FINS1612 SUMMARIES

Week 6
Debt Markets 1; Short-term Debt
Short term debt is a financing arrangement for a period of less than
one year with various characteristics to suit borrowers particular
needs.
Consideration is of timing of repayment, risk, interest rate
structures (variable/fixed) and the source of funds.
Remember the matching principal: Short-term assets should be funded
with short-term liabilities

Remember: DEBT
Gives no gain in ownership
Matures at a set date
Cash flows are contracted
Repayment is usually prioritised to equity

1/7 Trade Credit:

A supplier provides goods or services to a purchaser with an arrangement

for payment at a later date.
o There is usually a discount for early payment (2/10, n/30 for a 2%
discount if paid within 10 days else no discount with the balance due
in 30 days)

This is given to increase sales (advantage) HOWEVER, there

are costs of discounting and increased discount periods,
increased total credit period and accounts receivable, increased
collection and also bad debt costs.

o Hence a purchaser would be willing to borrow money at a rate up to

16.03% in order to gain the discount.

2/7 Bank Overdrafts:

This is a major and easy source of short-term finance that allows a firm
to place its cheque (operating) account into deficit, to an agreed limit.
o The lender also imposes many expensive fees establishment fee,
monthly account service fee and a fee on the unused overdraft limit
(recall this is an OBS commitment)

This is generally operated on a fully fluctuating basis.

These loans are always classed as 364-day loans so that they do not get
classed as loans in the banks books.

Overdraft rate:
o Are negotiated with a bank at a margin above an indicator rate that
reflects elements of the borrowers credit risk;
Financial performance
Future cash flows
Length of the mismatch between cash inflows and
outflows
Collateral
o Some countries require a credit average balance or
compensating credit balance.
o Indicator rate is a floating rate based on a published market rate such
as BBSW, according to the AFMA website this is;
The Bank Bill Swap (BBSW) reference rates are independent and
transparent rates for the pricing and revaluation of privately
negotiated bilateral Australian dollar interest swap transactions.

3/7 Commercial Bills:

A bill of exchange (discount security issued with a face value payable at a future
date) issued to raise funds for general business purposes (Not a trade bill
issued to finance a particular transaction)

Bank-accepted bill is a bill that is issued by a corporation and

incorporates the name of a bank as acceptor. (MOST are this)

Bank-endorsed bills

Non-bank bills

Features of commercial bills;

o Drawer (Borrower): This is the issuer of the bill with secondary
liability for repayment of the bill (usually the corporation)
o Acceptor: This party undertakes primary liability to repay the
face value to the holder of the bill at maturity (usually a bank or
merchant bank)
o Payee: This is the party to whom the bill is to be paid (usually the
drawer but can be specified as someone else by the drawer)
o Discounter: This is the party that discounts the face value and
purchases the bill (the provider or lender of funds who may also
be the acceptor of the bill)
o Endorser: Party that was previously a holder of the bill and signs the
reverse side of a bill when selling or discounting the bill.

Liability order: Acceptor > drawer > endorser

Advantages:
o Lower cost than other
short-term borrowing forms
(overdraft, fully-drawn
advances)
o Borrowing cost (yield)
determined at issued date
and not variable with
changes to market rate
o A bill line is an
arrangement with a bank
where it agrees to discount
bills progressively up to an
agreed amount.

o Possibly rollover at maturity

Flow of funds Bank Accepted Bills

Flow of funds Non-bank bills;

A bill can be drawn by the bank and accepted by the borrower

o The funds are lent to the borrower as payee
o Hence, at maturity the borrower, as acceptor, is liable to pay face
value to holder of the bill.

The bank is both the drawer and discounter

o If the bank rediscounts a bill (sells to a third party), the bank becomes
the endorser CREATING a bank-endorsed bill

Establishing bill financing;

Borrower approaches bill financing facility

Assessment made of borrowers credit risk

o Credit rating of borrower affects size of discount

Maturity usually 30,60,90,120,180 days

Minimum face value usually 100,000

4/7 Calculations: Discount Securities

Calculating price yield known

OR RATE TRANSFORMATION OF R

o >>>EG; A company is funding short-term inventory with a 30-day

bank-accepted bill with FV 500,000. Quoted yields are 9.52%p.a and
9.48%p.a which is better and what will the amount raised be?

