4.0 Types of Securities Flashcards
Indenture (Bonds)
The terms of bond agreements
- Can property purchased with bonds be Sold?
- Usually states that property bought with bonds can’t be pledged on another loan
Underwriting (by Investment Banker)
- An INSURANCE function when he buys securities and resells them
Risk of Price Fluctuations during distribution period borne entirely by Investment banker
Profit earned = underwriting spread. Difference purchase and resale price
Bond Pro/Con
pro: T,C
Con: LLII
Pro:
- Tax Deductible
- basic Control not shared with Debtholders
Con:
- Legal obligation: (Can force Insolvency), Raises Risk>S-holders demand higher capitalization rates>Decline in stock prices
- Limited: Debt Financing (Debt/Equity) limit decided by community. After which>too expensive
- Interest rates may fall and might be unable to refinance
- Indenture may call mgt to maintain specific ratios
Call Provision - Bond
Bond Sinking Fund
Issuer may Call the debt in (Redeem).
This is undesirable to Bond Holder
A fund established to retire Bond Debt
Term Bond v
Serial Bond
Matures at end
Serial Bond matures at stated amts over time
Variable Rate Bonds
Interest based on market
Zero Coupon Bond (Deep Discount Bond)
No interest rate, no pmts. Interest is the Discount
Commodity Backed Bond
Payable at rates tied to a commodity (ie Gold)
Convertible Bonds
Convertible into Equity
Types of Bond by Security
Mortgage - Backed by assets (usually real estate)
Debentures - By full faith and credit (no asset)
Equipment Trust - Equipment
Registered Bonds v
Bearer
Named owner receives interest and principal
Bearer: Holder receives
Junior Securities
Subordinated Debentures and Second Mortgage Bonds (Claims inferior to Senior Bonds)
Income Bonds
Pay interest only if issuer Earns the Interest
Revenue Bonds
Government Bonds payable from specific Revenue Sources
Bond Ratings
AAA - Investment Grade
BB or lower - Junk Bond
Bond (Lowest Return to Highest)
TSSI, SIJ
- Treasury
- Secured (1st Mortgage ie)
- Second Mortgage Bond
- Investment Grade
- Subordinated
- Income
- Junk
Interest Rate Risk (Bond)
Risk of fluctuation due to change in interest rates
Longer term of bond, more sensitive it is to this risk
Hi Inflation = Hi interest rate
Bond Valuation
- PV of principal and interest payments (discounted at market interest rate)
Yield to Maturity; Ultimate return to investor based on prevailing interest rates. The Effective interest rate
Stated Rate = market rate: PV = Face
Stated Rate less than Market : must Discount
Stated Rate exceeds Market: sell at premium
Convertible Bond (with Formula)
Can be exchanged for Stock
Formula:
Conversion Ratio =
Par Value
————-
Conversion Price
Debt Covenants
Def
Restrictions or protective clauses imposed ON borrower in formal agreement or Indenture
Eg
- Limit on LT / ST debt
- limit on Dividend pmts
- maintenance of certain Ratios
- maintaining specific collateral that backs debt
- more restrictive = lower risk = lower interest rate
Bond
States Rate = Market Rate
Stated Rate lower than Market
Stated Rate higher than Market Rate
Equal: PV IS EQUAL TO FACE (at par)
Lower: incentive offered because stated rate lower than Market. Sold at Discount
Higher: sold at Premium. Investors pay more because periodic interest is higher than Market
Debt Covenant Examples
LT,LD
R,C
- Limits on Long Term/Short Term Debt
- Limits on Dividends
- Ratios to be maintained
- Collateral to be maintained backing Debt
