Functions of Business, Part 5
Question 1: Describe some of the considerations involved in securing a long-term loan from a lending institution.
Answer 1: Long-term loans are generally offered to firms which have developed a strong relationship with a bank, an insurance company, a pension fund, or a commercial finance company. The term of long-term loans can range from 3 to 7 years but can range to terms of 15 or even 20 years. Long-term loans are typically more expensive, in the sense of having higher interest rates, than short-term loans, generally because the amounts involved tend to be significantly higher. Most long-term loans require collateral, which can be in the form of stock or physical assets such as equipment or real estate. Long-term loans require the borrower to sign a term-loan agreement, which sets out the term of the loan and the interest rate which the borrower will pay.
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Question 2: Define what a bond is. Discuss how a company issues bonds to obtain debt financing.
Answer 2: A bond is another type of long-term debt obligation, in which a company issues what are in essence IOUs with a promise to repay the debt in a specified period of time. Bonds are often resorted to when a company is unable to obtain long-term financing from a financial institution. Bonds are also issued by the government, which happens to be the main competitor to those bonds issued by private enterprise or a public enterprise like a utility. Bonds can be either secured or unsecured. Secured bonds are backed by some kind of collateral, such as a physical asset like real estate or equipment. Unsecured bonds, called debenture bonds, are backed by only the creditworthiness or the reputation of the bond issuer.
Question 3: Describe the following three methods of obtaining equity financing:Equity financing by selling stockEquity financing from retained earningsEquity financing from venture capital
Answer 3: Equity financing by selling stock: Often a company arrives at a point where it needs funds above and beyond those available through debt financing. One of the most common ways to obtain these funds is through selling partial ownership in the company in the form of stock. Before a company can offer stock for sale, it must meet various requirements set out by the SEC (Securities and Exchange Commission), as well as certain state agencies.Equity financing from retained earnings: This is the practice of reinvesting the profits a company earns back into the company, in the form of what are called retained earnings. The great advantage of this type of financing is that the company will not have to make interest payments or pay dividends to stockholders on the funds reinvested. Equity financing from venture capital: Venture capital is typically needed when a company is starting up and has few assets and no reputation upon which to attain loans from a bank or other financial institution.
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