BWFF3013 GROUP A CORPORATE FINANCE

SECOND SEMESTER SESSION 2018/2019 (A182)

INDIVIDUAL ASSIGNMENT - REPORT

Submitted to:

DR. HANITA BINTI KADIR @ SHAHAR

Prepared by:

NAME MATRIC NUMBER

NOR AZLIANA BINTI AZHAR 255650

Submitted date:
(14 March 2019)

SCHOOL OF ECONOMICS, FINANCE AND BANKING

UUM COLLEGE OF BUSINESS
UNIVERSITI UTARA MALAYSIA
 ZIZAN INC.

REPORT

To : Ms. Caroline, CEO

From : Nor Azliana Binti Azhar, Assistant

Date : 5 March 2019

Subject : The Impact of Bond Feature on Bond’s Coupon Rate

Introduction

The purpose of the report is to examine about the impact of bond feature on bond’s coupon rate
as has been discussed in detail with Jason Bourne, a representative from Merrill Lynch (an
underwriter). The discussion is about the issuing of 20-year new bonds with a total amount of
USD 50 million. From the discussion, there are a few impacts and suggestions that should be
highlighted as it can be used to help to expand Zizan Inc. There are also advantages and
disadvantages of each of the bond’s feature included in this report.

1.0 Bond Features

1.0.1 Collateral
From the discussion, Jason Bourne stated that if the bond has any collateral as
security, the interest rate for that bond will be lower as the issuers have something
to be compensated if the investor (Zizan Inc.) fail to make any payment and it is
less risky to the issuer. However, if the bond did not have any collateral, the interest
rate that have to be paid is higher because they will have higher risk compared to
the bond that has collateral as security. He also stated that normally, the bond that
has collateral is being issued by a company that has not many assets to be
collateralised or the company has been established and the issuer thought that they
are able to pay back their debt. The bond that has collateral is being issued by the
weaker issuance while the other one is being issued by the stronger issuance.
1.0.2 Bond Seniority
The bond’s seniority is depend on how many securities that the bond has in their
capital structure. Both type of bond can claim on the asset of the defaulted issuer,
but the secured bond will be get paid first, in the case the event of bankruptcy is
happening because the secured bond is considered as senior. While, the unsecured
bond also called as “subordinated” or junior will be paid later because the ranking
of the seniority starts from the secured bond debt to unsecured bond debt.
1.0.3 Sinking Fund
A sinking fund is an account managed by the bond trustee for the purpose of
repaying the bonds. If there is sinking fund available, it can help Zizan Inc. to
revoke the bond. This is because if the company has some money that has been put
aside from the starting on the regular basis for the sinking fund, at the end of the
maturity year, the company is able to redeem the bond on time. However, the
investor could loss the interest if the company use the sinking fund to purchase bond
at par or discount value.
1.0.4 Call Provision with Specified Price and Date
A call provision allows Zizan Inc. to repurchase or “call” part of all the bond issue
at the stated price during a period of time or after a predetermined date. If the par
value is below the call price for bond’s stated value and the differences between the
two is called call premium. The amount of the call premium can become smaller
from time to time. The situation where the call premium is decline to zero as the
call date moves closer to the time of maturity is when the annual coupon payment
is same with the call premium.
1.0.5 Deferred Call Attach Together with The Call Provision
Deferred call that attached together with the call provision is usually not operative
during the first part of a bond’s life. If Zizan Inc. decided to issue the bond, the
bondholders did not have to worry in the bond’s at the early years.
1.0.6 Make-Whole Call Provision
Make-whole call provision is a new type of the call provision where the
bondholders receive the approximately when the bonds are worth if they are called.
This is because they will not have any lost that might occur when the bond is being
repurchased back.
 1.0.7 Positive and Negative Covenants
The positive covenants is a “thou shalt” type of covenant where it tell the company
what thing that they must take or a condition that the company must abide by.
While, the negative covenants is a “thou shalt not” type of covenant where it limits
or prohibits the action that the company might take.
1.0.8 Conversion Feature
For the conversion feature, the bond can be swapped for a fixed number of shares
of stock anytime before maturity at the holder’s option. This type of feature is more
suspectible to issuers’ stock-price fluctuations than other types of bonds.
1.0.9 Floating Rate Coupon
For the floating rate coupon, the coupon payment is adjustable because it is tied to
an interest rate index such as the Treasury bill interest rate. It also determines the
value of the floating-rate bond. The coupon rate has a floor and a ceiling, meaning
the coupon is subject to a minimum and a maximum.

