Corporate Debt

Question 1

Bearer bonds

Answer 1

Issued in physical form with coupons attached. No record was kept of the owner. Coupons sent to paying agent to receive interest payments. No longer issued

Question 2

Fully registered bonds

Answer 2

These are registered as to principal and interest. They may have a physical cert (not used any more) which is sent to the owner but more usually now they are issued as book entry I.e. no physical cert but all details are registered by a transfer agent. Interest payments are made directly to the registered owner

Question 3

Indenture or trust indenture

Answer 3

This is a bond contract defining interest rate, maturity, collateral, call or put provisions and other features of the bond. An independent trustee is appointed to make sure the issuer sticks to the terms of the indenture

Question 4

Protective provisions or covenants

Answer 4

Required for corporate bonds:
An indenture may require the corporation to maintain specific protections for the bondholders e.g. insurance coverage, audit by independent accountant, ratios of assets to liabilities

Question 5

Cash settlement

Answer 5

These settlements occur on the same day as the trade date if done before 2:30 pm ET

Question 6

Regular way settlement

Answer 6

Same as standard settlement
T+1 days (as of 28th May 2024)
If the buyer and seller agree other arrangements can be made

Question 7

Secured bonds

Answer 7

Bonds with collateral pledged to back them
- Mortgage bonds (real estate pledged)
- Equipment trust certificates (backed by equipment owned by the issuing corp e.g. airlines pledge planes)
- Collateral trust certificates (portfolio of marketable securities used as collateral) - typically parent company uses the securities of a subsidiary as collateral
The bondowners have claim to the collateral if the issuer defaults.

Question 8

Liquidation order for paying debt

Answer 8

• Secured bondholders e.g. mortgage bondholders, equipment trust certificate holders
• Unpaid admin claims, unpaid wages, taxes, trade creditors
• Unsecured bondholders (Standard debentures i.e. unsecured creditors, Subordinated debentures)
• Preferred stockholders
• Common stockholders

Question 9

People involved with bond ownership and payments

Answer 9

Registrar monitors and audits the transfer agent
Paying agent send interest payments to owner and final principal repayment
Transfer agent transfers ownership record to new owner if bond is traded

Question 10

Arbitrage

Answer 10

This is when a trader buys a lower priced security and simultaneously sells an equivalent higher priced security to lock in a profit
For convertible bonds it only works when the bond trades below parity

Question 11

Convertible bonds

Answer 11

Corporate debentures that can be converted at the option of the owner into the common stock of the issuer. A conversion price is set per share at the time of issuance. The bond can be converted into a fixed number of common shares based on its par value. The conversion price is set at a premium to the stocks’s current market price at the time of issuance. The stock’s price must rise above the conversion price for the bondholder to benefit (shareholder benefit break point)

Question 12

Convertible bond trading relative to parity

Answer 12

Parity is when the market price of the bond equals the value of the stock it could be converted into. When the bond trades above parity there is no reason to convert the bond into stock as the stock received would be worth less than the bond’s current market value. When a bond trades below parity it would be profitable to convert the bond into the underlying stock.