Acct 230 1st Edition Lecture 23 Outline of Last Lecture I Current Liabilities a Current Liabilities Outline of Current Lecture II Long Term Liabilities a Overview of Long Term Debt Current Lecture III Explain financing alternatives a Financing Options i Debt Financing borrowing money liabilities ii Equity Financing obtaining additional investment from stockholders stockholders equity b Capital Structure is the mixture of liabilities and stockholders equity used by a business c What is a Bond i A formal debt instrument that obligates the borrower to repay a stated amount referred to as the principal or face amount at a specified maturity date ii In return the borrower agrees to pay interest over the life of the bond iii Similar to notes payable except bonds are usually issued to many lenders at the same time iv Traditionally interest on bonds is paid twice a year semi annually v Bonds are sold or underwritten by investment houses like JPMorgan Citibank and Bank of America vi The borrower pays a fee for underwriting services Other costs include legal accounting registration and printing fees vii To keep costs lower the issuing company may choose to sell the debt securities directly to a single investor This is referred to as a Private placement These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute IV viii Issue costs are lower because privately placed securities are not subject to the costly and lengthy process of registering with the SEC that is required of all public offerings Identify the characteristics of bonds a A bond indenture is a contract between a firm issuing bonds and the corporations or individuals who purchase the bonds as investments b Bonds may be secured or unsecured term or serial callable or convertible c Secured and Unsecured Bonds i Secured Bonds supported by specific assets the issuer has pledged as collateral 1 Mortgage bonds are backed by specific real estate assets 2 If the borrower defaults on the payments the lender is entitled to the real estate pledged as collateral ii Unsecured bonds referred to as debentures are not backed by a specific asset 1 Secured only by the full faith and credit of the borrower d Term and Serial Bonds i Term bonds require payment of the full principal amount of the bond at a single maturity date 1 Most bonds have this characteristic 2 To ensure that sufficient funds are available to repay the amount at maturity the borrower sets aside money in a sinking fund a A sinking fund is an investment fund used to set aside money to pay the outstanding debt as it comes due ii Serial bonds require payments in installments over a series of years 1 It makes it easier for the borrower to meet its bond obligations as they become due e Callable Bonds i Most corporate bonds are callable or redeemable ii Allows the borrower to repay the bonds before their scheduled maturity date at a specified call price 1 Call price is stated in the bond contract and usually exceeds the bond s face amount iii It helps protect the borrower against future decreases in interest rates If interest rates decline the borrower can buy back the highinterest rate bonds at a fixed price and issue new bonds at the new lower interest rate f Convertible Bonds i While callable bonds benefit the borrower convertible bonds benefit both the borrower and the lender ii Convertible bonds allow the lender to convert each bond into a specified number of shares of common stock iii The borrower also benefits Convertible bonds sell at a higher price and require a lower interest rate than bonds without a conversion feature iv Using IFRS we would divide the issue price of convertible debt into its liability bonds and equity conversion option elements Under U S GAAP the entire issue price is recorded as a liability g Summary of Bond Characteristics i