14CHAPTER - BIG PICTURE (Ch. 14) This chapter studies bond...

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1 BIG PICTURE (Ch. 14) This chapter studies bond payable which is a liability issued by the debtor/seller/borrower/issuer who sells the bond for cash (or other assets) and agrees to pay interest (unless it is zero-coupon bond) plus maturity value at maturity date. Long-Term Debt: Issuance of long-term debt requires formality such as the approval by the board of directors and the stockholders, if incorporated. Covenants (or restrictions) which protect both lenders and borrowers are included in the agreement (or indenture). Borrowers’ Protections Lenders’ Protections 1. Amounts authorized to be issued 2. Interest rate 3. Due date(s) 4. Call provisions 1. Property pledged as security 2. Sinking fund requirements 3. Working capital and dividend restrictions 4. Limitations concerning the assumption of additional debt Bonds: Bonds are issued in denominations of $100, $1000, or $10000 (1) indirectly through an investment bank who acts as a firm-underwriter (take risk 100%) or best-effort underwriter (charge commissions), or (2) directly through a private placement to a large institution. Types of Bonds o Secured (collateral) and unsecured (or debenture) bonds. o Term (mature on a single date), serial (mature in installments), and callable (right to retire bonds prior to maturity date) bonds. o Convertible (into other securities), commodity backed (asset-linked e.g., gold, silver, barrels of oil) and deep-discount (zero interest debenture bearing) bonds. o Registered (issued in the name of the owner and requires issuance of a new certificate to complete a sale) and bearer (transferrable from one owner to another) bonds. o Income (pay interests if profitable) and revenue (pay interest from a specific source of revenue) bonds. Inverse relationship between bond price and market interest rate. Bond price = PV (coupons, usually semiannual) + PV (Face Value)
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2 When does a bond sell at par value? When the stated/nominal/coupon rate market/effective/yield rate. When does a bond sell at a premium? When the stated/nominal/coupon rate market/effective/yield rate. When does a bond sell at a discount? When the stated/nominal/coupon rate market/effective/yield rate. Bonds Issued at Par on Interest Date When bonds are issued on an interest payment date at par, no interest has accrued and no premium or discount exists. Example: If 10-year term bonds with a par value of $800,000, dated January 1, 2004, and bearing interest at an annual rate of 10% payable semiannually on January 1 and July 1, are issued on January 1 at par, the entry would be: The entry for semiannual interest payment of $40,000 on July 1, 2004, would be as follows: Bonds Issued at Discount or Premium on Interest Date A premium or discount is written off to interest expense by the issuer over the life of the bond using either the effective interest method (use market/effective/yield rate, beginning CV of bonds payable, and interest payment to determine the amount of amortization) or
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14CHAPTER - BIG PICTURE (Ch. 14) This chapter studies bond...

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