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Chapter 21

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BU393 Chapter 21 – Long-Term Debt Week 7 The Public Issue of Bonds -The general procedures followed in a public issue of bonds are the same as those for stocks -A bond indenture includes: 1. The basic terms of the bond 2. A description of property used as security 3. The seniority of the bonds 4. Details of the protective covenants 5. The sinking fund arrangements 6. The call provision -Registered – bonds in which the issuing company keeps records of the ownership of each registered bond. The company will pay interest and principal by cheque mailed directly to the address of the owner of record -Bearer – a bond issued without record of the owner’s name -Protected covenant – parts of the indenture or loan agreement that limit certain actions a company takes during the term of the loan to protect the lender’s interest -Negative covenant – part of the indenture or loan agreement that limits or prohibits actions that the company may take -Sinking fund – an account managed by the bond trustee for the purpose of repaying the bonds -Call premium – the price of a call option on common stock -Deferred call - a provision that prohibits the company from calling the bond before a certain date. During this period the bond is said to be call protected -Call protected – describes a bond that is not allowed to be called, usually for a certain early period in the life of the bond Bond Refunding -Replacing all or part of an issue of outstanding bonds is called bond refunding -The first step is to call the entire issue of bonds at the call price -Call provisions have value -Bondholders will take the call provision into account when they buy the bond -The value of the company is the value of the stock plus the value of the bonds -In constructing a framework to analyze a refunding operation, there are three steps: cost of refunding, interest savings, and the NPV of the refunding operation Bond Ratings -Debt rated AAA is judged to be the best quality and to have the lowest degree of risk -The lowest rating, C or D, indicates that the firm is in default -Low-grade bonds are corporate bonds that are rated below investment grade by the major rating agencies (BBB and lower) -Bonds with lower ratings tend to have higher interest costs -Bond ratings can be imperfect measures of risk -Junk bonds are bonds with ratings of BB and lower -Investment-grade issues have much lower direct costs, particularly for straight bonds Some Different Types of Bonds -Zero coupon bonds – bonds that make no coupon payments and thus are initially prices at a deep discount -Floating-rate bonds – a debt obligation with an adjustab
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