Question

What is the advantage of selling a bond to a group of investors as opposed to selling stock in the company when it comes to raising capital? What is the difference between a Bond Premium and a Bond Discount in terms of selling a bond to investors?

Answer 1

What is the advantage of selling a bond to a group of investors as opposed to selling stock in the company when it comes to raising capital?

The advantages are:

1] Bonds have lower required return and the interest payable is tax deductible. This means cost of capital of bonds is lower than cost of equity.

2] The issue costs are also lower for bonds.

3] It increases financial leverage and is thus able to magnify the return on equity from a given return on total assets.

4] Issuance of bonds are subject to lower statutory compliance when compared to issue of equity.

What is the difference between a Bond Premium and a Bond Discount in terms of selling a bond to investors?

When bonds are issued at a price above its face value, the bond is said to be issued at a premium. This happens when, at the time of issue, the market interest rate is lower than the coupon rate. The premium goes to reduce the interest expense.

When bonds are issued at a price below its face value, the bond is said to be issued at a discount. This happens when, at the time of issue, the market interest rate is higher than the coupon rate. The discount goes to increase the interest expense.