Ch. 2, Corp and Municipal Debt Securities | Day 3 Flashcards
(16 cards)
What is a series issue of bonds, and why might a corporation choose it?
A series issue allows a corporation to spread the issuance of bonds over several years, giving them flexibility to borrow money as their funding needs evolve.
Differentiate between secured and unsecured corporate bonds.
Secured bonds are backed by pledged assets (collateral), while unsecured bonds (debentures) rely only on the issuer’s creditworthiness without any specific asset backing.
What are mortgage bonds and what collateral backs them?
Mortgage bonds are secured by real estate owned by the corporation. In case of default, bondholders may take ownership of the property.
What is an equipment trust certificate, and what industries commonly issue them?
It’s a secured bond backed by large equipment (e.g., airplanes, railcars, ships). Commonly used by airlines, railroads, and shipping companies.
What collateral backs a collateral trust certificate?
Securities like stocks or bonds purchased for investment or owned subsidiaries, held by a trustee for safekeeping.
Why do bondholders prefer not to take title to pledged collateral?
Bondholders invest for income and principal return, not ownership; they prefer the trustee to liquidate assets if needed.
What is a subordinated debenture and how is it prioritized in bankruptcy?
A subordinated debenture is an unsecured loan with junior claim status—paid after other general creditors if the issuer defaults.
Define income or adjustment bonds and identify when they are typically issued.
These are unsecured bonds issued by financially distressed corporations; they pay interest only if the issuer has earnings. High-risk and issued at deep discounts.
What is a zero-coupon bond and what makes it attractive to investors?
It pays no periodic interest and is sold at a deep discount, maturing at face value. The return is from price appreciation (phantom income).
How is phantom income associated with zero-coupon bonds taxed?
Investors are taxed annually on the imputed interest (price appreciation) even though no actual interest is received until maturity.
What distinguishes a guaranteed bond from other types?
Its principal and interest are backed by a third party, like a parent company, improving credit quality for investors.
What are convertible bonds and what benefits do they provide to both issuers and investors?
Convertible bonds can be exchanged for common stock. They offer lower interest rates to issuers and upside potential to investors if stock appreciates.
How do you calculate the number of shares received upon bond conversion?
Use the formula:
Number of shares = Par value / Conversion price
What is parity price and how is it calculated?
Parity price is the stock price that makes the bond’s value equal to the value of converted shares. Formula:
Parity Price = Market value of bond / Number of shares to be received
What are the key advantages and disadvantages of issuing convertible bonds for a corporation?
Advantages: Lower interest costs, more marketable, debt eliminated upon conversion, no immediate dilution.
Disadvantages: Loss of leverage, tax-deductible interest, shareholder equity dilution, and potential control shifts.
What is the purpose of the Trust Indenture Act of 1939, and to whom does it apply?
The Trust Indenture Act of 1939 requires corporate bond issues over $10 million with terms longer than one year to have a formal written agreement (trust indenture) between the issuer and a trustee, who ensures compliance with promises to bondholders. It applies only to corporate issuers; federal and municipal issuers are exempt.
