Bond Characteristics - YouTube

>> There are three common ways companies finance long-term assets and projects.

They are debt financing,

which will focus on bonds, equity financing,

which will focus on stocks,

and equity financing, which will focus on the use of retained earnings.

Each of these methods will be covered in detail in this video series,

but the focus of this video is debt financing with bonds.

A bond is a type of debt or long-term promissory note issued by a borrower,

promising to its holder a predetermined and fixed amount of interest per year,

and repayment of principal at maturity.

They are issued by corporations,

the US government, state governments,

and even local municipalities.

The issuance of bonds follows the procedures we learned earlier.

Often, they are issued through the help of investment bank.

State law grants corporations the power to use bonds,

but it's the board of directors with the approval of

the stockholders that must approve a bond issuance.

The board decides the size and the scope of the bond issuance.

Bonds are almost always issued in $1,000 increments,

and the interest payments are almost always made semi-annually.

This is really important to remember those two things when we move on to pricing bonds.

A bond represents both a promise to repay the principal amount at

maturity and semiannual interest payments over the life of the bond.

Generally, bonds are issued when the amount of

capital needed is too large for one lender to supply.

Bonds are contractual, negotiable instruments,

for those of you who are familiar with that term from business law.

As such, the face of a bond must state

specific things in order to remain negotiable or tradeable.

It must include the issuing company name, the principal amount,

the maturity date, the stated interest rate,

and the interest payment dates.

Here is an example of a bond certificate.

You can see where I've highlighted some of these must have information.

Finally, let's conclude with some key terms related to bonds.

The par value of the bond is

the principal amount that must be repaid when the bond matures.

It's also called the face value or maturity value.

The stated rate is

the annual interest rate used to calculate the periodic interest payments.

It is also called the coupon rate because it

is the rate found on the bond certificate or coupon.

Finally, maturity is the length of time until the bond's principal amount must be repaid.

An indenture is the legal agreement between the firm

issuing the bond and the trustee who represents the bond holders.

It provides for specific terms of

the loan agreement such as the rights of the bond holders and the issuing firm.

Many of these terms seek to protect the status of bonds from

being weakened by managerial action or by other security holders.

A call provision gives the corporation the option to

pay off bonds earlier than their contractual maturity date.

For example, if the prevailing interest rates decline,

the firm may want to pay off bonds early

and reissue new bonds at a more favorable interest rate.

When this happens, they almost always have to pay a call premium,

which is an amount more than the face value of the bonds