Corporate Finance Chapter 24

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Leveraged buy out

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a group of private investors purchase all of the equity of a public corporation

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corporate bonds

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securities issued by corporations. Often pay coupons semiannually. few corporations have issued zero-coupon bonds. wide range of maturities (often <30 yrs)

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indenture

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part of the offering memorandum needed for issuing public bonds. It is a formal contract between the bond issuer and a trust company.

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trust company

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respresents the bondholders and makes sure the terms of the indenture are enforced. In case of default the trust company represents the bondholders' interests.

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original issue discount

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if a coupon bond is issued at a discount (because of underwriting fees or the possibility that the bond might not actually sell for face value)

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bearer bonds

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like a currency: whoever physically holds the bond certificate owns the bond. get coupon by clipping off a coupon and handing to paying agent. serious security concerns (losing)

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registered bonds

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more common today. Issuer maintains a list of holders. brokers keep issuers informed of any changes in ownership. check gets mailed to owner when coupon paid. also facilitates tax collection for government.

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unsecured debt

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(e.g. debentures and notes) in the event of bankruptcy bondholders have a claim only to the assets of the firm that are not already pledged as collateral on other debt. Notes typically shorter maturity (<10 yrs) than debentures.

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secured debt

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(e.g. asset backed bonds and mortgage bonds) specific assets are pledged as collateral that bondholders have a claim to in the event of bankruptcy. asset-backed can be any asset. mortgage backed: real property. technically a corporate bond must be secured.

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tender offer

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public announcement of an offer to all existing bond holders to buy back existing debt (secured and unsecured).

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junk bonds

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high yield notes rated below investment grade. Higher yield because in case of bankruptcy lower claim seniority.

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seniority

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bondholders priority in claiming assets in case of default.

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subordinated debenture

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name of debt when a firm conducts a subsequent debenture issue that has a lower priority than its outstanding debt.

In the event of default, the assets not pledged as collateral for outstanding bonds cannot be used to payoff the holders of the subordinated debenture until all seniors are paid.

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domestic bonds

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bonds issued by a local entity and traded in a local market, but purchased by foreigners. Denominated in local currency.

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Foreign bonds

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bonds issued by a foreign company in a local market and are intended for local investors. denominated in local currency. (in US: Yankee bonds, Japan: Samurai bonds, UK: Bulldogs)

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Eurobonds

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international bonds that are not denominated in local currency of the country in which they are issued. So there is no connection to the physical location of the market on which they trade and the location of the issuing entity. Can be denominated in any number of currencies that might or might not be connected to location of the issuer. not subject to any nations regulation.

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Global bonds

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combine features of domestic, foreign and Eurobonds. are offered for sale on several different markets simultaneously.

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exchange rate risk

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a bond that makes its payments in a foreign currency contains a risk of holding that currency. therefore is priced off the yields of similar bonds in that currency. risk: foreign currency will depreciate in value relative to local currency.

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private debt

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(e.g. bankloans) debt that is not publicly traded. is a larger market than the public debt market. advantage: avoids cost of registration. disadvantage: illiquid. two segments: term loans and private placements.

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term loan

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a bank loan that lasts for a specific term (e.g syndicated bank loan)

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syndicated bank loan

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a single loan that is funded by a group of banks rather than just 1. often rated as investment grade. but if leveraged syndicated loans often rated as speculative grade.

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revolving line of credit

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credit commitment for a specific time period up to some limit, which can be used if needed. if backed by assets better rating than the term loan.

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private placement

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is a bond issue that does not trade on a public market but is sold to a small group of investors (no need for registration so less costly to issue). instead of indenture a simple promissory note is sufficient. doesnt need to conform to standard so can be tailored to specific conditions. after 1990 SEC rule, became more liquid. could be traded among large financial institutions.

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sovereign debt

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debt issued by national governments (eg treasury securities). US treasury 4 kinds of securities: bills, notes, bonds, TIPS

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bills, notes, bonds, TIPS

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1. discount, 4-13-26 weeks

2. semiannual coupon, btween 1-10 yrs

3. semiannual coupon, >10 yrs (30 yrs long bonds)

4. coupon, 5-10-20 years outstanding principal is adjusted for inflation.

