Borrowing money places an obligation on a business to repay specified amounts of the money borrowed when they are due and to meet regular interest payments of an agreed amount. This obligation remains irrespective of the size of the company. Apart from these basic principles, the terms of loan negotiated between businesses and people or organizations prepared to lend money vary according to the needs of the business and the conditions the lenders feel are required to safeguard their money. The following list of definitions will give some indication of the variety of agreements that can be made between those who borrow and those who lend.
1 Secured loans In return for granting the loan the lender insists on some asset of the business being tied to the repayment of the loan. In the event of bankruptcy or liquidation that lender will then have priority on the money from the sale of that asset for the repayment of that loan. A specialized form of secured loan is a mortgage. In this case the asset is always land or property. Unsecured loans are repaid from the fund generated by the sale of all other assets if the firm goes bankrupt or into liquidation. Lenders are less certain they will be repaid. These securities are known as collateral for the loan, i.e. properties pledged by the borrower to provide security for the lender.
2 Syndicated loans A syndicate is a group of people who join together to carry out a certain transaction. Where a great deal of money is borrowed no one person or organization may be able or willing to provide the total sum. In these circumstances a syndicate may be formed to provide the money, with members stating how much they will each lend.
3 Personal guarantee Limited liability protects the owners of a business from the need to repay debts above the amount they have directly invested in a business. A bank lending to a small limited company may demand a personal guarantee that the debt will be repaid. Effectively this removes the advantages of limited liability for the principal shareholders in that they will have to use personal assets to repay the loan if the assets of the business are inadequate.
4 Debentures These are known collectively as stock. A debenture is a long term loan which does not have to be repaid until an agreed date (its maturity). Debenture holders are entitled to a fixed rate of return each year and have priority over all shareholders. Unlike other forms of debt, debentures can be bought and sold on the Stock Exchange. The company will continue to pay the agreed rate of return to the new owner.
Because the rate of return is fixed when the loan is negotiated the price of a debenture will fluctuate according to the rate of interest. A fixed rate of interest of 10 per cent means that for every £100 the company gains from a particular debenture they will pay £10 each year to whoever owns that debenture. Let us assume that the rate of interest paid by a commercial bank on deposit accounts rises to 12.5 per cent. In practical terms it means that if a 10 per cent debenturestock is purchased at the price at which it was first issued buyers would be sacrificing £2.50 for each £100 of stock bought. The maximum price they would be prepared to pay would be one which gave them a return of 12.5 per cent, in this case £80. You should try the same calculation assuming a general interest rate of 8 per cent. The value of stock varies inversely with the rate of interest.
5. Bank loans These are possibly the simplest forms of loans available to business. The average bank manager dealing with a small to medium sized firm and responsible to head office for the performance of the branch uses a set of well-defined criteria when making a loan. Like other loans, a bank loan is for a fixed amount at a fixed rate of interest. There is likely to be a demand for regular repayments.
In practical terms a business may simply see its loans as those which will need to be repaid in the next accounting period (current) and those which have more than a year to run.
2.Read text 17 more carefully. Try to guess the words underlined from the context. Then use your dictionary to check the words.
3.Comprehension check.
Working in pairs, take turns answering the questions.
a) What obligation is placed on a business in case of borrowing money?
b) Can you differentiate between secured and unsecured loans?
c) What is the procedure of granting syndicated loans?
d) What is the main idea of the personal guarantee?
e) Why do debenture holders have priorities over all shareholders?
f) Why is a bank loan considered to be the simplest form of loan available to business?
4.Solve the problem.
What is the minimum opportunity cost to a small business owner who invests ₤10000 in the business when the rate of interest paid on bank deposit accounts is 9,5 per cent? What other sacrifices might be involved in this decision?
5.Draw a graph showing the changes in the value of stock with a nominal value of ₤100 when the interest rate changes as follows: 8 per cent, 10 per cent, 12 per cent, 14 per cent, 11,5 per cent.
