INTEREST RATES AND BOND

VALUATION
Accounting: You need to understand interest rates and the various types of
bonds in order to be able to account properly for amortization of bond
premiums and discounts and for bond purchases and retirements. Information
systems: You need to understand the data that you will need to track in bond
amortization schedules and bond valuation. Management: You need to
understand the behavior of interest rates and how they will affect the types of
funds the firm can raise and the timing and cost of bond issues and
retirements. Marketing: You need to understand how the interest rate level
and the firm’s ability to issue bonds may affect the availability of financing
for marketing research projects and new-product development. Operations:
You need to understand how the interest rate level may affect the firm’s
ability to raise funds to maintain and increase the firm’s production capacity
Ford and Ford Motor Credit Co. (FMCC), its finance unit, were frequent
visitors to the corporate debt markets in 2001, selling over $22 billion in
long-term notes and bonds. Despite the problems in the auto industry,
investors nervous about stock market volatility were willing to accept the
credit risk to get higher yields. The company’s 2001 offerings had something
for all types of investors, ranging from 2- to 10-year notes to 30-year bonds.
Demand for Ford’s debt was so high that in January the company increased
the size of its issue from $5 billion to $7.8 billion, and October’s plan to issue
$3 billion turned into a $9.4 billion offering. The world’s second largest auto
manufacturer joined other corporate bond issuers to take advantage of
strengthening bond markets. Even though the Federal Reserve began cutting
shortterm rates, interest rates for the longer maturities remained attractively
low for corporations. Unlike some other auto companies who limited the size
of their debt offerings, FMCC decided to borrow as much as possible to lock
in the very wide spread between its lower borrowing costs and what its auto
loans yielded. All this debt came at a price, however. Both major bond-rating
agencies—Moody’s Investors Service and Standard & Poor’s (S&P)—
downgraded Ford’s debt quality ratings in October 2001. Moody’s lowered
Ford’s long-term debt rating by one rating class but did not change FMCC’s
quality rating. Ford spokesman Todd Nissen was pleased that Moody’s
confirmed the FMCC ratings. “It will help us keep our costs of borrowing
down, which benefits Ford Credit and ultimately Ford Motor,” he said.
S&P’s outlook for Ford was more negative; the agency cut ratings on all Ford
and FMCC debt one rating class. The lower ratings contributed to the higher
yields on Ford’s October debt. For example, in April FMCC’s 10-year notes
yielded 7.1 percent, about 2 points above U.S. Treasury bonds. In October,
10-year FMCC notes yielded 7.3 percent, or 2.7 points above U.S. Treasury
bonds. For corporations like Ford, deciding when to issue debt and selecting
the best maturities requires knowledge of interest rate fundamentals, risk
premiums, issuance costs, ratings, and similar features of corporate bonds. In
this chapter you’ll learn about these important topics and also become
acquainted with techniques for valuing bonds.