Chapter 20 – Corporate
Debt II
BA 543 Financial Markets and Institutions
Chapter 20 – 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 and Real Rate
Bond Features (Call Options, Collateral, etc.)
Ratings by Agencies help assess the
information for market yields

Table 20-1
Chapter 20 – Corporate Debt II
 What do the ratings mean?
 Investment Grade BBB and above
 Distinctly Speculative B to BB
 Predominately Speculative Below B



Bonds in Default, D



“junk bonds”
“high-yield bonds”
Have missed payment on interest
Bond Trustee “filed” on missed payment
Fallen Angels
Chapter 20 – Corporate Debt II
 A Look at the High-Yield Bonds

Participants (Investment Bankers)



Firms – Major Financing of LBOs



Drexel, Burnham, & Lambert (Michael Milken)
Merrill Lynch, Morgan Stanley, and First Boston
John Kluge and Metromedia – 1984
Kolberg, Kravis, Roberts & Co. and Beatrice –
1986
A new market for attracting capital (replacing
bank loans)
Chapter 20 – Corporate Debt II
 Leverage Buy-Out (LBO)


Using a firms own borrowing capacity to pay
for outside management team’s purchase of
firm
Uses



Deferred Interest Bonds
Step-up Bonds
Payment-in-kind Bonds
 Management Buy-Out (MBO)
Chapter 20 – 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
Chapter 20 – 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
Chapter 20 – Corporate Debt II
 Other Information

Eurobonds



Preferred Stock




Issued outside of country of company
Many different features
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
Chapter 20 – Corporate Debt II
 Bankruptcy

The Bankruptcy Reform Act of 1978



Chapter 7 – Liquidation



Rules for liquidation or reorganization
Safe Harbor – Time to Think
Company sells off remaining assets
Pays creditors on a priority basis
Chapter 11 – Reorganization


Plan approved by Court
Plan approved by Claimants via Class