FINANCIAL ACCT BONDS

callable bonds

Most corporate bonds are redeemable. This feature allows the borrower to repay the bonds before their scheduled maturity date at a specified call price, usually at an amount just above face value. protect the borrower against future decreases in interest rates. If interest rates decline, the borrower can buy back the high-interest-rate bonds at a fixed price and issue new bonds at the new, lower interest rate. benefit the borrower.

convertible bond

benefit both the borrower and the lender. Convertible bonds allow the lender (the investor) to convert each bond into a specified number of shares of common stock. For example, let's say a $1,000 convertible bond can be converted into 20 shares of common stock. In this case, convertible bondholders benefit if the market price of the common stock goes above $50 per share (= $1,000 ÷ 20 shares), assuming the current market price of the bond is $1,000. If the company's stock price goes to $60 per share, the convertible bondholder can trade the $1,000 bond for 20 shares of stock worth $60 per share (or $1,200). Prior to conversion, the bondholder still receives interest on the convertible bond. The borrower also benefits. Convertible bonds sell at a higher price and require a lower interest rate than bonds without a conversion feature.

secured bonds

Bonds that are supported by specific assets pledged as collateral are similar. They are supported by specific assets the issuer has pledged as collateral. If the borrower defaults on the payments, the lender is entitled to the assets pledged as collateral.

sinking funds

an investment fund to which an organization makes payments each year over the life of its outstanding debt. For example, say a company borrows $20 million by issuing term bonds due in 10 years. The company might put $2 million each year into a sinking fund, so that at the end of 10 years, $20 million is available to pay back the bonds on the due date.

unsecured bonds

most bonds, also referred to as debentures, are not backed by a specific asset. These bonds are secured only by the "full faith and credit" of the borrower.

Term bonds

require payment of the full principal amount of the bond at the end of the loan term. Most bonds have this characteristic. To ensure that sufficient funds are available to pay back the bonds at the end of the loan term, the borrower usually sets aside money in a "sinking fund."

serial bond

require payments in installments over a series of years. Rather than issuing $20 million in bonds that will be due at the end of the 10th year, the company may issue $20 million of which $2 million is due each year for the next 10 years. This makes it easier to meet its bond obligations as they become due. Since most bonds are term bonds, we focus on term bonds in this chapter.