chapter ten notes

Question 1

bonds

Answer 1

long term debt sold to creditors

Question 2

what are the two promises that bonds make?

Answer 2

1. pay bond principal at maturity

2. pay interest periodically

Question 3

“sold bonds” or “issuance”

Answer 3

YOU borrowed money

Question 4

stated rate

Answer 4

aka “face rate” or “coupon rate”

DETERMINES INTEREST PAYMENT

Question 5

market rate

Answer 5

aka “effective rate” or “yield”

DETERMINES SELLING PRICE OF THE BOND

Question 6

bond indenture

Answer 6

bond contract

Question 7

term bond

Answer 7

all bonds mature on the same date

Question 8

debenture bonds

Answer 8

unsecured bonds
(no collateral, much higher interest rate)

Question 9

callable bonds

Answer 9

corporation reserves right to buy bonds back early at stated price (determined by issuer)

Question 10

convertible bond

Answer 10

can be exchanged for a stated number of shares of stock (determined by the lender)

Question 11

what are the advantages of issuing a bond?

Answer 11

1. interest expense is tax deductible

2. bonds don’t dilute ownership

Question 12

what are the disadvantages of issuing a bond?

Answer 12

1. interest expense is a legal obligation

2. you need to have enough tax flow to cover this obligation

Question 13

issuing bonds at a discount

Answer 13

market is more than stated

ISSUE LESS

Question 14

issuing bonds at face value

Answer 14

market equals stated

Question 15

issuing bonds at a premium

Answer 15

market is less than stated

ISSUE MORE

Question 16

selling price

Answer 16

PV of face value + PV of cash interest payments

Question 17

what are the steps to computing the issue price of bonds?

Answer 17

1. make adjustments to compounding periods
2. find interest payments
3. find PV of face (FV*PV(MKT%,n))
4. find PV of interest payments (PMT*PVOA(MKT%,n))
5. Add PV of face and PV of payments to get SELLING PRICE

Question 18

true cost of borrowing

Answer 18

AT THE MARKET RATE
“total interest expense”
cash interest payments+face value-issue price

Question 19

what kind of liability is a premium?

Answer 19

adjunct liability (increase)
eventual reduction of interest "you earn back a little bit of the premium each period"

Question 20

retirement of a bond

Answer 20

“reduction of a bond”

Question 21

what are the two ways you can retire a bond early?

Answer 21

1. callable bonds and pay the call price

2. repurchase through the market and pay the market rate

Question 22

gain on retirement

Answer 22

repurchase price is less than the carrying value

“you pay less than what you owe”

Question 23

loss on retirement

Answer 23

repurchase price is more than the carrying value

“you pay more than what you owe”