Reviewer for Treasury and Trust Management.

Debt Management:

 It is the treasurer’s (CFO’s) role to manage a company’s existing or procure new

debt/borrowings.
 Debt borrowings though secure a higher priority than common stock (lowest priority) in
settlement of claims.
 Types of Debt:
o Commercial Paper – unsecured debt issues by the company that has a fixed maturity
ranging from 1 to 270 days.
o Factoring Arrangement – Finance company takes over a company’s receivable
collections and keep the money from those collections in exchange for an immediate
cash payment to the company.
 This is contrast with Accounts Receivable Financing where A lender will typically
loan a maximum of only 80 percent of the accounts receivable balance to a
company, and only against those accounts that are less than 90 days old.
 However, TRUE FACTORING ARRANGEMENT is where the company, known as
the factor, BUYS the receivables and is not an intermediary.
 This type of arrangement is better only for short-term growth situations
where money is in short supply.
o Line of Credit - A line of credit is a commitment from a lender to lend a company
whenever it needs cash, up to a preset maximum level.
 The bank will typically charge commitment fee (not annual maintenance fee),
respective of the amount of funds drawn down on the loan, on the grounds that
it has invested in the completion of paperwork for the loan.
o Warehouse financing – uses raw materials as the collateral. Since the lender’s basis for
lending is strictly on the underlying collateral (as opposed to its faith in a business plan or
general corporate cash flows), it will undertake frequent recounts of the assets, and
compare them to its list of assets originally purchased for the distributor or retailer. This
is an expensive
o Bridge Loan- Short-term loan under the condition that the company will obtain longer-
term loan.
o Floor Planning – the lender pays for the all the assets and requires that the price of all
assets be no lower than the price the lender originally paid for it on behalf of the
distributor or retailer.
o Capital Lease - A lease covers the purchase of a specific asset, which is paid for by the
lease provider on the company’s behalf.
 The leasing option is most useful for those companies that want to establish
collateral agreements only for specific assets, thereby leaving their remaining
assets available as a borrowing base for other loans.
 This is when the lessee (not lessor) carries the assets on books and a records
depreciation. The lessee only records receivables from the rent.
o Asset-Based Loans – Loans which use fixed assets or inventory as collateral.
o Income Bond – A bond that pays only when income is earned by the company.
 o Debentures – unlike Asset-based loans, this bond does not require collateral or is
unsecured.
o Bonds – borrowing done by large corporations but this can be issued directly to investors,
called private placement, so there are no financial intermediaries to whom transactional
fees must be paid.
o Convertible Bond – a type of bond where the principal amount (not including accrued
interest) can be converted to shares.

 Credit rating in the Philippines – The only one accredited by the BSP is Phil Rating Services
Corporation.
 How do you know if the credit rating is an investment grade? You have three letters and the
minimum is B (e.g. BAA3)

Practice for Types of Debt:

1. A small company acquired by a big conglomerate, needing money for its new products and has a
huge amount of receivables.
a. Bank loan
b. Factoring Agreement
c. Convertible Bond
d. Sales and Leaseback

Since this company is acquired by a bigger bank, we can avoid the costs associated with factoring
agreement. The other 3 debt types are not suitable for a small company.

2. A big company, established cash flows, but has a very high debt equity ratios.
a. Bank Loan
b. Factoring Agreement
c. Convertible Bond
d. Sales and Leaseback

Convertible Bond converts to equity thereby lowering Debt-Equity Ratios.

3. A company planning to outsource its transport service to employees and in need of cash to buy
shares in an associated company.
a. Bank Loan
b. Factoring Agreement
c. Convertible Bond
d. Sales and leaseback

The company does not need to maintain the transport and can lease it after selling. Selling frees
up cash for the purchase.

4. A small, independent but highly leveraged company short of cash to buy new raw materials for a
smartphone part. This company has a contract with Apple that all of its production will be bought
by Apple.
 a. Field Warehousing
b. Factoring Agreement
c. Convertible Bond
d. Sales and Leaseback

The raw material acts as a collateral for this case as there are no other alternatives.

5. FV Company wants buy new equipment but does not have enough cash and is highly leveraged.
The company though, has unsold inventories and huge amount of receivables.
a. Field Warehousing
b. Factoring Agreement
c. Convertible Bond
d. Leasing

Because the equipment is a long-term asset, it should not be collateralized by short-term assets.
Therefore, the only answer here is Leasing. Convertible bonds are too big for just one equipment.

ACCOUNTING REVIEW:

1. Company P has printed 100,000 bonds of face value of $100 each, carrying a stated interest rate
of 10% and maturing in five year. When the company is ready to sell the bonds on 1 January 2013
the market rate is 8%. Since the stated interest rate is higher than the market interest rate the
bonds will be issued at a premium to the par value which means the price will be higher than the
par value. What is the price? Answer: $108 because the market rates prevail.
2. The interest expense recognized on bonds issued at premium to par is the difference between the
interest paid or payable of $10,000 based on the stated interest rate of 10% (calculated as the
product of 10% and the face value of $100,000) and the annual amortization of premium on bonds
payable. If the premium is amortized based on a straight line method the premium of $8,000 would
be written off over the 5 years of the bonds payable. Answer: $1,600 ($8,000/5).
3. An investor purchases $50,000 of bonds that are convertible into 10,000 shares of common stock
at a conversion price of $5. At the time of issuance, the stock had a fair market value of $6.50.
What is the intrinsic value of the conversion feature at time of issuance? Answer: Intrinsic Value is
simply conversion shares times the conversion price. The market value does not matter for
INTRINSIC. Thus, the intrinsic value is $15,000.
4. What is the value of this bond? Company D has printed 1,000 bonds of $100 par value having a
maturity of 5 years and annual coupon of $8 per year. When it was finally ready to issue the bond
on 1 July 2012 the interest rate prevailing in the market has soared to 10%. Answer: $92,420

Present Value of Bonds using the market rate:

 5. What is the effective annual interest rate for nominal annual interest rate of 5% compounded
monthly? Answer: 5.116%

Solution: [1 + (.05/12)]^12 = 1.05116. Then subtract 1. (This formula is important!!!!)

