1. Income bonds are similar to preferred stock in several ways.
Payment of interest on
income bonds depends on the availability of sufficient earnings, just like preferred stock.
However, income bonds would be paid ahead of preferred stock.
On the other hand, both
would be paid ahead of common stock.
Missed payments are cumulated as with
For purposes of analyzing debt, the major differences would be that
payments on income bonds, while they can be deferred, must be paid contractually and
are tax deductible.
Failure to make payments can lead to default and bring on
This is not the case with preferred stock.
2. The contractual payments on a commodity bond depend directly on the price of a
However, like a straight bond, the payments on the commodity bond are
capped at some predetermined amount.
The contractual payments on a straight bond do
not depend on the price of the commodity.
However, the ability of the company to make
the payments might depend upon commodity prices.
In the case of equity, there are no
contractual payments at all, although the value of the equity could depend on commodity
From the point of view of analyzing capital structure, commodity bonds would
qualify as debt, since the payments are contractual, and non-payment could bring on
However, since the amount that has to be paid is tied to commodity prices,
the risk of bankruptcy is smaller.
3. This security resembles straight debt, except for two things: the “dividend” is not tax-
deductible, and it is subordinated to all other debt.
Alternatively, it could be compared to
preferred stock with a finite life.
I would classify this security as equity, since the
payments are not contractual.
Alternatively, it might be included in a special category
like preferred debt.
4. If we assume that the straight preferred stock is trading at par, the return on the straight
preferred = 9%.
If the convertible preferred, which has a 6% dividend rate were evaluated as a straight
preferred at this yield, we would get a price of 6/0.09 = $66.67.
Since it is actually
trading at $105, the equity component = 105 - 66.67 = $38.33
5. The convertible bond is a 10-year bond with a face value of $1000 and a coupon rate
If it yielded the same rate as the straight bond, i.e. 8%, its price would be equal to
, assuming semi-annual coupons.
Hence, the equity
component of the convertible can be estimated as 1100 - 796.15 = 303.85.
The total equity component of the firm’s asset value = 50(1 m.) + 303.85(20000) =
The debt component = $25m. + 796.15(20000) = 40.923m.
Hence, the debt ratio = 40.923/(40.923 + 56.077) = 42.19%