finaloutline - Chapter 10 Reporting and Interpreting Bonds...

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Chapter 10- Reporting and Interpreting Bonds I. Understanding the Business A. Capital structure is the mixture of debt and equity a company uses to finance its operations B. Bonds are securities that corporations and governmental units issue when they borrow large amounts of money C. After bonds have been issued, they can be traded on established exchanges such as the New York Bond Exchange D. The ability to sell a bond on thebond exchange is a significant advantage for creditors because it provides them with liquidity or the ability to convert their investments into cash E. Most creditors demand a higher interest rate for long-term loans F. By issuing more liquid debt, corporations can reduce the cost of long-term borrowing II. Characteristics of Bonds Payable A. Why a corporation would want to issue bonds instead of stocks: 1. Stockholders maintain control. Bondholders do not vote or share in the company’s earnings 2. Interest expense is tax deductible which reduces the net cost of borrowing 3. The impact on earnings is positive. Money can be borrowed at a low interest rate and invested at a higher rate B. Bonds carry a higher risk that equity C. Major disadvantage of issuing bonds: 1. Risk of bankruptcy. Interest payments to bondholders are fixed charges that must be paid each period 2. Negative impact on cash flows. Debt must be repaid at a specific time in the future D. A bond usually requires the payment of interest over its life with repayments of principal on the maturity date E. Bond Principal - is the amount (1) that is payable at the maturity date and (2) on which the periodic cash interest payments are computed.
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F. Par value - another name for bond principal, or the maturity amount of a bond G. All bonds have a par value, which is the amount that will be paid when the bond matures H. A bond always specifies the stated rate of interest abd the timing of periodic cash interest payments, I. Stated rate - is the rate of cash interest per period stated in the bond contract J. Each periodic interest payment is computed as principal times the stated interest rate K. The selling price of a bond does not affect the periodic cash payment of interest L. Different types of bonds have different characteristics for good economic reasons M. Bond type: 1. Unsecured bond (debenture)- no assets are specifically pledged to guarantee repayment at maturity 2. Secured bond -specific assets are pledged as a guarantee of repayment at maturity 3. Callable bonds- may be called for early retirement at the option of the issuer 4. Convertible bonds -may be converted to other securities of the issuer (usually common stock). N. Indenture - a bond contract that specifies the legal provisions of a bond issue 1. These provisions include the maturity date, rate of interest to be paid, date of each interest payment, and any conversion privileges 2. Also ncludes covenants designed to protect the creditors O. Covenants may limit the company’s future actions, management prefers those that are
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finaloutline - Chapter 10 Reporting and Interpreting Bonds...

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