chapter ten notes Flashcards
bonds
long term debt sold to creditors
what are the two promises that bonds make?
- pay bond principal at maturity
2. pay interest periodically
“sold bonds” or “issuance”
YOU borrowed money
stated rate
aka “face rate” or “coupon rate”
DETERMINES INTEREST PAYMENT
market rate
aka “effective rate” or “yield”
DETERMINES SELLING PRICE OF THE BOND
bond indenture
bond contract
term bond
all bonds mature on the same date
debenture bonds
unsecured bonds (no collateral, much higher interest rate)
callable bonds
corporation reserves right to buy bonds back early at stated price (determined by issuer)
convertible bond
can be exchanged for a stated number of shares of stock (determined by the lender)
what are the advantages of issuing a bond?
- interest expense is tax deductible
2. bonds don’t dilute ownership
what are the disadvantages of issuing a bond?
- interest expense is a legal obligation
2. you need to have enough tax flow to cover this obligation
issuing bonds at a discount
market is more than stated
ISSUE LESS
issuing bonds at face value
market equals stated
issuing bonds at a premium
market is less than stated
ISSUE MORE
selling price
PV of face value + PV of cash interest payments
what are the steps to computing the issue price of bonds?
- make adjustments to compounding periods
- find interest payments
- find PV of face (FV*PV(MKT%,n))
- find PV of interest payments (PMT*PVOA(MKT%,n))
- Add PV of face and PV of payments to get SELLING PRICE
true cost of borrowing
AT THE MARKET RATE
“total interest expense”
cash interest payments+face value-issue price
what kind of liability is a premium?
adjunct liability (increase) eventual reduction of interest "you earn back a little bit of the premium each period"
retirement of a bond
“reduction of a bond”
what are the two ways you can retire a bond early?
- callable bonds and pay the call price
2. repurchase through the market and pay the market rate
gain on retirement
repurchase price is less than the carrying value
“you pay less than what you owe”
loss on retirement
repurchase price is more than the carrying value
“you pay more than what you owe”
