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Prof. Ian Giddy
New York University
Corporate FinancingChoices
Michigan/TMAMichigan/TMA
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Corporate Financing Choices
Do financing choices matter? Debt or equity? What kind of debt?
Certain kinds of market imperfections allow corporations to reduce costs by improving the financing mix
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
First Principles of Corporate Finance
Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for riskier projects and reflect the
financing mix used - owners’ funds (equity) or borrowed money (debt)
Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.
If there are not enough investments that earn the hurdle rate, return the cash to stockholders. The form of returns - dividends and stock buybacks - will depend
upon the stockholders’ characteristics. Manage financial risk
FINANCING ALTERNATIVES AVAILABLE TO MAJOR CORPORATIONS
DEBT
EQUITY
Subsidized funds
Privateplacement
Publicoffering
Revolvingfacility
Term loan
Real estate
Leasing
Assetbacked
Unsecured
Domestic
Eurobond
Fixed
Floating
Longterm
Shortterm
US CP
Euro CP
Bank debt
MTN
Dollar
Non-dollar
ARPFRN
VRN
StraightHybrid
Callable
Index-linked
Convertible
With warrants
Restricted
Full rights
Private sale
Public offering
Domestic
International
Equity options
Stripped
Unstripped
Projectfinance
Bankdebt
Debt?
Equity?
What kind?
Debt?
Equity?
What kind?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Does Capital Structure Matter?
Assets’ value is the present value of the cash flows from the real business of the firm
Value of the firm
=PV(Cash Flows)
Debt
Equity
Value of the firm
= D + E
You cannot change the value of the
real business just by shuffling paper
- Modigliani-Miller
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Most Value is Created on the Asset Side
Discounted Cash Flow (DCF) analysis for project evaluation
Value-Based Management for performance evaluation
?
Union Camp: Packaging Business
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Is There an Optimal Capital Structure?
Assets’ value is the present value of the cash flows from the real business of the firm
Value of the firm
=PV(Cash Flows)
Debt
Equity
Value of the firm
= D + E
VALUE OFTHE
FIRM
DEBT
RATIO
Optimal debt ratio?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
How Much Debt?
A $19.95 company...an “ISP”
Profits: Zero ~ Risks: High
Ciba-Geigy
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Case Study: Financing Ciba
1) What is Ciba's debt-to-equity ratio, and what might one advise the company about what it should be?
(2) How much of Ciba's debt is fixed-rate borrowing, and should this proportion change?
(3) How much of the company's debt should be long term?
(4) What is the composition, by currency, of Ciba's debt? What should it be?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Case Study: Financing Ciba
Could Ciba benefit from more debt?Tax shield?
Could Ciba be hurt by more debt?Risks of financial distress?Costs of financial distress?Reduce flexibility?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Ciba: How Much Debt?
Consideration General In Ciba's case
Tax shield Interest on debt is taxdeductible, so more leverageis better, other things beingequal.
Ciba is profitable, and hasbeen so since 1982, so itneeds as much of a taxshield as it can get.
Risk of financial distress Volatility of operating earningsincreases probability ofbankruptcy, which involvesout-of-pocket and other costs.
Ciba's earnings arediversified (health care,agricultural and industrialchemicals and materials) andrelatively s table (see chartbelow), unlike some large,capital-intensive firms. Thusit can tolerate more debt.
Intangible assets Firms with intangible assetssuch as reputation, patentsand human capital suffergreater losses when underfinancial stress.
Ciba relies heavily onresearch, reputation, andongoing customerrelationships, much of whichcould be lost i f bankruptcythreatened.
Consideration General In Ciba's case
Tax shield Interest on debt is taxdeductible, so more leverageis better, other things beingequal.
Ciba is profitable, and hasbeen so since 1982, so itneeds as much of a taxshield as it can get.
Risk of financial distress Volatility of operating earningsincreases probability ofbankruptcy, which involvesout-of-pocket and other costs.
