1. When a business needs funds to construct a new assembly line or to do extensive research and development which may not begin to bring in revenues for several years, short term financing wouldn’t work. In the case, business will need long-term source of funds. Firms may meet long-term needs by increasing the company’s debt either by getting loans or by selling bonds.
2. A long-term loan is a loan that has a maturity of from one to ten years. Within this period of time the firm pays interest on the debt. Sometimes the lender protects its financial position by requiring that the company obtain the lender’s permission before taking on any additional long-term debt. If a loan is particularly risky, the lender may even require the firm to limit or eliminate dividends to stockholders.
3. If the firm wants to be free of lender’s restrictions, it may issue bonds. These are long-term debts with a maturity date of 20 to 30 years in the future. Governments issue government bonds. Corporations issue corporate bonds, which may be secured or unsecured.
4. If a company wants to sell bonds it can offer some collateral. It is difficult, if not impossible, to find investors who are willing to buy bonds, which are not backed up by collateral. Only huge corporations such as AT&T can successfully issue unsecured bonds, which are called debentures.
5. Most bonds carry a face value of $1000 and pay a predetermined interest rate (the coupon rate). The company pays this interest regularly according to the indenture agreement, which specifies the terms of a bond issue.
6. The company may retire bonds before they mature if the indenture agreement contains a call provision. In this case the firm pays the bondholders a redemption premium. Another flexible feature in some agreements is the conversion privilege. It allows bondholders to convert their investment into stated number of shares of common stock. If the price of the company’s common stock is going up, the investors can profit from conversion. Convertibility makes the bond issue more attractive to potential investors.
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