Corporate & Municipal Debt Securities

Question 1

Fully Registered Bonds

Answer 1

Have the owner’s name recorded for both the interest and principal payments. The owner is not required to clip coupons and the issuer will send out the interest payments directly to the holder on a semiannual basis. The issuer will also send the principal payment along with last semiannual interest payment directly to the owner at maturity. Most bonds in the United States are issued in fully registered form.

Question 2

Principal-Only Bonds

Answer 2

Have the owner’s name printed on the bond certificate. The issuer knows who owns the bond and who is entitled to receive the principal payment at maturity. However, the bondholder will still be required to clip the coupons to receive the semiannual interest payments.

Question 3

Elements of an Issued Bond Certificate

Answer 3

Name of issuer, principal amount, issuing date, maturity date, interest payment dates, place where interest is payable, type of bond, interest rate, call feature, reference to the trust indenture.

Question 4

Factors that Affect Pricing of Bonds in Secondary Market

Answer 4

Rating, interest rates, term, coupon rate, type of bond, issuer, supply & demand, etc

Question 5

Par Value

Answer 5

Equal to the amount the investor has loaned to the issuer. The terms par value, face value, and principal amount are synonymous and are always equal to $1,000. The principal amount is the amount that will be received by the investor at maturity, regardless of the price the investor paid for the bond.

Question 6

Discount

Answer 6

Any time an investor buys a bond at a price that is below the par value.

Question 7

Premium

Answer 7

Any time an investor buys a bond at a price that exceeds its par value.

Question 8

Factors that Affect Bond Yield

Answer 8

Current interest rates, term of the bond, credit quality of the issuer, type of collateral, whether it’s convertible or callable, purchase price.

Question 9

Nominal Yield

Answer 9

A bond’s nominal yield is the interest rate that is printed on the bond. The nominal yield is always stated as a percentage of par. It is fixed at the time of the bond’s issuance and never changes. The nominal yield may also be called the coupon rate.

Question 10

Current Yield

Answer 10

Annual income / current market price. Relationship between the annual interest generated by the bond and the bond’s current market price.

Question 11

Yield to Maturity

Answer 11

The investor’s total annualized return for investing in the bond. A bond’s yield to maturity takes into consideration the annual income received by the investor along with any difference between the price the investor paid for the bond and the par value that will be received at maturity. It also assumes that the investor is reinvesting the semiannual interest payments at the same rate. The yield to maturity is the most important yield for an investor who purchases the bond.

Question 12

Term Maturity

Answer 12

The entire principal amount becomes due on a specific date, as well as the last semiannual coupon payment (if there is one).

Question 13

Serial Maturity

Answer 13

Has a portion of the issue maturing over a series of years. Traditionally, serial bonds have larger portions of the principal maturing in later years. The portion of the bonds maturing in later years will carry a higher yield to maturity because investors who have their money at risk longer will demand a higher interest rate.

Question 14

Balloon Maturity

Answer 14

Contains a maturity schedule that repays a portion of the issue’s principal over a number of years, just like a serial issue. However, with a balloon maturity, the largest portion of the principal amount is due on the last date.

Question 15

Secured Bond

Answer 15

Backed by a specific pledge of assets. The assets that have been pledged become known as collateral for the bond issue or the loan. A trustee will hold the title to the collateral and, in the event of default, the bondholders may claim the assets that have been pledged.

Question 16

Mortgage Bond

Answer 16

Backed by a pledge of real property owned by the company. A mortgage bond works in a similar fashion to a residential mortgage.

Question 17

Equipment Trust Certificate

Answer 17

Backed by a pledge of large equipment that the corporation owns.

Question 18

Collateral Trust Certificate

Answer 18

A bond that has been backed by a pledge of securities that the issuer has purchased for investment purposes. They can also be backed by shares of a wholly owned subsidiary. Both stocks and bonds are acceptable forms of collateral as long as another issuer has issued them. This collateral is held by a trustee for safekeeping. However, bond holders do not want to take title to the collateral - they’re in it for principal and interest payments.

Question 19

Unsecured Bond

Answer 19

Also known as a debenture, has no collateral for the loan. Only backed by the good faith and credit of the issuer. In the event of a default, the holder of a debenture is treated like a general creditor.

Question 20

Subordinated Debenture

Answer 20

An unsecured loan to the issuer that has a junior claim on the issuer in the event of default relative to the straight debenture. Should the issuer default, the holder of the regular debentures and other general creditors will be paid before the holders of the subordinate debentures.

Question 21

Income/Adjustment Bond

Answer 21

Usually issued by corporations in severe financial difficulty. The bond is unsecured and the investor is only promised to be paid interest if the corporation has enough income to do so. The interest rate is very high and the bonds are issued at a deep discount to par. An income bond is never an appropriate recommendation for an investor seeking income or safety of principal.

Question 22

Zero-Coupon Bond

Answer 22

Does not pay any semiannual interest. Issued at a deep discount from the par value and appreciates up to par at maturity. The price of zero-coupon bonds are most sensitive to changes in interest rates.

