# Ch020 - Chapter 20 Long-Term Debt 20.1 When you purchase a...

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Chapter 20: Long-Term Debt 20.1 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 10%, so the monthly interest is 10% / 12 = 0.83333%. Since the bonds are trading at 100 (or 100% of par), you will pay Price 100% (.8333%) N = + 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: Price 100% 2(.8333%) 101.667% = + = If the face value of the bonds is \$1,000, then you will pay \$1,000 + \$1,000 (0.016667) = \$1,016.67. b. If you purchase the bond on October 1, you owe the seller three months of interest. Therefore, N=3, and the price is Price 100% 3(.8333%) 102.5% = + = If the face value of the bonds is \$1,000, then you will pay \$1,000 + \$1,000 (0.025) = \$1,025. c. Since July 1 is an interest payment date, there is no accrued interest on the Raeo 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 Price 100% 1.5(.8333%) 101.25% = + = If the face value of the bonds is \$1,000, then you will pay \$1,000 + \$1,000 (0.0125) = \$1,012.50. B-98

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20.2 a. A protective covenant is the part of an indenture or loan agreement that limits the actions of the borrowing company. b. A negative covenant prohibits actions that the company may want to take. Examples include limits on dividends, inability to pledge assets, prohibition of mergers and prohibitions on additional issue of long-term debt. c. A positive covenant specifies actions that the firm is obliged to take. Examples include maintaining a minimum level of working capital and furnishing additional financial statements to the lender. d. A sinking fund is an account managed by a bond trustee for the purpose of repaying bonds. 20.3 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. A drawback to sinking funds is that they give the firm an option that the bondholders
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Ch020 - Chapter 20 Long-Term Debt 20.1 When you purchase a...

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