Ch 14 p. 2 Flashcards
What happens to the value of a bond during a leveraged buyout? Why?
They lose value
Loss in value occurs because additional debt added in capital structure increases likelihood of default
Firm underwriting
Investment banks underwrite entire issue of bond by guaranteeing certain sum to company
Taking risk of selling bonds for whatever price they can get
Best efforts underwriting
Investment bank sells bond issue for commission onProceeds of sale
Private placement
Issuing company sells bonds directly to large institution,Financial or otherwise without aid of underwriting
Secured bonds
Backed by pledge of some sort of collateral
Mortgage bonds
Secured by claim on real estate
Collateral trust bonds
Secured by stocks and bonds of other corporations
Unsecured bonds
Bonds not backed by collateral
Junk bond, define? what do companies use these bonds for?
Unsecured and very risky, paying high interest rate
Used to finance leveraged buyouts
Term bonds
Bond issues that mature on single date
Serial bonds
Mature in installments
Serially maturing bonds are frequently used by… 4 things
School or sanitary districts, municipalities or other local
Taxing bodies that receive money through special levy
Callable bonds
Give issuer right to call and redeem bonds prior to maturity
Convertible bonds
Bonds are convertible into other securities of corporationFor specified time after issuance
What 2 types of bonds have been developed in attempt to attract capital in a tight money market?
1 commodity backed bonds2 deep discount bonds
Commodity backed bonds AKA asset-linked bonds
Redeemable in measures of commodity such as barrels ofOil, tons of coal, ounces of rare metal
Ex. Sunshine mining sold 2 issues of bonds redeemable with either $1000 cash or 50 ounces of silver, whichever isGreater at maturity, stated interest rate 8.5%
Deep discount bonds AKA zero interest debenture
Sold at discount provides buyers with total interest payoff At maturity
Registered bonds define, what 2 things do they require?
Bonds issued in name of owner
Require surrender of certificate and issuance of new
Certificate to complete sale
Bearer AKA coupon bond
Not recorded in name of owner
May be transferred from one owner to another by delivery
Income bonds
Pay no interest unless issuing company is profitable
Revenue bonds
Interest is paid from specific revenue sources
Ex. Issued by airports, school districts, counties, toll road authorities and government bodies
Bond is valued by its
Present value of expected future cashflows from interest
And principal
Stated AKA coupon or nominal rate
Interest rate written on bond certificate
Expressed as percentage of Maturity value
2 other names for maturity value
Par value, principal amount
Discount
Bonds sell for less than face value
Premium
Bonds sell for more than face value
Effective yield AKA Market rate
Interest actually earned by bond holders
Recall that discount on bonds payable due to its relation to interest, companies…
Amortize the discount and charge it to interest expense
Over period of time that bonds are outstanding
Amortization: straight line method
Amortizes constant amount each interest period
1 Amortization of discount…
2 While amortization of premium…
1 Increases interest expense
2 Decreases interest expense
When companies issue bonds on other than interest payment dates, buyers of the bonds will pay the sell the…
Interest accrued from the last interest payment date
To the date of issue
Preferred procedure for amortization of discount or premium: effective interest method AKA present value amortization
Equation (simple, broken down)
Amortization amt. =Bond Interest Expense - Bond Interest Paid
(carrying value of bonds at beginning of period x effective int. rt.)
- (face amount of bonds x stated int. rt.)
How are unamortized bond issue costs treated?
Treated ad deferred charge and amortized over life of debt
IFRS: issue costs requirement, and it’s effect?
Requires issue costs reduce carrying amount of the bond
This increases the effective interest rate
Extinguishment of debt
Companies Payment of debt
Extinguishment of debt: if the company holds bonds to maturity
Company doesn’t compute any gains or losses
Reacquisition price
Amount paid on extinguishment or redemption before maturity
Including call premium and expense of Reacquisition
Net carrying amount of bonds on any specified sate
Amount payable at maturity adjusted for unamortized
Premium or discount and cost of issuance
Gain from extinguishment
Any excess of net carrying amount over Reacquisition price
Loss from extinguishment
Excess of reacquisition price over net carrying amount
In substance defeasance
Arrangement whereby company provides future repayment
Of Longterm debt issue by placing purchased securities in
Irrevocable trust
Not considered extinguishment of debt
The amortized premium or discount and any costs of issue applicable to the bonds must be…
Amortized up to reacquisition date
Refunding, when is it advantageous?
