Retiring Debt - Business Finance - ثاني ثانوي

7.6 Retiring Debt Key Terms Retiring debt Call feature National debt Link to dijital lesson www.den.edu. Retiring debt is when a borrower pays back the money they owed in full. Fahd knows that any debt issued by his company must ultimately be repaid, and this repayment must occur before the maturity date When the bond is issued, a method for periodic retirement is usually specified, as very few debt issues are retired in one lump payment at the final maturity date. Instead, part of the issue is systematically retired each year. This systematic retirement may be achieved by issuing the band in series. In addition, dramatic changes in interest rates may cause a corporation to retire bonds before maturity by repurchasing or by calling the debt. If interest rates rise and bond prices decline, Fahd's company may retire the debt by repurchasing it. Fahd can repurchase bonds from time to time, and sellers of the bonds may not know that the company is purchasing and retiring the bonds. Fahd's company could also announce the intention to purchase and retire the bonds at a specified price. The bondholders may sell their bonds at the specified price. EXAMPLE If the bonds are selling at a discount, Fahd's company has an advantage in retiring debt. Il a SAR 1,000 bond is currently selling for SAR 800, Fahd's company reduces its debt by SAR 1,000 with only a SAR 800 outlay in cash. There is a SAR 200 saving from purchasing and retiring the debt at a discount. This gain is classified as income for the firm's stockholders. Fahd knows that this strategy may appear to be a desirable means to retire debt; however, using money to repurchase debt is an investment decision just like buying plant and equipment. If the firm repurchases the debt, it cannot use the money for other purposes. Fahd needs to determine which is the better use of the money-purchasing other income-earning assets or retiring the debt. Hatiring des When a borrower pays back the money they owed in full وزارة التعليم OLAPTEN 7 Stocks and Bonds 299

Gail feature The night of a debtor to retire a bond prior to maturity 7.6a Calling the Debt Some bonds have a call feature, which permits the issuer to redeem the bond prior to maturity. If interest rates fall after a bond has been issued, it may be advantageous for the company to issue a new bond at the lower interest rate. The proceeds can then be used to retire the older bond with the higher interest rate. The company "calls" the older bond and retires it. This refunding hurts the bondholders, who lose the higher-yielding instruments. To protect these creditors, a call feature usually has a call penalty, such as a year's interest. 300Business Finance EXAMPLE If the initial issue had a 9% interest rate, the company would have to pay SAR 1,090 to retire SAR 1,000 worth of debt. While such a call penalty does protect bondholders, a company can still refinance if interest rates decline enough to justify paying the call penalty. 7.6b Government Securities In addition to corporations, governments issue a variety of debt instruments to raise capital from individuals, firms, and other governments with funds to invest. The general features of these securities are essentially the same as corporate debt; they pay interest and must be retired at some specified time in the future. If the securities are callable, the debt is often issued in series so that a specified series periodically matures. Governments issue securities that range from short-term to long-term. These securities emphasize short to intermediate-term financing, primarily because interest rates on short-term debt are usually less than on long-term debt. 1. Notes: government securities that mature within 10 years or less. 2. Bonds: securities that mature in more than 10 years. 3. Bills: matures in less than one year. The Saudi Arabian National Debt Management Center (NDMC) has the role to secure the Kingdom's financing needs at a fair cost and with acceptable levels of risk. The NDMC ⚫ works to secure the Kingdom's financing needs at the best possible costs through short-, medium-, and long-term issuance of securities;

⚫ develops an annual borrowing plan for Saudi Arabia to address debt management guidelines, risk management, the calendar for local sukuk issuances, and debt issuance guidelines; and ⚫ structures its borrowing activities to issue securities both domestically and internationally. Sukuks are issued for the domestic market. International financing is through sukuk and medium-term notes offered in dollars and Euros. Government securities are among the safest investments and are rated by the same rating agencies use for corporate securities. Although they are considered to be largely risk free, there are ways in which an investor can lose when investing in these securities. Changes in the current rate of interest cause security prices to fluctuate. An investor could purchase government security and its market price could decline. There is also the risk associated with exchange rates. The NDMC evaluates the exchange risk of its international debt issues. The Saudi Riyal is tied to the U.S. Dollar, so there is minimal exchange risk there. However, the value of the Euro to the Riyal floats with exchange markets. If the Euro increases in strength, it will take more Riyal to pay back a Euro denominated loan. If the Euro decreases in strength, it will take less Riyal to pay back the loans. Fahd knows that the yield rates on risk-free government securities impact the expected returns on company securities since their risk is normally higher. He watches the rates offered by the Saudi government treasury bills to determine the return his company will need to offer for its securities. 7.6c National Debt National debt, also called government debt, or public debt, is the total outstanding obligations of a country. Countries borrow funds to cover deficits between national income from taxes and other sources, and national expenditures. Countries may also borrow to invest in their development, such as building infrastructure. The total debt is less important than its proportion to the country's gross domestic product (GDP), as determined by the debt-to-GDP ratio. In Saudi Arabia, the NDMC monitors the debt-to-GDP ratio. In 2020, the ratio was at 32.4% and was expected to drop to 25.9% by 2022. Other countries can Mamal debt The total outstanding olaligations of a country وزارة التصليح CHAPTER 7 Stocks and Bonds 301

P 302Business Finance have very high debt-to-GDP ratios. In 2020, Greece's ratio was over 225% and the United States' ratio was 119%. High levels of the debt-to-GDP ratio could indicate financial risk, resulting in higher borrowing costs for the country. Exercises Choose the correct answer. 1. Many bonds have a call feature, which permits the firm to retire the bonds prior to maturity. True/False 2. If interest rates rise after a bond has been issued, it may be advantageous for the company to call the bond. True/False 3. Bonds may be retired prior to maturity by (1) repurchases, (2) new issue, (3) a call feature: a. 1 and 2 b. 1 and 3 c. 2 and 3 d. 1,2, and 3 4. The call feature permits the issuer to redeem a bond prior to maturity. True/False 5. The total debt is less important than its proportion to the country's gross domestic product (GDP) True/False