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Financial Markets

In fact the financing decisions form an integral part of a firm’s policy decisions. Usually, the financial managers prefer debt over equity on account of interest tax deductibility and low cost associated with debt. Mr Exposito plans to raise funds for the purpose of expanding his winery business. A careful analysis of the various sources of funding has been done to suggest the best available alternative based on the size of the winery business and the prevailing conditions in the market. Analysis of capital instruments There are two forms of financing – long term and short term. The long term financing instruments include debentures, bonds, term loans amp. shares and the short term debt instruments include bank overdraft amp. trade credit. Bonds- A bond is a long-dated financial instrument used by the companies to raise funds from the public. The bondholders are entitled to regular interest in the form of coupon payments. Normally, the bond is listed in the stock exchange. It has a fixed date of maturity which is the date at which the company agrees to pay back the principal amount to the holder of the instrument. The issue of a bond creates a legal binding on the company. Even in the event of a loss the company cannot dishonour the interest payments as this can have legal repercussions. The companies mostly issue fixed coupons bonds offering semi-annual payments until the date of maturity. There may be other types of bonds like fluctuating coupon bonds or bonds with an annual or quarterly payment feature. Besides there are zero coupon bonds that do not require any interest payments. The bonds can further be classified on the basis of the collateral as mortgage bonds, collateral trust bonds and equipment trust certificates. The real property is used as collateral in the case of mortgage bonds. The securities owned by the corporate act as a security for the collateral trust bonds whereas the inventories and company equipments act as security for equipment trust certificates. The price of the bond is inversely proportional to the interest rate. A rise in the interest rate can lower the price of the bonds and vice versa. Considering the interest rate sensitivity the bonds can be of two types- callable and non callable bonds. If after a bond issue the interest rates fall in the market then the corporate can call back the bonds issued at a higher interest rate and issue new bonds at a lower rate of interest (Rini, 2002, p.57). Debentures- The features of debentures are more or less similar to that of bonds except that unlike bonds the debentures carry a pre-determined rate of interest. Depending on ‘security’ the debentures can be classified as secured and unsecured. Secured debentures carry a charge on the company assets. The company cannot dispose-off these assets without the approval of the debenture holders. The unsecured debentures do not carry any such charge on the asset which makes it risky from the point of view of the investors. Again the debentures can be classified as per ‘convertibility’ into convertible and non-convertible debentures. The former gets converted into equity after a specified time period. Therefore in the future the debenture holders get an option to acquire a stake in the company. The non-convertible debentures are repaid at the end of the maturity and cannot be converted into equity. Depending on the ‘payment pattern’ the debentures c