Financial reporting Chapter 14

subordinated debenture

A type of debenture bond (an exception). It is not entitled to receive an liquidation payments until the claims of other specified debt issues are satisfied.

detachable stock purchase warrants

ANother (less common) way to sweten a bond issue is to include this as part of the security issue. It gives the investor an option to purchase a stated number of shares of common stock at a specified option price, often within a given period of time.

Mortgage bond

Backed by a lien on specified real estate owned by the issuer. It is considered less risky than debentures, so it will normally have a lower interest rate.

periodic interest

Equals the effective interest rate times the amount of the debt outstanding during the period.

bond indenture

The specific promises made to bondholders are described in a document called this. It is held by a trustee, usually a commercial bank or other financial institution, appointed by the issuing firm to represent the rights of bondholders. If the company fails to live up the terms of this, the trustee may bring legal action against the company on behalf of the bondholders

default risk

The type of risk that considers that the company will default on its obligations.

effective interest method

Recording interest each period as the effective market rate of interest multuiplied b the outstanding balance of the debt.

Serial bonds

Provide a more structured (less popular) way to retire bonds on a piecemeal basis. They are retired in installments during all or part of the ife of the issue. Each bond has its own specified maturity date.

Reasons for issuing convertible bonds rather than straight debt

1. To sell the bonds at a higher price 2. To use as a medium of exchange in mergers and acquisitions 3. To enable smaller firms or debt heavy companies to obtain access to the bond market.

straight line method

In some circumstances, there is an exception to the conceptually appropriate method for determining interest for bond issues. A company is allowed to determine interest indirectly by allocating a discount or a premium equally to each period over the term to maturity--if doing so produces results that are not materially different from the usual interest method.

Debenture bond

Most corporate bonds are this. They are secured only by the "full faith and credit" of the issuing corporation. No specific assets are pledged as security.

Callable (redeemable)

Most corporate bonds are this. This feature allows the issuing copany to buy back, or call, outstnading bonds from bondholders before their scheduled maturity date. Affords the company some protection against being stuck with relatively high-cost debt in the event interest rates fall during the period before maturity.

bonds

Obligate the issuing corporation to repay a stated amount at a specific maturity date and periodic interest between the issue date and maturity.

Sinking fund

Often, calls on a bond are mandatory. THe corporation may be required to redeem the bonds on a pre-specified, year by year basis.

Convertible bonds

Retired as a consequence of bondholders choosing to convert them into shares of stock.

private placement

The issuing company may choose to sell the debt securities directly to a single investor

Coupon bonds (bearer bonds)

The name of the owner of this was not registered. Instead, to collect interest on this, the holder actually clipped an attached coupon and redeemed it in accordance with instructions in the indenture.

implicit rate of interest

The rate implicit in the agreement.

Credit risk

The risk that the investor in the bonds will not receive the promised interest and maturity amounts at the times they are due.

premium

WHen the bond sells for more than the face amount

Debt issue costs

WIth either publicly or privately sold debt, the issuing company will incur costs in connection withissuing bonds or notes, such as legal or accounting fees and printing costs, in addition to registration and underwriting fees. They are recorded separately and amortized over the term of the related debt.

leverage

When debt is used as an advantage. It can be used to enhance the return to shareholders (called this) As a manager, you try to create favorable financial _____________.

early extinguishment of debt

When debt of any type is retired prior to its scheduled maturity date, the transaction is referred to as this.

discount

When the bond sells for less than the face amount