The process of raising funds required to meet the needs of a fixed asset or for long-term investment is called long- term financing. Long term financing is a form of financing that is provided for a period of more than a year. Long term financing usually for 5 years or more. Long term financing is also known as Fixed Capital Finance. Purpose of Long term financing → to finance fixed assets → Expansion of companies → Increasing facilities → Construction of projects on a large scale → Acquisition of companies Quotation: Financing with maturity from 7 to 15 years is called long-term financing.-J.J. Hampton 6.2 Sources of Long Term Financing Internal Sources a. Promoters Capital b. Retained Earnings c. Reserve Fund External Sources i. Institutional Sources: Bank and NBFI ii. Non-institutional Sources Equity Capital (Ordinary Share and Preferred Share) Debt Capital (Bond and Debenture) 6.3 Concept of Bond Definition 1: Bond is a long-term debt instrument which is sold by a joint venture company or govt to obtain long-term funds (typically for more than 5 years). Definition 2: A long-term debt instrument or contract by which a company raises debt capital from investors/lenders is called a bond. The interest rate, loan amount, loan tenure etc. are mentioned in such loan documents. Bond holders are creditors of the company. Those who issue/sell bonds are Bond Those who buy bonds/invest in bonds called: are called: 1. Bond Issuer 1. Bondholder 2. Bond Seller 2. Bond buyer 3. Borrower 3. Lender/ investor 4. Financing Institution
6.4 Bond Issuing Parties
1. Government: Treasury bond is a risk free bond which is issued by the government. The government periodically issues bond to meet its long-term financing needs. Treasury bond is risk-free so their interest rate is low. 2. Corporation: Bonds issued by corporations are generally called corporate bonds. Corporate bond is a type of debt contract in which the bond issuing authority promises to pay the bondholder a specified amount of interest and the principal amount of the bond at the end of the term. The primary risks associated with corporate bond are default risk and market risk. 3. Municipal Authority: Municipal bond is a debt securities issued by local state, city corporation or airport authority. Interest paid on municipal bond is tax free. 4. Foreign Government and Foreign Company: A foreign bond is a bond issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising capital. Foreign bonds have certain risks associated with them, including the impact of two interest rates, currency exchange rates, and geopolitical factors. 6.5 Types of Bond Classification based on Issuers 1. Treasury Bond 2. Corporate Bond 3. Municipal Bond 4. Foreign Bond Classification based on security 1. Unsecured Bond: Unsecured bonds are kinds of securities that allow an individual to lend money without having any specific assets serve as collateral. Types of unsecured bond: a. Debenture: When the issuing authority issues bond without any collateral/mortgage is called debenture. Only renowned companies with high credit rating are able to issue debenture. b. Subordinate Debenture: Subordinated debt (also known as a subordinated debenture) is an unsecured loan or bond that ranks below other, more senior loans or securities with respect to claims on assets or earnings. Subordinated debentures are thus also known as junior securities. c. Income Bond: An income bond is a type of debt security in which only the face value of the bond is promised to be paid to the investor, with any coupon payments paid only if the issuing company has enough earnings to pay for the coupon payment. 2. Secured Bond: A secured bond is the one that is backed by some specific assets that provide protection to the bondholders in case the issuer defaults. Classification on the basis of ownership: 1. Bearer Bond: A bearer bond is a fixed-income security that is owned by the holder, or bearer, rather than by a registered owner. As their ownership is not registered, the owner of a bearer bond is the person in possession of it. 2. Registered Bond: A registered bond has its owner's name and contact information recorded with the issuing entity, ensuring coupon payments are correctly distributed. Classification based on others types: 1. Coupon Bond: A coupon bond is a type bond with coupons attached that represent annual / semiannual interest payments. Bondholders receive these coupons during the period between the issuance of the bond and the maturity of the bond. 2. Zero Coupon Bond: A zero-coupon bond is a debt security instrument that does not pay interest. Zero-coupon bonds trade at deep discounts, offering full face value (par) profits at maturity. The difference between the purchase price of a zero-coupon bond and the par value indicates the investor's return. 3. Perpetual Bond: A perpetual bond is a fixed income security with no maturity date. Although perpetual bonds are not redeemable, they pay a steady stream of interest in forever. 