Unit 5 Flashcards
types of bonds issued by corporations
- mortgage bonds
- equipment trust certificates
- collateral trust bonds
- debentures
- guaranteed bonds
- Senior
- Subordinated
- income bonds
secured debt securities
backed by various forms of assets of the issuing corporation
unsecured debt securities
backed only by the reputation. credit record and financial stability of the corporation
mortgage bonds
corporation will borrow money back by real estate of the corporation. Value of real estate must be in excess of the amt borrowed. If corporation can’t pay loan back the real estate is sold off to pay the bondholders. If sale of the property results in an outstanding balance, the mortgage holder becomes a general creditor for the unsatisfied balance
equipment trust certificates
- often used by railroads, airlines
- typically pay 20% of the cost and finances the balance with equipment trust certificates
- when the company pays off the loan it gets clear title to the equipment from the trustee
- if the company doesn’t pay off the loan, the lender repossess it and sells it
collateral trust bonds
- company deposits securities it owns into a trust to serve as collateral for lenders
- can be any securities as long as they are marketable
- AKA collateral trust certificates
debentures
a debt obligation of the corporation backed only by its word and general creditworthiness. quality depends on overall assets and earnings of the corporation
guaranteed bonds
a bond that is guaranteed as to payment of interest, or both principal and interest but a corporate entity other than the issuer.
- popular with railroad industry
Senior
describes relative priority of claim of a security.
every debt security has senior claim over preferred stock.
Subordinated
usually describing a debenture
still senior to any stockholder
income bonds/adjustment bonds
are used when a company is reorganizing and coming out of bankruptcy.
pay interest only if the corporation has enough income to meet the payment and BOD declares a payment.
Not suitable for investors looking for stable income
income bonds
zero coupon bond
- debt obligations that make no interest payments
- trade at deep discount
- return is difference between discounted price and face value (1000) - accretion
- current market price for zero income bonds reflects the current interest rates for similar maturities
- allows investors to lock in yield/ROR for predetermined, investor selected time with no reinvestment risk
- often used to fund edu or retirement accounts
- price volatility
liquidation priority
1a. secured creditors (mortgage bonds, equipment trusts, collateral trust bonds)
1b. wages
1c. taxes
2. unsecured creditors (general creditors, debenture holders)
3. subordinated debt holders
4. preferred stockholders
5. common stockholders
convertible debt securities
investors may exchange debt into shares of the company’s common stock.
issued by company.
excised at the discretion of the investor
Conversion ratio varies
typically debentures
conversion price
is the stock price at which a convertible bond can be exchanged for shares of common stock
conversion ratio
- expresses the number of shares of stock a bond may be converted into
- bond always represents 1000, so compute the number of shares by dividing by 1000. Ex - convertible at $20. 1000/20 = 50 shares
benefits of convertible debt to issuer
sweetener for issuer: sold with lower coupon; can eliminate a fixed interest charge at conversion thus reducing debt; b/c it occurs over time, shouldn’t impact stock price; at issuance conversion price is higher than common stock
disadvantage of convertible debt to issuer
- when bonds are converted, shareholder equity is diluted
- common stockholders can vote - shift of control
- loss of leverage
- raises corporation’s taxable income
benefits of convertible debt to investor
- offer the safety of fixed income with potential appreciation
- pays fixed interest and is redeemable at face value at maturity. interest income is higher and surer than dividend income on common stock
- have priority over common stockholders
- tends to be more stable during market declines
- possible inflation protection
- no tax liability on the conversion transaction
disadvantage of convertible debt to investor
- lower interest rate
- not suitable for investors looking for income
- lower priority than other debt
- potentially callable
1/8
$1.25
1/4
$2.50
3/8
$3.75
1/2
$5
5/8
$6.25
3/4
$7.50
7/8
$8.75
taxation of corporate debt
- interest paid by corporations is taxed as ordinary income
- taxed at federal, state and local levels
- income tax is due regardless of market price
capital gain
bond is sold for a higher price than it costs
capital loss
bond is sold for a lower price than it costs
anti-dilutive provision
means that a stock dividend or stock split will not cause the investor’s conversion privilege to be diminished.
