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likely to decrease with increasing offering size. On the other hand, the risk to the
bondholders may increase, because larger offerings result in greater risk of default. Impact of Issuer’s Risk
The greater the issuer’s default risk, the higher the interest rate. Some of this risk
can be reduced through inclusion of appropriate restrictive provisions in the
bond indenture. Clearly, bondholders must be compensated with higher returns
for taking greater risk. Frequently, bond buyers rely on bond ratings (discussed
later) to determine the issuer’s overall risk. Impact of the Cost of Money
The cost of money in the capital market is the basis for determining a bond’s
coupon interest rate. Generally, the rate on U.S. Treasury securities of equal
maturity is used as the lowest-risk cost of money. To that basic rate is added a
risk premium (as described earlier in this chapter) that reflects the factors mentioned above (maturity, offering size, and issuer’s risk). 276 PART 2 Important Financial Concepts General Features of a Bond Issue conversion feature
A feature of convertible bonds
that allows bondholders to
change each bond into a stated
number of shares of common
A feature included in nearly all
corporate bond issues that gives
the issuer the opportunity to
repurchase bonds at a stated
call price prior to maturity.
The stated price at which a bond
may be repurchased, by use of a
call feature, prior to maturity.
The amount by which a bond’s
call price exceeds its par value.
stock purchase warrants
Instruments that give their
holders the right to purchase a
certain number of shares of the
issuer’s common stock at a
specified price over a certain
period of time. Three features sometimes included in a corporate bond issue are a conversion feature, a call feature, and stock purchase warrants. These features provide the
issuer or the purchaser with certain opportunities for replacing or retiring the
bond or supplementing it with some type of equity issue.
Convertible bonds offer a conversion feature that allows bondho...
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