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Hi sir,
If there is a new issue of debt (either redeemable or irredeemable), we always assume tat it is being issued at par value right? unless otherwise stated in the question. so if the answer is yes, we will say tat market value is equal to par value, i.e. the price at which bond investor have to pay to purchase the bond today, am i right? so if this is the case, the expected return / yield to bond investors will be the same as the coupon rate of the bond right?
Hope to hear from you soon. thank you sir.
Hi sir, please tell me whether my perception regarding the above issue is right or not?
and one more question here, If any bond or debt which is issued at discount to its par value, such as treasury bill and commercial paper, does it mean that there will be no coupon bearing element for which interest is to be paid? In other words, the issuer of the bond doesn’t have to make regular interest payment BUT only liable to pay the definite capital sum at the end of the maturity of the bond.
Your reply is highly appreciated. Thank you, Sir.
Best regards,
Esther PangIn answer to your questions:
1 Yes – if not told otherwise you assume that the bond is being issued at par value. However the return to the investors will only be the coupon rate if it is being redeemed at par also. If it is being redeemed at a premium, then the return will be the IRR of the flows.
2 Interest is paid on the nominal value, whatever price the bond is issued at.
What does it mean that bond issued at premium? Is it good for the company? Why do the investors buy it?
When bond issued at discount, it it compulsory to sign underwriting agreement with the bank?
Thank you.Why does the company choose to issue bond at par, discount, or premium? Or even zero coupon rate, pls? Only depending on the style of the project cash flow?
Up to what stage the mgt choose to use debt finance rather than equity finance? When mgt feel that the company shares are under valued?
It would be unusual to issue bonds at a premium (because the investor would make a loss on repayment). If they did this then they would have to offer a higher than normal coupon rate to persuade investors to buy.
The logic of issuing bonds at a discount is that because investors will make a gain on repayments, they will accept a lower interest rate. This is attractive for growing companies – paying a lower interest rate, but then effectively paying a premium on repayment which they would hope to be able to afford if they have been growing. (The same effect applies if they issue at par but promise to repay at a premium).
Zero coupon bonds are the extreme version of this – pay no interest at all while the company is growing but then a huge premium on repayment.
It is never compulsory to enter into an underwriting agreement when bonds are issued.
Management can choose how to raise money at any time, but once they have decided to issue shares (or issue bonds) then they cannot suddenly decide to change once the issue is underway.
I still don’t understand below statements, kindly elaborate more for: 1) who will suffer if debt issued at a premium, and 2) why debt will not be fully taken up and issued at discount if credit spread set too low. It looks like bank should bear the discount loss since the firm pays the issue cost. And it looks like to sign underwriting agreement is compusory since the firm does not specialise in finance than the bank, but the firm should protect itself to ensure debt fully subscribed. Thank you.
“(a) Advise on the coupon rate that should be applied to the new debt issue to ensure that it is fully subscribed.
(4 marks)(a) The coupon rate on the new debt
The coupon rate should be the same as the yield for four-year debt at 6%. If the firm’s bankers have overestimated the credit risk and set the spread too high, then a coupon of 6% will result in the debt being issued at a premium in the market. If they have set it too low then the debt will not be fully taken up and the underwriters will have to issue it at a discount. The investment banks suggest that at a yield and hence a coupon of 6% that this would guarantee that the issue would be taken up by their institutional clients. On this basis the firm may wish to ask for an underwriting agreement to that effect although there would inevitably be a charge for this.”Besides, Kd = yield to maturity -> a weighted average of term structure of int rates (or Kd includes: Rf, credit spread, and term/period)
Previously, we learned that Kd = IRR, but IRR seems to be fixed. Does this confict with ‘yield curve’ theory, pls?The coupon rate offered on new debt needs to be attractive to investors so as to make sure they are prepared to lend the money, but we do not want to offer too high a rate for obvious reasons.
I can understand why the second paragraph you quote is confusing you.
What it means is this.
Suppose that you issue debt at par and offer an interest rate of 10%.
Provided the investors find the interest rate attractive then the company will receive the full amount they want and they will pay interest on it at 10%. However, if 10% is too high an interest rate, then although the company will still only receive $100 for each unit, when they get quoted on the stock exchange they will be quoted at a price higher than $100 – lets say $110 (i.e. quoted at a premium). However that does not mean that the company received more – it simply means that people who originally paid $100 for it to the company can now sell the units to other people at a higher price.
On the other hand, using the same example, if 10% is not a high enough rate to attract investors, then the company is unlikely to be able to sell all the debt and raise all the money they want. On each unit they do sell they will receive $100. When the debt is quoted on the stock exchange it will trade at a price lower than $100. Again, it does not mean that the company received less than $100 for each unit sold – it simply means that those people who did pay the company $100 are then only able to sell it to others at a lower price.
There is no requirement whatsoever for companies to use underwriters. However, because there is always the risk of not being able to sell all the debt, it is common to use underwriters. The promise to take up all the debt that is not subscribed for, but they obviously charge a fee. If the debt is not all taken up, then the underwrite will buy it (at full price) but will then lose money because it will be traded at a lower price on the stock exchange.
So…….whatever happens, the company will still receive $100 for each unit sold. It maybe that they do not sell all the debt (unless they use an underwriter) because they offered too low a rate of interest. It may be that they have ended up offering too high a rate of interest.
Kd is the investors required return – this will be affected by the yield curve and is likely to change over time. The market value of the debt (on the stock exchange) is determined by the investors required return – if the required return increases then the market value of the debt will fall. If the required return falls then the market value of the debt will increase. This applies both in theory and in practice.
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Here is the practical question on the issue of loan stock, can someone please help me solve the problem:
On 12 April 2005, Western Bhd advertised the issue of RM500,000 10% loan stock (repayable at the end of year 2015) at RM98 per cent payable as follows:
On application RM20 per cent
On allotment – payable on 12 June 2005 RM40 per cent
On 21 August 2005 RM38 per centApplications were to be made for RM100 ( nominal value) of the stock or a multiple thereof on or before 28 April 2005 and they were to be accompanied by cheque.
Applications were received for RM650,000 worth of stock and allotment were made on May 2005 at which date excess application money were returned to unsuccessful applicants. The other money were received on the due dates except for a call on RM300 worth of stock.
You are required to record the transactions given above in the ledger of Western Bhd.
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