Professional Documents
Culture Documents
Bonds
A bond is a long-term debt instrument
A bond is an IOU a promise to pay both interest and
principal.
Issuance of bonds is a type of financing.
Interest (payment for the use of the principal) is
usually semiannual.
Principal (amount owed) is paid at maturity.
May be new issues or outstanding bonds/seasoned
issues.
4 main types of bonds, and they differ with respect to
expected return and degree of risk.
Kinds of Bonds
Types of Corporate Bonds:
Mortgage bonds bonds secured by a claim on real estate.
Equipment trust certificates serial bonds issued by transportation companies
secured by the equipment purchased with the proceeds of the loan
Debentures Unsecured bonds supported by the general credit of the firm.
Subordinated debentures bonds with a lower claim on the firm's assets than the
claims of other debt instruments.
Income bonds bonds whose interest is paid only if it is earned by the firm.
(Riskier than normal bonds)
Revenue bonds- they are income bonds issued by state and local governments and
are supported by the assets the bonds financed.
Convertible bonds bonds that may be converted into stock at the option of the
bondholder (Convert during boom)
Variable interest rate bonds interest payments vary with changes in short-term
interest rates or the Consumer Price Index.
Zero coupon bonds bonds that are initially sold at a discount and on which
Common Bonds
Fixed Rate Bond
A bond whose interest rate is fixed for its entire life.
Issue Date
Date when the bond was issued.
Call Provisions
Allows the issuer to pay back the bond before maturity it allows them to
refinance the bonds
Call Premium amount that is paid by the issuer to the bondholder for the right to
call the bonds before maturity.
Issuers will call the bond, when interest rate is declining.
Subjects the bondholder to reinvestment risk.
Most bonds have a deferred call and a declining call premium.
Deferred call bonds cannot be called until after several years after issuance.
Declining call premium the value of call premium decreases as the bond nears
maturity.
If the bonds sell for more than $1,000 in the open market or
when interest rate is falling, the issuer will call the bonds.
If the bonds are selling for less than $1,000, or when interest
rate is rising, the issuer will buy the bonds in the open
market.
Other Terms/Features
Warrant
Long-term option to buy a stated number of common stock at a specified price (Buy
when specified price is less than market price).
Putable Bond
Bondholders option to sell the bond back prior to maturity at a prearranged price (BH
put when interest rates are rising).
Eurobonds
Bonds sold outside of the country of issue but denominated in the currency of the
issuing company. (Issued in the Philippines, sold in Malaysia, but denominated in
pesos.
Other Features
Discount versus Premium Bonds
Discount Bonds
A bond that is issued for less than its par value.
A bond that is currently trading for less than its
par value in the secondary market.
Premium Bonds
A bond that is issued for more than its par value.
A bond that is currently trading for more than its
par value in the secondary market.
Bond Valuation
The value of any financial asset is the PV of
the cash flows it is expected to generate.
There are mainly two cash flows of a bond:
Principal and Interest
Bond Value = PV of interest + PV of principal
Pbond = INT (PVIFA) + M (PVIF)
Financial Asset Values
0 1 2 n
k
...
Value CF1 CF2 CFn
1,000
kd = 10%. M
kd = 12%.
950.78
3 0
Stronger companies can easily issue debentures. They dont need to pledge
specific property because they already established their reputation and
have gained the confidence of investors; but definitely not small
companies.
Bond Ratings Provide One Measure
of Default Risk
Is measured by bond ratings, such as Moodys, S&P, and Fitch Investors Service
Bonds can be rated as Investment Grade or Junk.