Module 2 - Corporate Debt Securities Flashcards
Corporate Debt Securities
Issued by corporations to raise CAPITAL (money) to fund their operations
CORPORATE BONDS
Debt securities that have more than one year to maturity. Corporate bonds are often referred to as FUNDED DEBT to differentiate them from the short-term debt obligations of a company
CORPORATE NOTES
Short-term debt securities with maturities of less than one year, usually less than 270 days
BONDHOLDER
A person who holds (owns) bonds of a corporation and is considered a creditor of the issuer
If a corporation goes bankrupt, bondholders have a claim to the assets of the corporation for repayment of their principal and interest. Secured bondholders’ claims have priority over any general creditors’ claims
Remember for Test
Bondholders have no voting rights or control over management of the corporation
Remember for Test
Corporations issue two types of bonds:
- Interest-bearing
* Non-interest-bearing, or zero-coupon bonds
Interest-bearing bonds
- Corporations usually issue bonds that pay interest to the bondholder (in contrast to dividends, which are paid on stocks). Interest payments on bonds are usually made semiannually, although some will pay the interest only at the bond’s expiration, called the MATURITY DATE.
- The principal amount, known as the FACE VALUE, is paid at maturity. All bonds today have a face value of $1,000, and are sold in multiples of $1,000.
- The interest that the corporations pay is called the NOMINAL YIELD, or more commonly called the COUPON or the RATE.
- Corporations try to issue the bonds with interest rates as low as possible to keep their own capital costs as low as possible.
- Corporations usually make the bonds CALLABLE, allowing the corporation the ability to repurchase the bond before the bond matures, especially if interest rates are high at the time the bond is issued (to be discussed later in this module).

Non-interest-bearing bonds (also known as ZERO-COUPON BONDS)
• Zero-coupon bonds pay no interest during their life. Instead, they pay all the interest upon maturity. ZEROS, as they are called, are sold at a discount. This means they are sold at less than face value. When the bonds mature at face value, the difference between the purchase price and the maturity price becomes the interest on the bond.
Bonds are generally classed as follows:
• SHORT-TERM BONDS mature in one to five years.
• MEDIUM-TERM BONDS mature in five to 12 years.
• LONG-TERM BONDS mature in over 12 years.
Notes and bank loans are short term
TRUST INDENTURE ACT OF 1939
An amendment to the Securities Act of 1933 that requires all corporate issues of $10 million or more to be issued under an INDENTURE
TRUST INDENTURE or DEED OF TRUST
The indenture is a promise by the issuer. Essentially, the INDENTURE is an agreement between the issuer and the bondholders that is overseen by the trustee, who may take legal action if the issuer fails to live up to the promises (covenants) made to the bondholders
Trust Indenture
States who is assigned as the trustee, and outlines what the trustee will do
The trustee has the responsibility to protect the bondholders.
Remember for Test
PROSPECTUS, or OFFERING CIRCULAR
- A document that is used to describe the terms of the bond, the disclosures of risk, and the use of the proceeds from selling the bonds.
- The prospectus will also include background information about the issuer
The indenture will indicate:
• If the bond is callable or convertible into shares of common stock, as well as any other ownership matters pertaining to the bond
• Authorized amount issued
• Form of the bond (registered or book-entry)
• A description of the collateral backing the bond, if any
• PROTECTIVE COVENANTS (promises), SINKING FUND PROVISIONS (an account managed by the bond trustee for the purpose for repaying bonds), and conversion provisions
- Duties and privileges of the trustees, issuers, and the bondholders
The issuer and the trustee who protects the rights of the bondholders execute the bond indenture
Remember for Test
CORPORATE BONDS may be issued in one of two ways.
• REGISTERED BONDS — The name of the owner is listed on the bond certificate. Interest is sent to the person whose name is on the bond and registered with the issuer. These are still being
issued.
• BOOK-ENTRY BONDS — No certificate is issued to the bondholder. The trustee and the transfer agent track the owner of the bond, interest payments, and any other matters that pertain to the bond.