The YIELD is
the change in
= 496 118.04
price as a
PV (9.48%) = 500,000/(0.0948*(30/365)+1)percentage of
PV
= 496 134.23
PV (9.52%) = 500000/(0.0952*(30/365)+1)

Calculating face value issue price and yield known

o Simply take the denominator (Yield) and apply
the PV
ThetoDISCOUNT

Calculating yield (Rearrange the price equation)

o Y = [FV/PV -1 ](365/TTM)

RATE is the
change in
price as a

For example, if the 2nd bill was purchased for PV and sold for
$497 057.36 after 7 days then the Yield =
[(497057.36/496134.23) 1]*(365/7) = 9.7%

Then if it was held to maturity, the yield for the holder at

maturity would be [(500000/497057.36)-1]*(365/23) = 9.39%

Calculating price discount rate known

o Price = FV-[FV(TTM/365)*Annual.Disc.]

Calculating discount rate (rearrange above for annual disc)

FV-PV/FV gives period discount, convert to annual by (365/TTM)

5/7 Promissory Notes (P-notes, Commercial Paper);

Discount securities, issued in the money market with a face value payable at
maturity but sold today by the issuer for less than the face value.

Available to companies with an excellent credit reputation because:

o

There is no acceptor or endorser

Unsecured instruments

Their calculations are the same as discount securities formulae

The issue programs:
o

Usually arranged by major commercial banks and money market

corporations

Standardised documentation

Revolving facility (new notes are issued and discounted as old notes
mature)

Most issued for 90 days.

By tender, tap issuance or dealer bids.

Underwritten issues (rarely underwritten as this is signal of risk,

bad for credit rep needed)

Underwriting guarantees the full issue of notes is purchased (typical

fee is around 0.1% p.a)

Underwriter is usually a commercial bank, investment bank or

merchant bank

The underwritten issue can incorporate a rollover facility,

effectively extending the borrowers line of credit beyond the shortterm life of the P-note issue.

Non-underwritten issues:
o

Issuer may approach money-market directly

Commercial bank, investment bank or merchant bank may be

retained as lead manager and receive fees.

6/7 Negotiable Certificates of deposit (CDs);

 Short-term discount security issued by banks to manage their liabilities and

liquidity with maturities ranging up to 180 days

Issued to institutional investors on the wholesale money market

(personalised)

Short-term money market is active secondary market in CDs

Calculations are same as discount securities formulae.

7/7 Inventory Finance, AR financing and factoring;
Inventory finance:

Most common is floor plan finance where the lender purchases the
inventory items off the borrower and, as the items sell, the borrower
repays the lender.

Bailment is the term used for when the finance company holds title to
dealerships stock.

Hence the creditworthy-ness of both parties must be very strong as well as

contingency plans for when stock is not sold.

Originally started in motor vehicle sales but spread to large appliance

dealers and now personal electronic dealers such as personal
computer dealers.

The dealer is expected to promote the financiers financial

products as well.

AR (accounts receivable) finance:

A loan to a business secured against its accounts receivable (debtors)

Mainly supplied by finance companies
The lending company takes charge of a companys accounts receivable;
however, the borrowing company is still responsible for the debtor book and
bad debts.

Factoring:
A company can also sell its AR to a factoring company
o This effectively converts future CF into current CF

 This provides immediate cash to the vendor; plus it removes administration

costs of accounts receivable.
o The factor is responsible for collection of receivables
Main providers of factor finance are the finance companies
o Notification basis: - Vendor is required to notify AR customers
(debtors) that payment is to be made to the factor.
o Recourse Arrangement: Factor has claim against the vendor if a
receivable is not paid
o Non-recourse arrangement: Factor has not claim against vendor
company