6. A Universal Entertainment Inc you want to purchase a Company XYZ zero-coupon bond that has a
$1,000 face value and matures in three years, and you would like to earn 10% per year on
the investment. Determine the bond price. Answer: $751.31

7. P100,000 worth of bonds are sold at a discount of P15,000. The amount for Bonds Payable account
should be? Answer: (P100,000) – As I have told in class, Bonds Payable in Accounting is always the
FACE VALUE OF OBLIGATION)
8. Supposed a company issued debt with a face amount of P1 Million, payable in ten years and at no
stated interest rate, and the market rate for interest at the time of issuance was 10 percent. What
is the value recorded in Notes Payable? - $385,543.

Assigning a Value to Warrant: (This is a very impt formula!!)

For example:
9. A bond/warrant combination is purchased by an investor for $1,300. The investment banker
handling the transaction estimates that the value of the warrant is $120, while the bond (with a
face value of $1,000) begins trading at $985. Answer: $141.18

[$120/($985 +$120)]*1300 = $141.18

TRUST

 A bank, investment house or any corporation can be an institutional trustee that is duly authorized
by the Monetary Board of the BSP to perform trust and fiduciary business. The minimum entry is
P100,000.

o Under BSP MORB Section 4 covering UIT Funds, UITFs are subject to exposure limit to a
single entity equivalent to 15% of market value of the UIT Fund.
 The Trust Department/Group of a bank should be organizationally, functionally, administratively
and operationally separate from other bank proper.
o Trust assets are separate from Bank assets and are off-balance sheet.

o Chinese wall - The conceptual barrier separating the Trust Entity (TE) from the other
groups of the bank proper
 In a fiduciary relationship, one person/entity justifiably vests confidence, good faith, reliance,
and trust in another whose aid, advice or protection is sought in some matter.
o Under the Prudent Investor Rule, a trustee or investment manager may take certain
risks in the management of the assets provided that the management thereof is
consistent with the risk/return objective of the Trustor/Principal; provided further that
trustee looks into the investments from a portfolio level and not on the individual
security level.
 Trustee - The entity with whom the confidence is reposed as regards the management of assets
for the benefit of another person/entity. The benefits of appointing trustee (institutions) are the
following:
o Continuity of existence and capacity
o Professional Asset Management/ specialization
o Transfer of Legal Title
 Trustees cannot, however, guarantee returns. When dealing with investments, risks are always
present so returns are not guaranteed.
 What are the Fiduciary Standards of a Trustee?
 Revocable – the beneficiary can be changed with the beneficiary’s consent.
o The assets/properties under a revocable trust are subject to estate taxes in the event
that the trustor dies.
 Types of Funds – no matter how large you hold UITF, you will never have a say in management
as opposed to owning common stock which has direct ownership of the votes. For UITFs, the
votes are held by the mutual fund or bank.
 o UITF - defined as an open-ended pooled trust fund denominated in pesos or any
acceptable currency, which are operated and administered by a trust entity and made
available by participation.
o Fixed Income UITF - a type of Unit Trust invested in a mix government securities,
corporate bonds and other fixed income instruments. A fixed income fund may invest in
short term money market placements. Note that these are not entirely risk-free, as the
management of funds contribute as a risk factor.
o Equity Fund – invests primarily with equity but may include a little money-market or fixed
income.
o Closed-Ended Funds – since it is “closed” you can only buy this from other investors who
already own the fund.
 UITFS replaced common trust funds (Common Trust Funds uses accrual valuation while UTIFS
uses MTM)
 Types of Trust:
o Reversionary Trust - Form of trust whereby Trustor does not reserve the right to get the
trust property but requires its automatic return to him after the lapse of a certain period
or upon the happening of a condition.
o Dry Trust - The trust agreement is executed before the property is actually transferred to
the trustee.
o Incentive Trust - The funds are set aside in a trust designed to motivate the beneficiary
into accomplishing something (ex: obtaining a college degree), upon the occurrence of
which the trust funds are distributed to the beneficiary
o Personal Management Trust - In this form of Trust, The TRUSTOR transfers/delivers assets
to the TRUSTEE who will manage it for the benefit of the designated BENEFICIARIES of
the Fund.
o Profit-Sharing Trust. This is a plan established and maintained by an employer whereby
employees and their beneficiaries may participate in the sharing of the company’s profits
as a retirement incentive
o Testamentary Trust - This form of Trust sets the appointment of a trustee through a will
but takes effect upon the testator’s death.
 Escrow - A type of agency agreement wherein documents, real estate, money, or securities
deposited with a neutral third party agent to be delivered to the parties involved upon fulfillment
of certain conditions, as established in a written agreement

Difference between Agency and Trust

 DEATH - Trust does not terminate even after the Trustor dies. In Agency, the agreement
terminates upon the death of Principal.
 LEGAL TITLE – In trust, the legal title transfers to the Trustee. In agency, this remains with the
PRINCIPAL.