Corporate Bonds

Characteristics You are loaning $ to a corporation Interest Rate Maturity Date Face Value

Characteristics Cont.  Typically the face value is $1000  Can be as much as $50,000  Interest is paid twice a year  At the maturity date, you would cash the bond in and receive a check for the face value.  Maturity dates range from 1 to 30 years.  Short Term = 1 to 5 years  Intermediate Term = 5 to 15 years  Long Term = More than 15 years

Why Corporations Sell Corporate Bonds  To borrow money  May be to start a business  May be to finance business activities  A corporation may sell stocks and bonds  Bonds must be repaid  Must be paid interest  Stocks do not have to be repaid  Are not required to pay dividends

Types of Corporate Bonds  Debenture  A bond that is backed only by the reputation of the issuing corporation  Mortgage Bond  A bond that is backed by assets of the company.  Risk is lower, interest rate is lower  Subordinated Debenture  An unsecured bond that gives bondholders claim to interest payments and assets of the corporation only after all other bondholders have been paid.  Convertible Bond  A bond that investors can trade for shares of the corporation’s common stock.

Methods Corporations use to Repay Bonds  Call Feature  Allows a corporation to buy back bonds before the maturity date.  May have to pay the bondholder a premium  Bond Indenture  A legal document that details all of the conditions pertaining to a particular bond issue.

Why Investors Buy Corporate Bonds  Interest Income  Receive Interest Income every 6 months  Registered Bond  Only the owner of the bond can collect money on the bond.  Registered bond coupon  Send the coupon in and the interest will be paid  Bearer Bond  Not registered in the owner’s name  Must present coupon  Will not be repaid if coupon is lost or stollen  No longer issued by corporations  Zero-coupon Bond  Provides no interest payments and is redeemed forr its face value at maturity  Sold far below face value

Bond Repayment  Investors have two choices after they have purchased a bond  First, you can keep the bond until its maturity date and then cash it in. Meanwhile, you earn interest every 6 months.  Or, you can sell the bond at any time to another investor.  Either way, the value of the bond is closely tied to the corporation ability to repay it.

Market Value vs. Face Value  Bond prices shift as a result of changes in overall interest rates in the economy.  If Vanessa has a bond with a 7.5% interest and interest rates fall below 7.5%, the market value of her bond increases.  If overall interest rates rise above 7.5%, new issue bonds would be more valuable.  When a bond is selling for less than its face value it is said to be selling at a discount.  When a bond is selling for more than its face value it is said to be selling at a premium.

Shawn purchased a New York Telephone bond that pays 4.5% interest based on a face value of $1,000. Comparable new corporate bond issues are paying 7%. How much is Shawn’s bond worth? Formula = Dollar Amount of Annual Interest $45 Interest Rate of Comparable New Bond 7% Face Value X Annual Interest Rate $1000 X 4.5% = $ The approximate market value of Shawn’s New York Telephone Bond is $642.86

A Typical Bond Transaction  Full-service brokerage firm  Provides information and advice  Discount brokerage firm  You do your own research and make your own decisions  Lower commission  Primary Market  Directly from the banker that represents the company  Secondary Market  Trade with other investors  Bonds issued by large corporations are traded on the New York Bond exchange or the American Bond Exchange Not too different from the stock exchange