Ciba's earnings arediversified (health care,agricultural and industrialchemicals and materials) andrelatively s table (see chartbelow), unlike some large,capital-intensive firms. Thusit can tolerate more debt.
Intangible assets Firms with intangible assetssuch as reputation, patentsand human capital suffergreater losses when underfinancial stress.
Ciba relies heavily onresearch, reputation, andongoing customerrelationships, much of whichcould be lost i f bankruptcythreatened.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Ciba: Are Revenues Stable?
Ciba Sales and Earnings(in billions of Swiss francs)
1982 1984 1986 1988 1990 1992
0.1
1
10
100
Legend
Sales Profits
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Measuring Financial Leverage
Two variants of debt ratioDebt to Capital Ratio = Debt / (Debt +
Equity)Debt to Equity Ratio = Debt / Equity
Ratios can be based only on long term debt or total debt.
Ratios can be based upon book value or market value.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Measuring Cost of Capital
It will depend upon:(a) the components of financing: Debt,
Equity or Preferred stock(b) the cost of each component
In summary, the cost of capital is the cost of each component weighted by its relative market value.WACC = k
e (E/(D+E)) + k
d (D/(D+E))
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Why Does the Cost of Capital Matter?
Value of a Firm = Present Value of Cash Flows to the Firm, discounted back at the cost of capital
If the cash flows to the firm are held constant, and the cost of capital is minimized, the value of the firm will be maximized.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Optimum Capital Structure and Cost of Capital
If the cash flows to the firm are held constant, and the cost of capital is minimized, the value of the firm will be maximized.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Financing Choices
Assets’ value is the present value of the cash flows from the real business of the firm
Value of the firm
=PV(Cash Flows)
From
How much debt?
to
What kind of debt?
You cannot change the value of the
real business just by shuffling paper
- Modigliani-Miller
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Corporate Financing Choices:What Kind of Debt?
Fixed/floating Currency of denomination Maturity or availability Domestic/Euro Public/private Asset-based Credit enhanced Swapped Equity-linked
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Short Term or Long Term?
In 1992, Ciba had fixed assets of SF13.9 billion and capital expenditures of SF1.9 billion.
Yet the majority of Ciba's debt is in the short-term commercial paper, bank debt, and suppliers-credit markets.
This suggests that if the proportion of debt financing as a whole is increased, much of it should be in the form of long-term debt.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Geographic location of sales and capital assets.
Currency distribution of sales. Nature of the company's businesses
Currency of Denomination of Ciba's Debt? What Should It Be?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Currency of Ciba’s Assets and Debt
Geographic distributionof
Currencydistribution
of sales Remarks on economic exposure
Estimatedcurrency
distribution ofdebt
Fixedassets Sales
Switzerland 41%
43%
2.4% Net short position because much ofproduction, but little of sales, here
9%
U.K.
27%
5.4% Part of sales effectively U.S. dollardenominated
7%
OtherEurope
34.6% 21%
U.S. andCanada
23% 32% 41.3% 54%
LatinAmerica
4% 7% 5.3% Most of sales effectively dollardenominated
2%
Asia 4% 13% 10.9% Part of sales effectively U.S. dollardenominated
6%
Rest of theworld
1% 5% Most of sales effectively dollardenominated
1%
Geographic distributionof
Currencydistribution
of sales Remarks on economic exposure
Estimatedcurrency
distribution ofdebt
Fixedassets Sales
Switzerland 41%
2.4% Net short position because much ofproduction, but little of sales, here
9%
U.K.
27%
5.4% Part of sales effectively U.S. dollardenominated
7%
OtherEurope
34.6% 21%
U.S. andCanada
23% 32% 41.3% 54%
LatinAmerica
4% 7% 5.3% Most of sales effectively dollardenominated
2%
Asia 4% 13% 10.9% Part of sales effectively U.S. dollardenominated
6%
Rest of theworld
1% 5% Most of sales effectively dollardenominated
1%
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
What Kind of Debt? Some Considerations Fixed/floating:
How certain are the cash flows? Are operating profits linked to interest rates or inflation?
