This chapter described some important aspects of long-term debt financing:
The written agreement describing the details of the long-term debt contract is called an indenture. Some of the main provisions are security, repayment, protective covenants, and call provisions.
There are many ways that shareholders can take advantage of bondholders. Protective covenants are designed to protect bondholders from management decisions that favor stockholders at bondholders' expense.
Unsecured bonds are called debentures or notes. They are general claims on the company's value. Most public industrial bonds are unsecured. In contrast, utility bonds are usually secured. Mortgage bonds are secured by tangible property, and collateral trust bonds are secured by financial securities such as stocks and bonds. If the company defaults on secured bonds, the trustee can repossess the assets. This makes secured bonds more valuable.
Long-term bonds usually provide for repayment of principal before maturity. This is accomplished by a sinking fund. With a sinking fund, the company retires a certain number of bonds each year. A sinking fund protects bondholders because it reduces the average maturity of the bond, and its payment signals the financial condition of the company.
Most publicly issued bonds are callable. A callable bond is less attractive to bondholders than a noncallable bond. A callable bond can be bought back by the company at a call price that is less than the true value of the bond. As a consequence, callable bonds are priced to obtain higher stated interest rates for bondholders than noncallable bonds.
Generally, companies should exercise the call provision whenever the bond's value is greater than the call price.
There is no single reason for call provisions. Some sensible reasons include taxes, greater flexibility, management's ability to predict interest rates, and the fact that callable bonds are less sensitive to interest rate changes.
There are many different types of bonds, including floating-rate bonds, deep-discount bonds, and income bonds. This chapter also compared private placement with public issuance.
