Characteristics You are loaning $ to a corporation Interest Rate Maturity Date Face Value
Characteristics Cont. Typically the face value is $1000 Can be as much as $50,000 Interest is paid twice a year At the maturity date, you would cash the bond in and receive a check for the face value. Maturity dates range from 1 to 30 years. Short Term = 1 to 5 years Intermediate Term = 5 to 15 years Long Term = More than 15 years
Why Corporations Sell Corporate Bonds To borrow money May be to start a business May be to finance business activities A corporation may sell stocks and bonds Bonds must be repaid Must be paid interest Stocks do not have to be repaid Are not required to pay dividends
Types of Corporate Bonds Debenture A bond that is backed only by the reputation of the issuing corporation Mortgage Bond A bond that is backed by assets of the company. Risk is lower, interest rate is lower Subordinated Debenture An unsecured bond that gives bondholders claim to interest payments and assets of the corporation only after all other bondholders have been paid. Convertible Bond A bond that investors can trade for shares of the corporation’s common stock.
Methods Corporations use to Repay Bonds Call Feature Allows a corporation to buy back bonds before the maturity date. May have to pay the bondholder a premium Bond Indenture A legal document that details all of the conditions pertaining to a particular bond issue.
Why Investors Buy Corporate Bonds Interest Income Receive Interest Income every 6 months Registered Bond Only the owner of the bond can collect money on the bond. Registered bond coupon Send the coupon in and the interest will be paid Bearer Bond Not registered in the owner’s name Must present coupon Will not be repaid if coupon is lost or stollen No longer issued by corporations Zero-coupon Bond Provides no interest payments and is redeemed forr its face value at maturity Sold far below face value
Bond Repayment Investors have two choices after they have purchased a bond First, you can keep the bond until its maturity date and then cash it in. Meanwhile, you earn interest every 6 months. Or, you can sell the bond at any time to another investor. Either way, the value of the bond is closely tied to the corporation ability to repay it.
Market Value vs. Face Value Bond prices shift as a result of changes in overall interest rates in the economy. If Vanessa has a bond with a 7.5% interest and interest rates fall below 7.5%, the market value of her bond increases. If overall interest rates rise above 7.5%, new issue bonds would be more valuable. When a bond is selling for less than its face value it is said to be selling at a discount. When a bond is selling for more than its face value it is said to be selling at a premium.
Shawn purchased a New York Telephone bond that pays 4.5% interest based on a face value of $1,000. Comparable new corporate bond issues are paying 7%. How much is Shawn’s bond worth? Formula = Dollar Amount of Annual Interest $45 Interest Rate of Comparable New Bond 7% Face Value X Annual Interest Rate $1000 X 4.5% = $642.86 The approximate market value of Shawn’s New York Telephone Bond is $642.86
A Typical Bond Transaction Full-service brokerage firm Provides information and advice Discount brokerage firm You do your own research and make your own decisions Lower commission Primary Market Directly from the banker that represents the company Secondary Market Trade with other investors Bonds issued by large corporations are traded on the New York Bond exchange or the American Bond Exchange Not too different from the stock exchange