Chapter 21 Corporate Debt II

1
Chapter 21 Corporate Debt II

• Typical or Standard Bond
• Interest paid as you go
• Principal paid at maturity date
• Yield determined by the market which views
• Default Potential (Risk of Bond)
• Inflation (Real Rate Necessary)
• Bond Features (Call Options, Collateral, etc.)
• Ratings by Agencies help assess the information
  for market yields
• Table 21-1

2
Chapter 21 Corporate Debt II

• What do the ratings mean?
• Investment Grade BBB and above
• Distinctly Speculative B to BB
• Predominately Speculative Below B
• junk bonds
• high-yield bonds
• Bonds in Default, D
• Have missed payment on interest
• Bond Trustee filed on missed payment
• Fallen Angels

3
Chapter 21 Corporate Debt II

• A Look at the High-Yield Bonds
• Participants (Investment Bankers)
• Drexel, Burnham, Lambert (Michael Milken)
• Merrill Lynch, Morgan Stanely, and First Boston
• Firms
• John Kluge and Metromedia 1984
• Kolberg, Kravis, Roberts Co. and Beatrice
  1986
• A new market for attracting capital (replacing
  bank loans)

4
Chapter 21 Corporate Debt II

• Leverage Buy-Out (LBO)
• Using a firms own borrowing capacity to pay for
  outside management teams purchase of firm
• Uses
• Deferred Interest Bonds
• Step-up Bonds
• Payment-in-kind Bonds
• Management Buy-Out (MBO)

5
Chapter 21 Corporate Debt II

• Bond Features
• Call Option right of the company to buy back
  the bond for a pre set price
• Put Option right of the bondholder to sell back
  the bond for a pre set price
• Conversion feature right of the bondholder to
  convert the bond into equity shares
• Warrants Attached an additional financial asset
  that grants the right to buy equity
• Zero-Coupon Bond pure discount bond
• Floating Rate Bond coupon rate changes

6
Chapter 21 Corporate Debt II

• Secondary Market for Bonds
• Exchange Market (NYSE) small volume
• OTC
• Market used by institutional investors and
  professional money managers
• Brokers search Dealers (Dealer Market)
• Trading Desks Bond Pits in investment banks
• The Technology Changes
• Moving to Web Sites that have prices
• Remove the extended search process

7
Chapter 21 Corporate Debt II

• Other Information
• Eurobonds
• Issued outside of country of company
• Many different features
• Preferred Stock
• Dividends preferred (guaranteed?)
• Convertible to Common in some cases
• Adjustable rate (floating rate)
• Financial Engineering of bonds and preferred
  stock to meet the market demands

8
Chapter 21 Corporate Debt II

• Bankruptcy
• The Bankruptcy Reform Act of 1978
• Rules for liquidation or reorganization
• Safe Harbor Time to Think
• Chapter 7 Liquidation
• Company sells off remaining assets
• Pays creditors on a priority basis
• Chapter 11 Reorganization
• Plan approved by Court
• Plan approved by Claimants via Class