1. Corporate Senior Instruments Markets: II
CHAPTER 23
Corporate Senior Instruments Markets: II
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CORPORATE BONDS
Basic Features of a Corporate Bond Issue
Bonds generally pay periodic interest at a percent of par value and principal at maturity or in amortized amounts
Failure to meet these terms may lead to default
Bondholders have a prior legal claim over stockholder in case of default or bankruptcy
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3. CORPORATE BONDS (continued)
Basic Features of a Corporate Bond Issue
Maturity of bonds: Most bonds are term bonds, for a term of years, often referred to as bullet-maturity, or bullet bonds
Obligations due less than 10 years from the date of issue are called notes
Most corporate borrowings take the form of bonds, due in 20 to 30 years
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4. CORPORATE BONDS (continued)
Basic Features of a Corporate Bond Issue
Some bonds are arranged to pay specified principal amounts at specific dates, which are called serial bonds
Collateral trust bonds: a holding company issues bonds to fund operations of a its subsidiaries, it may pledge collateral in the form of stock, note, bonds or whatever other financial assets it owns
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5. CORPORATE BONDS (continued)
Basic Features of a Corporate Bond Issue
Security of bonds: Bonds can be secured by collateral or asset liens
Debentures have no specific collateral, they are unsecured obligations of the firm
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6. CORPORATE BONDS (continued)
Basic Features of a Corporate Bond Issue
Subordinated debenture bond is an issue that ranks after secured debt, after debenture bonds, and often after some general creditors in its claims on assets and earnings
Guaranteed bond is an obligation guaranteed by another entity
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7. CORPORATE BONDS (continued)
Basic Features of a Corporate Bond Issue
Refunding: the opportunity to refund (or repay) the bonds prior to maturity will normally occur when interest rates decline, forcing the investor to earn lower returns
A call provision limits price increases on bonds, since if the price goes high enough, the firm will exercise its call privilege
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8. CORPORATE BONDS (continued)
Bonds With Special Features
Convertible bonds: grants the bondholder the right to convert his bond into common stock at a set price per share (usually adjusted for changes in the outstanding common stock, such as splits and mergers)
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9. CORPORATE BONDS (continued)
Bonds With Special Features
Exchangeable bonds: grants the bondholder the right to convert his bond into common stock of a firm other than the issuer
With this conversion privilege, the investor has an option for which he pays a premium in the form of a lower yield
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10. CORPORATE BONDS (continued)
Bonds With Special Features
Issues of debt with warrants: Permits the holder to purchase common stock at a set price per share from the issuer
In contrast to the convertible, the bond remains in existence after stock purchase
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11. CORPORATE BONDS (continued)
Bonds With Special Features
Putable bonds: These are bonds that can be sold back to the issuer at some price, usually par value
Zero-coupon bonds: These securities are sold at a discount from par or face value. The payment at maturity includes compounded interest. Investors benefit from a pre-determined return -- no reinvestment risk. Zero-coupon bonds are taxed as though they paid regular interest
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12. CORPORATE BONDS (continued)
Bonds With Special Features
Floating-rate securities: With this type of bond, interest rates periodically reset to meet changing market conditions
Popular in recent years as firms use them to: match cash flows
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13. CORPORATE BONDS (continued)
High-Yield Sector
There are three types of deferred coupon structures
Deferred-interest bonds are the most popular type
Step-up bonds do pay coupon interest, but the coupon rate is low for an initial period and then increases to a higher coupon rate
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14. CORPORATE BONDS (continued)
High-Yield Sector
Payment-in-kind (PIK) bonds give the issuer an option to pay cash at a coupon payment date or give the bondholder a similar bond
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15. CORPORATE BONDS (continued)
Corporate Bond Defaults
The recovery rate is the amount a bondholder recovers from the face value of the defaulted bond
An important measure in studying the performance of corporate bond sector is the default loss rate, which is defined as:
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16. CORPORATE BONDS (continued)
Corporate Bond Defaults
Default Loss Rate =
Default Rate x (100% – Recovery Rate)
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17. CORPORATE BONDS (continued)
Private-Placement Market for Corporate Bonds
There is an active private placement market for corporate bonds
Most of this market constitutes issues placed under Rule 144A
Liquidity in these issues is provided by investment banks
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MEDIUM-TERM NOTES
Medium-term note (MTN): corporate debt instrument, offered continuously to investors by an agent of the issuer
Such notes are usually SEC registered, although Shelf Registration (Rule 415) allows large amounts to be registered at one time even though the issues may be spread throughout several years
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19. MEDIUM-TERM NOTES (continued)
The Primary Market
A corporation that wants an MTN program will file a shelf-registration with the SEC for the offering of securities
The SEC registration for MTN offerings is between $100 million and $1 billion
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