4. Callable Bond: A callable bond is a bond that the issuer may redeem before it reaches the stated maturity date. A callable bond allows the issuing company to pay off their debt early. A business may choose to call their bond if market interest rates move lower, which will allow them to re-borrow at a more beneficial rate. Call price > (Higher than) Maturity Value 5. Putable Bond: A put bond is a debt instrument that allows the bondholder to resell the bond to bond issuers at specified dates before maturity. Putable bond price (lower than) < Maturity value Bondholders may choose to put (resell) their bond if market interest rates move higher, which will allow them to re-lend at a more beneficial rate. 6. Junk Bond: Junk bonds, also known as high-yield bonds, are bonds that are rated below investment grade by credit rating agencies. Junk bonds carry a higher risk of default than other bonds, but they pay higher returns to make them attractive to investors. 7. Convertible Bond: A convertible bond is a fixed-income corporate debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares. 6.6 Characteristics of Bond a. Coupon Rate: Coupon rate is the interest rate offered by bond issuer to bondholder/investor till maturity of the bond. Coupon payment paid on face value of the bond. Coupon payment paid on annual / semi-annual basis. Interest on bond is tax exempted cost. Coupon rate can be fixed rate or floating rate. b. Bond maturity: Bond maturity is the time when the bond issuer must repay the original bond value/ face value to the bond holder. c. Bond Redemption: Bond redemption is the process by which a bond issuer repays the principal amount of a bond to the bondholder on the bond's maturity date. Bond redemption can be done in two ways; sinking fund provision and call provision. d. Face value of bond: The face value of each bond, also referred to as the par value or redemption value, is set by the issuer and typically printed on the bond itself. It represents the amount the issuer promises to pay once the bond reaches maturity. e. Sinking fund: A sinking fund is maintained by companies for bond issues, and is money set aside or saved to pay off a debt or bond. f. Call provision: A call provision is a provision on a bond or other fixed-income instrument that allows the issuer to repurchase and retire its bonds. g. Bond’s Yields: A bond's yield is the return an investor expects to receive each year over its term to maturity. Other names of bond’s yield are Expected/required rate of return, discount rate and opportunity cost. 6.7 Valuation of Bond
Mathematical Part (Bond)
Part-A Part- B Bond Valuation (Calculation of Intrinsic value of bond) Calculation of Bond Yield
Zero Coupon Yield to Call Yield to
Coupon Bond Perpetual Bond Current Yield Bond (YTC) Maturity (YTM ) 6.7.1 Part: A Bond Valuation (Calculation of Intrinsic value of bond)
1. Valuation of Coupon Bond:
Formula: Valuation of coupon bond (annual compounding) Explanation 𝟏 𝟏 (𝟏 𝒌𝒅)𝒏 𝑴𝒗 I (Coupon Payment) 𝒗𝑩 = 𝑰 + (𝟏 )𝒏 𝒌𝒅 𝜿𝒅 I = face/ par/ written value * Coupon Valuation of coupon bond (semi-annual compounding) Rate 𝒎×𝒏 ⎡ 𝟏 ⎤ Kd = YTM/ Required or expected rate ⎢𝟏 − 𝒌𝒅 ⎥ of return / Opportunity cost/ discount 𝑰⎢ 𝟏+ ⎥ 𝑴𝒗 rate 𝒗𝜷 = ⎢ 𝒎 + 𝟐 𝒌𝒅 ⎥ 𝒌 𝒎×𝒏 MV= Maturity/ Face Value ⎢ 𝒎 ⎥ 𝟏+ 𝒅 𝒎 ⎢ ⎥ ⎣ ⎦ Practice: Mr. Russell passed a long expatriate life and while returning in the country, he intends in employ his hard-earned savings in a profitable sector of investment. Related information of A and B Bond is given below: - Bonds Face value Coupon interest rate Duration A 1000 12% 5 B 1000 12% 5 Expected rate of returns of these bonds are 10% a) Calculate the value of A bond mentioned in the stem. b) If B bond yields half-yearly compound interest, which bond should be invested? Comment.
2. Valuation of Zero-Coupon Bond and Perpetual Bond
Formula: Valuation of Zero-Coupon Bond 𝑴𝒗 VB = (𝟏 𝜿𝒅 )𝒏 Valuation of Perpetual Bond 𝑰 𝒗𝑩 = 𝒌𝒅 Practice: Mr. Raihan wants to investment in bond market. Bonds Face value Coupon interest rate Duration P 1000 - 5 Q 1000 12% - Expected rate of return is 10% a) Calculate the intrinsic value of P bond. b) Which bond will be best for investment? Analyze. 6.7.2 Part- B (Calculation of Bond Yield) Formulas: Yield to maturity (YTM) 𝑴𝒗 − 𝒔𝒗 𝑰+ 𝒀𝑻𝑴 = 𝒏 𝑴𝒗 + 𝒔𝒗 𝟐 Yield to call (YTC) 𝑪𝑷 − 𝑺𝑽 𝑰+ 𝒀𝑻𝑪 = 𝒏 𝑪𝑷 + 𝑺𝑽 𝟐 Current Yield (CY) 𝑰 𝑪𝒀 = 𝒔𝒗 Practice 22. Mr. Toufiq Omar is thinking to invest a portion of his business profit in bond market. He always invests in famous companies' bond. Here are some particulars about two bonds issued by ACI and Square Company- i. ACI Company has issued 12 year bond at Tk. 2,000 par value. Coupon rate and required rate of return is 15% and 12% respectively. Present market value of the bond is Tk. 2,400. ii. Square Company has issued 8 year zero coupon bond at Tk. 1,500 par value. Present market value of the bond is Tk. 600. Required rate of return is 13%. a) Calculate yield to maturity of the bond issued by ACI Company. b) Keeping present value in mind, logically explain whether Mr. Toufiq Omar should invest in any of these two bonds. 2. Face value of Hanif Enterprise's 15% bond is Tk. 1,000 and its term is 10 years. The bond is being sold at Tk. 1,300. Tk. 1,500 will be paid to bondholder at maturity. Cost of capital is 20%. The organization pays semi-annual interest. a) Calculate value of the bond. b) Determine yield to call if the bond is called in at Tk. 1,400 after 7 years. 6.8 Concept of share and Stock:
Share and stock
Share: A share is a unit of ownership in a company or An equal small unit of the total capital of the company is called a share. Shareholders: Those who buy/invest in shares of issuing company are called shareholders. A shareholder can be an individual, company or institution. 'Stock' represents the holder's part-ownership in one or several companies, while 'share' refers to a single unit of ownership in a company.
