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Bond market. Corporate senior instruments: Corporate senior instruments are financial obligations of a corporation that have priority over its common stock in the case of bankruptcy. Two popular sectors of corporate bond market: High yield or Junk bond market. The Eurobond market.
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Bond market Corporate senior instruments: Corporate senior instruments are financial obligations of a corporation that have priority over its common stock in the case of bankruptcy. Two popular sectors of corporate bond market: High yield or Junk bond market. The Eurobond market. Corporate bonds are issued by corporations. .
Corporate bonds are classified into four: • Utilities: • Electric power companies • Gas distribution companies • Water companies. • Communication companies. • Transportations: • Airlines • Railroads. • Trucking companies. • Industrials: Catch class & most heterogeneous of the groupings with respect to investment characteristics. • All kinds of manufacturing • Merchandising • Service companies. • Banks and Finance companies .
Features of a corporate bond issue: • The corporate issuer promises to pay a specified percentage of par values on the designated dates (the coupon payments) and to repay par or principal value of bond at maturity. • Failure to pay either the principal or interest when due constitutes legal default and investors can go to court to enforce the contract. • Bondholders, like creditors, have a prior legal claim over common and preferred stockholders as to both income and assets of the corporation for the principal and interest due them. .
Bond indentures • These are contracts where the promises of corporate bond issuers and the rights of investors who buy them are set forth in great detail. • The problems relating to contracts are solved for the most part by bringing in a corporate trustee as a third party to the contract. A trustee acts in a fiduciary capacity for investors who own the bond issue. .
Corporate trustee • A corporate trustee is a bond or trust company with a corporate trust department whose officers are experts in performing the functions of a trustee. • Most corporate bonds are term bonds as they run for a term of years, and then become due and payable. • Any amount of the liability that has not been paid of prior to maturity must be paid off at that time. • The term may be short or long. Most corporate borrowings take the form of bonds due in 20 or 30 years. • Term bonds may be retired by payments at final maturity or relived prior to maturity if provided for in the indenture. .
Security for bonds • A mortgage bond grants the bondholders a lien against the pledged assets. lien • It is a legal right to sell the mortgaged property to satisfy unpaid obligations to the bondholders. • In practice, foreclosure and sale of mortgaged property is unusual. • Usually in case of default a financial reorganization of the issuer provides for settlement of the debt to bondholders. Why mortgage lien is important? • The mortgage lien is important because it gives the mortgage bondholders a strong bargaining position relative to other creditors in determining the terms of any reorganization. .
Collateral trust bonds • Companies, not having fixed assets or other real property to give a mortgage lien to secure bondholders, may pledge securities of other companies such as stocks, notes, bonds or whatever other kind of obligations they own. These assets are termed collateral (or personal property) and bonds secured by such assets are called collateral trust bonds. .
Equipments trust certificates • Many years ago the railway companies developed a way of financing the purchase of cars and locomotives (rolling stock) that enabled them to borrow in the corporate bond market. This is through selling equipment trust certificates to obtain funds to pay the manufacturer. The trustee collecting lease payments from the railroad and uses the money to pay interest and principal on the certificates. • Although the railway companies developed the equipment trust arrangement, it has also been used by companies engaged in providing other kinds of transportation such as: • Trucking companies finance the purchase of huge fleets of trucks. • Airlines use this kind of financing to purchase transport planes. • International oil companies use it to buy huge tankers. .
Debenture bond • Debenture bonds are debt securities not secured by a specific pledge or property. They have the claim of general creditors on all assets of the issuer not pledged specifically to secure other debt. They have also claim on pledged assets if these assets have more value than necessary to satisfy secured creditors. Subordinated debenture bond • These are those bonds which rank after secured debt, after debenture bonds, and often some general creditors in their claim on assets and earnings. .
Guaranteed bonds • Guaranteed bonds are obligations guaranteed by another entity. The safety of a guaranteed bond depends upon the guarantor’s financial capability as well as the financial capability of the issuer. The terms may call for the guarantor to guarantee the payment of interest and / or repayment of the principal. .
Provisions for paying off bonds Shall the issuer have the right to redeem the entire amount of bonds outstanding on a date before maturity? • Issuers generally want this right because they recognize that at some time in the future the general level of interest rates may fall sufficiently below the issue’s coupon rate at which time reducing the issue and replacing it with another issue with a lower coupon rate could be attractive. .
What is refunding? • The usual practice is a provision that devices the issuer to redeem bonds with proceeds received from issuing lower-cost debt obligations ranking equal or superior to the debt to be redeemed. This type of redemption is called refunding. • In spite of refunding restrictions they may be callable immediately, in whole or in part, if the source of funds comes from other than lower-interest cost money. .
