East Coast Yacht's Expansion Plans
Chapter 5: Financing East Coast Yacht’s Expansion Plans with a Bond
1. If the company benefits from the provision of the bond, then the coupon rate will be higher. If the bondholder’s benefit, then the bond will have lower coupon rate.
a. Bond’s with collateral will have lower coupon rate as bondholders have claim on collateral no matter what. It provides an asset which lowers default risk. Downside to company is that this collateral cannot be sold as an asset and needs to maintain it.
b. The more senior the bond, the lower the coupon rate.
c. A sinking fund reduces coupon rate because it provides a kind of future guarantee to bondholders. The company must make payments into the sinking fund or default so it must have …show more content…
Further assume this is the correct average spread for the company’s bond over the life of the bond. Although the spread is correct on average, it is not correct at every specific time. The spread over the Treasury rate varies over the life of the bond, and is higher when the bond has a longer time to maturity. To see this, consider, at the extreme, the spread for any bond above the Treasury yield at maturity is zero. So, if the bond is called early in its life, the spread above the Treasury is likely to be too low. This means the investor is more than made whole. If the bond is called late in its life, the spread is too high. This means the interest rate used to calculate the present value of the cash flows is too high, which results in a lower present value. Thus, the bondholder is made less than whole. In practical terms, this difference is likely to be small, and is will almost always result in a higher price paid to the bondholder when compared to a traditional call feature.
7. There is no definitive answer to which type of bond the company should issue. If the intermediate cash flows for the coupon payments will be difficult, a zero coupon bond is likely to be the best solution. However, the zero coupon bond will require a larger payment at maturity.
As for the type of call provision, a make whole call provision is generally better for bondholders, therefore the coupon rate of the bond will likely be lower to sell the bond at par