Question

1. You are Kim’s assistant, and she has asked you to prepare a memo to Dan describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature.

1. The security of the bond, that is, whether or not the bond has collateral.

2. The seniority of the bond.

3. The presence of a sinking fund.

4. A call provision with specified call dates and call prices.

5. A deferred call accompanying the above call provision.

6. A make-whole call provision.

7. Any positive covenants. Also, discuss several possible positive covenants East Coast Yachts might consider.

8. Any negative covenants. Also, discuss several possible negative covenants East Coast Yachts might consider.

1. any’s tax rate is 35 percent.

2. How many of the coupon bonds must East Coast Yachts issue to raise the $40 million? How many of the zeroes must it issue?

3. In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes?

4. What are the company’s considerations in issuing a coupon bond compared to a zero coupon bond?

5. Suppose East Coast Yachts issues the coupon bonds with a make-whole call provision. The make-whole call rate is the Treasury rate plus .40 percent. If East Coast calls the bonds in 7 years when the Treasury rate is 5.6 percent, what is the call price of the bond? What if it is 9.1 percent?

6. Are investors really made whole with a make-whole call provision?

7. After considering all the relevant factors, would you recommend a zero coupon issue or a regular coupon issue? Why? Would you recommend an ordinary call feature or a make-whole call feature? Why?

Answer 1

You have asked multiple unrelated questions in the same post. As if this was not enough, your first question has multiple sub parts as well. I have addressed the first four sub parts of the first question. Please post the balance questions separately one by one.

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First Question

The general rule is:

• If the provision of the bond benefits the company, it will pay a higher coupon rate.
• If the provision of the bond benefits the bondholder, the bond will carry a lower coupon rate

1. The security of the bond, that is, whether or not the bond has collateral.

If the bond has collateral, the bondholder is secured. He has something to fall back upon, on default. It's beneficial for the bondholder. Hence, the bond with collateral will have a lower coupon rate; the one without collateral will have higher coupon.

2. The seniority of the bond.

The seniority of the bond governs who gets paid earlier in the peking order, in case of liquidation. A senior bond is therefore more secure than a junior bond. igher the seniority, lower will be the coupon.

3. The presence of a sinking fund.

A sinking fund is another type of guarantee to the bondholder. It adds to the security of the bond. Hence, the presence of a sinking fund will lower the coupon of the bond.

4. A call provision with specified call dates and call prices.

A call provision gives the right but not the obligation to the company to pay the bondholders in full and call the bond at specified call dates and at specified call prices. This is beneficial to the company and may not necessarily be beneficial to the bondholders. Hence, A call provision with specified call dates and call prices, will icrease the coupon.