What is sinking fund requirement? • Corporate bond indentures may require the issuer to retire a specified portion of an issue each year. This is referred to as a sinking fund requirement. What is Balloon Maturity? • This provision may be designed to liquidate all of a bond issue or part of the total by the end of the term. If only a part is paid, the remainder is called a balloon maturity. • The purpose of the sinking fund provision is to reduce credit risk. .
Conversion provision What is a convertible bond? • The conversion provision grants the bondholder the right to convert the bond to a predetermined number of shares of common stock of the issuer. What is an exchangeable bond? • These bonds grant the bondholder the right to exchange the bonds for the common stock of a firm other than the issuer of the bond. .
Issues of debt with warrant What is warrant? • A warrant grants the holder the right to purchase a designated security at a specified price. • A warrant is simply a call option that permits the holder to purchase the common stock of the issuer of the debt or the common stock of a firm other than the issuer’s. • Warrants generally can be detached from the host bond and sold separately. .
Corporate bond ratings What is credit analysis? • Professional money managers use various techniques to analyze information on companies and bond issuers in order to estimate the ability of the issuer to live up to its future contractual obligations. This activity is known as credit analysis. • Some large institutional investors and many investment banking firms have their own credit analysis departments. Few individual investors and institutional bond investor rely primarily on nationally recognized rating companies that perform credit analysis and issue their conclusions in the form of ratings. .
Bonds rated triple A (AAA or Aaa) are said to be prime; double A (AA or Aa) are of high quality; single A issues are called upper medium grade and triple B are medium grade. Lower rated bonds are said to have speculative elements. • In all systems the term high grade means low credit risk or conversely, high probability of future payment. • The corporate bond market can be divided into two sectors: • The investment grade • Non investment grade. • Bond issues that are assigned a rating in the top four categories are referred to as investment grade bonds. • Issues that carry a rating below the top four categories are referred to as no investment grade bonds. They are more popularly known as high-yield bonds or junk bonds. .
Event Risk What is event risk? • The ability of an issuer to pay interest and principal may change seriously and unexpectedly. This happens occasionally. The reasons may be: • A natural or industrial accident or some regulatory change: Examples are a change in the accounting treatment of loan losses for commercial banks of cancellation of nuclear plants by public utilities. • A takeover or corporate restructuring • These risks are referred to generically as event risk. .
High-yield corporate bond market What is junk bond? • High yield bonds are commonly called junk bonds. They are issues with quality ratings below triple B. What is an original issue high yield bond? • The non investment grade issues rated such at the time of issuance are called original issue high yield bonds. They may be rated investment grade at the time of issuance and subsequently downgraded to no investment grade. Downgraded bonds may fall into two groups: • Issues that have been downgraded because the issuer voluntarily significantly increased their debt as a result of a leveraged buyout or a recapitalization. • Issues that have been downgraded for other reasons. .
Distinguish between on extendable reset bond and a floating rate issue: • In a floating rate issue, the coupon rate resets according to a fixed spread over some benchmark, with the spread specified in the indenture. The amount of the spread reflects market conditions at the time the issue is offered. • The coupon rate on an extendable reset bond by contrast is reset based on market conditions at the time of the reset date. This coupon rate is suggested by several investment banking firms. • The advantage to issuers: The advantage to issuers of extendable reset bonds is that they can be assured of a long-term source of funds based on short-term rates. • The advantage to investors: The advantage to investors is that the coupon rate will reset to the market rage. .
Eurobond market What is Euro market? • The external market is commonly called the Euro market. What are the distinguishing features of securities of this market? The following are the distinguishing features: • They are underwritten by an international syndicate. • At issuance they are offered simultaneously to investors in a number of countries. • They are issued outside the jurisdiction of any single country. • They are in unregistered form. What is Euro bond? • A Euro bond refers to bonds issued with these characteristics. • Corporations in the USA and other countries as well as government entities have raised funds in this market. .
What are Euro straights? • The Eurobond market has been characterized by new and innovative bond structures to accommodate particular needs of issuers and investors such as fixed rate coupon bonds. They are referred to as Euro Straights. Features: • They are usually issued by high quality entities because they are issued on an unsecured basis. • Coupon payments are made annually rather than semi annually because of the higher cost of distributing interest to geographically dispersed bondholders. What is a Dual currency bond? • Dual currency bond are those bonds that pay coupon interest in one currency but pay the principal in a different currency. What are drop-lock bonds? • There are some issues which automatically change the floating coupon rate into a fixed coupon rate under certain circumstances. These are referred to as drop lock bonds. .
