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The Features of

Long Term Debts:


Characteristics of All
Debt Instruments
Bonds
Long-term debt instrument that specifies:
The principal (amount owed);
The interest (cost of borrowing);
Maturity date (the date on which the principal must be
repaid)

Ranges from a few years to 20 or 30 years.


The issuer must pay the investor interest, which are
made at a predetermined rate and schedule.
Interest rate is often fixed and referred as coupon
Indenture
A legal document stating the terms that the
debtor (issuer) must meet.
Collateral
Other examples of common loan restrictions:
(1)Limits on dividend payments;
(2)Limits on the issue of additional debt;
(3)The requirement to periodically retire a proportion of
the debt.

Default is not just the failure to
pay the interest. It is also the
failure to meet any of the
indenture provisions even
though the interest is still being
paid.


Trustee
A representative of the rights of
bondholders who enforces the
terms of the indenture.
the potential of gaining
or losing something of
value

Risk
Risk that the interest and principal will not be
repaid;
Risk that the price of the debt instrument may
decline;
Risk that inflation will erode the purchasing
power of the interest payment and principal
repayment.
Risk of default on interest and principal
payments varies with different types of
debt.
Federal Government has no risk of default
Debt of firms or individuals not so riskless
Credit Ratings
Classification scheme designed
to indicate the risk associated
with a particular debt instrument.
Mergents Bond Ratings
Aaa Bonds of highest quality
Aa Bonds of high quality
A Bonds whose security of principal and interest is considered
adequate but may be impaired in the future.
Baa Bonds of medium grade that are neither highly protected nor
poorly secured.
Ba Bonds of speculative quality whose features cannot be
considered well assured.
B Bonds that lack characteristics of a desirable investment.
Caa Bonds in poor standing that may be defaulted.
Ca Speculative bonds that are often in default
C Bonds with little probability of any investment value (lowest
rating)

For ratings Aa through B, 1, 2, 3 represent the high, middle, and low ratings
within the class.
Standard and Poors Ratings
AAA Bonds of highest quality
AA High-quality debt obligations
A Bonds that have strong capacity to pay interest and
principal but may be susceptible to adverse effects
BBB Bonds that have an adequate capacity to pay interest and
principal but are more vulnerable to adverse economic
conditions or changing circumstances
BB Bonds of lower medium grade with few desirable
investment characteristics
B and Primarily speculative bonds with great uncertainties and
CCC major risk if exposed to adverse conditions
C Income bonds on which no interest is being paid
D Bonds in default
Whats the use of
credit ratings?
Risk of price fluctuations.

Interest Price of
Rates Debt

Interest Price of
Rates Debt
Risk of inflation
Reduces the purchasing power of the
interest and principal;
Higher rate of interest to offset the
effects of inflation.
WHAT ARE
CORPORATE BONDS
CORPORATE BONDS
To raise money for
capital
expenditures,
operations and
acquisitions

It issued by all types


of businesses, and
are segmented into
major industry
groups.
Corporate bondholders receive the
equivalent of an IOU from the issuer of
the bond. But unlike equity stockholders,
the bondholder doesn't receive any
ownership rights in the corporation.

However, in the event that the


corporation falls into bankruptcy and is
liquidated, bondholders are more likely
than common stockholders to receive
OF
type
MORTAGE BONDS
A bond that is backed by assets of the
company.
Issued to purchased specified real estate
assets.
In a default situation, mortgage
bondholders have a claim to the underlying
property and could sell it off to compensate Risk is lower
the default.

Acquired asset serves as collateral.

These are assets used to secure a loan or Interest rate is


debt instrument lower
EQUIPMENT TRUST CERTIFICATES

Serial bonds issued by transportation


companies that are secured by the equipment
purchased with the proceeds of the loan.
Issued to finance specified equipment.
In a default situation, the trustee could sell the
equipment to recoup funds due that were owed by
the owners of the certificates.
DEBENTURES
Unsecured bonds supported by the
general credit of the firm.
Backed only by the general creditworthiness
and reputation of the issuer.
Both corporations and governments
frequently issue this type of bond in order
to secure capital. Risk is higher
It has no collateral.
In a default situation, the secured debt is Interest rate is
redeemed before the debentures. higher
Debenturesissuedbygovernmentsare
consideredrisk-free.
SUBORDINATED
DEBENTURES
Bonds with a lower claim on the firms
assets than the claims of other debt
instruments.
Often issued by companies that have already
borrowed a lot of money, and need to borrow more.
Have a high credit and default risk, and the
yields that the issuer must pay on these
bonds are higher.
It has no collateral.
Should the issuer be liquidated, all other
bonds and debts must be repaid before the
subordinated debenture bond is paid.
INCOME BONDS
Bonds whose interest is paid only if it is earned by the firm.
Theissuerisonlyresponsibleformakingcoupon
paymentswhenithassufficientincometodoso.
Mostcommoninreorganizationplansinwhichtheissuerisattemptingtom
aintainoperationsin bankruptcy.
Usefulfortheissuerbecauseitprovidescapitalquickly.
Disadvantageousforthebondholderbecausethereislittleorno
guaranteeofrepayment.
Incomebonds arerelativelyraresecurities.
REVENUE BONDS
Bonds supported by the assets the bonds financed;
income bonds issued by state and local governments.
Pay interest only if the revenue is earned.
Finances income-producing projects and are secured by a specified
revenue source such as toll roads.
Revenue bonds mature in 20 to 30 years and are issued in $5,000 units.
Convertible bonds
These are bonds that MAY
be converted into a
specified number of
shares of common stock.
Advantages:
Lower interest rate
Reduce payouts to Investors.
Reduce debt upon conversion
Outstanding shares does not
immediately increase.
Variable interest rates
These are long term debt
instruments whose
interest payments vary
with changes in short
term interest rates or the
Consumer Price Index.
Zero coupon bonds
These are bonds that are
initially sold at a discount and
on which interest accrues and
is paid at maturity.
Example:
JC Penney bond was
sold in 1981 for $330
and paid $1,000 at
maturity in 1989. Find
the yield or the rate of
Answer:

