?9: Woodside Petroleum Limited is about to raise additional short-term funding to meet its funding needs over the next three-month planning period. It is considering issuing commercial bills or promissory notes. (a) What is a promissory note? Identify and briefly explain the roles of the parties to a P-note issue. (b) What are the main differences between P-notes and commercial bills of exchange?
A promissory note, which typically has a maturity of 90 days, is described as ‘an unconditional promise in writing made by one person to another, signed by the maker engaging to pay, on demand at a fixed or determinable future time, a sum certain in money to the order of a specified person or to the bearer’ (Viney & Phillips 2012, 308). The structure of the promissory note is that of a discount security, sold by the issuer for less than the face value in exchange for the face value at maturity (Viney & Phillips 2012, 308).
The discount amount, which is the difference between the face value and the issue price, is the cost of borrowing to the issuer and the gain for the buyer of the P note. The roles of the parties to a P-note issue are dealers and lead managers. Most P-note issue is done by major commercial banks, investment banks and merchant banks. The lead manager would arrange for a dealer panel of market participants. The roles of the dealers are to distribute the notes in the market and to have good success with investors and to also oversee a secondary market for the notes (Viney & Phillips 2012, 309).
The P-notes are similar to the commercial bills of exchange with some differences. The P-note is a promise to pay while the bill is an order to pay. While the P-notes do not require the sellers to endorse the note, the commercial bills of exchange require the endorsement of the sellers. The P-notes enjoy the option of selling the notes in the money market without paying a future debt. However, as the P-notes do not require seller endorsement and are a form of unsecured instruments, this form of short term fund is only available to companies with excellent credit reputation.
As Woodside Petroleum Limited is a strong and well-reputed company, it should not have any problems raising P-notes as short-term funding. 10: Santos Limited issues 90-day P-notes(commercial paper) as part of a three-year underwritten facility established with an investment bank syndicate. The commercial paper has a face value of $ 7 million and is discounted at a yield of 8. 33 per cent per annum. (a) Why might Santos seek the services of an investment bank syndicate? (b) Explain the role of the underwriters to the issue.
(c) Why has Santos established a three-year facility if the P-notes are issued with only a 90-day maturity? Santos seeks the services of an investment bank syndicate possibly because it does not have a strong reputation in the market to attract sufficient investors. Since the P-note is a promise to pay rather than an order to pay, only large corporations with an excellent reputation are able to attract sufficient investment for its P-notes. The role of an investment bank syndicate is to help with the distribution of the paper and they also guarantee up to an agreed amount of paper that is not taken up by the investors.
Due to the agreement to purchase a limited amount of unsold paper, the investment syndicate is motivated to actively promote the paper. The reason for Santos establishing a three year facility is the flexibility that the rollover facility will allow it to extend the loan beyond a short-term tenure. Additionally, raising the P-notes is an expensive exercise, it is prudent for Santos to avail itself to a rollover facility for a possible line of credit. 15: On further reflection, the business manager in Question 14 decides to implement a different strategy and factor the firm’s accounts receivable.
The manager approaches a factor company and is advised that the factoring agreement will include with-resourse and notification conditions in the contract. (a) Describe the nature and operation of factoring as a form of finance. (b) Explain the effects of the with-resource and notification conditions that may be incorporated in a factoring contract. Factoring is the means in realising debts whereby a firm sells its receivables to a factoring company, which will then chase the creditors for the debts, making this form of debts a form of asset-based finance (Kravaica et al 2006). The factoring firm would purchase the accounts receivable at a
discount to the face value, which is the cost of the firm’s efforts in collecting the debts on behalf of the firm. The cost of the firm is the discount of the accounts receivable but the benefit of the firm relying on the factoring service is its access to the funds and not having to expend its efforts in chasing for the debts (Viney & Phillips 2012, 313). Factoring has been used in increasing popularity for small and medium sized enterprises because these firms do not have the advantage of a large firm in terms of borrowing and therefore, rely on factoring for their working capital (Borgia et al 2010).
The factoring contract may vary for different firms but it will specify the parties that are responsible for future bad debts in case some of the debts become uncollectible. A contract with recourse factoring means that the factoring company may make a claim against the firm should the accounts receivable debt becomes bad (Viney & Phillips 2012, 313). Logically, the contract with recourse would have a lower discounting to the face value since the risk is less for the factoring firm.
