Corporate Bonds By Mrs Belen Apostol Corporate Bonds

Corporate Bonds By: Mrs. Belen Apostol

Corporate Bonds • Bonds – long term debt of a firm or the government set forth in writing and made under seal. - it does not represent equity capital, but they are long-term liabilities of the company. - a long-term contract under which a borrower agrees to make payments of interest and principal on specific dates, to the holder of the bond. - unlike long-term loans, it is generally advertised, offered to the public and sold to many investors

Kinds of Bonds 1. Government Bonds – issued by the government to finance its activities 2. Corporate Bonds – issued by private corporations to finance their long-term funding requirements.

Bonds as Distinguished from Stocks Bonds Stocks Debt Instrument of Ownership Bondholders have priority over stockholders when payments are made by the company Stockholders shall wait for the bondholders to be paid Interest payments due to bonds are fixed Dividends are contingent upon earnings and must be declared by the board of directors Bonds have specific maturity date, at which time, repayment of principal is due Stocks are instruments of permanent capital financing and does not have maturity dates Bondholders have no vote and no Stockholders (common stocks) have influence on the management of the right to vote firm, except when provisions of the bond and the indenture agreement are

Alternative Ways of Bond Issuance • Bonds are issued in the following ways: 1. Public Offering – selling of corporate bonds to the general public through investment bankers. The investment banker provides assistance in the issuance of bonds by: 1. helping the firm determine the size of the issue and the types of bonds to be issued 2. establishing the selling price 3. selling the issue

Alternative Ways of Bond Issuance • Bonds are issued in the following ways: 2. Private placement – sale of bonds directly to an institution and is a private agreement between the issuing company and the financial institution without public examination. Advantages 1. the issue can be tailor-made to fit the needs of the issuing firm, as well as the investing firm. 2. the issues does not have to be registered 3. there are no underwriting fees paid by the issuing firm.

Classes of Bonds • Three general types 1. By type of security 2. By manner of participation in earnings 3. By method of retirement or repayment

Classification of Bonds as to Type of Security 1. Earnings and general unpledged assets of issuing company (Debentures) 2. Earnings of issuing company plus pledge of specific property (mortgage bonds). This is further classified as follows: a. Real estate mortgages (senior & junior liens) i. closed-end issues ii. Open-end issues b. Chattel mortgages 3. All or some of original security plus general credit of another company which may be: a. assumed bonds b. guaranteed bonds 4. Combined earnings of allied companies plus collateral protection in some cases (joint bonds).

Classification of Bonds as to Type of Security • Debenture bonds – general credit bonds not secured by specific property. The earning power of the issuing corporation provides the protection to the debenture bondholder. The claim of debenture bondholders is superior to any stockholder regarding unpledged property of the issuing corporation.

Classification of Bonds as to Type of Security • Mortgage bonds – secured by a lien on specifically named property such as land, buildings and other fixed assets. Mortgage bondholders have a prior claim to the assets specifically pledged as security. • The specific property pledged are of two general types: 1. Real estate – consists of land property attached to the land 2. Chattels – consist of personal and movable property

Classification of Bonds as to Type of Security • Real estate mortgages may be classified according to claims: 1. Senior liens (first mortgage bonds)-Having prior claim to fixed assets pledged as security. 2. Junior liens (second mortgage or third mortgage bonds) – having subsequent liens to fixed assets pledged as security. They have a subordinated priority claim to senior liens.

Classification of Bonds as to Type of Security • Real estate mortgages may be classified according to type of issue: 1. Closed-end issue – subsequent issues on the specific property pledged are not allowed. 2. Open-end issue – permits the issuance of additional bond issues or series to be made under the original mortgage secured by a single lien. - characterized by series bonds (having various maturity dates, principal amounts, and interest rates but with identical security) 3. Limited open-end issue – allowing additional bonds to be sold after a maximum amount. The issue becomes closed when the specified amount of bonds have been issued.

Classification of Bonds as to Type of Security • Assumed Bonds – when a corporation buys another corporation, or merged with another, the liabilities of the deceased corporation are “assumed” by the surviving corporation • Guaranteed Bond – payment of interest, principal or both is guaranteed by one or more individuals or corporations. • Joint bonds – property owned jointly be several companies which was used as a security for a bond issue. The companies bind themselves jointly as debtors.

