Question

Define the Following terms.

What is Capital structure? Example of Debt/ Equity instruments What Is a bond? Bond Terminology/Features: Indenture Principal/Par value/face value Coupon Rate Coupon/ coupon payment Maturity (maturity date) Yield to maturity Discount and Premium bonds Collateral Sinking fund Call provision Call premlum Call protection Bond rating Types of bonds Secured bonds Mortgage bonds Debentures Putable bonds

Answer 1

1. Capital Structure(also expressed as a debt-to-equity or debt-to-capital ratio) refers to a company’s outstanding debt and equity which is used to fund its operations and expansions.

2. i)Debt Instrument: Debt instruments are typically agreements where a financial institution agrees to loan a borrower money in exchange for set payments of principal and interest over a set period of time. Basically, anything that obliges a borrower to make payments based on a contractual arrangement is a debt instrument. Examples : Bond, Debentures and Loans

    ii) Equity instruments: Unlike debt instruments, equity instruments cede ownership, and some control, of a business to investors who provide private capital to a business. Examples : Common stock, Convertible debenture, Preferred stock, Depository receipt, Transferable Subscription Rights (TSR)

3.What is a bond: A bond is a security that pays its holder a fixed sum on a regular schedule for a fixed term. Most simply, bonds represent debt obligations – and therefore are a form of borrowing. If a company issues a bond, the money they receive in return is a loan, and must be repaid over time. Bond investors are lenders; bond issuers are borrowers. When you purchase a bond, you effectively are lending a company or a government money. The company or government agrees to pay whoever holds the bond interest on a regular basis, and then to return the principal on the loan when the bond matures.

4. Indenture : It is a formal contract between a bond issuer and the bondholders. It states all the details of all the terms and conditions of the bonds, such as the exact day of their maturity, the timing of the interest payments and how they are calculated, and the details of any special features.

5.Principal/Par value/Face value : The par value/face value or principal of the bond is the amount that is returned to the investor when the bond matures. For Example if a bond is bought at issuance for $1,000, the investor bought the bond at its par value. At the maturity date, the investor will get back the $1,000.

6. Coupon Rate : This is the interest rate that the issuer is paying based on the face value of the bond. A coupon is set at the time the bond is issued and, for most bonds, stays the same until maturity. If the coupon rate is 5%, the issuer of the bonds promises to pay $50 in interest on each bond per year (5% x $1,000).

7. Coupon Payment : This is the actual dollar amount that is paid by the issuer to the bondholders at each coupon date. It is calculated by multiplying the coupon rate by the face value of the bond and then dividing by the number of payments per year. For example, a 10% coupon bond with semiannual payments and a $1,000 face value would pay $50 every six months.
8. Maturity(maturity Date): The date on which the bond ceases to earn interest. On this date, the last interest payment will be made, and the face value of the bond will be repaid. Generally, a bond that matures in one to three years is referred to as a short-term bond. Medium- or intermediate-term bonds are generally those that mature in four to 10 years, and long-term bonds are those with maturities greater than 10 years.

9.Yield to Maturity: This is used to determine the rate of return an investor would get if a bond (or any long term investment) is held until maturity, assuming all coupons and principal payments will be made and that the coupon payments are reinvested in the bond’s promised yield. When a bond first comes out, the bond’s yield is equal to its current yield or coupon rate. But if you purchase it at a later date, it might be at a premium (where you pay more) or at a discount (where you pay less). YTM is usually presented in terms of Annual Percentage Rate (APR). The yield of a bond is measured by the income it generates. Yield is calculated as the amount of interest paid on a bond divided by the price.

10. Discount and Premium Bonds : Bonds do not necessarily trade at their par values. They may trade above or below their par values. Any bond trading below $1,000 is said to be trading at a discount and a bond trading above $1000 is trading at premium.

11.Collateral : Normally Collateral are Securities or property pledged by a borrower to secure payment of a loan. If the borrower fails to repay the loan, the lender may take ownership of the collateral. Bonds that have specific assets pledged as collateral are secured bonds and Bonds that do not have specific collateral and instead rely on the corporation's general financial position are referred to as unsecured bonds or debentures.

12. Sinking Fund : A sinking fund bond is a bond that requires the issuer to set aside a specific amount of assets on certain dates to repay bondholders. In other words, it’s a bond that requires the issuing entity to create a sinking fund to be used as collateral in case the issuer can’t pay the bondholders in the future. Bonds with sinking funds are likely to be viewed as less risky.

13. Call Provision : Many bonds have a call provision, which means that the issuer of the bonds can call, or redeem, the bonds at a specified price before their scheduled maturity. Issuers exercise the call provision when market rates of interest fall well below the coupon rate of the bonds. Why? Because they can then issue new bonds at the lower rate of interest which costs them less in interest payments to bondholders.

14. Call Premium : A dollar amount, usually stated as a percentage of the principal amount called, paid as a “penalty” or a “premium” for the exercise of a call provision.

15. Call Protection : Bonds that are not callable for a certain number of years before their call date.

16. Bond Rating : Various rating services gives a grade to the bond which indicates bond's credit quality. Factors like bond issuer's financial strength or its ability to pay a bond's principal and interest in a timely fashion is taken into consideration while rating them.

17. Secured Bonds : As explained above in 11. collateral, Bonds that have specific assets pledged as collateral are known as Secured bonds.

18. Mortgage bonds : Mortgage bonds are type of Secured bonds wherein the collateral used is the property for which mortgage is taken. In case of default, the mortgaged properties may be sold to pay back bondholders.

19. Debentures : Again as explained above in 11. collateral, Bonds that do not have specific collateral and instead rely on the corporation's general financial position are referred to as unsecured bonds or debentures.

20. Putable Bonds : Bonds that give the holder the right to sell his or her bond to the issuer prior to the bond's maturity date are known as Putable bonds.