Corporate Finance Mini Case Chapter 7

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Corporate Finance Mini Case Chapter 7
工資 109 林佳妤 H34055041
1. A collateral is a security pledged as security for payment of debt. The advantages of a
bond with collateral is that it will have a lower coupon rate. Since the bondholders have
the claim on the collateral, even in bankruptcy, it lowers their risk in default. The
disadvantage of collateral is that the company cannot sell the asset used as
collateral since it’s pledged as security.
2. Seniority is the preference in position over the other lenders. The advantage of seniority
is that the more senior the bond is, the lower the coupon rate. Senior bonds get full
payment in bankruptcy proceedings before other bonds. But the disadvantage of senior
bonds is that the bond covenant may restrict the company from issuing any future bonds
senior to the current bonds.
3. Sinking fund is the account managed by the bond trustee for any early bond redemptions
by buying the bond himself or call fractions of outstanding bond. A sinking fund will
reduce the coupon rate since it’s a partial guarantee to bondholders. The disadvantages of
a sinking fund are that the company must make the interim payments to a sinking fund or
face default.
4. A call provision is an agreement for the company to repurchase the bond prior to its
maturity. A call provision with a specific call date and price would increase the coupon
rate. A company would issue a call provision when it is for its advantage, and thus the
bondholder’s disadvantage. Furthermore, the advantages of a call provision include a
higher coupon rate. The company benefits from refinancing at a lower rate if the interest
rates fall significantly (enough to offset the call provision cost).
5. A deferred call provision prohibits the company to repurchase the bond prior to a specific
date. A deferred call would reduce the coupon rate relative to a call provision
with a deferred call. This offers the bondholders protection for this period. The
disadvantage of a deferred call is that the company cannot call the bond during the
call protection period. Interest rates could potentially fall to the point where it would be
beneficial for the company to call the bond.
6. A make-whole call provision is a type of call provision on a bond allowing the issuer to
pay off remaining debt early. It would lower the coupon rate in comparison to a call
provision with specific dates since the make-whole call repays the bondholder the present
value of the future cashflows. If a bond with a make-whole provision is called,
bondholders r e c e i v e t h e m a r k e t v a l u e o f t h e b o n d , w h i c h t h e y c a n
r e i n v e s t i n a n o t h e r b o n d w i t h s i m i l a r characteristics. If we compare this to a
bond with a specific call price, investors rarely receive the full market value of the future
cash flows.
7. A positive covenant is a part of the indenture which states what the company’s
responsibilities should be. A positive covenant would reduce the coupon rate. The
presence of positive covenants protects bondholders by forcing the company to
undertake actions that benefit bondholders. Some examples would include: the company
must maintain audited financial statements, the company must maintain a minimum
specified level of working capital or a minimum specified current ratio, the company
must maintain any collateral in good working order. But the disadvantages of
the positive covenants are that the company is restricted in its actions, it may
force the company into actions that would harm its own interests.
8. A negative covenant is a part of the indenture which states the limits of the dividends
paid to its bondholders. A negative covenant would reduce the coupon rate. The
presence of negative covenants protects bondholders from actions by the company
that would harm the bondholders. Examples of negative covenants would be the company
cannot increase dividends, or at least increase beyond a specified level, the company
cannot issue new bonds senior to the current bond issue, the company cannot sell any
collateral. The downside of negative covenants is the restriction of the company’s
actions.
9. A conversion feature is the feature by which the amount the price of a convertible
security exceeds the current market value of the common stock into which it may be
converted. Even though the company is not public, a conversion feature would
likely lower the coupon rate. The conversion feature would permit bondholders to
benefit if the company does well and go public. The disadvantage is that the company
may be selling security at a discounted price.
10. A floating rate-coupon is a coupon where the payments are adjustable with a ceiling and
a floor rates. The disadvantage of a floating-rate coupon is that if interest rates rise, the
company must pay a higher interest rate. However, if interest rates fall, the company pays
a lower interest rate.
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