Classification of Bonds by Method of Participation in Earnings • Bonds may be classified according to the method of participation in earnings of the company. 1. Bonds with fixed contractual interest rates of which there are two types a. Coupon bonds b. Registered bonds 2. Bonds with fixed contractual rate with payment contingent upon earnings (income bonds)

Classification of Bonds by Method of Participation in Earnings • Bonds may be classified according to the method of participation in earnings of the company. 1. Bonds with fixed contractual rate with participating feature of which there are four types: a. Participating bonds b. Convertible bonds c. Bonds with warrants d. Bonds with junior security attached.

Classification of Bonds by Method of Participation in Earnings • Coupon bonds – having attachments of a series of postdated certificates (coupons) payable to the bearer for the interest over the life of the bonds (bearer bonds). • Registered bonds – names of owners are recorded on the transfer books of the company. The owners receive payment for interest and principal by checks drawn in their favor

Classification of Bonds by Method of Participation in Earnings • Income bonds – debt instruments with a fixed rate of interest payable only if earned and declared by the Board of Directors. • Participating bonds – bonds which stipulate a fixed coupon rate but which also provide a method of receiving additional income over and above this minimum sum. This additional incomes from the corporate earnings then available and paid out as dividends.

Classification of Bonds by Method of Participation in Earnings • Convertible bonds – debenture bonds or junior-lien mortgage bonds wherein the owner has the option to exchange his bond to a specified number of shares of common stock, preferred stock (less frequent), or other types of bonds. • Bonds with Warrants – warrants attached to bonds, having an option or a right to purchase stock at a stated price during a stipulated period of time

Classification of Bonds by Method of Participation in Earnings • Warrants may be detachable (sold or exercised apart form the bond) or nondetachable(cannot be sold separately from the bond) • Bonds with Junior Security Attached – issued along with some share of stock in a package sale or block sale. Bondholders may share with stockholders with dividends declared.

Bonds Classified by Method of Retirement • Serial bonds – mature semi-annually or annually instead of a single date. Matured in series because of its staggered repayment schedule. • Sinking Fund Bonds – retired with the provision of a sinking fund. The provision requires the issuer to deposit annually certain sums of money with the trustee of the issue for the retirement of the part of the issue before maturity. (periodic repayments)

Bonds Classified by Method of Retirement • Callable bonds – the terms of the issue can be cancelled or called. The call privilege enables the issuing company to pay off a bond issue prior to maturity. • Convertible bonds – bonds exchange for common stock of the issuing company at a fixed price, at a pre-determined redemption date, and at the option of the bondholder. Once converted, it is considered as retired.

Bonds Classified by Method of Retirement • Perpetual bonds – cannot be redeemed by demanding repayment. Used in public finance in which the debtor (government), is assumed to have permanent existence.

Reasons for the Use of Bonds 1. When a franchise or a license is issued to a corporation providing a guarantee of a return on capital investments 2. When economic conditions allow the payment of interest at a rate lower than what is paid to common stock in the form of dividends 3. When the present owners of the corporation want to retain their share of the voting power.

Reasons for the Use of Bonds 4. When investor resistance to the purchase of common stock is very strong; and when such resistance is not found in the sale of bonds. 5. When the degree of safety offered by the issuer attracts investors. 6. When tax advantages are derived from the exercise 7. When there is a sufficient demand from institutional investors like banks, insurance companies, and pre-need firms.

Indenture • Indenture – contract between the corporation and the trustee on behalf of the bondholders. – Contains the terms of the bond issue, the manner of its fulfillment, rights and responsibilities of bondholders and duties of the trustee. – Contents of the indenture: 1. The amount, duration, and denomination of the bond issue 2. If applicable, the serial issues and size of each issue

Indenture Contents of the indenture: 3. The rate of interest, terms of payment, designated place of collection 4. The rights, privileges, limitations attached to the issue 5. Type of security and its terms 6. Terms and conditions of mortgage or pledge of securities. 7. The manner of redemption 8. Remedies available to bondholders in case of default of the issuing corporation 9. Replacement of mutilated or lost bond certificate 10. Duties and remunerations of the trustees

Trustee • Person who handles the money or property on behalf of another in a trust. • The role of trustee in a bond issue is to see that the issuing corporation complies with the provision of the indenture. • Duties include: 1. To represent the bondholder in case of default 2. To make payment of interest and principal

Trustee • Duties include: 3. To take care of the sinking fund 4. To report annually to the bondholders on his operations and the condition of the bond issue and its pledged security; 5. To supply lists to bondholders to any bondholder, enabling the bondholders to form special committees to protect their interest at any time 6. To notify the bondholder of any default 7. To inform bondholder of any loans by the trustee to the corporation