Chapter 11: Long-Term Debt Financing

Mortgage bond

A bond issued by a business that pledges real property (land and buildings) as collateral.

Zero-coupon bond

A bond that pays no interest. It is bought at a discount from par value, so its return comes solely from price appreciation.

Junk bond

A bond with a BB or lower rating.

Investment grade bond

A bond with a BBB or higher rating.

Financial intermediary

A business that buys securities with funds that it obtains by issuing its own securities. Examples include commercial banks and mutual funds.

Subordinated debenture

A debt security that, in the event of bankruptcy, has a claim on assets that is below (subordinate to) other debt.

Promissory note

A document that specifies the terms and conditions of a loan. Also called loan agreement or, in the case of bonds, indenture.

Inverted yield curve

A downward sloping yield curve.

Credit enhancement

Insurance that guarantees the payment of interest and repayment of principal on a bond even if the issuing company defaults. Also called bond insurance.

Term structure

The relationship between yield to maturity and term to maturity for debt of a single risk class, say, Treasury securities.

Price risk

The risk that rising interest rates will lower the values of outstanding debt.

Interest rate risk

The risk to current debtholders that stems from interest rate changes.

Private placement

The sale of newly issued securities to a single investor or small group of investors.

Coupon (interest) rate

The stated annual rate of interest on a bond, which is equal to the coupon payment divided by the par value.

Indenture

A legal document that spells out the rights and obligations of both bondholders and the issuing corporation. In other words, the loan agreement for a bond.

Yield curve

A plot of the term structure of interest rates (yield to maturity versus term to maturity).

Call provision

A provision in a bond indenture (contract) that gives the issuing company the right to redeem (call) the bonds prior to maturity.

Restrictive covenant

A provision in a bond indenture or loan agreement that protects the interests of lenders by restricting the actions of management.

Municipal bond (muni)

A tax-exempt bond issued by a governmental entity such as a healthcare financing authority.

Liquid asset

An asset that can be quickly converted to cash at its fair market value.

Trustee

An individual or institution, typically a commercial bank, that represents the interests of bondholders.

Debenture

An unsecured bond.

Normal yield curve

An upward sloping yield curve.

Corporate bond

Debt issued by for-profit businesses, as opposed to governmental or tax-exempt (municipal) bonds.

Bond

Long-term debt issued by a business or governmental unit and generally sold to a large number of individual investors.

Term loan

Long-term debt obtained directly from a financial institution, often a commercial bank.

Coupon payment

The dollar amount of annual interest on a bond.

Yield to call

The expected rate of return on a debt security assuming it is held until it is called.

Yield to maturity

The expected rate of return on a debt security assuming it is held until maturity.

Capital gains yield

The percentage capital gain (loss) over some period, usually applied to stocks and bonds.

Default risk premium

The premium that creditors demand (add to the base interest rate) for bearing default risk. The greater the default risk, the higher the default risk premium.

Liquidity premium

The premium that debt investors add to the base interest rate to compensate for lack of liquidity.

Inflation premium

The premium that debt investors add to the real risk-free (base) interest rate to compensate for inflation.

Refunding

The process of calling (redeeming) a debt security. Usually involves issuing new debt at a lower interest rate and using the proceeds to redeem existing higher interest rate debt.

Real risk-free rate

The rate of interest on a riskless investment in the absence of inflation.