BDHch15

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Chapter 15

Debt Financing

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Corporate Debt

Private Debt

Bank Loans

Term Loan

Syndicated Bank Loan

Revolving Line of Credit

Asset-Backed Line of Credit

Private Placements

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Corporate Debt

Public Debt

The Prospectus

Indenture

A formal contract between a bond issuer and a trust company,which represents the bondholders interests

Original Issue Discount (OID) Bond

A coupon bond issued at a discount

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Front Cover of the Offering

Memorandum for the Hertz

Junk Bond Issue

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Corporate Debt

Public Debt

Unsecured Corporate Debt

Notes

Debentures

Secured Corporate Debt

Mortgage Bonds

Asset-Backed Bonds

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Corporate Debt

Public Debt

Seniority

A bondholders priority, in the event of a default, in

claiming assets not already securing other debt

Subordinated Debenture

A debenture issue that has a lower priority claim to the firms

assets than other outstanding debt

Tranches Different classes of securities that comprise a single bond

issuance

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Corporate Debt

Public Debt International Bonds

Domestic Bonds

Issued by a local entity and traded in a local market, but

purchased by foreigners

Denominated in the local currency

Foreign Bonds

Issued by a foreign company in a local market and are intended

for local investors

Denominated in the local currency

Yankee bonds -- Foreign bonds issued in the United States

Eurobonds

International bonds that are not denominated in the local

currency of the country in which they are issued

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Corporate Debt

Public Debt

International Bonds

Global Bonds

Combines the features of domestic, foreign, and Eurobonds,and are offered for sale in several different markets

simultaneously

Can be offered for sale in the same currency as the country of

issuance

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Bond Covenants

Covenants

Restrictive clauses in a bond contract that limit the issuerfrom taking actions that may undercut its ability to repaythe bonds

Advantages of Covenants With more covenants, a firm can reduce its costs of

borrowing.

The reduction in the firms borrowing cost can more

than outweigh the cost of the loss of flexibilityassociated with covenants

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Typical Bond Covenants

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Repayment Provisions

Call Provisions Call Date

Call Price

Call Premium

Call Provisions and Bond Prices

Investors will pay less for a callable bond than for an otherwise

identical noncallable bond

A firm raising capital by issuing callable bonds instead of non-callable bonds will either have to pay a higher coupon rate or

accept lower proceeds

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Call Provisions Yield to Call

The yield of a callable bond calculated under the assumption

that the bond will be called on the earliest call date

Yield to Worst

Quoted by bond traders as the lower of the yield to call or

yield to maturity

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Bond Calls and Yields

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Calculating the Yield to Call

Problem: IBM has just issued a callable (at par) five-year, 8% coupon bond with

annual coupon payments. The bond can be called at par in one year or

anytime thereafter on a coupon payment date. It has a price of $103 per

$100 face value, implying a yield to maturity of 7.26%. What is the bondsyield to call?

The timeline of the promised payments for this bond (if it is not called) is:

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If IBM calls the bond at the first available opportunity, it will call the bond

at year 1. At that time, it will have to pay the coupon payment for year 1

($8 per $100 of face value) and the face value ($100). The timeline of the

payments if the bond is called at the first available opportunity (at year 1)

is:

For the YTC, setting the present value of these payments equal to the

current price gives:

108103 Solving for the yield to call gives:(1 YTC)

108YTC = 1 4.85%

103

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Given: 1 -103 8 100

Solve for: 4.85

Excel Formula: =RATE(NPER, PMT, PV,FV) = RATE(1,8,-103,100)

The YTM is higher than the YTC because it assumes that you will

continue receiving your coupon payments for 5 years, even though

interest rates have dropped below 8%. While under the YTC

assumptions, you are repaid the face value sooner, you are deprived

of the extra 4 years of coupon payments, so your total return is

lower.

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Sinking Fund

A company makes regular payments into a fundadministered by a trustee over the life of the bond.

These payments are then used to repurchasebonds, usually at par.

Balloon Payment

A large payment that must be made on thematurity date of a bond when the sinking fundpayments are not sufficient to retire the entirebond issue.

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Convertible Provisions

Conversion Ratio

Convertible Bond Pricing

Consider a convertible bond with a $1000 face value and a

conversion ratio of 20

If you converted the bond into stock on its maturity date,

you would receive 20 shares

If you did not convert, you would receive $1000

Conversion Price

By converting the bond you essentially paid $1000 for 20 shares,

implying a conversion price per share of $1,000/20 = $50.

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Convertible Provisions

Convertible Bond Pricing

Straight (Plain-Vanilla) Bond A non-callable, non-convertible bond

Convertible Bonds and Stock Prices

When a firms stock price is much higher than theconversion price, conversion is very likely and the

convertible bonds price is close to the price of theconverted shares

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Convertible Bond Value

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Leveraged Buyout (LBO)

When a group of private investors purchases all the

equity of a public corporation and finances the purchase

primarily with debt.

Documents

BDHch15