FMGT 2421 - ch 14

pg.50

vocab: long-term debt

Long-term debt consists of obligations that are not payable within a year or the operating cycle of the business, whichever is longer, and will require probable sacrifices of economic benefits in the future.

→ e.g. bonds,

vocab: restrictive convenants

The contracts may also include restrictive covenants (terms or conditions) that are meant to limit activities and protect both lenders and borrowers.

firm commitment underwriting

when the investment banker buys a bond issue , may underwrite the entire issue by guaranteeing takes all the risk of selling the the bond for whatever price the agent

best effort underwriting

the investment banker buys a bond issue, they do their best to sell the issue for a commission

vocab: registered bonds

Bonds that are issued in the owner’s name

vocab: bearer or coupon bond

is not recorded in the owner’s name and may therefore be transferred from one owner to another by simply delivering it to the new owner.

vobcab: secured debt

is backed by a pledge of some sort of collateral.

vocab: unsecured debt

not backed by collateral

vocab: mortgage bonds/notes

Mortgage bonds or notes are secured by a claim on real estat

vocab: collateral trust bonds or notes

are secured by shares and bonds of other corporations.

vocab: income bonds

pay no interest unless the issuing company is profitable.

deep discount bonds or notes

have very little or no interest each year and therefore are sold at a large discount that basically provides the buyer with a total interest payoff (at market rates) at maturity.

vocab: callable bonds and notes

Callable bonds and notes give the issuer the right to call and retire the debt before maturity

vocab: convertibale debt

Convertible debt allows the holder or the issuer to convert the debt into other securities such as common shares

vocab: legal defeasance

• set money aside in a trust and allow trust to repay the original debt

financing is obtained through

Financing is generally obtained through three sources:

• borrowing

• issuing equity (shares)

• using internally generated funds

A company plans to issue 10-year term bonds with a par value of $800,000, dated January 1, 2027, and bearing interest at an annual rate of 10% payable semi-annually on January 1 and July 1. The company decides to issue the bonds on January 1 at par.

Instructions

Record the journal entries for 2027.

vocab: stated rate

The interest rate that is written in the terms of the bond indenture

vocab: effective yield/market rate

The interest rate that is actually earned by the bondholders

discount and premium

• when the interest rate ↑, the bond price ↓, market rate is higher (discount)

• when the interest rate ↓, the bond price ↑, market rate is lower (premium)

effective interest method with a bond premium example

example: Company issues 10-year bonds with a par value of
$800,000 on Jan 1, 2027. Interest is at 10% payable semi-
annually on Jan 1 and Jul 1. Now assume the bonds are
issued on March 1 at 102.

example: Company issues 10-year bonds with a
par value of $800,000 on Jan 1, 2027. Interest is at 10%
payable annually on Dec 31. Bonds are issued at 97.S

example: To help finance the construction of a
building, the government provides $100,000 in cash, in
exchange for a $100,000 five-year, zero-interest-bearing
note at face value when the market rate is 10%.