1. Prof. Ian Giddy New York University
SIM/NYU
The Job of the CFO
Designing Debt
Prof. Ian Giddy
New York University

2. Designing Debt: Match the Business
Fixed/floating:
How certain are the cash flows? Are operating profits linked to interest rates or inflation?
Currency:
Consider currency of the assets: currency of denomination vs. currency of location vs. currency of determination.
Maturity or availability:
Are the assets short term or long term? Should the firm assume ease of refinancing, or buy an option on access to financing?

3. Three Views of Market Price Risk: Market Risks: Definitions
Transactions
Balance Sheet/Portfolio
Economic risk.
Transactions
Exposure
Portfolio
Exposure
Economic
Exposure

4. Ciba-Geigy

5. Case Study: Financing Ciba
1) What is Ciba's debt-to-equity ratio, and what might one advise the company about what it should be?
(2) How much of Ciba's debt is fixed-rate borrowing, and should this proportion change?
(3) How much of the company's debt should be long term?
(4) What is the composition, by currency, of Ciba's debt? What should it be?

6. Case Study: Financing Ciba
Could Ciba benefit from more debt?
Tax shield?
Could Ciba be hurt by more debt?
Risks of financial distress?
Costs of financial distress?
Reduce flexibility?

7. Ciba: How Much Debt?

8. Ciba: Are Revenues Stable?
Ciba Sales and Earnings
(in billions of Swiss francs)
100 10 1
Legend
Sales
Profits
0.1
1982
1984
1986
1988
1990
1992

9. Financing Choices
Assets’ value is the present value of the cash flows from the real business of the firm
Value of the firm
=PV(Cash Flows)
From
How much debt? to
What kind of debt?
You cannot change the value of the
real business just by shuffling paper
- Modigliani-Miller

10. Corporate Financing Choices: What Kind of Debt?
Fixed/floating
Currency of denomination
Maturity or availability
Domestic/Euro
Public/private
Asset-based
Credit enhanced
Swapped
Equity-linked

11. Short Term or Long Term?
In 1992, Ciba had fixed assets of SF13.9 billion and capital expenditures of SF1.9 billion.
Yet the majority of Ciba's debt is in the short-term commercial paper, bank debt, and suppliers-credit markets.
This suggests that if the proportion of debt financing as a whole is increased, much of it should be in the form of long-term debt.

12. Currency of Denomination of Ciba's Debt? What Should It Be?
Geographic location of sales and capital assets.
Currency distribution of sales.
Nature of the company's businesses

13. Currency of Ciba’s Assets and Debt
Geographic distribution
Geographic distribution of of
Estimated
Estimated
Currency
Currency
currency
currency
Fixed
Fixed
distribution
distribution
distribution of
distribution of
assets
assets
Sales
Sales
of sales
of sales
Remarks on economic exposure
Remarks on economic exposure
debt
debt
Switzerland
Switzerland
41%
41%
2.4%
2.4%
Net short position because much of
Net short position because much of 9% 9%
production, but little of sales, here
production, but little of sales, here
43%
U.K.
U.K.  
5.4%
5.4%
Part of sales effectively U.S. dollar
Part of sales effectively U.S. dollar 7% 7%
denominated
denominated  
27%
27%
Other
Other
34.6%
34.6%
21%
21%
Europe
Europe
U.S. and
U.S. and
23%
23%
32%
32%
41.3%
41.3%
54%
54%
Canada
Canada
Latin
Latin 4% 4% 7% 7%
5.3%
5.3%
Most of sales effectively dollar
Most of sales effectively dollar 2% 2%
America
America
denominated
denominated
Asia
Asia 4% 4%
13%
13%
10.9%
10.9%
Part of sales effectively U.S. dollar
Part of sales effectively U.S. dollar 6% 6%
denominated
denominated
Rest of the
Rest of the 1% 1% 5% 5%
Most of sales effectively dollar
Most of sales effectively dollar 1% 1%
world
world
denominated
denominated

14. Guidelines for Financing
Liabilities to match assets: economic exposure of the firm determines base financing choices.
Decision on whether or not to fully match depends on company's view relative to the view implied by market prices.
When strategy is chosen, use the financing/hedging techniques that offer the lowest effective cost.

15. Designing Debt Cash Flows on Assets/ Projects Define Debt
Start with the
Cash Flows
Cyclicality &
Growth Patterns
Other Effects
on Assets/
Duration
Currency
Effect of Inflation
Projects
Uncertainty about Future
Fixed vs. Floating Rate
Straight versus
Special Features
Commodity Bonds
* More floating rate
Convertible
on Debt
Catastrophe Notes
Define Debt
Duration/
Currency
- if CF move with
- Convertible if
- Options to make
Characteristics
Maturity
Mix
inflation
cash flows low
cash flows on debt
- with greater uncertainty
now but high
match cash flows
on future
exp. growth
on assets
Design debt to have cash flows that match up to cash flows on the assets financed
Overlay tax
Deductibility of cash flows
Differences in tax rates
Zero Coupons
preferences
for tax purposes
across different locales
If tax advantages are large enough, you might override results of previous step
Consider
Analyst Concerns
Ratings Agency
Regulatory Concerns
ratings agency
- Effect on EPS
- Effect on Ratios
- Measures used
Operating Leases
& analyst concerns
- Value relative to comparables
- Ratios relative to comparables
MIPs
Surplus Notes
Can securities be designed that can make these different entities happy?
Observability of Cash Flows
Type of Assets financed
Factor in agency
by Lenders
- Tangible and liquid assets
Existing Debt covenants
Convertibiles
conflicts between stock
- Less observable cash flows
create less agency problems
- Restrictions on Financing
Puttable Bonds
and bond holders
lead to more conflicts
Rating Sensitive
Notes
If agency problems are substantial, consider issuing convertible bonds
LYONs
Consider Information
Uncertainty about Future Cashflows
Credibility & Quality of the Firm
Asymmetries
- When there is more uncertainty, it
- Firms with credibility problems
may be better to use short term debt
will issue more short term debt

16. Ban Pu How much debt in relation to equity should Ban Pu have?
Should the debt be fixed or floating?
How much of the company's debt should be long term?
What should be the currency composition of its debt?
Why a convertible?
How should its financing change over the company’s life cycle?

17. Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING
RISK MGT
PORTFOLIO
MEASUREMENT
CAPITAL
DEBT
EQUITY
M&A
TOOLS

18. Young and Old Size Maturity Financial Leverage Operating Leverage

19. Domestic and Global Size Maturity Financial Leverage
Operating Leverage
Financial Leverage
Operating Leverage
Financial Leverage
Maturity

20. Asian Companies: Life-Cycle Financing

21. Asian Companies: Life-Cycle Financing
DOMESTIC
BANK
DEBT D E B T
DOMESTIC
PUBLIC
BONDS
AND PAPER
EURO,
FOREIGN,
AND GLOBAL
BONDS
MEDIUM-
TERM NOTE
AND CP
PROGRAMS

22. Asian Companies: Life-Cycle Financing
DOMESTIC
BANK
DEBT D E B T
DOMESTIC
PUBLIC
BONDS
AND PAPER
EURO,
FOREIGN,
AND GLOBAL
BONDS
MEDIUM-
TERM NOTE
AND CP
PROGRAMS
FAMILY
OR STATE
OWNERSHIP E Q U I T Y
DOMESTIC
PUBLIC
EQUITY
LIMITED
FOREIGN
EQUITY
GLOBAL
EQUITY

23. Corporate Financing Choices
Do financing choices matter?
Debt or equity?
What kind of debt?
Certain kinds of market imperfections allow corporations to reduce costs by improving the financing mix

24. Corporate Financing Choices
Do financing choices matter?
Debt or equity?
What kind of debt?
Certain kinds of market imperfections allow corporations to reduce costs by improving the financing mix
IMPLEMENTATION

25. Banpu

26. Corporate Financing Choices: What Kind of Debt for Banpu?
Fixed/floating
Currency of denomination
Maturity or availability
Domestic/Euro
Straight/convertible

27. Banpu: Capital Structure

28. Conclusion Fixed/floating: Currency: Maturity or availability:
How certain are the cash flows? Are operating profits linked to interest rates or inflation?
Currency:
Consider currency of the assets: currency of denomination vs. currency of location vs. currency of determination.
Maturity or availability:
Are the assets short term or long term? Should the firm assume ease of refinancing, or buy an option on access to financing?

29. giddyonline.com Ian Giddy NYU Stern School of Business
Tel ; Fax