Chapter 6 Case

Chapter 6 Case

1. The security of the bond: In order to classify the security of a bond (debt), we must identify collateral and mortgages that are used, or not used to protect the bondholder. If a bond has collateral, that means that the lender has some sort of asset, property mortgage or stock that they can claim if they are not sufficiently paid as stated in the indenture. An advantage to issuing secured/collateral bonds is that S&S can be aware of what they may need to give up in the future, as a form of payment if they can not make the payments stated on the indenture. A disadvantage to issuing secured bonds is that S&S must worry about the condition of whatever the collateral items may be. What I mean by this is that if they pledge a tangible asset as collateral, S&S must make sure that they retain that asset and keep it in adequate condition in case they need to liquidate it as a form of payment. A secured bond will have a lower coupon rate, and there is less risk of non-payment because there are certain things pledged as collateral. Thus, the price of the bond is usually higher than an unsecured bond because payment is more likely. An unsecured/no collateral bond is an advantageous option to S&S if they do not have assets, mortgages or stocks to pledge, or if most all of that is already tied up in other bonds. A disadvantage to issuing unsecured bonds is that if S&S defaults on their payments, then the lenders can claim whatever is left that has not been already pledged. An unsecured bond will typically have a higher coupon rate than a secured one. But risk of non payment is also higher than a secured bond. Thus, the price the lender pays for the bond Is lower than that of a secured bond because payment from the debtor is less likely.

2. Seniority: A senior (per the text) bond will be paid off before junior and subordinate bonds, in the event of a default or if there is not enough money to pay off all lenders. Bonds with more seniority will have typically lower coupon rates because there is less risk for them when it comes to default on payments by S&S.

3. The presence of a sinking fund: A sinking fund will likely reduce the coupon rate because it will reduce the risk of payment on the bond. The disadvantage to S&S is that they must make additional payments on top of the coupon rate, but this can also be an advantage if they don’t want to pay back the entire principal at the maturity date, but it could result in one large balloon payment at the end of maturity depending on the sinking fund arrangement.

4. A call provision with specified call dates and call prices: A call provision with a specified call date and a specified price will likely increase the coupon rate of the bond. This will be advantageous for S&S because they can set specified call dates for a time they may believe that interest rates will fall. They can set a call price accordingly to what they may think interest rates will rise to, and can then buy back these bonds and sell them for a possible higher price and lower interest rate. A disadvantage is that a bond with a specified call date or call price may cause disinterest lenders.

5. A deferred call accompanying the preceding call provision: If S&S sets a deferred call, it can be to a disadvantage if interest rates lower during the deferred call time. S&S is forced to make the above market interest payments at least