Currency:Consider currency of the assets: currency of
denomination vs. currency of location vs. currency of determination.
Maturity or availability:Are the assets short term or long term? Should the
firm assume ease of refinancing, or buy an option on access to financing?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Guidelines for Financing
Liabilities to match assets: economic exposure of the firm determines base financing choices.
Decision on whether or not to fully match depends on company's view relative to the view implied by market prices.
When strategy is chosen, use the financing/hedging techniques that offer the lowest effective cost.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
When Debt and Equity are Not Enough
Value
of future
cash flows
Value
of future
cash flows
Claims on
the cash flows
Claims on
the cash flows
Assets Liabilities
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
When Debt and Equity are Not Enough
Value
of future
cash flows
Value
of future
cash flows
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Assets Liabilities
Debt
Residual payments
Upside and downside
Residual claims
Voting control rights
Residual payments
Upside and downside
Residual claims
Voting control rights
Equity
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
When Debt and Equity are Not Enough
Value
of future
cash flows
Value
of future
cash flows
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Assets Liabilities
Debt
Residual payments
Upside and downside
Residual claims
Voting control rights
Residual payments
Upside and downside
Residual claims
Voting control rights
Equity
What if...
Claims
are inadequate?
Returns
are inadequate?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
When Debt and Equity are Not Enough
Value
of future
cash flows
Value
of future
cash flows
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Contractual int. & principal
No upside
Senior claims
Control via restrictions
Assets Liabilities
Debt
Residual payments
Upside and downside
Residual claims
Voting control rights
Residual payments
Upside and downside
Residual claims
Voting control rights
Equity
Alternatives
Collateralized Asset-securitized Project financing
Preferred Warrants Convertible
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
SPONSORINGCOMPANY
SPECIALPURPOSEVEHICLE
ACCOUNTSRECEIVABLE
ACCOUNTSRECEIVABLE
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
CONTINUEDSERVICINGOF ASSETS
Asset Securitization: Sell Your Cake and Eat It Too
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
CremoniniGroup
ItalianObligors
PurchaserSPC
IssuerCrystal Castle (SPC)
Spread Account
SubordinatedLender
FX and InterestRate SwapSwiss Bank
Investors
FSA
Subordinated NoteLire 16%inter.
Receivables &Contract
Rights
Lire 2% interest
84%
LirePledges:SPC’s stock,receivables,
contract rights
Dollars 84%
SeniorEuronotes
Guaranty of Euronotes
Guaranty of SPC’sLire Obligation
Purchase Price& fee 98%
Purchase 98%
Sale of Receivables
Receivables
Goods &Services
Cremonini Securitization
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Managing Hybrid Securities
Principles of hybrid instruments Market imperfections as motives for
hybrids Hybrids in the Eurobond market:
Asset-backed securitiesWarrant bonds and convertiblesIndex-linked bonds
Application: callable bonds
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
A Day in the Lifeof the Eurobond Market
Examine the dealsWhy were each done in that particular
form?What determines the pricing?
Can you break the hybrids into their component parts?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
A Day in the Life...
NEW INTER NA TIONAL BO ND ISSUES
Bo r rowe rBo r rowe r Am ou nt m .Am ou nt m . C ou pon %C ou pon % P r iceP r ice M a t ur ityM a t ur ity F eesF ees Boo k ru nn erBoo k ru nn er
C elworks Trust 1990-1¶ (b) US $250 9 1/4 99.80 1998 1 7/8-1 5/8 C redit Suisse
M arui Corp* US $500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nom ura
Holderbank ( a) US $150 9 3/4 101 1994 1 3/8-1 C SF B
Battle M ountaingold US $100 7 1/2 100 2006 2 1/2-1 1/2 M er rill Lynch
SN CF F Fr750 9 1/4 98.55 1997 1 7/8-1 1/4 C C F
Viennische Stadtsba nk (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L
Eurofim a (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank
Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IB J
Bank of M ontreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon C re dit
¶F inal te rm s. *With equity war rants. P rivate plac em ent. C onvertible. (a) Non-callable. ( b) C allable at par af ter 5 year s. I f c all notexe rcised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .
