short term debt

Short-term debt

A financing arrangement for a period of less than one year with various characteristics to suit borrowers' particular needs.

Matching principle

Short-term assets should be funded with short-term liabilities.

Negotiable certificates of deposit

A short-term security issued by banks to manage their liabilities and liquidity, issued at a discount to its face value, with maturities ranging up to 180 days.

Commercial and bank-accepted bills

A short-term security issued with a face value payable at a future date, issued at a discount to its face value.

Commercial bill

A bill of exchange issued to raise funds for general business purposes.

Bank-accepted bill

A bill that is issued by a corporation and incorporates the bank as acceptor.

Drawer

Issuer of the bill, with secondary liability for repayment of the bill after the acceptor.

Acceptor

Usually a bank, takes primary liability to repay the face value to the holder of the bill at maturity.

Payee

The specified party to whom the bill is to be paid, typically also the drawer.

Discounter

The provider or lender of the funds who discounts the face value and purchases the bill.

Endorser

The party that was previously a holder of the bill and signs the reverse side of the bill when selling or discounting it.

Order of liability

The order for payment of the bill runs from acceptor to drawer and then to endorser.

Issue date

The date on which a bill is accepted.

Maturity date

The date on which the bill is due for repayment.

Face value

The amount payable at maturity as stated on the bill.

Discounted bill

A bill that is sold for less than its face value before maturity.

Funds lent

The amount of money provided to the drawer, typically less than the face value of the bill.

Bill discharged

The process by which the holder receives the face value of the bill at maturity.

Active secondary market

A market where negotiable certificates of deposits are actively traded.

Tradeable securities

Securities that can be bought and sold in the market.

Non-tradeable sources

Financing sources that cannot be traded, such as trade credit and bank overdrafts.

Accounts receivable financing

A financing arrangement where a business borrows against its accounts receivable.

Factoring

A financial transaction where a business sells its accounts receivable to a third party at a discount.

Commercial and bank-accepted bills

Advantages of commercial bill financing include lower cost than other short-term borrowing forms, borrowing cost determined at issue date, a bill line arrangement with a bank, the ability to extend the term of loan by 'rollover' at maturity, and a bank providing both a bill acceptance facility and a bill discount facility.

Promissory notes

Discount securities issued in the money market with a face value payable at maturity but sold today by the issuer for less than face value. Also called commercial paper, typically available to companies with an excellent credit reputation.

Underwriting of promissory notes

Underwriting guarantees the full issue of notes is purchased, usually performed by a commercial bank, investment bank, or merchant bank, which charges a fee for the underwriting process.

Non-underwritten issue

An issuer may approach the money market directly, retaining a commercial bank, investment bank, or merchant bank as lead manager, which may receive fees.

Calculations for short-term tradeable securities

Some knowledge of financial mathematics is required to do calculations of discount debt securities, with formulae being the same for different types of discount securities.

Price of short-term tradeable securities

The formula to calculate the price of a discount security where the yield is known is P = Σα CFt / (1+r)t.

Expected cash flow (CF)

The expected cash flow is part of the formula for calculating the price of a discount security.

Required rate of return (r)

The required rate of return is used as the appropriate discount rate in the price calculation formula.

Price calculation example

A company issues a 30-day bank-accepted bill with a face value of $500,000 and is quoted yields of 9.52% p.a. and 9.48% p.a.

Face value calculation

The formula to calculate the face value of a discount security where the issue price and yield is known is Face value = Price × (365 / (365 + (Yield × Days to maturity))).

Face value example

A company needs to raise $500,000 through a 60-day bank-accepted bill rollover facility discounted at a yield of 8.75% p.a.

Yield of discount security

The yield refers to the rate of interest on the amount paid to purchase the discount security, calculated as Yield = ((Sell price - Buy price) / Buy price) × (Days in year × 100) / Days to maturity.

Yield example

A company issued a 30-day bank-accepted bill with a face value of $500,000 discounted at a yield of 9.48% p.a., representing a price of $496,134.23.

Discount rate

The discount rate is part of the calculations for short-term tradeable securities.

Days to maturity

Days to maturity is a component in the yield calculation formula.

Discount securities

Discount securities are financial instruments sold for less than their face value, with the difference representing the interest earned.

Negotiable certificates of deposits

A type of discount security issued into the money market, similar to commercial and bank-accepted bills and promissory notes.

Bill acceptance facility

A service provided by banks to accept bills of exchange, allowing the issuer to obtain funds.

Bill discount facility

A service provided by banks to discount bills, providing immediate cash to the issuer.

Rollover facility

A feature that allows the term of a loan to be extended at maturity by issuing a new bill.

Commercial paper

Another term for promissory notes, typically issued by companies with strong credit ratings.

Investment bank

A financial institution that assists in underwriting and issuing securities.

Merchant bank

A financial institution that provides capital to companies in the form of share ownership instead of loans.

Face value

The nominal value of a security that is paid back to the holder at maturity.

Discount rate

The discount rate is expressed in terms of the face value of the security, while the yield is expressed in terms of the purchase price or current price.

Formula to calculate the discount rate

Discount rate = (Face value - Current price) / (Days in year × 100) × Face value / Days to maturity

Example of discount rate calculation

What is the discount rate of a 180-day bill with a face value of $100,000 and selling currently at $92,000, with a full 180 days to run to maturity?

Trade credit

A supplier provides goods or services to a purchaser with an arrangement for payment at a later date, often including a discount for early payment.

Example of trade credit terms

2/10, n/30 and 3/14, n/60

Opportunity cost of forgoing discount

Opp cost = % Discount / (100 - % Discount) × 365 / Days difference between early and late settlement

When is it beneficial to pay early?

When the purchaser can obtain funds at an after-tax rate of less than the opportunity cost or when surplus cash has less after-tax return than the opportunity cost.

Bank overdrafts

An overdraft facility is a major source of short-term finance that allows a firm to place its current operating account into deficit up to an agreed limit.

Interest rates on bank overdrafts

Interest rates are negotiated with the bank at a margin above an indicator rate, reflecting the borrower's credit risk.

Inventory finance

Most common form is floor plan finance, particularly designed for the needs of motor vehicle dealers to finance their inventory of vehicles.

Bailment in inventory finance

Finance company holds title to a dealership's stock, and the dealer is expected to promote the financier's financial products.

Accounts receivable financing

A loan to a business secured against its accounts receivable, mainly supplied by finance companies.

Factoring

Company sells its accounts receivable to a factoring company, often at a discount, to raise funds.

Benefits of factoring

Factoring provides immediate cash to the company as well as removes the administration costs of accounts receivable.

Notification requirement in factoring

Company is required to notify its customers that payment is to be made to the factor instead.

Recourse arrangement in factoring

Factor has a claim against the company if a receivable is not paid.

Non-recourse arrangement in factoring

Factor has no claim against the company.

Short-term tradeable securities

Calculations of short-term tradeable securities.

Short-term non-tradeable financing sources

Sources of financing that are not traded in the market.