Question

Please respond to the following questions pertaining to bonds. Please remember to fully explain your answers and provide examples whenever possible.

1. Explain the difference between a secured corporate bond and an unsecured corporate bond.
2. Explain why bonds with lower seniority have higher yields than equivalent bonds with higher seniority.
3. Explain what are the differences among a foreign bond, a Yankee bond and a Eurobond.
4. Define what are restrictive covenants and what it means to (how it affects) the company that is issuing bonds.
5. Explain what happens to the price of a new bond that contains restrictive covenants and why a company would voluntarily choose to put restrictive covenants into a new bond issue.
6. Define what is a call feature and what it means to (how it affects) the company that is issuing bonds and what it means to (how it affects) the bondholder.
7. Explain why a call feature may be valuable to a company issuing bonds.

Answer 1

(A):- Secured Bonds :- Secured bonds are those that are collateralized by an asset – for instance, property, equipment (as is commonly the case for bonds issued by airlines, railroads and transportation companies), or by another income stream.

EXAMPLE :- Mortgage-backed securities (MBS) are an example of a single bond-type secured by both the physical assets of the borrowers — the titles to the borrowers' residences— and by the income stream from the borrowers' mortgage payments.

Unsecured binda :- Unsecured bonds are not secured by a specific asset, but rather by "the full faith and credit" of the issuer. In other words, the investor has the issuer’s promise to repay but has no claim on specific collateral.

A secured corporate bond is backed by an asset so that should the bond default, the bondholder will not be left with nothing. An unsecured corporate bond is not backed by an asset.

EXAMPLE :- An income bond is example of an unsecured bond. These securities are issued by large corporations, and the payment of interest is contingent upon sufficient earnings. Also known as an adjustment bond, this last type of security is frequently issued by companies attempting to maintain their operations while seeking bankruptcy protection.

(B) :- Requiring coupon payments protects the bondholders from waiting a long time in case the debtor defaults. %ithout coupon payments, default only happens when the bond matures, but by then thecorporation might ha!e depleted all of its assets. In contrast, with coupon payments the debtor would be in default the moment it misses one of the coupon payments, and the bondholders can then force thefirm into ban?ruptcy. &t this stage, they might be able to get a larger fraction of the !alue of theoriginal debt than if they waited until maturity.

Bonds with lower seniority are paid after bonds with higher seniority, so there is more of a risk associated with lower seniority bonds, thus, a higher return is required.

(C):- EURO BOND :- A international bond that is denominated in one or more currencies but that is traded in external markets outside the borders of the countries issuing the currencies.

•Need not comply with regulatory restrictions that apply to domestic issuers.

•Market remains relatively unregulated, untaxed and convenient.

FOREIGN BOND :- Are issued by non-residents in a country’s domestic capital market & are subject to domestic regulations rather than trading conventions of the borrower’s country.

Yankee bond :- A Yankee bond is a bond issued by a foreign entity, such as a bank or company, but is issued and traded in the United States and denominated in U.S. dollars.

Foreign bonds are issued by foreign companies in a local market denominated in the local currency. Eurobonds are international bonds in which there is no connection between the physical location of the market they are traded in and the location of the issuing entity, and they may be denominated in any currency.

(D) :- A restrictive covenant is a promise a company makes to not exceed certain financial ratios or not conduct certain activities, usually in return for a loan or bond issue.

EXAMPLE :- Let’s assume Company XYZ wants to borrow $10 million from Bank ABC. The loan agreement contains restrictive covenants that limit Company XYZ to $0.10 per share in dividends per year and prevent it from issuing additional debt without Bank ABC’s consent.

Restrictive covenants can exist in employment agreements and even merger or acquisition agreements, but they are most common in lending agreements and bond indentures. Covenants, in general, can be financial or operational in nature.

• how it affects :-

Lenders attach restrictive covenants to bond issues and loans as a way to force the borrower to operate in a financially prudent manner that most ensures it will repay the debt. Issuers, on the other hand, usually negotiate the most flexible covenants they can so they have the freedom to make decisions and take risks that might ultimately benefit the lenders and the shareholders. Thus, the more restrictive covenants a bond issue has, the lower the interest rate on those bonds tends to be.

Violating a restrictive covenant can trigger a technical default. This means that although the issuer is making interest and principal payments on time, it is not operating within the agreed-upon guidelines and is thus increasing the risk of nonpayment in the eyes of the lender or bondholders. Often borrowers have a certain amount of time to remedy (or "cure") the technical default (for example, the borrower must lower its debt-to-equity ratio within 30 days), but technical defaults often lower the borrower’s credit rating and stock price.