Question 23

Convertible Bond

Answer 23

A corporate bond that may be converted or exchanged for common shares of the corporation at a predetermined price known as the conversion price. Convertible bonds have benefits to both the issuer and the investor. The bond will usually pay a lower rate of interest than nonconvertible bonds. The investor can also realized significant capital appreciation if the stock of the corporation does well. The investor enjoys senior position as creditor, while enjoying the potential for capital appreciation.

Question 24

Number of Shares Upon Conversion

Answer 24

Par value / Conversion Price

Question 25

Parity Price

Answer 25

Current market value of the convertible bond / number of shares to be received. Determines the value at which the stock must be priced in order for the value of the common stock to be equal to the value of the bond that the investor already owns.

Question 26

Advantages of Issuing Convertible Bonds

Answer 26

Makes the issue more marketable, can offer a lower interest rate, if the bonds are converted the debt obligation is eliminated, the issuance of the convertible bonds does not immediately dilute ownership or eps.

Question 27

Disadvantages of Issuing Convertible Bonds

Answer 27

Reduced leverage upon conversion, conversion causes the loss of tax-deductible interest payments, conversion dilutes shareholder’s equity, conversion by a large holder may shift control of the company.

Question 28

The Trust Indenture Act of 1939

Answer 28

Requires that corporate bond issues in excess of $5,000,000, that are to be repaid during a term in excess of one year, issue a trust indenture for the issue.

Question 29

Trust Indenture

Answer 29

A contract between the issuer and the trustee. The trustee acts on behalf of all of the bondholders and ensures that the issuer is in compliance with all of the promises and covenants made to the bondholders. The trustee is appointed by the corporation and is usually a bank or a trust company.

Question 30

Open-End Indenture

Answer 30

Allows the corporation to issue additional bonds secured by the same collateral and whose claim on the collateral is equal to the original issue.

Question 31

Closed-End Indenture

Answer 31

Does not allow the corporation to issue additional bonds having an equal claim on the collateral of the original bonds. If the corporation wants to issue new bonds, their claim must be subordinate to the claim of the original issue or secured by other collateral.

Question 32

General Obligation Bond

Answer 32

General obligation bonds (also known as GOs) are full faith and credit bonds. The bonds are backed by the full faith and credit fo the issuer and by their ability to raise and levy taxes. In essence, tax revenues back the bonds. GOs will often be issued to fund projects that benefits the entire community and the finance projects generally do not product revenue of any kind. General obligation bonds would be issued, for example, to fund a local park. General obligation bonds that have been issued by the state are backed by income and sales taxes while GOs that have been issued by local governments or municipalities are backed by property taxes. The maximum amount of general obligation debt that may be issued is known as the statutory debt limit.

Question 33

Revenue Bonds

Answer 33

A revenue bond is a municipal bod that has been issued to finance a revenue producing project such as a toll bridge. The proceeds from the issuance of the bond will construct or repair the facility, and the debt payments will be supported by revenue generated by the facility.

Question 34

Industrial Revenue Bonds

Answer 34

An industrial revenue bond is a municipal bond issued for the benefit of a private corporation. The proceeds from the issuance of the bond will go toward building a facility or toward purchasing equipment for the corporation. The facility or equipment will then be leased back to the corporation and the lease payments will support the debt service on the bonds. Interest earned by some high-income earners on industrial revenue bonds may be subject to the investor’s alternative minimum tax. States are limited as to the amount of industrial revenue bonds that may be issued, based on the population of the state.

Question 35

Special Assessment Bonds

Answer 35

A special assessment bond will be issued in order to finance a project that benefits a specific geographic area or portion of a municipality. Sidewalks and reservoirs are example of projects that may be financed through issuance of special assessment bonds. The homeowners in the area that benefit from the project will be subject to a special tax assessment. The assessment then will be used to support the debt service of the bonds. Homeowners that do not benefit from the project are not subject to the tax assessment.

Question 36

Double-Barreled Bonds

Answer 36

Double-barreled bonds are bonds that have been issued to build or maintain a revenue-producing facility such as a bridge or a roadway. The initial debt service is supported by the user fees generated by the facility. However, if the revenue generated by the facility is insufficient to support the bond’s interest and principal payments, the payments will be supported by the general tax revenue of the state or municipality. The debt service on double-barreled bonds is backed by two sources of revenue.

Question 37

Moral Obligation Bonds

Answer 37

A moral obligation bond is issued to build or maintain a revenue-producing facility such as a park that charges an entrance fee or a tunnel that charges a toll. If the revenue generated by the facility is insufficient to cover the debt service, the state legislature may vote to allocate tax revenue to cover the shortfall. A moral obligation bond does not require that the state cover any shortfall; it merely gives them the option to. Some reasons why a state may elect to cover a shortfall are to: keep a high credit rating on all municipal issues, ensure that interest rates on their municipal issues do not rise.