14 1 B40 2302 Class 6 BM6 chapters 14 4 24 22 1 22 3 25 1 23 14 4 24 22 1 22 3 25 1 debt varieties 23 debt valuation Based on slides created by Matthew Will Modified 10 18 2001 by Jeffrey Wurgler Irwin McGraw Hill The McGraw Hill Companies Inc 200 Principles of Corporate Finance Brealey and Myers Sixth Edition An Overview of Corporate Financing Slides by Matthew Will Jeffrey Wurgler Irwin McGraw Hill Chapter 14 4 The McGraw Hill Companies Inc 200 14 3 Topics Covered Debt At first glance many different forms of debt But all share common features Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 4 Corporate Debt General features of debt Borrower stockholder promises a certain stream of interest and principal payments But borrower may choose to default Lender doesn t usually have voting rights but in case of default lender gets assets Asset administration handled by bankruptcy court Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 5 Corporate Debt TABLE 14 5 Large firms typically issue many different securities This table shows some of the debt securities on Mobil Corporation s balance sheet at the end of 1996 and 1997 figures in millions Debt Security 6 1 2 notes 1997 6 3 8 notes 1998 7 1 4 notes 1999 8 3 8 notes 2001 8 5 8 notes 2006 8 5 8 debentures 2021 7 5 8 debentures 2033 8 debentures 2032 8 1 8 Canadian dollar eurobonds 1998 a 9 ECU eurobonds 1997 b Irwin McGraw Hill 1996 148 200 162 200 250 250 240 250 110 148 1997 200 148 180 250 250 216 164 The McGraw Hill Companies Inc 200 14 6 Corporate Debt Mobil continued Debt Security 9 5 8 sterling eurobonds 1999 Variable rate notes 1999 Japanese yen loans 2003 2005 Variable rate project financing 1998 Industrial revenue bonds 1998 2030 Other foreign currencies due 1997 2030 Other long term debt Capital leases Commercial paper Bank and other short Irwin McGraw Hill 1996 187 110 388 105 491 1090 660 247 1634 894 1997 182 347 52 484 764 716 335 1097 1168 The McGraw Hill Companies Inc 200 Principles of Corporate Finance Brealey and Myers Sixth Edition The Many Different Kinds of Debt Slides by Matthew Will Jeffrey Wurgler Irwin McGraw Hill Chapter 24 The McGraw Hill Companies Inc 200 14 8 Topics Covered Domestic Bonds and International Bonds The Bond Contract Interest Security Seniority Asset Backed Securities Repayment Retirement Provisions Covenants Private Placements and Project Finance Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 9 Bond Terms Markets Foreign bonds Bonds that are sold to local investors in another country s bond market in local currency Yankee bond a foreign bond sold in the United States Samurai bond a foreign bond sold in Japan Eurobond market Bonds sold across several international markets in a single major currency Note nothing specific to Europe nothing to do with euro currency Just denotes bonds that are issued distributed across many countries Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 10 Bond Terms The contract Indenture or trust deed the bond agreement between the borrower and a trust company Agreement lists main terms of the contract Trustee s role Agent for individual bondholders Represents them in event of default Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 11 Bond Terms Who keeps track Registered bond company keeps track of bond owners repays them directly Most common in US Bearer bond bondholder sends in coupons to claim interest payments and must send the certificate to claim principal repayment More common overseas Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 12 Bond Terms Interest Fixed rate debt keeps paying a constant interest rate over the life of the bond Floating rate debt pays an interest rate that fluctuates with the general level of interest rates Common benchmark rate is LIBOR London InterBank Offered Rate Loan agreements negotiated with banks are commonly floating rate Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 13 Bond Terms Security Unsecured debt obligations are most common for industrial and financial firms Debentures long term unsecured issue Notes short term unsecured issue Secured bonds have a claim to certain assets upon default Mortgage bonds long term secured debt that may contain a claim against a specific building or property Collateral trust bonds bonds issued by holding companies that use common stock in other companies as collateral Equipment trust certificate not a bond debt issued to finance railroad equipment trucks aircraft or ships Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 14 Bond Terms Seniority Priority of claims on firm s assets Senior secured debt Senior unsecured debt Junior subordinated debt Junior or subordinated debt Residual claimants are shareholders Preferred shareholders rank above common Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 15 Asset backed securities Asset backed securities Rather than borrow directly companies may bundle a group of assets and then sell the cash flows from these assets Example Mortgage lenders They get cash now They pass through the mortgage repayments they receive to the AB securityholders Example Rock star David Bowie Got 55 million in 1997 passed through the royalties to his albums to the Bowie bondholders Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 16 Bond Terms Retirement Sinking fund a fund established to retired debt before maturity Low quality issues strict sinking fund requirement High quality issues light requirement so large balloon payment of principal left at maturity Callable bond a bond for which the firm has the option to repay early for a specified call price Putable or retractable bond a bond for which investors have the option to demand early repayment Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 17 Straight Bond vs Callable Bond Value of bond Straight bond 100 Bond callable at 100 75 50 25 Value of straight bond 25 Irwin McGraw Hill 50 75 100 125 150 The McGraw Hill Companies Inc 200 14 18 Bond Terms Covenants Restrictive negative covenants must not limits set by bondholders Limits on debt ratios Limits on dividends Limits on leasing Negative pledge clause me too clause Gives unsecured debentures equal protection if and when assets are mortgaged Positive covenants must limits Minimum net working capital Irwin McGraw Hill The McGraw Hill Companies Inc 200 14 19 Value of covenants An example 1992 1993 Marriott spun off its hotel management business worth 80 of its value Before the spin off Marriott s long