Chapter 3 Flashcards
Bond
is a debt security issued by the corporation. The bond’s indenture contractually stipulates that the investor will be repaid his or her invested principal plus interest
Corporate Bond
is a contract between a corporation and the investor, whereby the investor lends the corporation money, in return for a legal promise that the corporation will pay the principal back to the investor on a specified date, with interest.
bond’s indenture
also called the “deed of trust”) on the bond certificate. It will specify how and when the principal will be repaid, the rate of interest (also called the coupon), a description of property secured as collateral against default, and steps that shall be taken in the event of default.
Secured Debt
secured debt, corporation goes bankrupt, the trustee will take possession of the assets and liquidate them on the bondholders’ behalf. If the company defaults on its bond payments, there is still the protection of income from the sale of the company’s assets, which secure the payments
types of secured corporate bonds
Mortgage bonds are secured by a first or second mortgage on real property.
Equipment trust certificates are secured by a specific piece of equipment.
Collateral trust bonds are secured by the securities of another corporation, which is usually affiliated with the issuer in some way.
Unsecured Debt
are secured only by the corporation’s good faith and credit, and not by a specific asset. If the company defaults, the bondholders will have the same claim on the company’s assets as any other general creditor. Though secured bondholders will be paid before debenture holders, owners of stock will be paid after unsecured bondholders.
High-Yield (Junk) Bonds
Unsecured corporate bonds that are not considered investment grade by credit rating companies - those rated BBB or below by Standard & Poor’s (S&P) or Baa or below by Moody’s, for example - are called high-yield bonds, or junk bonds
Convertible Bonds
A corporation may issue convertible bonds, which allow investors to convert a bond into shares of the company’s common stock at a predetermined ratio. A corporation will issue these bonds to borrow money at a lower rate of interest than the company would pay on an equivalent non-convertible bond issue. The assumption is that investors will forgo a bit of interest on exchange for the conversion feature.
Conversion price
is the price per share at which the corporation will sell the bondholder the stock in exchange for the bond.
conversion ratio
is the par value of the bond divided by the conversion price, and it gives you the number of shares received for each bond.
Cconversion ratio = Par value
Conversion price
parity
market price of the stock equals the conversion price of the stock, the situation is called parity.
Zero Coupon Bonds
debt securities issued at a deep discount from par, with the difference between the discount and the face value paying out at maturity. These bonds do not make regular interest, or coupon, payments. Corporations, municipalities and the U.S. government all offer zero-coupon bonds.
CMOs
collateralized mortgage obligations, are mortgage-backed securities purchased in $1,000 denominations that pool together a large number of private mortgages (usually on single-family residences), mortgage pass-through securities like those issued by Fannie Mae and Ginnie Mae, and other CMOs.
tranches.
own estimated life, interest rate and payment priority, even though all tranches are backed by the same pool of mortgages.
capital market
is a source of intermediate-term to long-term financing in the form of equity or debt securities with maturities of more than one year.
Money Markets
provides very short-term funds to corporations, municipalities and the United States government. Money market securities are debt issues with maturities of one year or less
3 Characteristics of Money Markets
Liquidity - Since they are fixed-income securities with short-term maturities of a year or less, money market instruments are extremely liquid.
Safety - They also provide a relatively high degree of safety because their issuers have the highest credit ratings.
Discount Pricing- A third characteristic they have in common is that they are issued at adiscount to their face value.
Money market securities issued by the U.S. government and its agencies include the following vehicles:
Treasury bills (T-bills)
Treasury and agency securities with remaining maturities of less than a year
Federal National Mortgage Association (Fannie Mae) short-term discount notes
Federal Home Loan Bank short-term discount notes and interest-bearing notes
Federal Farm Credit Bank notes and bonds maturing in one year
Short-term discount notes issued by other smaller agencies
Construction loan notes (CLNs)
A short-term obligation in the form of a note, used for the funding of construction projects such as housing developments. In most cases, the note issuers will repay the note obligation by issuing a longer term bond and using the proceeds from the bond to pay back the note.
Revenue anticipation notes (RANs
A short-term debt security issued on the premise that future revenues will be sufficient to meet repayment obligations.
RANs are generally used to generate immediate investment capital to begin a large project. These securities are repaid with future expected revenues from the completed project, which may come from sources like turnpike tolls or stadium ticket sales.