Share Issue MBA Corporate FinanceQ&a's
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Transcript of Share Issue MBA Corporate FinanceQ&a's
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8/13/2019 Share Issue MBA Corporate FinanceQ&a's
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Q1. You are Renatas assistant, and she has asked you to prepare a memo to Dan
describing the effect of each of the following bond features on the coupon rate of the bond.
List any adantages and disadantages of each feature.
!." #ffect of collateral on coupon rate
$ %f #&Y pledges assets against bonds as collateral, issued bonds will hae less risk, and
will hae the effect of a lower coupon rate.
$ !dantage' lower coupon rate
$ Disadantage' %nfle(ibility with assets
)." )ond *eniority
$ +he more senior the bonds are relatie to other debt obligations, the lower the risk, and
lower the coupon rate.
$ !dantages' igher seniority will re-uire lower coupon rate due to higher payment
priority.
$ Disadantages' ay constrain ability to issue more/senior bonds in the future.
&." 0resence of a sinking fund
$ Reduces coupon rate due to trustee management of bond interest payments. Lowers
risk by partially guaranteeing repayment of bond obligations.
$ !dantages' !llows #&Y more control of bond obligations through the ability to buy
back bonds. Reduces coupon rate.
$ Disadantages' eed for annual cash flow or risk default.
D." &all 0roision 2specific dates3prices"
$ aing a call proision will increase the coupon rate due to reduced profit potential for
buyer.
$ !dantages' 0ossibility of purchasing bonds at a more attractie price and issuing new
bonds at lower rate.
$ Disadantages' igher coupon rate. ay pay unnecessary premium in rates if interest
rates increase.
#." Deferred &all 0roision
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$ Lower coupon rate relatie to standard call proision due to longer period of call
prohibition.
$ !dantages' 0ossibility of buying back bonds at a faorable price 2after deferred period"
$ Disadantages' 0ossibility of paying coupon premium unnecessarily.
4." ake/whole call proision
$ Lower coupon rate relatie to specified call date3price bonds.
$ !dantages' 4le(ibility in buying back bonds at 053market alue.
$ Disadantages' 3!
6." 0ositie &oenants
$ Reduce coupon rates due to guarantees offered in the coenant.
$ !dantages' Reduce coupon rate.
$ Disadantages' Restricts certain actions.
$ #(amples'
/ ust maintain collateral in good condition
/ ust periodically proide audited financials
/ ust maintain working capital at or aboe specified leel
." egatie &oenants
$ Reduce coupon rates due to restrictie guarantees offered in the coenant.
$ !dantages' Lowers coupon rate, reassures bond holders due to guarantees.
$ Disadantages' Restricts certain actions.
$ #(amples'
/ ust limit amount of diidends it pays
/ &annot pledge assets to lenders
/ &annon merge with another firm
/ &annont issue additional long/term debt or until certain D3#
/ &annont sell or lease ma7or assets without approal by bondholders
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%." &onersion 4eature
$ Lowers the coupon rate due to the potential upside of bondholders 2if the company
goes to %08"
$ !dantages' )ond is more attractie for e-uity seekers, and likely reduce coupon rate.
$ Disadantages' &ompany may be selling e-uity at a discounted price.
9." 4loating Rate &oupon
$ &oupon rate will be dependent on interest rate inde(.
$ !dantages' %f interest rates fall, #&Y will pay lower coupon rate.
$ Disadantages' %f interest rates rise, #&Y will pay higher coupon rate.
!*:#R*
1.
&ollateral
! kind of security proided in lieu of loan.
%f the borrower defaults, )ank confiscates the collateral.
%t could be Li-uid' eg houses.Li-uid eg treasury bills3 other instruments.
+heory of &ollateral'
!fter been gien a loan % hae ; options to pay3 not repay.
y effort is unobserable.
ow there is a continuum of types of debtors, with a certain distribution.
Result'
8nly the good type will produce.
!nother theory is there is a lifetime blacklisting, so we do a net discounting.
Result' 8nly people with a large
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originally lent out.
0otential loss of good business.
Lending on basis of physical capital, certainly doesn
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>.
! sinking fund is a fund established by an economic entity by setting aside reenue oer a
period of time to fund a future capital e(pense, or repayment of a long/term debt.
+he sinking 4und is a near li-uid capital. %t also shows the management
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1E.
!lready Defined. %t sometimes seems sensible to pay interest depending on the risk free
rate.
%f somehow the risk free rate increases due to a tightening policy, the issuer ends up paying
a higher rate. Rates might be pegged to any inde(, or security.