Debt management

Debt, alongside equity, is where the cash for working capital, expansion and equipment comes from — and it is never free. Its cost varies with the source, the term and the borrower's credit quality, and managing that cost is a defined treasury function with three jobs:

• Minimise the cost of borrowing across all sources and maturities.
• Manage the risks debt creates — refinancing risk, interest rate risk, currency risk.
• Maintain continued access to credit at reasonable rates.

The trade-off running through all three is cost against risk. The cheaper source often carries the greater danger: short-term money is cheaper but must be refinanced repeatedly, and the moment you most need to roll it over is exactly the moment lenders are least willing. Every decision in this step is a position on that trade-off.

Which source fits depends on the amount, the duration, the company's credit standing and the state of the market. Five to know:

The Zambian market weights this list heavily toward the top: bank loans dominate corporate borrowing, the government issues bonds regularly in kwacha and dollars, but shallow capital markets keep corporate bonds uncommon and commercial paper rare. Leasing and hire purchase carry equipment finance. Reading a Zambian case, assume bank debt unless told otherwise.

The matching principle says the maturity of the funds should match the maturity of the use: short-term assets financed short, long-term assets financed long. The reasons sit in the two columns of advantages and risks.

Violating the principle in either direction has a price. Fund a factory with 90-day paper and the business re-runs its refinancing gamble forty times over the asset's life. Fund seasonal inventory with a 10-year loan and you pay long-term rates on money that sits idle most of the year. The principle is the default; departures from it are the aggressive and conservative financing policies from the working capital lesson, chosen deliberately or not at all.

A covenant is a restriction the lender writes into the loan to protect its repayment. Affirmative covenants say what the borrower must do: maintain minimum working capital or current ratios, keep interest cover (PBIT over interest expense) above a floor, deliver financial statements, insure the financed assets, pay taxes on time. Restrictive covenants say what it cannot do without consent: issue further debt beyond a set level, dispose of the financed assets, pay dividends that would breach a gearing ratio, exceed a capex ceiling, or change the nature of the business.

Breaching a covenant can trigger default and give the lender the right to demand early repayment — which converts a technical breach into a cash crisis. That is why treasury monitors covenant headroom as carefully as cash itself.

A bond promises a coupon each year and its face value at maturity, and its market price is simply those cash flows discounted at the market yield for similar bonds. When the market yield is above the coupon, the price sits below par; when below, above par. The price is where an old coupon meets today's rates.

The lecture's example, corrected: a 5-year bond, face value ZMW 1,000,000, coupon 12% (ZMW 120,000 a year), priced when similar bonds yield 14%.

The bond is worth about ZMW 931,300 — a discount to par, as it must be: nobody pays full price for 12% coupons when the market pays 14%. An issuer selling new debt at par in this market simply sets the coupon at 14%. And duration from the previous lesson applies here directly — the longer the maturity and the lower the coupon, the harder the price falls when yields rise, which is the risk a bondholding treasury is carrying.

Rating agencies — Moody's, Standard & Poor's, Fitch — grade the likelihood that a borrower defaults, and that grade prices its debt. The scale's crucial line runs between investment grade and speculative.

Investment grade — BBB and above — is what most institutional investors are permitted to hold, so falling below it doesn't just raise a borrower's rate, it shrinks the pool of lenders. The swap example in the risk lesson ran on exactly this machinery: Zambia Sugar's AAA against Lafarge's BBB is what created the rate differentials the swap arbitraged.

The sovereign rating sits above every corporate one. Zambia's government rating sets the ceiling for how the country's borrowers are perceived: a downgrade signals higher risk to international investors, tightens credit and raises rates for the state and companies alike — felt sharply through Zambia's debt restructuring years. For treasury the insight is simple: the company's cost of debt is built on a floor it does not control, which is one more reason to lock funding when conditions are good.