Loan notes and debenturesThe relatively low interest rate risk associated with short-datedloan notes tends to
mean that lower returns are available from them as compared with those from notes
not due for redemption for some time.Ease of liquidating the investment
Businesses that wish to make public issues of loan notes must seek a capital market
listing for them if they are to have any serious hopes of success. Thus, publicly issued
loan notes can be liquidated by sale in the market.Loan notes and personal tax
Interest is subject to income tax in the hands of individual loan notes holders. Capital
gains are also taxed. Since all, or almost all, of the returns from loan notes are usually
in the form of interest, capital gains tend not to be significant.Degree of control
Loan notes do not give their holders any control over the business, except that which
is necessary to enforce payment of their dues in the event of the business defaulting
and to enforce any loan covenants.Eurobonds
Eurobondsare unsecured loan notes denominated in a currency other than the
home currency of the business that made the issue. They are foreign currency loans.
Businesses are prompted to make Eurobond issues to exploit the availability of
loan finance in an overseas country. Also, Eurobonds can offer innovative features
making them more attractive, both to the lenders and to the issuing business. This lat-
ter point arises from the fact that the bonds are traded in an unregulated market.
Despite their name, Eurobonds are not linked to Europe or the euro currency. They
are simply international bonds. The airline business British Airways plcis an example
of a UK business with a large Eurobond loan (£309 million), according to its 2007
annual report.Interest rate swaps
A business may have borrowed money where the contract specified a floating interest
rate, that is, an interest rate that varies with the general level of interest rates in the
economy. It may have preferred a loan with a fixed interest ratebut has been unable
to negotiate such an arrangement.
Under these circumstances, it may be possible for the business to find another busi-
ness with exactly the opposite problem, that is, with a fixed rate loan but a preference
for a floating rate loan. Having identified one another, each of the businesses might
agree to service the loan of the other. In practice they would probably make contact
first and then issue the loan notes or undertake the borrowing in some other form.
Interest rate swapshave practical relevance because different businesses have dif-
ferent credit ratings. One may be able to negotiate a floating rate loan at a reasonable
rate, but not a fixed rate one. The other business may find itself in the opposite posi-
tion. Swaps are another example of a derivative.
The supermarket businessTesco plcuses interest rate swaps to limit its exposure
to interest rate risk. In its 2007 annual report, the business says that its policy is to have
about 40 per cent of its long-term borrowings on fixed rates.‘
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