Chapter 3 Debenture Issue 3 1 Debentures Defined

Chapter 3 Debenture Issue

3. 1 Debentures Defined

What are debentures? Debentures are a fixed interest debt. They are issued with a fixed or floating charge over specific assets of the company.

What are charges? Fixed charge: a specific asset (s). Floating charge: a class of assets (eg. Accounts Receivable).

The Prospectus Is the disclosure document. Registered and issued with ASIC approval. Has an expiry date, after which a new prospectus must be registered.

Who commonly issues debentures? Banks Large companies Finance companies Government business enterprises

Features of Debentures • • Term usually 2 – 10 years. Interest – fixed or variable. Paid semi-annually in arrears. Issue by tender or prospectus. Traded through stockbrokers.

Features of the Debenture Market Recent high profile crashes have resulted in tighter ASIC regulation. Recent economic turmoil has meant reduced interest in the debenture market, which is considered relatively high-risk.

Mortgage Debentures Must not exceed 60% of the value of the property. Lower interest paid due to lower risk.

Unsecured Notes Similar to a debenture. However: Does not have a charge over company assets. Unsecured notes carry a higher interest rate due to the higher risk.

Other Forms of Company Debt Commercial bills: The Drawer issues the bill and borrows funds The Drawee/Acceptor – is liable on the bill to the Payee The Payee – purchases a bill

Other Forms of Company Debt Promissory notes: A negotiable instrument and differs from a commercial bill in that the borrower’s name appears on the note.

3. 2 Difference Between Debt and Equity Finance

Debt Finance Debt is an investment in the form of a loan. The borrower pays the lender an agreed rate of interest. Debt financing is indirect

Equity is a direct investment. The investor buys shares in the company, giving the owner part ownership of that company.

Examples of Equity and Debt EQUITY DEBT Ordinary shares Debentures Preference shares Unsecured notes Company options Promissory notes Property trusts Bills of exchange Equity trusts Treasury notes and bonds

Characteristics of a Debt Instrument Fixed maturity date Defined interest payments Face value Interest rate tied to risk Short term or long term Negotiable Mostly have a secondary market Secured or unsecured

Characteristics of Equity Instruments Equity investment in a company gives the investor a part ownership and a share in company profits. Non-listed equity investments are traded outside the official market.

Characteristics of Ordinary Shares • • • They do not have a limited life. They do not have a fixed rate of return. Dividends do not have to be paid. Issued (face) value has little relevance after issue. Capital growth is important. Voting rights are attached.

Characteristics of Preference Shares • Fixed rate of return. • Preference over ordinary shareholders at liquidation. • Ranked below debt investors (eg debenture holders). • Limited or no voting rights.

What are Company Options? • • These are options issued to shareholders to purchase additional shares. They have an exercise price and expiry date after which the option to purchase shares lapses.

What is marketability? • • • Marketability is the ability to trade a security quickly and get prompt payment/delivery. A deep market refers to the ability to buy and sell securities readily. High risk = low marketability.

Marketability of Listed Equity Investments The share market allows a conversation of shares into cash. Turnover statistics are an indication of a company’s marketability.

Marketability of Debt Investments Marketability of debt investments depends on the risk involved, as determined by: • • Credit risk of the issuer Length of time to maturity

3. 3 Accounting for Debenture Issues

Example: Issue of Debentures Payable in Full on Application

Interest Payments

3. 4 Accounting for Redemption at Maturity

Redemption at Maturity

Redemption Prior to Maturity Debentures redeemed prior to maturity will be redeemed at a discount or a premium to face value. Its market value will rise or fall if market interest rates change.

Redemption at a Premium Example: Carlton Ltd had issued 150, 000 $100 10% Debentures. Maturity date is 31 August. On 15 April, the company purchased on the Stock Exchange 30, 000 of the debentures at a price of $102.

Redemption at a Discount Example: International Design Ltd issued 5, 000 $100 7% Debentures on 1 February. Maturity date is 31 December. On 1 July, the company purchased on the ASX 5, 000 of the debentures at a price of $95.