NEW INTER NA TIONAL BO ND ISSUES
Bo r rowe rBo r rowe r Am ou nt m .Am ou nt m . C ou pon %C ou pon % P r iceP r ice M a t ur ityM a t ur ity F eesF ees Boo k ru nn erBoo k ru nn er
C elworks Trust 1990-1¶ (b) US $250 9 1/4 99.80 1998 1 7/8-1 5/8 C redit Suisse
M arui Corp* US $500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nom ura
Holderbank ( a) US $150 9 3/4 101 1994 1 3/8-1 C SF B
Battle M ountaingold US $100 7 1/2 100 2006 2 1/2-1 1/2 M er rill Lynch
SN CF F Fr750 9 1/4 98.55 1997 1 7/8-1 1/4 C C F
Viennische Stadtsba nk (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L
Eurofim a (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank
Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IB J
Bank of M ontreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon C re dit
¶F inal te rm s. *With equity war rants. P rivate plac em ent. C onvertible. (a) Non-callable. ( b) C allable at par af ter 5 year s. I f c all notexe rcised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Equity-Linked Eurobonds
Eurobonds with warrantsMarui
Convertible EurobondsBattle Mountaingold
Index-linked EurobondsBank of Montreal
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Warrants
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Convertibles
ConversionValue
StraightBond Value
Market ValueMarket Premium
Value
of
Convertible
Bond
($) 0
Price Per Share of Common Stock
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Nikkei-Linked
28,00019,000
PRINCIPAL
REPAYMENT
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Tracking Stock
QUANTUM CORPORATION to Issue Tracking Stock to Reflect Separate Performance of DLT & Storage Systems, Hard Disk Drive Groups
Milpitas, Calif., March 1, 1999
Quantum Corporation (NMS: QNTM), a leader in the rapidly growing information storage industry, today announced a broad strategy to accelerate its growth in the storage systems business, including tape automation, and strengthen its position in the hard disk drive (HDD) market, where it has been the leading volume supplier in the desktop segment for the past five years. As a supporting financial step in executing the strategy, the company is also proposing to replace its existing common stock with two classes of tracking stock. If approved by shareholders, the tracking stock is intended to reflect the separate performance of the company's two major businesses, hard disk drives, and DLT & storage systems. Quantum would become the first technology company based in Silicon Valley to employ tracking stock.
Storage Systems Strategy
The strategy Quantum is announcing today will accelerate its diversification process with several new initiatives in the storage systems business. First, Quantum plans to extend its automated tape library business further into enterprise-level storage area network applications, and offer the industry's first flexible combinations of disk and tape storage within a single system. Second, Quantum is preparing to enter the rapidly emerging market for storage appliances later this year. This new class of product is aimed at the workgroup level, and promises greatly improved ease-of-use and flexibility for end-users implementing storage solutions. Third, Quantum is developing system software to provide intelligence in future storage systems and storage devices. Activities in this area have enabled the company to take an early lead in demonstrating self-configuring disk drive appliances within the Jini™ network architecture being developed by Sun Microsystems.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Tracking Stock (Continued)
Chairman and CEO Michael A. Brown said that the storage systems strategy will allow Quantum to build on the
industry's broadest range of storage devices and begin offering systems- and solutions-level storage products and services. In doing this, he said, the company expects to strengthen its position within the storage industry value chain.
