Bond Issue Process

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Typically, at the time a bond is issued, its coupon payment is set at a level that will enable the bond to be issued at or near its par value.

Types of Bonds Again:

- Fixed-rate Bonds - The coupon payment, which is fixed at the time the bond is issued, remains in force during the life of the bond.

- Floating Rate Bonds - Coupon rate is set for, say, the initial 6-month period then adjusted every 6 months based on some market rate. Market rates like treasury rates or LIBOR for example.

Additional Provisions:

- Convertibility to fixed rate bonds

- Zero Coupon Bonds - coupon rate too low for the bond to be issued at par, so the bond is issued at a price less than its par value - original issue discount (OID) bond.

- PIK Payment-in-kind Bonds - Some bonds don’t pay cash coupons but pay coupons consisting of additional bonds (or a percentage of an additional bond).

Usually issued by companies with cash flow problems, which makes them risky.

Coupon Interest Rate =Coupon Payment/Par Value

Maturity Period: Date on which the par value must be repaid.

The effective maturity of a bond declines each year after it has been issued.

Provisions with Bonds for Corporates Issuers-

- Call Provision: Company must pay the bondholders an amount greater than the par value if they are called.

How a call provision is valuable to the firm but potentially detrimental to investors?

The additional sum – Call Premium = 1 year’s interest if the bonds are called during the first year Call Premium for subsequent years = premium declines at a constant rate of INT/N each year thereafter (where INT = annual interest and N = original maturity in years).

Bonds are often not callable until several years (generally 5 to 10) after they are issued = Deferred Call

- Step-up Provision: If the company’s bond rating is downgraded, then it must increase the bond’s coupon rate. But High reward

- Refunding Operation: If a company sold bonds when market interest rates were relatively high. Provided the issue is callable, the company could sell a new issue of low-yielding securities if and when market interest rates drop. It could then use the proceeds of the new issue to retire the high-rate issue and thus reduce its interest expense.

- Make-Whole Call Provision: This allows a company to call the bond, but it must pay a call price that is essentially equal to the market value of a similar noncallable bond. This provides companies with an easy way to repurchase bonds as part of a financial restructuring, such as a merger.

Provisions with Bonds for Investors:

- Redeemable at par option: Holders have the option of turning their bonds in and having them redeemed at par, then they are protected against rising rates. If interest rates have risen, holders will turn in the bonds and reinvest the proceeds at a higher rate.

- Super Poison Put: