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From Wikipedia, the free
encyclopedia Debt is that
which is owed; usually referencing assets owed, but the term can
also cover moral obligations and other interactions not requiring
money. In the case of assets, debt is a means of using future
purchasing power in the present before a summation has been earned.
Some companies and corporations use debt as a part of their overall
corporate finance strategy.[citation
needed]
A debt is created when a creditor
agrees to lend a sum of assets to a debtor. In modern society, debt
is usually granted with expected repayment; in many cases, plus
interest. Historically, debt was responsible for the creation of
indentured servants.
Etymology
The word comes from the Old French
dette and ultimately Latin debere (to owe), from de
habere (to have). The letter b in the word debt
was reintroduced in the 17th century, possibly by Samuel Johnson in
his Dictionary of 1755— several other words that had existed without
a b had them reinserted at around that time.
Payment
Before a debt can be made, both the
debtor and the creditor must agree on the manner in which the debt
will be repaid, known as the standard of deferred payment. This
payment is usually denominated as a sum of money in units of
currency, but can sometimes be denominated in terms of goods.
Payment can be made in increments over a period of time, or all at
once at the end of the loan agreement.
Types of debt
A company uses various kinds of
debt to finance its operations. The various types of debt can
generally be categorized into: 1) secured and unsecured debt, 2)
private and public debt, 3) syndicated and bilateral debt, and 4)
other types of debt that display one or more of the characteristics
noted above.
A debt obligation is considered
secured if creditors have recourse to the assets of the company on a
proprietary basis or otherwise ahead of general claims against the
company. Unsecured debt comprises financial obligations, where
creditors do not have recourse to the assets of the borrower to
satisfy their claims.
Private debt comprises bank-loan
type obligations, whether senior or mezzanine. Public debt is a
general definition covering all financial instruments that are
freely tradeable on a public exchange or over the counter, with few
if any restrictions.
Loan syndication is a risk
management tool that allows the lead banks underwriting the debt to
reduce their risk and free up lending capacity.
A basic loan is the simplest form
of debt. It consists of an agreement to lend a principal sum for a
fixed period of time, to be repaid by a certain date. In commercial
loans interest, calculated as a percentage of the principal sum per
year, will also have to be paid by that date.
In some loans, the amount actually
loaned to the debtor is less than the principal sum to be repaid;
the additional principal has the same economic effect as a higher
interest rate (see point (mortgage)).
A syndicated loan is a loan that is
granted to companies that wish to borrow more money than any single
lender is prepared to risk in a single loan, usually many millions
of dollars. In such a case, a syndicate of banks can each agree to
put forward a portion of the principal sum.
A bond is a debt security issued by
certain institutions such as companies and governments. A bond
entitles the holder to repayment of the principal sum, plus
interest. Bonds are issued to investors in a marketplace when an
institution wishes to borrow money. Bonds have a fixed lifetime,
usually a number of years; with long-term bonds, lasting over 30
years, being less common. At the end of the bond's life the money
should be repaid in full. Interest may be added to the end payment,
or can be paid in regular installments (known as coupons) during the
life of the bond. Bonds may be traded in the bond markets, and are
widely used as relatively safe investments in comparison to equity.
Debt Syndication
There are two types of debt
syndication: fund base and non fund base.
Fund
Base
Cash Credit
This is the primary method in which
Banks lend money against the security of commodities and debt. It
runs like a current account except that the money that can be
withdrawn from this account is not restricted to the amount
deposited in the account. Instead, the account holder is permitted
to withdraw a certain sum called "limit", "credit facility" in
excess of the amount deposited in the account. Cash Credits are, in
theory, payable on demand. These are, therefore, counter part of
demand deposits of the Bank.
Working capital:
Firms need cash to pay for all
their day-to-day activities. They have to pay wages, pay for raw
materials, pay bills and so on. The money available to them to do
this is known as the firm's working capital. The main sources of
working capital are the current assets as these are the short-term
assets that the firm can use to generate cash. However, the firm
also has current liabilities and so these have to be taken account
of when working out how much working capital a firm has at its
disposal.
Working capital is therefore:-
WORKING CAPITAL = Current Assets || stock + debtors + cash - Current
liabilities Thus working capital is the same as net current assets,
and is an important part of the top half of the firm's balance
sheet. It is vital to a business to have sufficient working capital
to meet all its requirements. Many businesses have gone under, not
because they were unprofitable, but because they suffered from
shortages of working capital. Working Capital Cycle
Bank Overdraft:
The word overdraft means the act of
overdrawing from a Bank account. In other words, the account holder
withdraws more money from a Bank Account than has been deposited in
it. An overdraft occurs when withdrawals from a bank account exceed
the available balance which gives the account a negative balance - a
person can be said to be "overdrawn".
If there is a prior agreement with
the account provider for an overdraft protection plan, and the
amount overdrawn is within this authorised overdraft, then interest
is normally charged at the agreed rate. If the balance exceeds the
agreed terms, then fees may be charged and higher interest rate
might apply
Term loan:
Term Loan are the counter parts of
Fixed Deposits in the Bank. Banks lend money in this mode when the
repayment is sought to be made in fixed, pre-determined
installments. This type of loan is normally given to the borrowers
for acquiring long term assets i.e. assets which will benefit the
borrower over a long period (exceeding at least one year). Purchases
of plant and machinery, constructing building for factory, setting
up new projects fall in this category. Financing for purchase of
automobiles, consumer durables, real estate and creation of infra
structure also falls in this category.
Bill discounting:
Bill discounting is a major
activity with some of the smaller Banks. Under this particular type
of lending, Bank takes the bill drawn by borrower on his(borrower's)
customer and pay him or her immediately deducting some amount as
discount/commission. The Bank then presents the Bill to the
borrower's customer on the due date of the Bill and collect the
total amount. If the bill is delayed, the borrower or his customer
pay the Bank a pre-determined interest depending upon the terms of
transaction.
Project Financing:
Project finance is the financing of
long-term infrastructure and industrial projects based upon a
complex financial structure where project debt and equity are used
to finance the project, rather than the balance sheets of project
sponsors. Usually, a project financing structure involves a number
of equity investors, known as sponsors, as well as a syndicate of
banks that provide loans to the operation.
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