The certificate shows the name of the issuer, the type of bond, the interest rate, and the maturity date. These four items must be visible and readable when a bond is presented for “good delivery.” If any or all are not readable, the bond must be sent to the trustee to be validated.
Remember for Test
Bonds are issued in denominations of $1,000, and are traded in increments of $1,000. Prices, though, are quoted in terms of a percentage of par with increments of 1 point, where 1 point equals $10 (e.g., 98 would mean that the investor pays $980 for a $1,000 face value bond.)
Remember for Test
SECURED BONDS
Backed by a specific property, such as land, buildings, or some other type of security that can be used as collateral. The most common secured bonds are the various mortgage bonds
MORTGAGE BONDS
Backed by real estate owned by the company.
Guaranteed bonds
Issued by one corporation but guaranteed by a second against default of interest and principal by the issuing corporation. If the issuing corporation defaults by not being able to pay interest or principal, the bondholders can rely on the second corporation as backing for the principal.
EQUIPMENT TRUST CERTIFICATES
- Bonds that are backed by rolling stock (movable equipment), such as railroad cars, equipment, and airplanes.
- Risky since they are only backed by rolling stock.
DEBENTURE BONDS
Only backed by the “full faith and credit” of the issuing corporation
SUBORDINATED DEBENTURE BONDS
Unsecured bonds that have no backing except the “full faith and credit” of the corporation.
INCOME BONDS are also called ADJUSTMENT BONDS
Income bonds do not have to make interest payments unless there is sufficient income to the corporation
COLLATERAL BOND
Issued by a corporation when it uses the securities of another issuer as collateral to secure a bond. Often the securities have been issued by a very strong corporation
TRADING FLAT
- indicates that the bond issuer is not paying interest to the bondholders of the corporation
- All adjustment bonds trade flat. They do not trade with accrued interest because the corporation cannot assure bondholders that interest will be paid.
CALLABLE BONDS
- Can be repurchased by the issuer at a stated call price and date before maturity
- A callable bond allows the corporation to “refund” its debt at a lower interest rate.
CALLABLE BONDS
- Can be repurchased by the issuer at a stated call price and date before maturity
- A callable bond allows the corporation to “refund” its debt at a lower interest rate.
Paying off outstanding bonds with the proceeds of a new issue is called REFUNDING the issue. Bonds are called “funded debt” and when refunding is occurring, the company is “funding the debt over again.” You may know this as “refinancing.”
Remember for Test
CALL PROTECTION
A method of protecting the investors who have purchased the corporate bonds. Generally, the issuing corporation includes a provision in the trust indenture that the bonds cannot be called for a certain period of time (for example, the first five years). Since corporations tend to call outstanding bonds when interest rates are falling, the longer periods of call protection are more valuable to buyers.
SINKING FUND
A corporation may set up a SINKING FUND in which it will place excess income in order to have the cash available when the bonds can be called.
SINKING FUND
A corporation may set up a SINKING FUND in which it will place excess income in order to have the cash available when the bonds can be called.
CALL PROTECTION
A method of protecting the investors who have purchased the corporate bonds. Generally, the issuing corporation includes a provision in the trust indenture that the bonds cannot be called for a certain period of time (for example, the first five years). Since corporations tend to call outstanding bonds when interest rates are falling, the longer periods of call protection are more valuable to buyers.
CONVERTIBLE BONDS
- Can be converted into shares of common stock if the bondholder chooses to do so
- If the underlying stock has appreciated above the conversion price and the corporation calls the convertible bonds, holders of these bonds convert them to stock instead of accepting the call price. This is known as FORCED CONVERSION
ANTIDILUTION CLAUSE
To ensure that the company will always increase the conversion ratio and decrease the conversion price, the indenture of a convertible bond should contain an ANTIDILUTION CLAUSE.
YIELD
The amount of investment return earned on debt instruments expressed as a percentage
For bonds, there are four yields to consider:
- Nominal yield
- Current yield
- Yield to maturity
- Yield to call