Debt is amount borrowed by a firm to finance its business by issuing debt instruments.Firms usually pay interest on their debt at the end of each period e.g. annually,semiannually, quarterly etc. Interest is cost of debt for firm and fixed income for creditors. Debt has maturity
refers to time period until particular debt remainsoutstanding such as a 10-year bond, 20-year bond etc. Debt can be categorized asshort term debt and long term debt. Short term debt is borrowing of firm that havematurity of one year or less such as short term bank loan, T-bill etc, while long termdebt represents the debt that remains outstanding for more than one year for example,note, debenture, bond etc. Debt can also be classified as secured and unsecured debt.Secured debt is borrowing that pledge certain asset of firms as a security in condition of financial distress such as collateral. Unsecured debt is borrowing that does not pledgeany asset of firm such as note and debenture (Ross et al 2008). The instruments differ by maturity, interest rate (fixed or floating), currency, seniority, security, and whether thedebt can be converted into equity. Hybrid securities are particular type of securities thatpossess the characteristics of equity and debt i.e. convertible bond, income bond.Convertible bonds are bond that can be converted into equity before maturity and anychange in price of shares affects convertible bond. Income bonds have fixed maturitybut are paid interest if firm earns sufficient income. We regard hybrid securities as debtbecause they possess characteristics of either fixed income that is tax deductible andfixed maturity.
Goals / Principles of Capital Structure Management:
For considering the suitable pattern of capital structure, it is necessary toconsider certain basic principles which are militant to each other. It is necessary to finda golden mean by giving proper weight age to each of them.
(I) Cost Principle:
According to this principle, ideal capital structure should minimize costfinancing and maximize earnings per share. Debt capital is a cheaper form of capitaldue to-two reasons. First, the expectations of returns of debt capital holders are less