Ch 14 p. 2 Flashcards Preview

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Flashcards in Ch 14 p. 2 Deck (65):

What happens to the value of a bond during a leveraged buyout? Why?

They lose value

Loss in value occurs because additional debt added in capital structure increases likelihood of default


Firm underwriting

Investment banks underwrite entire issue of bond by guaranteeing certain sum to company

Taking risk of selling bonds for whatever price they can get


Best efforts underwriting

Investment bank sells bond issue for commission onProceeds of sale


Private placement

Issuing company sells bonds directly to large institution,Financial or otherwise without aid of underwriting


Secured bonds

Backed by pledge of some sort of collateral


Mortgage bonds

Secured by claim on real estate


Collateral trust bonds

Secured by stocks and bonds of other corporations


Unsecured bonds

Bonds not backed by collateral


Junk bond, define? what do companies use these bonds for?

Unsecured and very risky, paying high interest rate

Used to finance leveraged buyouts


Term bonds

Bond issues that mature on single date


Serial bonds

Mature in installments


Serially maturing bonds are frequently used by... 4 things

School or sanitary districts, municipalities or other local

Taxing bodies that receive money through special levy


Callable bonds

Give issuer right to call and redeem bonds prior to maturity


Convertible bonds

Bonds are convertible into other securities of corporationFor specified time after issuance


What 2 types of bonds have been developed in attempt to attract capital in a tight money market?

1 commodity backed bonds2 deep discount bonds


Commodity backed bonds AKA asset-linked bonds

Redeemable in measures of commodity such as barrels ofOil, tons of coal, ounces of rare metal

Ex. Sunshine mining sold 2 issues of bonds redeemable with either $1000 cash or 50 ounces of silver, whichever isGreater at maturity, stated interest rate 8.5%


Deep discount bonds AKA zero interest debenture

Sold at discount provides buyers with total interest payoff At maturity


Registered bonds define, what 2 things do they require?

Bonds issued in name of owner

Require surrender of certificate and issuance of new
Certificate to complete sale


Bearer AKA coupon bond

Not recorded in name of owner

May be transferred from one owner to another by delivery


Income bonds

Pay no interest unless issuing company is profitable


Revenue bonds

Interest is paid from specific revenue sources

Ex. Issued by airports, school districts, counties, toll road authorities and government bodies


Bond is valued by its

Present value of expected future cashflows from interest
And principal


Stated AKA coupon or nominal rate

Interest rate written on bond certificate

Expressed as percentage of Maturity value


2 other names for maturity value

Par value, principal amount



Bonds sell for less than face value



Bonds sell for more than face value


Effective yield AKA Market rate

Interest actually earned by bond holders


Recall that discount on bonds payable due to its relation to interest, companies...

Amortize the discount and charge it to interest expense
Over period of time that bonds are outstanding


Amortization: straight line method

Amortizes constant amount each interest period


1 Amortization of discount...

2 While amortization of premium...

1 Increases interest expense

2 Decreases interest expense


When companies issue bonds on other than interest payment dates, buyers of the bonds will pay the sell the...

Interest accrued from the last interest payment date
To the date of issue


Preferred procedure for amortization of discount or premium: effective interest method AKA present value amortization
Equation (simple, broken down)

Amortization amt. =Bond Interest Expense - Bond Interest Paid
(carrying value of bonds at beginning of period x effective int. rt.)
- (face amount of bonds x stated int. rt.)


How are unamortized bond issue costs treated?

Treated ad deferred charge and amortized over life of debt


IFRS: issue costs requirement, and it's effect?

