Bonds(1) - Differences Between Debt and Equity Debt Not an...

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1-1 6-1 1 Differences Between Debt and Equity Debt Not an ownership interest Creditors do not have voting rights Interest is considered a cost of doing business and is tax- deductible Creditors have legal recourse if interest or principal payments are missed Excess debt can lead to financial distress and bankruptcy Equity Ownership interest Common stockholders vote to elect the board of directors and on other issues Dividends are not considered a cost of doing business and are not tax deductible Dividends are not a liability of the firm until declared. Stockholders have no legal recourse if no dividends are declared An all-equity firm cannot go bankrupt
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1-2 6-2 2 The Bond Indenture Contract between the company and the bondholders and includes The basic terms of the bonds The total amount of bonds issued A description of property used as security, if applicable Sinking fund provisions Call provisions Details of protective covenants
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1-3 6-3 3 Bond Classifications Registered vs. Bearer Forms Security Collateral – secured by financial securities Mortgage – secured by real property, normally land or buildings Debentures – unsecured Notes – unsecured debt with original maturity less than 10 years Seniority
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1-4 6-4 4 Bond Characteristics and Required Returns The coupon rate is usually set close to the yield, which depends on the risk characteristics of the bond when issued
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