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To carry out this requirement the corporation makes

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Unformatted text preview: stematic retirement of bonds prior to their maturity. To carry out this requirement, the corporation makes semiannual or annual payments that are used to retire bonds by purchasing them in the marketplace. Security Interest The bond indenture identifies any collateral pledged against the bond and specifies how it is to be maintained. The protection of bond collateral is crucial to guarantee the safety of a bond issue. CHAPTER 6 Interest Rates and Bond Valuation 275 Trustee trustee A paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders if the terms of the indenture are violated. A trustee is a third party to a bond indenture. The trustee can be an individual, a corporation, or (most often) a commercial bank trust department. The trustee is paid to act as a “watchdog” on behalf of the bondholders and can take specified actions on behalf of the bondholders if the terms of the indenture are violated. Cost of Bonds to the Issuer The cost of bond financing is generally greater than the issuer would have to pay for short-term borrowing. The major factors that affect the cost, which is the rate of interest paid by the bond issuer, are the bond’s maturity, the size of the offering, the issuer’s risk, and the basic cost of money. Impact of Bond Maturity on Bond Cost Generally, as we noted earlier, long-term debt pays higher interest rates than short-term debt. In a practical sense, the longer the maturity of a bond, the less accuracy there is in predicting future interest rates, and therefore the greater the bondholders’ risk of giving up an opportunity to lend money at a higher rate. In addition, the longer the term, the greater the chance that the issuer might default. Impact of Offering Size on Bond Cost The size of the bond offering also affects the interest cost of borrowing, but in an inverse manner: Bond flotation and administration costs per dollar bo...
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