Requires issue costs reduce carrying amount of the bond

This increases the effective interest rate


Extinguishment of debt

Companies Payment of debt


Extinguishment of debt: if the company holds bonds to maturity

Company doesn't compute any gains or losses


Reacquisition price

Amount paid on extinguishment or redemption before maturity

Including call premium and expense of Reacquisition


Net carrying amount of bonds on any specified sate

Amount payable at maturity adjusted for unamortized
Premium or discount and cost of issuance


Gain from extinguishment

Any excess of net carrying amount over Reacquisition price


Loss from extinguishment

Excess of reacquisition price over net carrying amount


In substance defeasance

Arrangement whereby company provides future repayment
Of Longterm debt issue by placing purchased securities in
Irrevocable trust

Not considered extinguishment of debt


The amortized premium or discount and any costs of issue applicable to the bonds must be...

Amortized up to reacquisition date


Refunding, when is it advantageous?

Replacement of an existing bond issue with a new one

Advantageous to replace entire outstanding bond issue
With a new issue bearing a lower interest rate


Longterm notes payable, 2 similarities to bonds, 1 difference

Similar in substance to bonds: 1 fixed maturity dates
2 carrying either stated or implicit interest rate

Difference: do not trade as readily as bonds in
Public security markets


In instances where company measures present value of debt instrument by fair value of property, goods or services: if there is no stated rate of interest, the amount of interest is...

Difference between face amount of note and fair value
Of property


1 Imputation

2 Imputed interest rate

1 process of interest rate approximation

2 resulting interest rate from imputation


Mortgage note payable

Promissory note secured by document called mortgage
That pledges title to property as security for loan

Most common form of Longterm notes payable



One percent of effective interest rate of note


Fixed rate mortgages

Interest rate stays constant


Variable rate mortgages AKA floating rate or adjustable rate mortgages

When are they adjusted? What are they pegged to either of 2 rates?

Feature interest rates tied to changes in fluctuating market

Lenders adjust interest rates in either 1 year or 3 year intervals

Adjustments pegged to changes in prime rate or US Treasury
Bond rate


What happens if companies choose the fair value option?

Noncurrent liabilities: bonds, and notes payable are recorded
At fair value

unrealized holding gains or losses reported as part of
net income


Unrealized holding gain or loss

Net change in fair value of liability from 1 period to another
Exclusive of interest expense recognized but not recorded


Off balance sheet financing

Attempt to borrow monies in such a way to prevent
Recording obligations


3 common forms of off balance sheet financing

1 non-consolidated subsidiary

2 special-purpose entity (SPE)

3 operating leases


Off balance sheet financing: non-consolidated subsidiary

Parent company doesn't have to consolidate subsidiary
Company that is less than 50 percent owned

Parent doesn't need to report assets and liabilities of


Off balance sheet financing: special-purpose entity (SPE)

2 Project financing arrangement, why is it used?

1 Created to perform special project

2 management creates an SPE for purpose to build project

Management does not want to report the plant or borrowing
Used to fund the construction on the balance sheet


Off balance sheet financing: SPE: take or pay contracts

The SPE finances and builds the plant, while the company
Guarantees that it or outside party will purchase all products
Produced by plant

Allows company to keep assets and liabilities from project
Off balance sheet


Off balance sheet financing: operating leases

Instead of owning assets companies lease them

Only report rent expense and note of disclosure


In order to get off balance sheet financing special purpose entities (SPEs) often use...



Why do companies engage in off balance sheet financing? 2 main reasons

1 many believe removing debt enhances quality of balance
Sheet and permits credit to be obtained more readily at
Cheaper rate

2 loan covenants limit amount of debt company may have


To fight off balance sheet debt, what does SOX require companies to disclose? 2 things, how are they presented?

1 all contractual obligations in tabular format

2 contingent liabilities and commitments in either textual
Or tabular format


IFRS securities are not required to disclose...

All contractual obligations or contingent liabilities


Debt to assets ratio, what does it measure?

Debt to assets = total liablities/total assets

Measures percentage of total assets provided by creditors


Times interest earned ratio, what does it measure?

Times interest earned =
(Income before income taxes and interest expense)/(interest exp.)

Indicates company's ability to meet interest payments
As they come due


In the banking industry when the company bond's credit rating drops...

They can record a gain, because their liability value drops

If value of company's liability is less they are better off
So they can record a gain