured or unsecured, and the of credit. They may be secured or unsecured, and the interest rate is normally quoted as a given interest rate is normally quoted as a given percentage above the prime loan rate. Although percentage above the prime loan rate. Although provisions in term loans vary and are negotiable, the provisions in term loans vary and are negotiable, the following features are common:following features are common: Most term loans are securedMost term loans are secured Lenders often require personal guarantees from Lenders often require personal guarantees from
smaller companiessmaller companies Borrowers have to provide the lender with periodic Borrowers have to provide the lender with periodic
information about the operations of the firminformation about the operations of the firm
SummarySummary Various restrictions may be imposed on the Various restrictions may be imposed on the
operations of the borrowing firm in order to operations of the borrowing firm in order to strengthen the position of the lenderstrengthen the position of the lender
Interest rates charged are typically variable and tied Interest rates charged are typically variable and tied to fluctuations in the prime rate.to fluctuations in the prime rate.
4. Money market instruments such as treasury bills, 4. Money market instruments such as treasury bills, commercial and finance company paper, and commercial and finance company paper, and banker acceptance, are short-term promissory banker acceptance, are short-term promissory notes issued by major corporations and notes issued by major corporations and governments. Most money market securities governments. Most money market securities provide returns by selling at a discount from face provide returns by selling at a discount from face value.value.
SummarySummary
5. A country with lower interest rates will sell at 5. A country with lower interest rates will sell at a forward premium relative to the currency of a forward premium relative to the currency of a country with higher interest rates.a country with higher interest rates.
6. Factoring entails the sale of accounts 6. Factoring entails the sale of accounts receivable.receivable.
7. Trade credit is an important source of short-7. Trade credit is an important source of short-term funds for Canadian business. It arises term funds for Canadian business. It arises spontaneously with the purchase of goods if spontaneously with the purchase of goods if payment is called for sometime after delivery.payment is called for sometime after delivery.
SummarySummary
8. Credit terms vary, and can be classified by the 8. Credit terms vary, and can be classified by the timing of called-for payments and the cash timing of called-for payments and the cash discounts provided. Datings, commonly used in discounts provided. Datings, commonly used in seasonal industries, allow delayed payments to seasonal industries, allow delayed payments to stimulate sales during the off-season.stimulate sales during the off-season.
9. Federal programs and agencies that provide term 9. Federal programs and agencies that provide term financing include the Business Development Bank financing include the Business Development Bank of Canada, the Export Development Corporation, of Canada, the Export Development Corporation, and federally guaranteed loan plans such as and federally guaranteed loan plans such as those extended under the those extended under the Canada Small Business Canada Small Business Financing Act.Financing Act.
SummarySummary
10. 10. Venture capital firms provide Venture capital firms provide money for riskier equity money for riskier equity investments that typically entail investments that typically entail promising start-up or development promising start-up or development situations.situations.