ACC 210 Chapter 9

Term bonds

Require payment of the full principal amount of the bond at the end of the loan term. Most bonds have this characteristic. Principal amount, face amount, maturity amount.

Bond contract

Specify legal liability and if interest is paid annually or semi-annually. Focus on this BEFORE looking at market stuff.

Bonds issued at face amount

State interest rate = market interest rate

Secured Bonds

Supported by specific asseys the issuer has pledged as collateral. Ex: mortgage bonds are backed by specific real estate assets. If the borrower defaults on the payments, the lender is entitled to the real estate pledged as collateral so if the borrower defaults on the payments, the lender is entitled to the real estate pledged as collateral.

Carrying value

The balance in the Bonds Payable account, the amount actually owed

Capital Structure

The mixture of liabilities and stockholders' equity a business uses. Determine using balance sheet.

Face value of a bond is...

The one-time amount due at maturity

Default Risk

The possibility that a company will be unable to pay the bond's face amount or interest payments as they become due.

Early extinguishment of debt

When the issuer retires debt of any type before its scheduled maturity date

Why lease rather than buy?

1) Leasing improves cash flows through up to 100% financing 2) Leasing improves the balance sheet by reducing long-term debt 3) Leasing can lower income taxes

Debt financing

Borrowing money (liabilities). Interest expense incurred when borrowing money is tax deductible. Reduces taxable income. Debt can be a less costly source of external financing; bonds, notes, and leases. Three primary sources of long-term debt financing

Discount

Bonds issued below face amount are issued at a discount. When stated interest rate is lower than the market interest rate.

Determine the price of a bond issue...

Present value of face amount + present value of the periodic interest payments. Always use market rate to calculate the bond issue price, never stated. Stated is only used to calculate the interest payment each period.

Stated Interest Rate

The rate quoted in the bond contract used to calculate the cash payments for interest.

Private Placement

To keep costs down, the issuing company may choose to sell the debt securities directly to a single investor, such as a large investment fund or an insurance company. Issue costs are lower.

Debt to equity ratio

Total liabilities/stockholders' equity

Operating Lease

ex: renting an apartment. NOT a long term liability. RENTAL

Sinking fund

A designated fund to which an organization makes payments each year over the life of its outstanding debt.

Operating leases

Are like rentals. Ex: short term car rentals and most apartment rentals

Semi annual cash outflows...

Are the cash interest payments. Cash interest payments are based on the information found on the face value of the base. face value x face rate x time

PV=

FV x PVFactor (use periods and percent)

Interest expense

The carrying value X the market rate

Times interest earned ratio

Ratio used to measure the risk of failure to pay interest when it is due that may invoke penalties, possibly leading to bankruptcy. Measures a company's ability to meet interest payments as they become due. (net income + interest expense + tax expense)/interest expense

Market Interest Rate

Represents the true interest rate used by investors to value the bond issue. Determined by the forces of supply and demand. The higher the market interest rate, the lower the bond issue price will be.

Convertible bonds

Call feature is more common that conversion feature. Benefit both borrower and lender. Allow the lender (the investor) to convert each bond into a specified number of shares of common stock. Sell at a higher price and require a lower interest rate than bonds without a conversion.

The price of a bond is...

Equal to the present value of the face amount (principal) payment at maturity, plus the present value of the periodic interest payments.

Cash paid for interest

Face amount X the stated rate

Bonds

Formal debt instrument that obligates the borrower to repay a stated amount, referred to as the principal or face amount, at a specific maturity date. Similar to notes except bonds are usually issued to many lenders while notes most often are issed to a single lender, like a bank. Interest on bonds is traditionally paid twice a year on designated interest dates, beginning 6 months after the original bond issue date.

Each Installment Payment...

Includes both an amount that represents interest and an amount that represents a reduction of the outstanding loan balance.

Capital Lease

Long term liability. Sign lease and monthly payments used to purchase whatever asset it.

Unsecured Bonds (debentures)

Most bonds are unsecured. Not backed by a specific asset. Secured only by the "full faith and credit" of the borrower.

Callable

Most corporate bonds are callable, or redeemable. 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. Benefit only the borrower.

Return on equity

Net income/Average stockholders' equity

Return on assets

Net income/Average total assets

Record the retirement of bonds...

No gain/loss recorded on bonds retired at maturity. For bonds retired before maturity, we record a gain or loss on early extinguishment equal to the difference between the price paid to repurchase the bonds and the bonds' carrying value

Equity financing

Obtaining additional investment from stockholders (SE). Dividends paid to stockholders are not tax deductible. Does not reduce taxable income.

Capital leases

Occur when the lessee essentially buys an asset and borrows the money through a lease to pay for the asset.

Premium

Occurs when the issue price of a bond is above its face amount. When the stated interest rate is greater than the market interest rate.

Amortization schedule

Provides a summary of the cash paid, interest expense, and changes in carrying value for each semiannual interest period

Serial bonds

require payments in installments over a series of years. Certain amount due each year instead of all at the end. Most bonds are term bonds, not serial.