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Unformatted text preview: al payments are missed missed Excess debt can lead to Excess financial distress and bankruptcy bankruptcy Equity Ownership interest Common stockholders Common vote for the board of directors and other issues directors Dividends are not Dividends considered a cost of doing business and are not tax deductible deductible Dividends are not a Dividends liability of the firm and stockholders have no legal recourse if dividends are not paid are An all equity firm can not An go bankrupt merely due to debt since it has no debt debt 21 The Bond Indenture Contract between the company and the Contract bondholders that includes bondholders The basic terms of the bonds The total amount of bonds issued A description of property used as security, if description applicable applicable Sinking fund provisions Call provisions Details of protective covenants 22 Bond Classifications Registered vs. Bearer Forms Security Collateral – secured by financial securities Mortgage – secured by real property, normally land or Mortgage buildings buildings Debentures – unsecured Notes – unsecured debt with original maturity less Notes than 10 years than Seniority 23 Bond Characteristics and Bond Required Returns Required The coupon rate depends on the risk The characteristics of the bond when issued characteristics Which bonds will have the higher coupon, all Which else equal? else Secured debt versus a debenture Subordinated debenture versus senior debt A bond with a sinking fund versus one without A callable bond versus a non-callable bond 24 Bond Ratings – Investment Quality High Grade Moody’s Aaa and S&P AAA – capacity to pay is Moody’s extremely strong extremely Moody’s Aa and S&P AA – capacity to pay is very strong Medium Grade Moody’s A and S&P A – capacity to pay is strong, but Moody’s more susceptible to changes in circumstances more Moody’s Baa and S&P BBB – capacity to pay is Moody’s adequate, adverse conditions will have more impact on the firm’s ability to pay the 25 Bond Ratings - Speculative Low Grade Moody’s Ba, B, Caa and Ca S&P BB, B, CCC, CC Considered speculative with respect to capacity to pay. Considered The “B” ratings are the lowest degree of speculation. The Very Low Grade Moody’s C and S&P C – income bonds with no interest Moody’s being paid being Moody’s D and S&P D – in default with principal and Moody’s interest in arrears interest 26 Government Bonds Treasury Securities Federal government debt T-bills – pure discount bonds with original maturity of one year or T-bills less less T-notes – coupon debt with original maturity between one and T-notes ten years ten T-bonds coupon debt with original maturity greater than ten years years Municipal Securities Debt of state and local governments Varying degrees of default risk, rated similar to corporate debt Interest received is tax-exempt at the federal level 27 Example 7.4 A taxable bond has a yield of 8% and a taxable municip...
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This document was uploaded on 10/01/2013.

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