Other Types Of Bonds Flashcards
Convertible Bonds
VERY SIMILAR TO (Equity Warrants) think fo them as (Debt warrants)
Convertible bonds are bonds that can be converted into shares of preferred or (more often) common stock at a fixed conversion ratio, which is stipulated in the indenture. The convertible feature allows issuers to pay lower yields on debt and to raise equity capital without a public equity offering. It generally allows investors to choose when they want to convert
Conversion Ratio
The number of shares of stock that a bondholder will receive upon converting a bond
specified in the indenture.
Par Value of Convertible Bond
($1000) Conversion Price= ————————————————-
Conversion price
Thus, the conversion ratio would be 50 ($1,000 / $20), meaning the investor would receive 50 shares for converting one bond.
Convertible Debentures
Convertible debentures are usually offered as subordinated debt. This means that they have a lower repayment status than other debt securities if the issuer goes bankrupt. Convertible debentures have two distinct advantages for the issuer, assuming the company flourishes: (1) they raise equity capital now at prices that reflect expected future performance, and (2) they raise equity capital without seriously deflating the current price of stock the way a new stock issue would. If the company flounders, stockholders are unlikely to convert, so convertibles provide the company with borrowed money at substantially lower interest rates.
DEBENTURES
bonds not secured by a physical asset or collateral but simply by the “full faith and credit” of the issuer. Generally issued by well-established companies with high credit ratings, debentures are purchased in the belief that the issuer is unlikely to default on the repayment.
High Yield JUNK BONDS
Non-investment-grade bonds (BB+ credit rating or lower) are also known as junk bonds. Junk bonds are a type of unsecured or partially secured corporate bond that typically offers significantly higher yields to compensate for its lower credit rating. For this reason, junk bonds are also known as high-yield bonds. Non-investment-grade ratings are usually given to companies that do not have a long track record or that have a questionable ability to meet their debt obligations.
Like other bonds, junk bonds generate a steady stream of income from a stated coupon rate.
INCOME BONDS
Income bonds are a long-term debt security in which the principal is usually secured by a mortgage. The coupon payments, unlike those of a mortgage bond, are not guaranteed, but are contingent on a company’s ability to pay, like preferred stock dividends. Income bonds are generally issued by companies that are in weak financial condition, often in an effort to avoid bankruptcy.
ZERO COUPON BOND
A zero coupon bond (or “zero”) is one that makes no periodic interest payments. Instead, zero coupon bonds are issued at a deep discount to their face value, with the face (or par) value being delivered at maturity; a zero, thus, is a type of discount bond.
Zeros are attractive to the issuer (borrower) because they do not cost anything in terms of interest payments until the bond matures. They are attractive to the lender (investor) because they offer greater leverage.
Callable Bonds
With callable bonds, the issuer has the option to redeem them prior to the stated maturity date.
To compensate investors for the increased risk and to mitigate possible losses, callable bonds come with higher yields than non-callable bonds. Some callable bonds provide a call premium to lessen the risk of a call. When a call price is set at a higher value than the face value of the bond, the difference is the call premium. For instance, a $1,000 bond with a call price of $1,100 has a $100 call premium payable to the investor if the bond is called. The trust indenture of a callable bond will include a call provision which includes both the call date and the call price. The call provision will sometimes require an issuer to pay such a premium for early redemption.
Refunding Bonds
When issuers retire outstanding bonds and issue new ones in their place, it is called refunding. Bond refunding may or may not involve an early redemption. Refunding is similar to a homeowner refinancing her mortgage. When interest rates fall, the homeowner refinances to replace her current mortgage with a new mortgage at a lower rate. Similarly, when interest rates fall, a company may issue new bonds, called refunding bonds, at a lower interest rate. The proceeds of the refunding bonds are for the sole purpose of retiring an existing issue, the refunded bonds.
Put Bonds
Put bonds allow the investor the discretion to redeem the bonds at par before the maturity date. A put makes the bonds more attractive to investors when rising interest rates force the price of bonds down. Investors can redeem the bonds at par and reinvest the principal at the higher interest rates. Put bonds also offer protection should the credit rating of the company deteriorate, reducing bond prices and increasing the chances of default. Put bonds carry slightly lower yields than straight bonds
