Corporate Debt Securities

Question 1

Corporate bonds are also known as…

Answer 1

Senior securities, because they rank above general creditor claims and both come before equity securities

Question 2

The Trust Indenture Act 1939 covers which type of bonds?

Answer 2

New issues of corporate bonds. Note the Act doesn’t cover municipal or government bonds.

Question 3

What’s the threshold above which a corporation must provide an indenture under the Act?

Answer 3

Above $10m

Indenture is with a trustee

Question 4

Name 7 items in an indenture…

Answer 4

1. Amount of issue
2. Maturity date
3. Coupon rate and payment dates
4. Collateral (if applicable)
5. Conversion terms
6. Early retirement provisions
7. Restrictive covenants (eg liquidity or capital ratios)

Question 5

The Securities Act 1933 requires SEC registration for what type of corporate debt security?

Answer 5

An issue with a maturity >270 days

Question 6

A closed-end indenture limits issue of additional bonds against the same collateral.
What protections typically apply to an open-end indenture?

Answer 6

Typically

• must meet earnings target before additional issue (earnings test / additional bond test)
• maintenance of specified working capital
• limit common stock dividends
• ratio of total debt : total assets

Question 7

Name three types of secured bond

Answer 7

• Mortgage bond (against real property)
• Equipment Trust Certificate (bond redeemed faster than asset depreciates so high level of protection)
• Collateral Trust Bond (against securities of another corporation)

Question 8

Unsecured bonds are known as…

Answer 8

Debentures

Two ranks - debentures and subordinated debentures

Question 9

Advantages of convertible bonds - list three

Answer 9

1. Issued at lower interest rate than a non convertible issue
2. Investor sits before preferred and common stockholders in a liquidation
3. Conversion can reduce long term debt and improve interest coverage ratio

Question 10

How do you calculate the conversion ratio?

Answer 10

Par value of bond ($1000) divided by conversion price

Parity price of a bond is conversion ratio x market price of stock

Question 11

What’s the difference between a Eurobond and and Eurodollar Bond?

Answer 11

Eurobond – bond sold in a country other than the one in whose currency it is denominated

Eurodollar Bond – a dollar bond outside US. They are not registered in US and can’t trade in US for at least 40 days

Question 12

Where do most corporate bonds trade?

Answer 12

OTC market as most not listed

Question 13

How are corporate bond prices quoted?

Answer 13

As $ price percentage of par, quoted in points and eighths of a point.
93 4/8 = 93.5 = $935

Question 14

How are corporate bond trades settled?

Answer 14

Regular way (T+3) unless a cash transaction

Question 15

How is the final transaction amount calculated?

Answer 15

Purchase price plus accrued interest

Seller due interest up to but not including settlement date.
Calculated on a 360 day year.

Question 16

What grades are investment grade?

Answer 16

Moody’s: Aaa, Aa, A, Baa

S&P: AAA, AA, A, BBB

Question 17

What’s the window to report TRACE transactions?

Answer 17

15 minutes

Question 18

What types of fixed income securities are reported on TRACE?

Answer 18

• Investment, non-investment grade and split rated securities
• SEC registered debt securities
• Securities issued under 1933 Act and traded according to 144a
• Debt securities issued or guaranteed by US govt agency or govt sponsored enterprise

Question 19

What are income/adjustment bonds?

Answer 19

Pay principal at maturity but only pay interest if earnings pass a certain level. Trade flat and at a discount

Question 20

What’s the tax treatment of a zero coupon bond?

Answer 20

Annually holder increases cost basis - representing taxable income (phantom income). If held to maturity, basis accreted to par and no capital gain. If sold before for more/less than accreted basis there’s a gain/loss (sold at purchase price creates loss)