Chapter 20 Long-Term Debt,20.1 Long Term Debt: A Review 20.2 The Public Issue of Bonds 20.3 Bond Refunding 20.4 Bond Ratings 20.5 Some Different Types of Bonds 20.6 Direct Placement Compared to Public Issues 20.7 Long-Term Syndicated Bank Loans 20.8 Summary and Conclusions,20.1 Long Term Debt: A Review,Corporate debt can be short-term (maturity less than one year) or long-term. Different from common stock: Creditors claim on corporation is specified Promised cash flows Most are callable Over half of outstanding bonds are owned by life insurance companies some sensible reasons for call provisions include: taxes, managerial flexibility and the fact that callable bonds have less interest rate risk.,20.4 Bond Ratings,What is rated: The likelihood that the firm will default. The protection afforded by the loan contract in the event of default. Who pays for ratings: Firms pay to have their bonds rated. The ratings are constructed from the financial statements supplied by the firm. Ratings can change. Raters can disagree.,Bond Ratings: Investment Grade,Bond Ratings: Below Investment Grade,Junk bonds,Anything less than an S&P “BB” or a Moodys “Ba” is a junk bond. A polite euphemism for junk is high-yield bond. There are two types of junk bonds: Original issue junkpossibly not rated Fallen angelsrated Current status of junk bond market Private placement Yield premiums versus default risk,20.5 Different Types of Bonds,Callable Bonds Puttable Bonds Convertible Bonds Deep Discount Bonds Income Bonds Floating-Rate Bonds,Puttable bonds,Put provisions Put price Put date Put deferment Extendible bonds Value of the put feature Cost of the put feature,Convertible Bonds,Why are they issued? Why are they purchased? Conversion ratio: Number of shares of stock acquired by conversion Conversion price: Bond par value / Conversion ratio Conversion value: Price per share of stock x Conversion ratio In-the-money versus out-the-money,Convertible Bond Prices,Example of a Convertible Bond,More on Convertibles,Exchangeable bonds Convertible into a set number of shares of a third companys common stock. Minimum (floor) value of convertible is the greater of: Straight or “intrinsic” bond value Conversion value Conversion option value Bondholders pay for the conversion option by accepting a lower coupon rate on convertible bonds versus otherwise- identical nonconvertible bonds.,Example of an Exchangeable Bond,20.6 Direct Placement Compared to Public Issues,A direct long-term loan avoids the cost of registration with the SEC. Direct placement is likely to have more restrictive covenants. In the event of default, it is easier to “work out” a private placement.,20.7 Long-Term Syndicated Bank Loans,20.8 Summary and Conclusions,The details of the long-term debt contract are contained in the indenture. The main provisions are: security, repayment, protective covenants and call provisions. Protective covenants are designed to protect bondholders from management decisions that favor stockholders at bondholders expense. Most public industrial bonds are unsecuredthey are general claims on the companys value. Most utility bonds are secured. If the firm defaults on secured bonds, the trustee can repossess the asset.,20.8 Summary and Conclusions (cont.),Long-term bonds usually provide for repayment of principal before maturity. This is usually accomplished with a sinking fund whereby a firm retires a certain number of bonds each year. Most publicly issued bonds are callable. There is no single reason for call provisions. Some sensible reasons include taxes, greater flexibility, and the fact that callable bonds are less sensitive to interest-rate changes. There are many different types of bonds, including floating-rate bonds, deep-discount bonds, and income bonds.,