Corporate Debt Securities

7/28/2019 Corporate Debt Securities

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Corporate Debt Securities

2 2010 Kaplan, Inc.

Corporate capitalization Earn money from business Issue stock

Ownership (equity) Limited liability

Issue debt Bonds, notes Holder of note or bond is creditor of issuer


3 2010 Kaplan, Inc.

Debt FinancingBonds Par value$1,000 Semi-annual interest payments

$1000 PAR

6%

ABCCompany

6/1/2025


4 2010 Kaplan, Inc.

Tracking Corporate Bonds 1 point = $10 Often quoted as a percentage of par 100 basis points = 1%

Par (face, principal)

PAR VALUE

Discount

Premium


5 2010 Kaplan, Inc.

Yields Nominal yield = stated yield = coupon Current yield (CY)

Annual interest current market price Yield to maturity (YTM, effective yield)

Reflects gain at maturity of a discount bond Reflects loss at maturity of a premium bond

Yield to Call Reflects yield if bond is called on the call date

Highest yield for discount bonds Lowest yield for premium bonds


6 2010 Kaplan, Inc.

NominalYield

CurrentYield(CY)

Yield toMaturity(YTM)

6.00% 6.00% 6.00%Par$1,000

6.00%

Yield toCall



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7 2010 Kaplan, Inc.

BOND

PRICES

INTEREST

RATES

Nominal

Yield

Current

Yield(CY)


6.00%

Premium$1,200

5.00%

Par$1,000

Yield toCall


8 2010 Kaplan, Inc.

BOND

PRICES

INTEREST

RATES

Nominal

Yield

Current

Yield(CY)

Yield to

Maturity(YTM)

6.00%

Discount$800

7.50%Par$1,000

Yield to

Call


9 2010 Kaplan, Inc.

BOND

PRICES

INTEREST

RATES

NominalYield

CurrentYield(CY)


Premium$1,200

Discount$800

Par$1,000

Yield toCall


10 2010 Kaplan, Inc.

Price of long-term debt more volatile thanshort-term debt

Duration The greater the duration, the greater the volatility

20 years to maturity

9%

8%maturity

discount



Issuer is in default. Payment of interest and/or principal is in arrearsDD

No interest is being paid on this bond at this timeCaaC

Issuer has missed one or more interest or principal paymentsBB

Speculative. Significant chance that issuer could m iss an interest paymentBaBB

Speculative (noninvestment grade)bonds

Adequate capacity to repay principal and interest. Slightly speculativeBaaBBB

Judged to be slightly more susceptible to adverse economic conditions.AA

Very strong. Only slightly less secure than the highest rating.AaAA

Highest rating. Capacity to repay principal and interest judged high.AaaAAA

Bank grade (investment grade) bonds

InterpretationMoody'sStandard & Poor's

Ratings measure credit riskCorporate Debt Securities


Yield Spread between investment grade andspeculative

Large difference during doubtful economic times Smaller difference during periods of investor confidence

Widens: Negative

Maturity

Yield

Narrows: Positive

Maturity

Yield



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Characteristics of CorporateDebt


Secured Bonds

EQUIPMENT TRUSTCERTIFICATE

COLLATERAL TRUSTBOND

MORTGAGE BOND



Unsecured Bonds Debentures Subordinated debentures



Convertible Bonds

$1000 par

$40 conversion price

Par $1000

ConvertibleBond

$40

25 shares ofcommon stock



Parity When two security positions are valued

equally

Par $1000

ConvertibleBond

$40

$50 CMV of common stock

25 shares $50 per share

$1,250$1250

25 shares ofcommon stock



Redemption Principal and last interest payment returned

upon maturity



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Zero Coupon Bonds Purchased at a discount

Generates phantom income (accreted)

Duration = maturity



Liquidation Priority

Taxation of Corporate Bonds


Collateralized MortgageObligations (CMOs)



Collateralized mortgage obligations Created by broker dealers or financial

institutions Buy, then package GNMA, Freddie Mac and

Fannie Mae mortgages

Tranche



Pass through certificates Pays a monthly check of principal and/or

interest Subject to prepayment risk

If interest rates fall and people refinance

Subject to extension risk The chance that principal payments will be slower

than anticipated Interest rates rise and stay up for an extended period of

time



Classes of CMOs Principal-only CMO (PO)

The income comes from principal payments Scheduled and prepayments

Interest-only (IO) Sells at a discount Receives the interest Cash flow declines over time


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Planned Amortization Class (PAC) Targeted maturity dates Retired first Low prepayment and extension risk

Targeted Amortization Class (TAC) Longer maturities Greater prepayment and extension risk Higher interest rate



Zero-Tranche (Z-Tranche) Receives no payment until all preceding tranches areretired

Very volatile

CMO characteristics Considered relatively safe in terms of default risk Taxed at all levels CMOs with complex characteristics may have a

limited secondary market Customers required to sign a suitability statement

before purchase

Documents

Corporate Debt Securities