6.9 Types of shares
Share
Ordinary Preferred Deferred
Right Share Bonus Share Share Share Share
Ordinary Share Definition: Ordinary shares, also known as a common share, typically come with voting rights, represent ownership of a company but don't have the rights on capital in the first place when distributing dividends and termination of the organization. Features of Ordinary Share Ordinary shares are easily transferable. Ordinary shares provide ownership of the company to the share investors. Ordinary shares give full authority to its owners to control the company by applying their voting right. In case of profit and property distribution, the residual profit and capital is distributed among the common shareholders. Preferred Share Definition: Those share owners have priority over others in terms of distribution of dividends and return of capital of the business but don’t have voting rights are called preference shares. Features of Preferred Share Ownership: Preference share owners neither can participate in the ownership of the company nor can vote. They are considered in between the owners of ordinary shares and the owners of bonds and debentures. Convertibility: Many preference shares have an option to convert into ordinary shares after a certain period of time. Deferred Share: Shareholders who receive dividends at a proportionate rate after distributing the dividends of rest of the shareholders. Such shares are purchased by the promoters of the company and are called promoter shares. In case of winding up of the company the claim of the shareholders is made after paying the dues of all other shareholders. Right share: A rights share is a way for a publicly-traded company to raise additional capital by offering existing shareholders the opportunity to purchase additional shares of the company at a discounted price.
Bonus share: When the undistributed profit of the company is converted into shares and distributed among the old shareholders at a proportionate rate instead of being distributed as dividend to the shareholders, such shares are called bonus shares.
6.10 Share Market
A stock market or stock exchange is a place where securities of various public limited companies registered in the stock exchange are bought and sold between issuing companies and investors. Private limited companies cannot trade in the stock market. The world's first stock market was established in 1773 in Sweeting Alley, London. There are 2 major stock markets in the US. Such as: New York Stock Exchange and NASDAQ. 5. Types of Stock Market Initial Public Offering (IPO) Primary Market Private placement Share/Stock Market Dhaka Stock Exchange Secondary Market Chittagong Stock Exchange
5.1 Primary Market
The primary market is a mechanism where new securities are issued for the first time by companies or governments to raise capital. In this market, people apply directly from the company and purchase shares through lottery. In this case, the issuing company receives the money from the sale of shares or securities directly. In the primary market a company can issue shares in the following alternative ways- Private placement Private placement refers to the sale of new shares of a private limited company to a specified number of investors or a small group of investors. In case of private placement, investors usually mean institutional investors. For example, banks, insurance companies, investment companies or merchant banks etc. Initial public offering (IPO) When a public limited company offers to sell its shares to the public for the first time, it is called an initial public offering (IPO). In IPO, underwriters (merchant banks and brokers) act as intermediaries between the issuing company and the public (investors). Those who take the main responsibility of selling shares of the company are called Underwriters. In Bangladesh, ICB- Investment Corporation of Bangladesh acts as underwriter. 5.2 Secondary market The secondary market is a financial market where previously issued securities, such as stocks and bonds, are bought and sold among investors. In contrast to the primary market, where new securities are issued for the first time, the secondary market allows investors to trade existing securities with other investors. There are two secondary stock markets in Bangladesh. Such as: Dhaka Stock Exchange Limited and Chittagong Stock Exchange Limited. Investing in primary markets – less risky; Investing in the secondary market is riskier. Investing in primary markets – less liquid; Investment in secondary market – more liquid. The primary market has less scope for fraud; Chances of fraud in the secondary market are high. 5.3 OTC market (OTC - Over the Counter) or Third market The market where shares of unlisted companies are bought and sold is called OTC market. Securities are bought and sold in this market through dealers. This market has characteristics of both primary and secondary markets. OTC is operational in Dhaka Stock Exchange and Chittagong Stock Exchange.
6. Information related to Dhaka Stock Exchange and Chittagong Stock Exchange
Dhaka Stock Exchange (DSE) Ltd Chittagong Stock Exchange 1954- registered in the name of East 1995- Registered Pakistan Stock Exchange Ltd. 1998- Automation launched (June 2, 1998) 1956- started its operation in Narayanganj 2004- OTC market launched. 1958- Transferred to Dhaka Indexes: 5 (CASPI INDEX, CSEX INDEX, CSE 1964- Name changed to DSE. 30 INDEX, CSE 50 INDEX, CSI INDEX) 1976- Started operation after independence 1998- Automation launched (August 10, 1998) 2009- OTC market launched Indices: 3 (DSEX INDEX, DSES INDEX, DSE30 INDEX)