"There is an explosion occurring in the demand for storage capacity," Brown said. "It's being fueled by the rapid growth of digital content–-data, video and audio–-along with the pervasiveness of networked computers, and the phenomenal rise of the Internet. As a result, the worldwide demand for storage is growing by 100 percent a year, making it the fastest growing segment of information technology. “
Tracking Stock Strategy
According to Brown, Quantum plans to issue tracking stock as the financial tool that will enable the company's strategy. Tracking stock recognizes that financial markets value differently the two businesses in which Quantum is engaged. "While Quantum remains a single corporation, tracking stock enables the financial markets to value more accurately the earnings potential of our two distinct businesses," Brown said. “We believe tracking stock is the best option of all the different ways of linking stock value directly to business unit performance. It gives us the financial advantages of separate valuations without the loss of shared strategy, technology, brand and company infrastructure."
If the plan is approved, shareholders would receive one-half share of the hard disk drive-based stock and one share of the DLT & storage systems-based stock for each share of Quantum common stock held. The two classes of tracking stock would comprise the company's common stock. Quantum would continue to be one company with one board of directors and one senior management.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Tracking Stock (continued)
Tracking stock–-sometimes called "targeted stock" or "letter stock"–-is a financial instrument that has been used successfully by several Fortune 500 companies, including General Motors, Sprint and USX (U.S. Steel). While Quantum is the first Silicon Valley company to use tracking stock, as of this year a total of 15 companies have employed the technique, with some 395 billion currently outstanding or pending. All major institutional investors have tracking stock in their holdings.
Tracking stock is considered most appropriate when a company has distinct businesses that are valued differently, each business would have a large market capitalization individually, and there is a strategic benefit to keeping the businesses together in a single company. Brown noted that Quantum easily meets all three of these criteria, making it an ideal financial structure for the company.
Do you agree? As a shareholder, how would you vote? Would such a financing strategy apply to your company?
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Economics of Financial Innovation
Certain kinds of market imperfections allow hybrids to flourish
But innovation are readily copied; so only certain kinds of firm can profit from innovations.
There is a product cycle and profitability cycle of innovations.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
What Conditions Permit Hybrids to Thrive?
Government Rules and RegulationsExample: Japan Air Lines Yen-linked Eurobond
Tax DistortionsExample: Money Market Preferred
Constraint on Issuers or InvestorsExample: Nikkei-Linked Eurobond
Segmentation-Driven InnovationExample: Collateralized Mortgage Obligations
(CMOs)
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Structured Notes
Bundling and unbundling basic instruments Exploiting market imperfections (sometimes
temporary) Creating value added for investor and issuer
by tailoring securities to their particular needs
Key: For the innovation to work, it must provide value added to both issuer and investor.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Case Study: Endesa Equity-Linked Notes
Client’s objectives The “Guaranteed Minimum Return” product How is this priced? Who else could benefit
from it?
80 85 90 95 100
105
110
115
120
125
130
135
140
145
150
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Index Level at maturity (Initial index level = 100)
Profit (Loss) with 100% Principal ProtectionProfit (Loss) with 90% Principal Protection
Prof
it (L
oss)
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Principles of Innovation Through Financial Engineering
Bundling and unbundling basic instruments Exploiting market imperfections (sometimes
temporary) Creating value added for investor and issuer
by tailoring securities to their particular needs
Key: For the innovation to work, it must provide value added to both issuer and investor.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Anatomy of a Deal
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Anatomy of a Deal
Issuer:Looking for large amounts of floating-rate
USD and DEM funding for its loan porfolio.Wants low-cost funds: target CP-.10Is not too concerned about specific timing
of issue, amount or maturityIs willing to consider hybrid structures.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Anatomy of a Deal
