1. Chapter 24 Principles PrinciplesofCorporateFinance Tenth Edition The Many Different Kinds of Debt Slides by Matthew Will Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin

2. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 2 McGraw Hill/Irwin Bond Terminology  Foreign bonds - bonds that are sold to local investors in another country's bond market  Yankee bond- a bond sold publicly by a foreign company in the United States  Samurai - a bond sold by a foreign firm in Japan  Eurobond market - when European and American multinationals are forced to tap into international markets for capital

3. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 3 McGraw Hill/Irwin Bond Terminology  Indenture or trust deed - the bond agreement between the borrower and a trust company  Registered bond - a bond in which the Company's records show ownership and interest and principal are paid directly to each owner  Bearer bonds - the bond holder must send in coupons to claim interest and must send a certificate to claim the final payment of principal  Accrued interest - the amount of accumulated interest since the last coupon payment

4. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 4 McGraw Hill/Irwin Bond Contract Summary of terms of 8.25% sinking fund debenture 2022 issued by J.C. Penney

5. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 5 McGraw Hill/Irwin Bond Terminology  Debentures - long-term unsecured issues on debt  Mortgage bonds - long-term secured debt often containing a claim against a specific building or property  Asset-backed securities - the sale of cash flows derived directly from a specific set of bundled assets

6. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 6 McGraw Hill/Irwin Recovery Rates Ultimate Percentage Recovery Rates on Defaulting Debt (1987 – 2005) Recovery Percentage

7. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 7 McGraw Hill/Irwin Bond Terminology  Sinking fund - a fund established to retired debt before maturity  Callable bond - a bond that may be repurchased by a the firm before maturity at a specified call price  Defeasance - a method of retiring corporate debt involving the creation of a trust funded with treasury bonds

8. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 8 McGraw Hill/Irwin Bond Terminology  Restrictive covenants - Limitations set by bondholders on the actions of the Corporation  Negative Pledge Clause - the processing of giving unsecured debentures equal protection and when assets are mortgaged  Poison Put - a clause that obliges the borrower to repay the bond if a large quantity of stock is bought by single investor, which causes the firms bonds to beat down rated

9. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 9 McGraw Hill/Irwin Covenants  Debt ratios: –Senior debt limits senior borrowing –Junior debt limits senior & junior borrowing  Security: –Negative pledge  Dividends  Event risk  Positive covenants: –Working capital –Net worth

10. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 10 McGraw Hill/Irwin Event Risk: An Example October 1993 Marriott spun off its hotel management business worth 80% of its value. Before the spin-off, Marriott’s long-term book debt ratio was 2891/3644 = 79%. Almost all the debt remained with the parent (renamed Host Marriott), whose debt ratio therefore rose to 93%. Marriott’s stock price rose 13.8% and its bond prices declined by up to 30%. Bondholders sued and Marriott modified its spinoff plan.

11. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 11 McGraw Hill/Irwin Project Finance 1. Project is set up as a separate company. 2. A major proportion of equity is held by project manager or contractor, so provision of finance and management are linked. 3. The company is highly levered.

12. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 12 McGraw Hill/Irwin Parties In Project Finance

13. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 25- 13 McGraw Hill/Irwin Risk Allocation