On the other hand the risk to the bondholders may

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Unformatted text preview: rrowed are 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 stock. call feature 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. call price The stated price at which a bond may be repurchased, by use of a call feature, prior to maturity. call premium 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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This document was uploaded on 01/19/2014.

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