Investor:Has distinctive preference for high grade
investmentsLooking for investments that will improve
portfolio returns relative to relevant indexesInvests in both floating rate and fixed rate
sterling and dollar securitiesCan buy options to hedge portfolio but
cannot sell options
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Anatomy of a Deal
Intermediary:Has experience and technical and legal
background in structure financeHas active swap and option trading and
positioning capabilitiesHas clients looking for caps and other
forms of interest rate protection.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
The Deal
1 Initiate medium term note programme for the borrower, allowing for a variety of currencies, maturities and special structures
2 Structuring a MTN in such a way as to meet the investor’s needs and constraints
3 Line up all potential counterparties and negociate numbers acceptable to all sides
4 Upon issuer’s and investor’s approval, place the securities
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
The Deal / 2
5 For the issuer, swap and strip the issue into the form of funding that he requires
6 Offer a degree of liquidity to the issuer by standing willing to buy back the securities at a later date.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
The Issue
Issuer: Deutsche Bank AG Amount: US$ 40 Million Coupon:
First three years: semi-annual
LIBOR + 3/8% p.a., paid semi-annually
Last 5 years: 8.35% Price: 100 Maturity: February 10, 2000 Call: Issuer may redeem the notes in full at par on
February 10, 1995 Fees: 30 bp Arranger: Credit Swiss First Boston
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
The Parties in the Deal
SCOTTISH
LIFE
CSFB
DEUTSCHE
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
The Deal in Detail
SCOTTISH
LIFE
CSFB
DEUTSCHE
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
For an additional 3/4% p.a., Deutsche buys three-year put option on 5-
year fixed-rate 8.35% note to SL in 3 years
For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years)
CLIENT
CSFB sells the swaption to a corporate client seeking to hedge its funding cost against a rate rise
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
What’s Really Going On?
Note: Issuer has agreed to pay an above-market
rate on both the floating rate note and the fixed rate bond segment of the issue
FRN portion: .75 % above normal cost
Fixed portion: .50% above normal cost Issuer has in effect purchased the right to pay
a fixed rate of 8.35% on a five-year bond to be issued in three years time.
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Motivations for Issuing Hybrid Bonds
Company has a view There are constraints on what the
company can issue The company can arbitrage to save
money Always ask: given my goal, is there an
alternative way of achieving the same effect (e.g., using derivatives?)
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
Designing Debt
Duration Currency Effect of InflationUncertainty about Future
Growth PatternsCyclicality &Other Effects
Define DebtCharacteristics
Duration/Maturity
CurrencyMix
Fixed vs. Floating Rate* More floating rate - if CF move with inflation- with greater uncertainty on future
Straight versusConvertible- Convertible ifcash flows low now but highexp. growth
Special Featureson Debt- Options to make cash flows on debt match cash flows on assets
Start with the Cash Flowson Assets/Projects
Overlay taxpreferences
Deductibility of cash flowsfor tax purposes
Differences in tax ratesacross different locales
Consider ratings agency& analyst concerns
Analyst Concerns- Effect on EPS- Value relative to comparables
Ratings Agency- Effect on Ratios- Ratios relative to comparables
Regulatory Concerns- Measures used
Factor in agencyconflicts between stockand bond holders
Observability of Cash Flowsby Lenders- Less observable cash flows lead to more conflicts
Type of Assets financed- Tangible and liquid assets create less agency problems
Existing Debt covenants- Restrictions on Financing
Consider Information Asymmetries
Uncertainty about Future Cashflows- When there is more uncertainty, itmay be better to use short term debt
Credibility & Quality of the Firm- Firms with credibility problemswill issue more short term debt
If agency problems are substantial, consider issuing convertible bonds
Can securities be designed that can make these different entities happy?
If tax advantages are large enough, you might override results of previous step
Zero Coupons
Operating LeasesMIPsSurplus Notes
ConvertibilesPuttable BondsRating Sensitive
NotesLYONs
Commodity BondsCatastrophe Notes
Design debt to have cash flows that match up to cash flows on the assets financed
Copyright ©1999 Ian H. Giddy Corporate Financing Choices # #
www.giddy.org
Ian Giddy
NYU Stern School of Business
Tel 212-998-0332; 917-930-0291
Fax 212-995-4233; 630-604-7413
http://www.giddy.org