Since the early 1900s, bonds have been assigned quality ratings that reflect their probability of going into default. The three major rating agencies are Moody’s Investors Service (Moody’s), Standard & Poor’s Corporation (S&P), and Fitch Investors Service. Moody’s and S&P’s rating designations are shown in Table 4-1.14 The triple- and double-A bonds are extremely safe. [...]
Development Bonds Some companies may be in a position to benefit from the sale of either development bonds or pollution control bonds. State and local governments may set up both industrial development agencies and pollution control agencies. These agencies are allowed, under certain circumstances, to sell tax-exempt bonds, then to make the proceeds available to [...]
At times, Savannah Electric was unable to issue any new first mortgage bonds because of another indenture provision: its interest coverage ratio (pre-interest income divided by interest expense) was below 2.5, the minimum coverage that it must have in order to sell new bonds. Thus, although Savannah Electric passed the property test, it failed the [...]
Mortgage Bonds Under a mortgage bond, the corporation pledges certain assets as security for the bond. To illustrate, in 2002 Billingham Corporation needed $10 million to build a major regional distribution center. Bonds in the amount of $4 million, secured by a first mortgage on the property, were issued. (The remaining $6 million was financed [...]
Default risk is affected by both the financial strength of the issuer and the terms of the bond contract, especially whether collateral has been pledged to secure the bond. Several types of contract provisions are discussed below.
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Another important risk associated with bonds is default risk. If the issuer defaults, investors receive less than the promised return on the bond. Therefore, investors need to assess a bond’s default risk before making a purchase. Recall from Chapter 1 that the quoted interest rate includes a default risk premium—the greater the default risk, the [...]
As we saw in the preceding section, an increase in interest rates will hurt bondholders because it will lead to a decline in the value of a bond portfolio. But can a decrease in interest rates also hurt bondholders? The answer is yes, because if interest rates fall, a bondholder will probably suffer a reduction [...]
The values of the 1-year and 14-year bonds at several current market interest rates are summarized and plotted in Figure 4-3. Note how much more sensitive the price of the 14-year bond is to changes in interest rates. At a 10 percent interest rate, both the 14-year and the 1-year bonds are valued at $1,000. [...]
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