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TIPS

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Treasury Inflation Protected Securities. coupon rate is fixed, the dollar coupon varies because the semiannual coupon payments are a fixed rate of the inflation adjusted principal. Final repayment of the principal at maturity is protected against deflation. if final principal is less than original principal amount: original principal amount is repaid.

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noncompetitive bidders

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usually individuals, submit the amount of bonds they want to buy and are guaranteed to have their orders filled at the auction.

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competitive bidders

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submit sealed bids in terms of yields and the amount of bonds they are willing to purchase. treasury accepts lowest yield (highest price) competitive bids up to the price required to fund the deal.

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stop-out yield

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highest yield accepted. all succesful bidders are awarded this yield. (determines price of bill, or coupon of bond)

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STRIPS

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Separate Trading of Registered Interest and Principal securities. Zero coupon treasuries with maturities longer than one year that trade in the bond market. not issued by treasury but by investment banks. they resell each coupon of a treasury note and bond separately.

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agency securities

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are issued by agencies of the US government or government sponsored enterprises.

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pass through securities

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(eg Morgage backed securities), backed by an underlying portfolio or pool of mortgages. Annuities that pay fixed monthly payments for 30 years. principal is not paid back at maturity but paid back gradually over the life of the bond. prepayment risk!

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Municipal bonds

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issued by state or local governments. income on this is not taxable on federal level. also referred to as tax exempt bonds. mostly pay semiannual coupons (fixed or floating)

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serial bonds

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a single issue that contains a serie of bonds that mature serially over a number of years.

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general obligation bonds

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bonds backed by the full faith and credit of a local government. not as secure as bonds bcked by full faith and credit of federal government. sometimes a special fee is added as a particular revenue source (double barreled).

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revenue bonds

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local government that pledges specific revenues generated by projects that were initially financed by the bond issue.

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covenants

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restrictive clauses in a bond contract that limit the issuer from taking actions that might undercut its ability to repay the bonds. eg dividend payment, further indebtedness, minimum amount of working capital.

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equity holders and covenants

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including more covenants issuers can reduce costs of borrowing, beneficial for equity holders. if failed to live up to any covenant: bond goes in default.

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ways of repaying bond

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1. pay coupon payments and principal

2. buy part of outstanding bonds in market\

3. tender offer

4. call a provision that allows issuer to repurchase at a predetermined price (call price). (callable bonds) at call date.

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call price

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generally set at or above, and expressed as a percentage of, the bonds face value. call price is gradually reduced until the bond becomes callable at par. e.g. on page 791

will only be called if the coupon rate of the bond exceeds the prevailing market rate. FIGURE 24.3 and 24.4!!

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Yield to Call

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YTC: annual yield of a callable bond assuming that the bond is called at the earliest opportunity. See example 24.2

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sinking fund

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another repayment option: instead of repaying entire principal balance on maturity date, the company makes regular payments into a sinking fund administered by a trustee over the life of a bond. these payments are then used to repurchase the bonds. in this way company can reduce the amount of outstanding debt without affecting CF of the remaining bonds.

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how does the trustee decide which bonds to purchase?

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if the bonds are trading below face value the company simply repurchases the bonds in the market. but if >FV the decision is made by lottery.

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sinking fund provisions

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usually specify a minimum rate at which issuer must contribute to the fund. in some cases issuer has the option to accelerate these payments. because the sinking fund allows the issuer to repurchase the bonds at par, the option to accelerate the payments is another form of a call provision.

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balloon payment

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sometimes sinking fund payments are not sufficient to retire the entire issue and the company must make a large payment on the maturity date.

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convertible bonds

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another way of retiring bonds is converting them into equity.

can be thought of as a regular bond plus a special type of call option called a WARRANT.

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conversion ratio

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ratio at which a bond can be converted into a fixed number of shares of common stock.

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warrant

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is a call option written by the company itself on new stock (whereas a regular call option is written on existing stock). so when holder of warrant exercises it the company issues new stock.

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conversion price

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on maturity date of the bond, the strike price of the embedded warrant in a convertible bond is equal to the face value of the bond divided by the conversion ratio.

prior to the maturity date: if stock does not pay dividend it is not optimal to exercise call early. figure 24.5