A:

Favorable market conditions or the strengthening of a company's credit rating may lead to the refinancing of corporate debt. The two primary factors for influencing a company to refinance are decreases in the interest rate or improvements in the company's credit quality.

When a company issues debt, usually in the form of long-term bonds, it is agreeing to pay a periodic interest charge, known as a coupon, to the bondholders. The coupon rate reflects the current market interest rates and the company's credit rating.

When interest rates drop, the company will want to refinance its debt at the new rate. Because the debt was issued during a time of higher interest rates, the company is paying a larger interest rate than what current market conditions would specify. In this case, the company may refinance by issuing new bonds at the lower coupon rate and use the proceeds to buy back the older bonds. This allows the company to capitalize on the lower interest rate, which allows it to pay a smaller interest charge.

A company's credit rating is reflected in the coupon rate on newly issued debt. A risky company will need to offer lenders a larger return, to compensate them for the additional risk of investing in that company. When a company's credit quality improves, investors won't require such a high return because that company's bonds will be a safer investment. If lenders are requiring a lower return than before, a company will probably want to refinance its older debt at the new rate.

To learn more about corporate borrowing, read When Companies Borrow Money.

RELATED FAQS

  1. Why should investors research the C-suite executives of a company?

    Learn how C-suite officers affect shareholders; discover how the CEO impacts financial performance and why governance is ...
  2. What is the difference between a direct and an indirect distribution channel?

    Learn about the primary differences between direct and indirect distribution channels, and under what circumstances a company ...
  3. How can an investor determine a company's annual return from looking at its financial ...

    Understand what a share premium account is, what funds go into the account and the specific purposes for which the funds ...
  4. How do companies identify and manage business risk?

    Learn what risks businesses can be exposed to during any phase of the business life cycle, and how these risk can be identified ...
RELATED TERMS
  1. Altman Z-Score

    The output of a credit-strength test that gauges a publicly traded ...
  2. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
  3. Business Judgment Rule

    A legal principle which grants directors, officers, and agents ...
  4. Separation Of Powers

    An organizational structure in which responsibilities, authorities, ...
  5. Protected Cell Company (PCC)

    A corporate structure in which a single legal entity is comprised ...
  6. Estimated Recovery Value (ERV)

    The projected value of an asset that can be recovered in the ...

You May Also Like

Related Articles
  1. Investing News

    A New Corporate Governance Initiative ...

  2. Stock Analysis

    Will American Airlines Fall Back To ...

  3. Stock Analysis

    Qualcomm's New Buyback Program Is Well-Timed

  4. Stock Analysis

    Is Prospect Capital Exposed To Elevated ...

  5. Stock Analysis

    Why Investors Bailed On Halcon's Stocks

Trading Center