Long-term debts are non-current liabilities with obligations beyond one year. Long-term debt can be viewed from two perspectives: financial statement reporting by issuer and financial investing.
The balance sheet must record long-term debts and the related payment obligations in the non-current section of the balance sheet.
On the other hand, investing in long-term debt means putting in debt instruments having maturities of more than one year.
Companies chose long-term debt with various considerations. They focus on the timeframe for repayment including the interest component.
Investors invest in long-term debt for the advantages of regular interest payments and consider the time to maturity as liquidity risk.
The risk of long-term debt depends largely on market rate changes and whether or not it has fixed or floating rate interest terms.
Investing in Long-Term Debt
Companies have to consider various factors when both issuing and investing in long-term debt. For investors, long-term debt simply means debt maturing beyond one year.
There are various long-term debts that the company can choose from for investing. Generally, these debts include central bank-backed treasuries, corporate bonds, and municipal bonds.
Why Companies Use Long-Term Debt Instruments?
Any company takes on long-term debt to obtain immediate capital. The housing finance companies and startup ventures are leveraged on financial aspects and they have to regularly take debts in order to meet basic business expenses.
Overall, all businesses need to have capital on hand and debt is one source for obtaining immediate funds to finance business operations.
Long-term debt has advantages over short-term debts. Interest from long-term debts is taken as business expenses and deductible. Long-term debt has a higher than one-year obligation.
7 Types of Long-term Debts
The various types of long term debts are discussed below:
The central banks and governments issue both short-term and long-term debt securities.
The long-term treasuries maturities have the maturity of say 2 years, 5 years, and 10 years. Some government issues as far as 15 to 20-year maturity treasuries.
These are debt instruments issued by the government to fund infrastructure projects launched by the government.
Municipal bonds are typically considered to be the lowest risk bond with a risk slightly higher than the treasuries.
The government issues short term and long term municipal bonds for public investment.
Corporate bonds have higher default risks than Treasuries and municipals. These bonds receive ratings from the rating agencies and since these are backed by the companies, these carry a higher risk than the municipal bonds and treasuries.
Rating agencies depend on solvency ratios when analyzing and providing entity ratings. These bonds are common types of long-term debts.
Corporations may issue debts with various maturities. All corporate bonds with maturities greater than one year are considered long-term debt investments.
The company here puts collateral such as real estate, buildings, or lands to get a loan equivalent to up to 80% value of the collateral.
These are generally long-term debt meaning obligations are spread for more than one year.
Debentures refer to unsecured bonds of the corporation. Debentures are not secured by any specific company. The debenture holder becomes the creditor general in case of liquidation of the company.
Hence, investors try to look earning power of the company as a basic prerequisite for investment or raising debt. Although unsecured, debenture holders get priority over the equity shareholders.
This means that debenture holders will be paid before any amount is paid to equity or preference shareholders.
6. Income Bonds
The company is required to pay interest on an income bond only when the interest is earned. The interesting feature may be cumulative meaning it accumulates if not paid.
If the company does not generate enough profits, it will have to provide for interest to the extent the earnings of the company permits.
7. Equity-Linked Debt Some debt issues
These are linked to common stock or preferred stock and allows the holder to exchange the security for the company’s common stock at the option of the holder.
Interest costs of the convertible debt issue are less than similar debt issues without conversion options and investors willing to accept conversion.
Likewise, another type of equity-linked debt is the issuance of warrants with debt securities.