The contract with recourse can be considered to the benefit of the firm if it has a low risk of debtors defaulting and the sales volume is high for the year. Notification conditions require the firm to inform the debtors that accounts receivable should be made directly to the factor company (Viney & Phillips 2012, 314). Chp10: 8: Mr and Mrs Lim have recently married and are in the process of purchasing their first home. They have lodged an application to the Commonwealth Bank for a housing loan. The bank has offered them a mortgage loan.
Outline the main features of a mortgage loan. In particular, define a mortgage, explain the purpose and operation of a mortgage loan and identify and describe the parties to a mortgage loan. A mortgage loan is a term loan with a security, often the house or/and land, for which the loan is used for. The mortgage agreement requires the borrower also known as the mortgagor to borros against a certain value of the land or/and property that is used as collateral in return for a loan amount provided by the lender or mortgagee.
This allows the lender the right of foreclosure, which is to seize and dispose of the property, if the borrower fails to meet the terms of the mortgage loan contract. The typical amount of loan the lender is willing to make is usually 80% of the assessed value of the properties. However, the Commonwealth Bank may agree to loan up to the maximum value of the properties on the condition that Mr & Mrs Lim take up a mortgage insurance; the mortgage insurance covers the bank should the borrower defaults such that the bank does not suffer any financial loss from the default.
A mortgage is only discharged when the loan is repaid (Viney & Phillips 2012). The residential mortgage in Australia typically has tenure of up to 30 years. Mortgage loan comes with the option of fixed or variable interest. A fixed interest loan allows the borrowers, such as Mr and Mrs Lim, to fix the loan at the interest rate stipulated by the bank for a certain period of years. Fixed interest loan in Australia often runs for a short period of time, such as 1 to 3 years and fixed interest loan for up to 5 years is quite uncommon in Australia (Daniel 2010).
Commonwealth Bank is currently offering a fixed interest rate of 6. 69% for up to three years for residential mortgage finance (Home Loan Calculator 2012). This means that Mr. & Mrs. Lim will pay 6. 69% of the agreed principal amount borrowed against their security regardless of the movement of the variable interest rate, which is largely determined by the Reserve Bank of Australia (RBA) and also the lending cost of the banks. In other words, if the variable interest rate moves up to 7% in the future, Mr & Mrs Lim would make a gain of 0.
31% by fixing the interest rate. If Mr & Mrs Lim decide to take on a mortgage loan with variable interest rate, it means that their interest rate can change anytime when the RBA increases or decreases the interest rate or/and when Commonwealth Bank decides to increase or decrease the interest rate. A variable interest loan is more volatile as the borrowers have to meet the interest of borrowing in all circumstances (HOME FINANCE ADVERTISING FEATURE home loan debate: Fixed or variable? 2008). However, Mr. & Mrs.
Lim may decide to tolerate the volatility if they feel that the variable interest rate is likely to be less than the fixed interest loan. The parties to a mortgage loan include the lender, the borrower(s) or/and the insurance company which sells the mortgage insurance to the borrower(s) (Viney & Phillips 2012). 10: A corporation listed on the ASX is expanding its business operations into China. In order to expand, the company will need to raise additional funds through the issue of corporate bonds direct to the capital markets.
Two securities that are issued into the corporate bond market are debentures and unsecured notes. (a) Outline the attributes of each of these securities. In your answer, include a discussion on the nature of a fixed and floating charge. (b) Explain which types of borrowers will have access to funds through the issue of debentures and unsecured notes into the capital markets. A corporate bond is a form of long-term debt instrument used by companies to fund certain projects in which they will pay a regular interest stream (Viney & Phillips 2012).
A corporate bond takes the form of debentures and unsecured notes; they are contracts with the lenders that the company (borrower) will pay regular payments to the lender, including the face value of the bond upon contract maturity. The main distinction between the two categories of corporate bond is the attachment of security; a debenture is a type of corporate bond, which comes with a security while an unsecured note is issued without any security attached (Viney & Phillips 2012).
A debenture is secured by a fixed and/or a floating charge over those assets that are not pledged to another party. A fixed charge means that the debenture holders will have the rights to the assets of the company that are not sold in the normal course of business, such as manufacturing equipment and vehicle fleet. A floating charge allows the debenture holders the rights to the assets of the company that are in the normal course of the business when the company fails to make good the bond payment, during which the floating charge becomes a fixed charge (Viney & Phillips 2012).
