Question

Communication Activity CT10.6 Sam Masasi, president of Masasi Corporation, is considering the issuance of bonds to finance an expansion of his business. He has asked you to (1) discuss the advantages of bonds over common stock financing, (2) indicate the types of bonds he might issue, and (3) explain the issuing procedures used in bond transactions. Instructions Write a memo to the president, answering his request.

Answer 1

Hi, so to begin with, I shall answer the question in the similar point wise manner as it is asked.

1) Advantages of bonds over common stock - a) The first and foremost advantage of bonds over stock is that they do not dilute control of the organization. They are treated as a form of debt, which means that the future gains from use of such debt will flow straight to the stock holders and not bond holders. (b) Secondly, interest expense of bonds is tax deductible whereas dividends distributed to stock holders are not tax deductible.

2) Types of bonds - these can be classified based on various functions, such as duration (refers to how long the bond will take to mature) or on basis of risk or on the basis of interest to be paid. Duration can be (i) Short term (less than 3 years) (ii) Medium term (4-10 years) (iii) Long term (more than 10 years). Risk can be Rated bonds (rated by agencies such as Moody's/Fitch etc) and Junk Bonds (usually considered as 'not' investment grade and speculative in nature). Interest can be Fixed rate bonds (self explanatory), floating rate (interest rate changes based on prevailing interest rate of treasuries), zero coupon bonds (interest payments are withheld till maturity) and convertible bonds (giving the right to convert bonds to stock).

3) Issuing procedure in issue of bonds - First, the organization needs to approach a financial institution which provides it with advice and assisted by the financial institution. Secondly it needs to get its organization rated by rating agencies along with legal compliances such as preparation of contracts, etc. Third step will be to present it to the appropriate class of investors so as to gauge the price range and maturity of the bonds. Fourth step is to place the bond in the market for offer to the investors. The final step is then allocation process where on the basis of applications received, bonds are allocated to the investors.

Hope you are satisfied with the answer. If you require any further clarity on the same, do leave a comment. Also, please do leave a positive feedback. :)