CIMA F3 Syllabus B. Sources of long term funds - Factors influencing the choice of debt finance - Notes ^{4 / 15}

The criteria for choosing different types of long term debt finance

e.g. bank borrowings, bonds, convertibles

• Availability

  Only listed companies will be able to make a public issue of bonds on a stock exchange. 

  With a 'public issue' the bonds are listed on a stock market, although most bond trading is off-exchange. 

  A stock market acts as a primary market for raising finance, and as a secondary market for the trading at existing securities.

  Most investors will not invest in bonds issued by small companies. 

  Smaller companies are only able to obtain significant amounts of debt finance from a bank.

• Credit rating

  Large companies may prefer to issue bonds if they have a strong credit rating. 

  Credit ratings are given to bond Issues by credit rating agencies such as Standard & Poofs and Moody's. 

  The credit rating given to a bond issue affects the interest yield that investors will require. 

  If a company's bonds would only be given a sub-investment grade rating ('junk bond' rating), the company may prefer to seek debt finance from a bank loan as it will be less expensive.

• Amount

  Bond issues are usually for large amounts. 

  It a company wants to borrow only a small amount of money, a bank loan would be appropriate.

• Duration

  If loan finance is sought to buy a particular asset to generate revenues tor the business, the length of the loan should match the length of time that the asset will be generating revenues.

• Fixed or floating rate

  Expectations of Interest rate movements will determine whether a company chooses to borrow at a fixed or floating rate. 

  Fixed rate finance may be more expensive, but the business runs the risk of adverse upward rate movements if it chooses floating rate finance. 

  Banks may refuse to lend at a fixed rate for more than a given period of time.

• Security and covenants

  The choice of finance may be determined by the assets that the business is willing or able to offer as security, also on the restrictions in covenants that the lenders wish to impose.