LONG-TERM

FINANCING

BOND
•LONG-TERM EXTERNAL FINANCING
•Shares
•Preferred stock (Ownership)
•Common stock (Residual ownership actual)

•Bonds
Bonds and preferred stocks are generally classified as
FIXED INCOME SECURITIES because they involve
relatively constant distributions of interest or dividend
payments.

Common stock is a VARIABLE INCOME SECURITY

because dividends may vary
 BOND

A bond is a long-term debt instrument in which the

issuer (Corporation or Government) promises to
pay the bondholder specified amounts of interest
and principal amount on predetermined date or
time period.
Bond holders are creditors
 The conditions in which bonds may be issued

1. Sales earnings are relatively stable.

2. Coverage ratios and profit margins are adequate.
3. The firm’s liquidity position is adequate and stable.
4. The existing debt ratio is low.
5. Interest rates are low.
6. Indenture provisions (terms conditions) of prior
debt issues or the proposed debt issue are not too
burdensome.
7. The firm’s credit rating is satisfactory.
8. The firm’s stock price is depressed.
9. Control considerations are important.
 Major features / Characteristics of Bond

1. Indenture: The legal document(agreement)

between the corporation issuing bonds and the
bondholders, also called the deed of trust, that
contains terms and conditions of bond issue. It
specifies: Type of bond, amount of bond, the
annual interest rate and maturity date or period
2. Trustee: A trustee is the bondholder’s agent in a
public debt offering, appointed by the issuer
before the bonds are sold, is usually the trust
department of commercial bank.
 Major features / Characteristics of Bond

3. Par value: It is nominal value stated on the bond.

Other terms for par value are face value, maturity
value, denomination, stated value, and principal
amount. The par value a bond represents the
amount to be paid to the lender at the bond’s
maturity.
4. Discount and premium: A bond sells at a
premium whenever its market value is above its
par value, and at a discount whenever its market
value is below its par value.
5. Maturity date: Bonds almost always have a
stated maturity. This is the time when the company
is obligated to pay the bondholder the par value of
the bond. The maturity on long-term bonds
typically range 10 to 30 years.
 Major features / Characteristics of Bond

6. Coupon rate: The coupon rate is the stated or

nominal rate of interest based on a bond’s par
value. Bond interest payments are typically made
semiannually on corporate bonds and are tax
deductible.
7. Call provision: A call provision gives the issuer
the right to repurchase the bond prior to its
maturity under specified terms.
8. Points and basis points: A point is the
percentage change of the face value of a bond. A
change of 1 percent is a move of one point. A basis
point is the smallest measure used in quoting
yields on bonds and notes.
 Major features / Characteristics of Bond

10. Conversion features: A conversion feature

allows the bondholder to exchange a bond for a
certain number of shares of shares of preferred or
common stock.
11. Sinking fund: A sinking fund is a provision which
facilitates the orderly retirement of portion of a
bond issue before its maturity date.
 Types of bonds according to collateral pledged
against bonds issue
Major types are secured and unsecured bonds
1. Secured bonds: The secured bonds are bonds
backed by the pledge of collateral. Collateral is an asset
pledged to a lender until an obligation is paid.

• Mortgage bonds: Mortgage bonds backed by real

property (land and buildings). Some mortgage bonds
are secured by blanket (general) mortgages in which all
or most the firm’s assets serve as collateral.
A first-mortgage bond (Senior debt) gives its
bondholders a first claim on secured assets.
A second-mortgage bond (Junior debt) gives
its bondholders a secondary claim against the real
property already used as security for the first-mortgage
 Types of bonds according to collateral pledged
against bonds issue

• Equipment trust certificate: Bonds are issued by

transportation company, such as railroad line or
airline, that is used to finance new equipment.

• Collateral trust bond: are corporate debt securities

backed by other securities which are usually held by a
trustee.
 Types of bonds according to collateral pledged
against bonds issue

2. Secured bonds: Are obligations not backed by the

pledge of a specific collateral. These bonds represent a
claim against the firm’s earnings but not against any
specific assets.

• Debentures: are unsecured, long-term bonds backed

only by the borrower’s creditworthiness.

• Subordinate debentures: are unsecured bonds

that rank behind other types of debt with respect to
claims against earnings and assets.
 Advantages of bonds

1. Safe
2. Money secure from your spending
3. Low maintenance
4. If company goes bankrupt, bonds are still paid off
5. Less risky of the two securities
6. Better liquidity
7. Fixed rate
8. Minimal sales risk
9. Low cost
10. Financing flexibility
11. Inflation hedge
 Disadvantages of bonds

1. Low rate of return

2. Cannot sell until mature
3. Definite maturity date
4. May not keep up with inflation
5. Expensive at start
6. Takes years to get guaranteed money
7. Commitment to contract for entire valid period
8. High financial risk
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