Corporate Debt Securities

Corporate capitalization
Earn money from business Issue stock
Ownership (equity) Limited liability

Corporate Debt Securities

Issue debt
Bonds, notes Holder of note or bond is creditor of issuer

2010 Kaplan, Inc.

Corporate Debt Securities

Debt FinancingBonds
Par value$1,000 Semi-annual interest payments

Corporate Debt Securities

Tracking Corporate Bonds
1 point = $10 Often quoted as a percentage of par 100 basis points = 1% Premium

$1000 PAR

ABC Company
6/1/2025

PAR VALUE
Par (face, principal)
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6%
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Discount
4

Corporate Debt Securities

Yields
Nominal yield = stated yield = coupon Current yield (CY)
Annual interest current market price

Corporate Debt Securities

Nominal Yield Current Yield (CY) Yield to Yield to Maturity Call (YTM)

Yield to maturity (YTM, effective yield)

Reflects gain at maturity of a discount bond Reflects loss at maturity of a premium bond
Par $1,000 6.00% 6.00% 6.00% 6.00%

Yield to Call
Reflects yield if bond is called on the call date
Highest yield for discount bonds Lowest yield for premium bonds
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Corporate Debt Securities

Nominal Yield B O N D P R I C E S Premium $1,200 Current Yield to Yield to Yield Maturity Call (CY) (YTM) I N T E R E S T R A T E S
7

Corporate Debt Securities

Nominal Yield B O N D P R I C E S Par $1,000 6.00% 7.50% Current Yield to Yield to Yield Maturity Call (CY) (YTM) I N T E R E S T R A T E S
8

Par $1,000

6.00% 5.00%

Discount $800

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2010 Kaplan, Inc.

Corporate Debt Securities

Nominal Current Yield to Yield to Yield Yield Maturity Call (CY) (YTM) B O N D P R I C E S Premium $1,200 I N T E R E S T R A T E S
9

Corporate Debt Securities

Price of long-term debt more volatile than short-term debt
9% maturity 20 years to maturity discount 8%

Par $1,000

Discount $800

Duration
The greater the duration, the greater the volatility
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2010 Kaplan, Inc.

Corporate Debt Securities

Ratings measure credit risk
Standard & Poor's Moody's
Interpretation

Corporate Debt Securities

Yield Spread between investment grade and speculative
Large difference during doubtful economic times Smaller difference during periods of investor confidence

Bank grade (investment grade) bonds

AAA AA A BBB Aaa Aa A Baa Highest rating. Capacity to repay principal and interest judged high. Very strong. Only slightly less secure than the highest rating. Judged to be slightly more susceptible to adverse economic conditions. Adequate capacity to repay principal and interest. Slightly speculative

Widens: Negative

Narrows: Positive

Speculative (noninvestment grade) bonds

BB B C D Ba B Caa D Speculative. Significant chance that issuer could miss an interest payment Issuer has missed one or more interest or principal payments No interest is being paid on this bond at this time Issuer is in default. Payment of interest and/or principal is in arrears

Yield

Yield

Maturity
11

Maturity
12

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2010 Kaplan, Inc.

 Secured Bonds

Characteristics of Corporate Debt

Characteristics of Corporate Debt

MORTGAGE BOND
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COLLATERAL TRUST BOND

EQUIPMENT TRUST CERTIFICATE

14

Characteristics of Corporate Debt

Unsecured Bonds
Debentures Subordinated debentures

Characteristics of Corporate Debt

Convertible Bonds
Par $1000

Convertible Bond
$40

25 shares of common stock

$1000 par $40 conversion price

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Characteristics of Corporate Debt

Parity
When two security positions are valued equally
Par $1000

Characteristics of Corporate Debt

Redemption
Principal and last interest payment returned upon maturity

Convertible Bond
$40

25 shares of common stock

$50 CMV of common stock
25 shares $50 per share

$1250
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$1,250
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Characteristics of Corporate Debt

Zero Coupon Bonds
Purchased at a discount
Generates phantom income (accreted)

Characteristics of Corporate Debt

Liquidation Priority

Duration = maturity

Taxation of Corporate Bonds

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Collateralized Mortgage Obligations (CMOs) Collateralized Mortgage Obligations (CMOs)

Collateralized mortgage obligations
Created by broker dealers or financial institutions
Buy, then package GNMA, Freddie Mac and Fannie Mae mortgages
Tranche

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Collateralized Mortgage Obligations (CMOs)

Pass through certificates
Pays a monthly check of principal and/or interest Subject to prepayment risk
If interest rates fall and people refinance

Collateralized Mortgage Obligations (CMOs)

Classes of CMOs
Principal-only CMO (PO)
The income comes from principal payments
Scheduled and prepayments

Interest-only (IO)
Sells at a discount Receives the interest Cash flow declines over time

Subject to extension risk

The chance that principal payments will be slower than anticipated
Interest rates rise and stay up for an extended period of time
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2010 Kaplan, Inc.

24

Collateralized Mortgage Obligations (CMOs)

Planned Amortization Class (PAC)
Targeted maturity dates Retired first Low prepayment and extension risk

Collateralized Mortgage Obligations (CMOs)

Zero-Tranche (Z-Tranche)
Receives no payment until all preceding tranches are retired Very volatile

Targeted Amortization Class (TAC)

Longer maturities Greater prepayment and extension risk Higher interest rate

CMO characteristics
Considered relatively safe in terms of default risk Taxed at all levels CMOs with complex characteristics may have a limited secondary market Customers required to sign a suitability statement before purchase 26

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25

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