Replacement of an existing bond issue with a new one
Advantageous to replace entire outstanding bond issue
With a new issue bearing a lower interest rate
Longterm notes payable, 2 similarities to bonds, 1 difference
Similar in substance to bonds: 1 fixed maturity dates
2 carrying either stated or implicit interest rate
Difference: do not trade as readily as bonds in
Public security markets
In instances where company measures present value of debt instrument by fair value of property, goods or services: if there is no stated rate of interest, the amount of interest is…
Difference between face amount of note and fair value
Of property
1 Imputation
2 Imputed interest rate
1 process of interest rate approximation
2 resulting interest rate from imputation
Mortgage note payable
Promissory note secured by document called mortgage
That pledges title to property as security for loan
Most common form of Longterm notes payable
Point
One percent of effective interest rate of note
Fixed rate mortgages
Interest rate stays constant
Variable rate mortgages AKA floating rate or adjustable rate mortgages
When are they adjusted? What are they pegged to either of 2 rates?
Feature interest rates tied to changes in fluctuating market
Rate
Lenders adjust interest rates in either 1 year or 3 year intervals
Adjustments pegged to changes in prime rate or US Treasury
Bond rate
What happens if companies choose the fair value option?
Noncurrent liabilities: bonds, and notes payable are recorded
At fair value
unrealized holding gains or losses reported as part of
net income
Unrealized holding gain or loss
Net change in fair value of liability from 1 period to another
Exclusive of interest expense recognized but not recorded
Off balance sheet financing
Attempt to borrow monies in such a way to prevent
Recording obligations
3 common forms of off balance sheet financing
1 non-consolidated subsidiary
2 special-purpose entity (SPE)
3 operating leases
Off balance sheet financing: non-consolidated subsidiary
Parent company doesn’t have to consolidate subsidiary
Company that is less than 50 percent owned
Parent doesn’t need to report assets and liabilities of
Subsidiary
Off balance sheet financing: special-purpose entity (SPE)
2 Project financing arrangement, why is it used?
1 Created to perform special project
2 management creates an SPE for purpose to build project
Management does not want to report the plant or borrowing
Used to fund the construction on the balance sheet
Off balance sheet financing: SPE: take or pay contracts
The SPE finances and builds the plant, while the company
Guarantees that it or outside party will purchase all products
Produced by plant
Allows company to keep assets and liabilities from project
Off balance sheet
Off balance sheet financing: operating leases
Instead of owning assets companies lease them
Only report rent expense and note of disclosure
In order to get off balance sheet financing special purpose entities (SPEs) often use…
Leases
Why do companies engage in off balance sheet financing? 2 main reasons
1 many believe removing debt enhances quality of balance
Sheet and permits credit to be obtained more readily at
Cheaper rate
2 loan covenants limit amount of debt company may have
To fight off balance sheet debt, what does SOX require companies to disclose? 2 things, how are they presented?
1 all contractual obligations in tabular format
2 contingent liabilities and commitments in either textual
Or tabular format
IFRS securities are not required to disclose…
All contractual obligations or contingent liabilities
Debt to assets ratio, what does it measure?
Debt to assets = total liablities/total assets
Measures percentage of total assets provided by creditors
Times interest earned ratio, what does it measure?
Times interest earned =
(Income before income taxes and interest expense)/(interest exp.)
Indicates company’s ability to meet interest payments
As they come due
In the banking industry when the company bond’s credit rating drops…
They can record a gain, because their liability value drops
If value of company’s liability is less they are better off
So they can record a gain
