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Raising Money to Grow a Business. Lesson 1 Taking Loans and Issuing Bonds. How Companies Expand. Aim: What are the pros and cons of borrowing the money you need to grow your business? Do Now: - PowerPoint PPT Presentation

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Why do Financial Markets Exist Anyway?

Raising Money to Grow a Business

Lesson 1 Taking Loans and Issuing Bonds1How Companies Expand

Aim:What are the pros and cons of borrowing the money you need to grow your business?

Do Now: From your experience hearing about loans people take to buy homes and cars, identify the essential elements of every loan.

Do Now answer: There are at least three for a conventional term loan: $ amount borrowed, the rate of interest, and how long the borrower has to pay it off. These will be used to calculate the monthly payment.2How Companies Expand

Do Now answers: The dollar amount borrowed.The annual interest rate applied to the borrowed money.The amount of time, usually in years or months, the borrower has to pay it back.

Ice cream and restaurant.Opening new Frizzles around the world for the past five years.One of the most popular ice cream restaurants in the United States and Europe.20% market share.25,000 employees in multiple locations in the United States and Europe.Headquartered in New York, NY.Looking to expand to China or Russia.Needs $500 million in order to expand.Financial statements indicate a healthy, profitable company.Frizzle, Inc.

Borrow money from a bankIssue BondsFrizzle, Inc.Frizzle, Inc.Frizzle, Inc. has 2 choices to borrow money

Similar to an individual borrowing moneyMust be paid back in a certain time by a specified date with interest

Borrowing from a BankCompany can take a loan from abank in order to get the capital (ie: cash to use for a long while) it needs

AdvantagesMay be able to secure loan quicklyOwners dont give up controlLess restrictions on what the money can be used forDisadvantagesMay be more expensive and have to pay a higher rate of interest (than the other form of borrowing, a bond)Potential prepayment penaltyCould decrease cash flow if repayment starts right awayBorrowing from a Bank

What is a bond?A document (ie: security) that represents an amount of money (usually $1,000), which is clearly printed on the bond (ie: Principal)For each $1,000 an investor wants to lend to a governent or business, it receives one bondBorrowing with BondsLender/Bondholder We say the investor buys the bond because he or she pays (the Principal $ amount) for it.Issuer The company or government that borrows the money. It has this name because it issues the bonds!

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BondsThe issuer is repaying the lenders/bondholders original investment (Principal) when the term of the bond is due. This date, also printed on the bond, is called the Maturity Date)

BondsThe issuer pays interest to the bondholder during the term of the bond. The coupon payments end when the bond reaches maturity.

In the days before computers, the bond was issued with coupons. Every six months, one would be torn off and turned in to receive interest. The coupons went away, but we continue to call the interest rate the coupon rate, and the payment itself the coupon payment.

BondsPrincipal (aka Face Value): The original investment is repaid when the bond matures.

Maturity Date: Predetermined date in the future when the bond matures and the lender/bondholder receives the principal investment.

Coupon Rate (%): The interest that the lender/bondholder receives.

Coupon Payment ($): A dollar amount that is paid to the lender/bondholder regularly until the bond matures (payment is based on the Coupon Rate and Principal)

Principal+ CouponPayment

BondsCash Flows of a Bond012345

CouponPayment

CouponPayment

CouponPayment

CouponPaymentYearMaturity

Bonds012345

CouponPayment

CouponPayment

CouponPayment

CouponPaymentYearCredit risk is the chance that a bond issuer will fail to repay the principal and interest on the specified date

To assess a companys risk of failing, bond investors turn to the following three credit ratings agencies:

Rating Process For Bonds

A AAA high grade bond offers more security but a lower yield than a C bondA C bond is more riskybut has a higher yield

Ratings are based on whether or not the issuer will be able to make their principal and interest payments, to the bond holder, on timeCREDIT RATINGS*MOODYSSTANDARD & POORSFITCHINVESTMENT GRADESTRONGESTAaaAAAAAAAaAAAAAAABaaBBBBBBNON-INVESTMENT GRADEWEAKESTBaBBBBBBBCaaCCCCCCCaCCCCCCCCDD*These credit ratings are reflective of obligations with long-term maturities.

BondsMaturity DateCoupon RateFace Value (Prin.)Coupon Payment

AdvantagesCompany can borrow at a lower interest rate than they would have to pay the bankCompany will be able to raise a large sum of money from the large community of bond investorsDisadvantagesCompany may have difficulty issuing bonds if they are experiencing financial difficulties within their companyCompany may not be large enough to issue bondsIssuing a Bond(vs. Borrowing From a Bank)

Lesson Summary

What are the two choices corporations have if they want to borrow money?What are the relative pros and cons of each?What are the major elements of a bond?Identify the three big bond ratings agenciesWhat are the highest and lowest available ratings?What are the pros and cons of borrowing the money you need to grow your business?

Take a loan from a bank or issue bonds.A bank loan may be able to be secured by companies not big enough to issue bonds. The rate, however, will be higher than with bonds. On the downside, a bank loan may require the lender to begin repayment right away, which lessens the amount of cash the company can use. On the plus side, however, a bank loan may provide the company with more freedom to use the money in the way it believes will provide the most benefit.Its Principal dollar amount, the coupon rate, and the maturity date.Moodys, Standard & Poors, and Fitch.AAA (for Fitch and S&P) Aaa for Moodys. D (for Fitch and S&P), which actually stands for Default!When money is borrowed, the lender does not have a say in the running of the business. It is only entitled to be paid back. When the occurs, the relationship ends. On the downside, any money that is borrowed must be paid back. It is critical that a business use the borrowed money to make a profitable product or service because it is those profits that will allow the borrowing to be repaid.

18Web Challenge #1

Q: The Federal Reserve has tried to keep down the interest rate at which people and corporations can borrow money. Will this cause there to be more or less money borrowed?A: It will encourage more borrowing because low rates means less interest costs.Challenge: Find corporations that have issued bonds because its just cheap to borrow and they want to lock in a low rate. Hint: Look for the explanation that the money will be used for general corporate purposes.

19Web Challenge #2

Challenge: Not any company can walk into a bank and get a loan. Research the characteristics a business must have to qualify for a bank loan. Prepare a checklist of five to 10 requirements. Indicate the most challenging one, explaining why. (Hint: the evaluation by the bank is formally called underwriting.)

20Web Challenge #3

Q: The Small Business Administration is a government department that was created to help small businesses, including providing loans to them.Challenge 3a: Visit sba.gov. Identify three ways that it can help a small business.Challenge 3b: Prepare one argument for and one against having the government loan money to businesses. After all, who loses if the business fails and cant repay the loan?

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