=14.86%
High-yield securities
These are also known as JUNK
BONDS.
These are poor quality debt
with very high yields , which
may be 3% or 4% higher than an
ordinary high quality bond and
high probability of default.
FOREIGN
BONDS
FOREIGN BONDS
A bond that is issued in a domestic
market by a foreign entity, in the
domestic market's currency.
Example: Bond that is issued by a non-
U.S. entity but then trades in
the U.S. market.
YANKEE
SAMURAI
BONDS
BONDS
ITS
EFTYPESK
BE N RI
BULLDOG
S
BONDS
EUROBONDS
Bonds sold in a foreign country but
denominated in the currency of the
issuing firm.

Example: A UK-based company can


issue a U.S. dollar-
denominated Eurodollar bond in Japan.
ITS
E
SFK
BERI
ISSUER
N
Registere
d and
Book
Entry
Bonds
Possession of the bond was
evidence of ownership, and
the owner would detach
the interest coupons and
send them to the paying
agent for collection.
Coupon Clippers

Individuals who
owned the bonds
and lived on the
fixed interest
payments.
What is Registered Bonds?
These are issued as engraved
certificates.
The issuer maintains a record of who
owns each bonds.
The owners name and address are
printed on the certificate.
To transfer ownership, the current
owner endorses the certificate and
presents it to the issuers transfer
agent.
Carolina, Clinchfield and Ohio Railroad 5% registered
bond of 1938. The bonds term was thirty years. This
specimen has been cancelled by the transfer agent
by punching holes along the bottom.
2 Kinds of
Registered
Bonds
Partially Registered Bonds
Are also called registered coupon
bonds or registered as to principal
only.
This is a bond in which the principal is
registered inn the investors name.
The bearer coupon payments can go to
anyone, but only the person named on
the bond can claim the principal
payment at maturity.
This type of bond is still traded, but no
longer issued.
Fully Registered Bonds
Currently the most common
form of bond certificate.
This type of bond is registered
in an investors name and
doesnt have any bearer
coupons attached.
An investor doesnt have to
submit coupons to receive the
semiannual interest payments;
Book-Entry Securities
Book-Entry Securities (such as
stocks and bonds) whose
ownership is recorded
electronically.
It eliminates the need to issue
paper certificates of ownership.
Retiring Debt
Debt is often ultimately repaid
before the maturity date
Part of the issue is systematically
retired each year
Changes in interest rates may
cause a corporation to retire
bonds before maturity
Serial Bonds
Bond issue in which a portion of the
outstanding bonds mature at regular intervals
until all of the bonds have matured
Usually issued to finance specific projects that
provide income streams
Serial bonds (or installment bonds) describes a
bond issue that matures in portions over
several different dates. Instead of facing a large
lump-sum principal re-payment at maturity, an
issuer can opt to spread the principal
repayment over several periods.
Sinking Funds
A sinking fund is a means of repaying funds that
were borrowed through a bond issue. The issuer
makes periodic payments to a trustee who
retires part of the issue by purchasing the bonds
in the open market.
Eases the retirement of corporate bonds
Payment may be paid to a trustee
Another type of sinking fund:
Firm is required to retire a specified amount of
the principal each year
Permits the firm to buy back the bonds on the
Repurchasing Debt
If bond prices decline and the debt is
selling for less than face value or at a
discount, the firm may try to retire the
debt by purchasing it on the open
market.
A firm may retire debt by purchasing it
Selling at a discount means there is
immediate savings for the firms
stockholders
Voluntary act
GOVERNMENT SECURITIES
Pay interest & must be retired at some
specified time in the future

The bonds may be callable while many


do not have sinking funds

Debt is often issued in series


Calling the Debt
Some bonds may have a call feature that
allows for redemption prior to maturity.
A call feature permits the issuer to
redeem the bond prior to maturity
Call feature has a call penalty which
protected bondholders, and this penalty
is a premium paid for exercising a call
feature
Federal Government
Debt
EE Savings Bond
Most widely held federal
government debt
Designed to attract the funds of modest
investors and compete directly to
savings vehicles
The earned interest may be tax
deferred until you redeem the bonds
or it matures
No security market
Short-term
Example: Treasury Long-term
Bills
Example: Treasury
Mat: Up to 1 year Bonds
Intermediate-term Den: $1000- $1000,000
Mat: 10 years or more
Example: Treasury
May be purchased
Notes through banks and
brokerage firms
Den: $1000-
$100,000+
Treasury Bonds or Treasury
Bills
There is and active market
Quoted in 32nds
Example: Bond is quoted $101:23 - $101:24 ,
for 1000 bonds
101 24/32 for
100 bonds
Bid Price: $1017.19 101 23/32 for
100 bonds
Ask Price: $1017.50
Municipal
Bonds
General features are the same as corporate debts
Main Difference:
Taxation of the interest income
o Interest on municipal bonds is
exempt from federal income taxation
o and vice on
Interest versa
corporate debts may be
taxed by the state and local
governments or the federal
government
Corporate Versus State and Local
Government Debt

1+t)=

= interest paid on the corporate bond

= interest paid on the municipal bond


t = individuals tax bracket