2.0 Recommendation
The information that has been used in the calculation of the both bond are the yield to
maturity for both bonds are 7.5%, coupon rate is at 6.5%, while the corporate tax rate is
35%. From the calculations (in Appendix), the number of bond that should be issued by
Zizan Inc. in zero coupon bond is 176,180 units which is more than the number of bond
that should be issued by Zizan Inc. in coupon-bearing bond which is only 88,224 units.
The principal paid to the bondholder for zero coupon bond is also higher at USD3,
250,000 while the coupon-bearing bond is only at USD1, 625,000. Before issuing any
bonds, Zizan Inc. should make a few consideration regardless bond maturity, interest rate,
selling price and callable feature. This have to be done, so that Zizan Inc. will make a
better decision when choosing what type of bond should it issued. However, if Zizan Inc.
decided to issue the coupon-bearing bonds with make-whole call provision that have a
call rate of Treasury rate plus 0.4%, the call price of the bond is USD 377.42 with the
current Treasury rate of 4.8%. Thus, if the current Treasury rate is 8.2%, the call price of
the bond is USD 336.60 (calculation in Appendix). This both callable bond prices
happened when Zizan Inc. decided to call the bonds after seven years.
Conclusion

In conclusion, Zizan Inc. should choose to issue 20-year new bonds with a total amount of USD
50 million with zero-coupon bonds. This is because the ordinary call feature is better than a
make-whole call feature for Zizan Inc. Moreover, the number of bond that will be issued if
Zizan Inc. issue zero-coupon bonds is the highest compared to the another one. Besides, the
amount of principal that will be obtained by the bondholder is also the highest.

Appendix

F
Zero coupon bond value =
(1 + r)t
USD 1,000
=
(1 + 0.065)20
= USD 283.80

No. of bond should be issued by Zizan Inc.

USD 50,000,000
=
USD 283.80
= 176,180 units

1
[1 - ( )] M
(1 + i)n
Bond Price = C X +
i (1 + i)n
1
[1 - ( )] 1,000
(1 + 0.075)20
= 32.5 X +
0.075 (1 + 0.075)20
[1 - 0.2354 ] 1,000
= 32.5 X +
0.075 4.2479
= 32.5 X 10.1947 + 235.4104
= USD 566.74
No. of bond should be issued by Zizan Inc.
USD 50,000,000
=
USD 566.74
= 88,224 units
 Principal paid for zero coupon bond = Face Amount of the Bond X i
= 50,000,000 X 0.065
= USD3, 250,000
6
Principal paid for coupon-bearing bond = Face Amount of the Bond X i X of a year
12
6
= 50,000,000 X 0.065 X of a year
12
= USD1, 625,000

r -n X m
c 1 - (1 + ) c
P= XFX m +
m r r nXm
m (1 + m)

0.052 -7 X 2
0.065 1 - (1 + 2 ) 0.065
= X 1,000 X +
2 0.052 0.052 7 X 2
(1 +
2 2 )
0.3019 0.065
= 32.5 X +
0.026 1.4324
= USD 377.42

r -n X m
c 1 - (1 + m) c
P= XFX r +
m r nXm
m (1 + m)

0.086 -7 X 2
0.065 1 - (1 + 2 ) 0.065
= X 1,000 X +
2 0.086 0.086 7 X 2
(1 +
2 2 )
0.4453 0.065
= 32.5 X +
0.043 1.8029
= USD 336.60
References

Langager, Chad (2019, February 24). What is the difference between a

zero-coupon bond and a regular bond?. Retrieved from
https://www.investopedia.com/ask/answers/06/zerocouponregularbond.asp

Rogers, Karen (2017, November 21). What Key Factors Need to Be Considered When a
Company Wants to Issue Bonds to Finance Growth?. Retrieved from
https://smallbusiness.chron.com/key-factors-need-considered-company-wants-issue-
bonds-finance-growth-73602.html

Ross, Stephen A.; Westerfield, Randolph W.; Jaffe, Jeffrey; Lim, Joseph; Tan, Ruth; Wong,
Helen (2016). Corporate Finance.: McGraw-Hill Education.