chapter20Long-TermDebt,PreferredStock,andComm

20-1Chapter20Long-TermDebt,PreferredStock,andCommonStock©2001Prentice-Hall,Inc.FundamentalsofFinancialManagement,11/eCreatedby:GregoryA.Kuhlemeyer,Ph.D.CarrollCollege,Waukesha,WI20-2Long-TermDebt,PreferredStock,andCommonStockBondsandTheirFeaturesTypesofLong-TermDebtInstrumentsRetirementofBondsPreferredStockandItsFeaturesRightsofCommonShareholdersDual-ClassCommonStock20-3BondsandTheirFeaturesBasicTermsParValueCouponRateMaturityBondRatingsBond--Along-termdebtinstrumentwithafinalmaturitygenerallybeing10yearsormore.20-4TrusteeandIndentureTrustee--Apersonorinstitutiondesignatedbyabondissuerastheofficialrepresentativeofthebondholders.Typically,abankservesastrustee.Indenture--Thelegalagreement,alsocalledthedeedoftrust,betweenthecorporationissuingbondsandthebondholders,establishingthetermsofthebondissueandnamingthetrustee.20-5TypesofLong-TermDebtInstrumentsInvestorslooktotheearningpowerofthefirmastheirprimarysecurity.Investorsreceivesomeprotectionbytherestrictionsimposedinthebondindenture,particularlyanynegative-pledgeclause.Anegative-pledgeclauseprecludesthecorporationfrompledginganyofitsassets(notalreadypledged)toothercreditors.Debenture--Along-term,unsecureddebtinstrument.20-6TypesofLong-TermDebtInstrumentsInthiscase,subordinateddebentureholdersrankbehinddebentureholdersbutaheadofpreferredandcommonstockholdersintheeventofliquidation.Frequently,thesecurityisconvertibleintocommonstocktolowertheyieldrequiredbysubordinateddebentureholders(oftenlessthanregulardebentures).SubordinatedDebenture--Along-term,unsecureddebtinstrumentwithalowerclaimonassetsandincomethanotherclassesofdebt;knownasjuniordebt.20-7TypesofLong-TermDebtInstrumentsFrequently,thereisacumulativefeature,whichprovidesthatanyunpaidinterestinaparticularyearaccumulates.Thecumulativeobligationisusuallylimitedtonomorethanthreeyears.Thebondsareunpopularwithinvestors(usuallylimitedtoreorganizations),butarestillseniortopreferredandcommonshareholdersintheeventofliquidation.IncomeBond--Abondwherethepaymentofinterestiscontingentuponsufficientearningsofthefirm.20-8TypesofLong-TermDebtInstrumentsThesearebondswitharatingofBa(Moody's)orlower.Principalinvestorsarepensionfunds,high-yieldbondmutualfunds,andsomeindividualinvestors.Liquidityvariesdependingoninvestorsentiments.Junkbondswereusedfrequentlyinthe1980sasameansoffinancingleveragedbuyouts(LBOs).JunkBond--Ahigh-risk,high-yield(oftenunsecured)bondratedbelowinvestmentgrade.20-9TypesofLong-TermDebtInstrumentsTheissueissecuredbyalienonspecificassetsofthecorporation.Themarketvalueofthecollateralshouldexceedtheamountofthebondissuebyareasonablemarginofsafetytohelpprotectbondholders.MortgageBond--Abondissuesecuredbyamortgageontheissuer’sproperty.20-10TypesofLong-TermDebtInstrumentsIfthecorporationdefaults,thetrusteecanforecloseonbehalfofthebondholders.Thebondholdersbecomegeneralcreditorsforanyresidualamountafterthesaleofthecollateral.Thecorporationmayhaveafirstmortgageandasecondmortgageonthesameassets.Thefirstmortgagehasaseniorclaimontheassets.MortgageBond(Continued)20-11TypesofLong-TermDebtInstrumentsArailroadarrangeswithatrusteetopurchaseequipmentfromamanufacturer.Therailroadsignsacontractwiththemanufacturerfortheconstructionofspecificequipment.Whentheequipmentisdelivered,equipmenttrustcertificatesaresoldtoinvestors.EquipmentTrustCertificate--Anintermediate-tolong-termsecurity,usuallyissuedbyatransportationcompanysuchasarailroadorairline,thatisusedtofinancenewequipment.Letuslookatanexampleusingarailroad.20-12TypesofLong-TermDebtInstrumentsProceedsplustherailroaddownpaymentareusedtopaythemanufacturer.Titleoftheequipmentisheldbythetrustee,andthetrusteeleasestheequipmenttotherailroad.Leasepaymentsareusedtopayafixeddividendtothecertificateholdersandtoretireaspecifiedportionofthecertificatesatregularintervals.Afterthefinalleasepayment(allcertificatesareretired),titletotheequipmentpassestotherailroad.EquipmentTrustCertificates(Continued)20-13AssetSecuritizationPurpose:ToreducefinancingcostsFirmpicksassetsto“package”andusecashflowsAssetsremovedfromthebalancesheetandsoldtobankruptcy-remoteentity(special-purposevehicle--SPV)SPVraisesmoneybysellingasset-backedsecuritiesAssetSecuritization–Theprocessofpackagingapoolofassetsandthensellinginterestsinthepoolintheformofasset-backedsecurities.Asset-backedSecurity–Debtsecuritieswhoseinterestandprincipalpaymentsareprovidedbythecashflowscomingfromadiscretepoolofassets.20-14RetirementofBondsThecorporationmakesacashpaymenttothetrustee,whichcallsthebonds.Thecorporationpurchasesbondsintheopenmarketanddeliversthemtothetrustee.SinkingFund--Fundestablishedtoperiodicallyretireaportionofasecurityissuebeforematurity.Thecorporationisrequiredtomakeperiodicsinking-fundpaymentstoatrustee.Twoformsforthesinking-fundretirementofabond:20-15SinkingFundandtheRetirementofBondsWhenbondsarecalledforredemption,thebondholderswillreceivethesinking-fundcallprice.Thebondsarecalledonalotterybasis(bytheirserialnumbers)andpublishedinperiodicalslikeTheWallStreetJournal.Bondsshouldbep