Assignment:1

Financial Management

Submitted To:

Sir Waseem-Ul-Haq

Submitted By:

Muhammad Waseem

#055

BBA-5 TH-M2
Legal Aspects of Corporate Bonds
Purchase of bond is protected by certain legal arrangements. Bondholders are protected primarily
through Indenture and Trustee.

Bond Indenture:
“A bond indenture is a legal document or contract between the bond issuer and the
bondholder that records the obligations of the bond issuer and benefits owed to the bondholder”.

How Does Bond Indenture Work?

The bond indenture is created during the bond issuing process when bond issuers are
receiving approval from state and federal governments to issue bonds to the public. After an agreed
upon amount of bonds is authorized by the applicable government agency, the company issuing the
bonds must contract a bond indenture.

Example:
Bond indentures are not issued to individual bondholders. It would be pretty impractical for
a company to try to enter into a contract with every single bondholder. That is why the bond indenture
is actually issued to a trustee or third party that represents the bondholders. The trustee is most often a
bank or some other financial institution. If the company breaks the agreement set forth in the bond
indenture, the trustee can sue the company on behave of the bondholders.

Standard Provision:

The standard debt provisions in the bond indenture specify certain record
keeping and general business practices that the bond issuers must follow.

The most common covenants do the following:

1. Require a minimum level of liquidity, to ensure against loan default.

2. Prohibit the sale of accounts receivable to generate cash.
3. Impose fixed asset restrictions. The borrower must maintain a specified level of fixed
asset to guarantee its ability to repay the bonds.
4. Constraint subsequent borrowing. Additional long term debt may be prohibited, or
additional borrowing may be subordinate to the original loan.
5. Limit the firm annual cash dividend payments to a specified percentage or amount.

Sinking Fund Requirements:

Another common restrictive provision is a sinking fund requirement.

Its objective is to provide for the systematic retirement of the bond prior to the maturity. To carry out
this retirement, the corporation makes semiannual or annual payments that are used to retire bonds by
purchasing them in the market.

Security Interest:

The bond indenture identifies any collateral pledged against the bond and specifies
how it is to be maintained. The protection of the bond collateral is crucial to guarantee the safety of a
bond issue.

Trustee:
Bond trustee is a financial institution having trust powers and responsible for transfer,
registration or payments of bonds. ... A bond trustee ensures interest payments are made as planned
and on time as well as protects the interests of the bondholders in cases of default issues.

A trustee is a third party to a bond indenture. The trustee can be an individual, corporation or a
commercial bank trust department. The trustee is paid to act as “watch dog” on the behalf of the bond
beholders.

Roles and Responsibilities of a Trustee:

The bond trustee is responsible for the registration,
transfer, and payment of bonds. It is required to maintain separate accounts, monitor bond document
requirements, and provide monthly statements. It also approves amendments to some documents and
acts on behalf of the bondholders if the borrower or issuer violates certain bond documents. A bond
trustee must have adequate staff and systems to efficiently perform its duties and comply with the
various federal, states, and bond issue requirements.

General Features of a Bond Issue

Three features sometimes include in a corporate issue are a conversion feature, a call feature, and
stock purchase warrants.

Conversion feature:
A feature of convertible bond that allows bondholders to change each bond into
a stated number of shares of common stock. Bondholders convert their bonds into stock only when the
market price of the stock is such that conversion will provide a profit for the bondholders.
Call Feature:
A feature included in all corporate bond issues that gives the issuer the opportunity to
purchase bond at a stated call price prior to maturity.

Call Price:
The stated price at which a bond may be purchased, by use of all features, prior to maturity.

Call Premium:
The amount, by which a bond’s call price exceeds its par value.

Stock Purchase Warrants:

Instruments that give their holders the right to purchase a certain number
of shares of the issuer’s common stock at a specified price over a certain period of time.

Bond Yields:
The yield or rate of return on a bond is frequently used to assess a bond’s
performance over a given period of time, typically 1 year. Because there are number of ways to measure
a bond yield, it is popular to understand popular yield measures. Three most widely cited bond yields
are (i) Current yield (ii) Yield to maturity (iii) yield to call.

Current Yield:
The simplest is current yield. It is a measure of bond’s cash return for the year,
calculated by dividing the bond’s annual interest payment by it’s current price.

Bond Prices:
As most corporate bonds are purchased and held by institutional investors such as
banks rather than individual investors, bond trading and price data are not readily available to investors.

Bond Rating:
Independent agencies such as Moody’s, Fitch and Standard and Poor assess the
riskiness of publicly traded bond issues. The agencies derive their ratings by using financial ratio and
cash flow analysis to assess the likely payment of bond interest and principal.