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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
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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