FIN 614: Financial Management Larry Schrenk, Instructor

1.Bond Basics 2.Bond Example 3.Additional Issues

A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond. Debt/Liability–Source of Corporate Capital Fixed-Income Security

Primarily traded in the over-the-counter (OTC) market. Most bonds are owned by and traded among large financial institutions. Full information on bond trades in the OTC market is not published, but a representative group of bonds is listed and traded on the bond division of the NYSE.

Par Value/Face Value/Principal Coupons Coupon Rate (cr) Fixed Payment Bankruptcy Trigger Period (typically semi-annual) Maturity Yield Debentures vs. Mortgages Indenture (Bond Agreement/Covenant)

TermsExplanations Amount of issue$125 millionThe company will issue $125 million worth of bonds. Date of issue 2/28/86The bonds were sold on 2/28/86. Maturity 3/1/16The principal will be paid in 30 years. Annual coupon 9.25The denomination of the bonds is $1,000. Each bondholder will receive $92.50 per bond per year (9.25% of the face value). Offer price 100The offer price will be 100% of the $1,000 face value per bond.

TermsExplanations Coupon payment dates3/1, 9/31Coupons of $92.50/2 = $46.25 will be paid on these dates. SecurityNoneThe bonds are debentures. Sinking fundAnnual, toward The firm will make annual payments the sinking fund. beginning 3/1/97 Call ProvisionNot callableThe bonds have a deferred call before 2/28/93 Call price initially,After 2/28/93, the company can buy declining to 100back the bonds for $1, per bond, declining to $1,000 on 2/28/05. RatingMoody’s A2This is one of Moody’s higher ratings. The bonds have a low probability of default.

Negative Covenants (Thou shalt not…): Pay dividends beyond specified amount Sell more senior debt and amount of new debt is limited Refund existing bond issue with new bonds paying lower interest rate Buy another company’s bonds Positive Covenants (Thou shalt…): Use proceeds from sale of assets for other assets Allow redemption in event of merger or spinoff Maintain good condition of assets Provide audited financial information

Zero-Coupon Bonds Fixed-Coupon Bonds Variable Rate Coupon Bonds

Government U.S. Treasury Securities Treasury Inflation-Protected Securities (TIPS) State and Local (‘Muni’s’) Corporate Corporate Bonds Short-Term Debt Commercial Paper Home Mortgages

Default Risk Interest Rate Risk Price Risk Reinvestment Risk

Pros Leverage Payments Tax-Deductible No Voting Rights Cons Fixed Interest Payments Principal Repayment Bankruptcy

Embedded Options Callable Bond Convertible Bond Sinking Fund

Financial Performance Debt Ratio TIE Ratio Current Ratio Bond Contract Provisions Secured vs. Unsecured Debt Senior vs. Subordinated Debt Guarantee and Sinking Fund Provisions Debt Maturity

Premium: cr > r Price > par value At par: cr = r Price = par value Discount: cr < r Price < par value

EXAMPLE Consider a ten year, semi-annual, bond with a par value of $1,000 and a coupon rate of 8%: r = 6%price = $1, r = 8%price = $1, r = 10%price = $

FIN 614: Financial Management Larry Schrenk, Instructor