In the event of payment default, the ranking of the bond holders are in the order of fixed charge debenture holders, followed by the floating charge debenture holders and finally, the unsecured note holders (Viney & Phillips 2012). Other than treasury bonds issued by the Australian Government and state government, there are covered bonds issued by Australian financial institutions, asset backed securities and Australian dollar bonds. Companies looking to fund their expansion projects also access funds through the issue of debentures and unsecured notes into the capital markets.
Investors will assess their own risk appetite while using the credit rating of the companies to decide if they should take the risk to lend funds by buying debentures and unsecured notes since there is a higher risk attached to putting their money in such debt instruments. However, some investors are willing to lend their money to such companies in return for a higher return. Of course, companies with good credit rating will have better access to such funds since they are considered less risk than companies with poor credit rating (Viney & Phillips 2012).
11: The corporate bond market is a significant source of funds for corporations raising finance direct from the capital markets. (a) Describe the structure and operation of the corporate bond market. In your answer explain why corporations seek to raise debt funds direct from the markets, why investors provide debt funds directly to the capital markets and who are the main providers of direct finance in the capital markets. (b) Commercial banks also issue bonds into the capital markets. Some of these bonds may be described as covered bonds.
What are covered bonds issued by commercial banks? The corporate bond market provides companies with a platform for them to raise debt funds direct from the capital markets. Companies can issue either debentures or unsecured notes through three primary methods, namely public issues, family issues and private placement. Corporations sometimes prefer to raise funds directly in the capital markets instead of through the bank because it is more cost effective to raise funds in the capital markets themselves as they remove the cost charged by the bank.
Diversification of funding source is another reason why corporations are motivated to raise funds directly in the capital market (Viney & Phillips 2012). The main providers of direct finance in the capital markets are retail and institutional investors, fund managers and insurance companies. Some investors are motivated to take the higher risk of buying corporate bonds in exchange for a better return. Investors will also rely on the credit rating of the company to decide if they wish to buy the corporate bonds.
Some investors are also looking at diversifying their investment portfolio by buying corporate bonds. The improvement in technology, along with the increase in superannuation savings and the deregulation of the financial system as well as investor sophistication and the growth in professional fund management have contributed to the growth of the corporate bond market (Viney & Phillips 2012). Covered bonds are defined as ‘bonds issued by commercial banks that are supported or secured by mortgage assets held by the bank’ (Viney & Phillips 2012, 332).
These are considered safer instruments than corporate bonds; Flantsbuam (2009) reported that investors’ purchases of these bonds have the propensity to increase asset prices and reduce mortgage rates. Covered bond is an established financial instrument in Europe and the U. S. Treasury is recommended to establish the covered bond market further in the U. S. to help the ailing property market (Flantsbuam 2009). References Borgia, D. J. , Swaleheen, M. , Jones, T. L. , & Weeks, H. S. 2010. Accounts receivable factoring as A response to weak governance: Panel data evidence.
The International Business & Economics Research Journal, 9(2), 11-21. http://search. proquest. com/docview/195152523? accountid=10382(accessed 7/9/12) Daniel, J. 2010. A fixed-rate loan prepayment model for australian mortgages. Australian Journal of management, 35(1), 99-112. http://search. proquest. com/docview/288227380? accountid=10382(accessed 7/9/12) Flantsbaum, S. 2009. Covered bonds: Shelter from financial turmoil, exposure to the 1940 act. fordham Journal of Corporate & Financial Law, 14(4), 849-874. http://search. proquest. com/docview/89067827?
accountid=10382(accessed 7/9/12) HOME FINANCE ADVERTISING FEATURE home loan debate: Fixed or variable. 2008. http://search. proquest. com/docview/354945372? accountid=10382(accessed 7/9/12) Home Loan Calculator 2012, www. commbank. com. au(accessed 7/9/12) Kravaica, A. V. , Aidone, E. R. , & Tomljenovic, L. 2006. Factoring – advantages in financing small and medium-size enterprises. Page 834-843. http://search. proquest. com/docview/217737160? accountid=10382(accessed 7/9/12) (Borgia etl, 2010) (Daniel, 2010) (Flantsbaum, 2009) View as multi-pages