Ross5eChap21sm - Chapter 21 LongTerm Debt 21.1 21.1 When...

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Chapter 21: Long–Term Debt 21.1 21.1 When you purchase a bond on a day other than a coupon payment date, there will be an adjustment in the actual price paid. Since coupons are paid in arrears, you can think of them as earned monthly, but paid at the end of each 6–month period. Therefore, if you buy a bond during any 6–month period, at the end of that period you will receive a coupon for some months you did not "earn." Those months of coupon must be paid to the one who earned them –– the seller, and you make that payment at the time you buy the bond. In each of the following, the rate is 6%, so the monthly interest is 6% / 12 = 0.5%. Since the bonds are trading at 100 (or 100% of par), you will pay %) 5 . 0 ( % 100 Pr N ice + = where N is the number of months since the last coupon payment. a. If you purchase the bond on March 1, you owe the seller two months of interest. Therefore, N=2, and the price is: % 101 %) 5 . 0 ( 2 % 100 Pr = + = ice If the face value of the bonds is $1,000, then you will pay $1,000 + $1,000 (0.01) = $1,010.00. b. If you purchase the bond on October 1, you owe the seller three months of interest. Therefore, N=3, and the price is % 5 . 101 %) 5 . 0 ( 3 % 100 Pr = + = ice If the face value of the bonds is $1,000, then you will pay $1,000 + $1,000 (0.015) = $1,015. c. Since July 1 is an interest payment date, there is no accrued interest on the bonds. If today is July 1, you will pay 100% of the face value for the bond. If the face value of the bonds is $1,000, then you will pay $1,000. d. If you purchase the bond on August 15, you owe the seller six weeks (1 1/2 months) of interest. Therefore, N=1.50, and the price is % 75 . 100 %) 5 . 0 ( 5 . 1 % 100 Pr = + = ice If the face value of the bonds is $1,000, then you will pay $1,000 + $1,000 (0.0075) = $1,007.50. 21.2 Sinking funds provide additional security to bonds. If a firm is experiencing financial difficulty, it is likely to have trouble making its sinking fund payments. Thus, the sinking fund provides an early warning system to the bondholders about the quality of the bonds. Answers to End–of–Chapter Problems B– 63
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A drawback to sinking funds is that they give the firm an option that the bondholders may find distasteful. If bond prices are low, the firm may satisfy its sinking fund by buying bonds in the open market. If bond prices are high though, the firm may satisfy its sinking fund by purchasing bonds at face value. Those bonds being repurchased are chosen through a lottery. 21.3 Characteristic Public Issues Direct Financing a. Require OSC registration Yes No b. Higher interest cost No Yes c. Higher fixed cost Yes No d. Quicker access to funds No Yes e. Active secondary market Yes No f. Easily renegotiated No Yes g. Lower floatation costs No Yes h. Require regular amortization Yes No i Ease of repurchase at favorable prices Yes No j. High total cost to small borrowers Yes No k. Flexible terms No Yes l. Require less intensive investigation Yes No 21.4 The difference between the call price and the face value is the call premium. The first few years during which a company is prohibited from calling its bonds is the call –protected period ( or the grace period).
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This note was uploaded on 07/18/2010 for the course ECONMICS ECM359 taught by Professor Matazi during the Summer '10 term at University of Toronto.

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Ross5eChap21sm - Chapter 21 LongTerm Debt 21.1 21.1 When...

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