Topic 6 – Short Term Debt (Debt Markets)

This article is a topic within the subject Capital Markets and Institutions.

Required Reading

Viney, (2009) Financial Institutions, Instruments and Markets, 6th Edition: McGraw-Hill, pp. 302-331.

Short Term Debt

Short term debt is a financing arrangement for a period of less than 1 year. Short term assets should be funded with short term liabilities (matching principle).

Trade Credit

• Suppliers provide goods and services to a purchaser with an arrangement for payment at a later date
  • E.g. 2/10, n/30 - 2% discount if payed within 10 days or full payment due in 30 days
• Providers Advantages - Increased Sales
• Providers Disadvantages - Costs of Discounts, Increases in Credit Periods, Collection & Bad Debt Costs

Bank Overdrafts

• A major source of short term finance allowing a firm to place its cheque (operating) account into deficit (agreed limit).
  • Operated on a fully fluctuating basis (bring to credit every now & again) to meet NOWC needs & mismatch of CF’s
  • Interest rates negotiated with a bank at a margin above an indicator rate (e.g. BBSW) reflecting credit risk
    • Financial Performance, Future CF’s, Length of Mismatch Between Inflows/Outflows, Collateral
• Providers Advantages - Establishment, Monthly Account Service, Unused Over Draft Limit, Fee Revenue

Commercial Bills (Securities)

• Bill of Exchange – a discount security issued with a face value payable at a future date
  • Electronic transactions via Austraclear (authorised central securities depository) who records ownership
• Commercial Bill – Bill of exchange used to raise funds for general business purposes
  • Bank Accepted Bill – Bill issued by a corporation that a bank has accepted (increases creditworthiness)
  • Drawer - issuer of the bill, secondary liability for repayment of the bill (after acceptor)
  • Acceptor - repays the face value to the bill’s holder at maturity, usually a bank
  • Payee - the party who receives the funds (usually drawer or drawer’s subsidiary)
  • Discounter - Discounts the face value of the bill & buys it, i.e. the lender, (bank can be acceptor & discounter)
  • Endorser - previous holder of the bill, signs the reverse side of the bill when selling/discounting
• Non Bank Bills – bill is drawn by bank an accepted by the borrower  bank is drawer & discounter
  • If bank re-discounts a bill, the bank becomes an endorser - Bank Endorsed Bill Prescribed Textbook Pg310
  • At maturity the borrower (as acceptor of the bill) pays the face value to the holder of the bill
• Advantages of Commercial Bill Financing - lower Cost than other short term borrowing forms - no balance sheet funding by bank, cost determined at issue date – no interest rate risk (unless rollover), loan term can be extended by ‘rollover’,
• Bill Line – arrangement with bank where the bank agrees to discount bills progressively up to an agreed amount
• Bill Financing Facility – bill acceptance & discount facility &/or rollover facility (discount new bills as old bills mature)- facility fees

Order of liability Acceptor - Drawer - Endorser

Commercial Paper (Promissory Notes) - Securities

'A discount security issued into the money market with a face value payed at maturity. Available to firms with excellent credit reputation as there is no acceptor/endorser (sole liability of the issuer) & they are unsecured securities. Arranged by major banks & money market firms with standardised documentation & usually mature in 90 days (up to 180). They may involve a revolving facility.

Issues can be underwritten for 0.1% p.a. by a bank (+underwriting syndicate & tender panel) & can incorporate a rollover facility extending the borrowers line of credit beyond the life of the P-note. However, the issuer can directly enter the money market without underwriting & may have a bank as lead manager & a dealer panel to distribute the paper into the markets.

Negotiable Certificates of Deposit

Negotiable Certificates of Deposit are short term (180 days or less) discount securities issued by bank in the wholesale money market (institutional investors) that has an active secondary market in certificate deposits, to manage their liabilities & liquidity.

Inventory Finance, Accounts Receivable Finance & Factoring

A common form of Inventory Finance is floor plan finance that is designed for car dealers (who are expected to promote financier’s financial products).

• Bailment Common - Financier holds title to dealership stock

Accounts Receivable Finance is loans secured against receivables (supplied by finance companies who take charge of the firm’s receivables). The borrower is responsible for the debtor book & bad debts.

Factoring involves selling accounts receivable to a factor (responsible for collection) to provide immediate cash. Recourse arrangement – factor has a claim against vendor for unpaid receivables. Non-recourse arrangement– factor has no claim against the firm.

• Notification Basis - vendor notifies debtors to pay directly to the factor company – greater control of outstanding debts or non-notification basis (addressed to P/O box controlled by factor) to avoid adverse perceptions.

In determining the discount to FV, the firm’s customer credit ratings, industry diversification, regular/longstanding nature & outlook of the customers/industry would be considered.

Discount Security Calculations - Commercial Bills And PRomissory Notes

Yield Calculations

Discount Rate Calculations

End

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References

Textbook refers to Viney, (2009) Financial Institutions, Instruments and Markets, 6th Edition: McGraw-Hill.