Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionIII. Valuation of Future
Cash Flows- Interest Rates and Bond
Valuation
© The McGraw−Hill^243
Companies, 2002There are many other dimensions to long-term debt, including such things as secu-
rity, call features, sinking funds, ratings, and protective covenants. The following table
illustrates these features for a bond issued by May Department Stores. If some of these
terms are unfamiliar, have no fear. We will discuss them all presently.
Many of these features will be detailed in the bond indenture, so we discuss this first.
The Indenture
The indentureis the written agreement between the corporation (the borrower) and its
creditors. It is sometimes referred to as the deed of trust.^3 Usually, a trustee (a bank, per-
haps) is appointed by the corporation to represent the bondholders. The trust company
must (1) make sure the terms of the indenture are obeyed, (2) manage the sinking fund
(described in the following pages), and (3) represent the bondholders in default, that is,
if the company defaults on its payments to them.
The bond indenture is a legal document. It can run several hundred pages and gener-
ally makes for very tedious reading. It is an important document, however, because it
generally includes the following provisions:
- The basic terms of the bonds
- The total amount of bonds issued
- A description of property used as security
- The repayment arrangements
- The call provisions
- Details of the protective covenants
We discuss these features next.
Features of a May Department Stores Bond
Term Explanation
Amount of issue $200 million The company issued $200 million worth of bonds.
Date of issue 8/4/94 The bonds were sold on 8/4/94.
Maturity 8/1/24 The principal will be paid 30 years after the
issue date.
Face value $1,000 The denomination of the bonds is $1,000.
Annual coupon 8.375 Each bondholder will receive $83.75 per
bond per year (8.375% of face value).
Offer price 100 The offer price will be 100% of the $1,000
face value per bond.
Coupon payment 2/1, 8/1 Coupons of $83.75/2 $41.875 will be paid
dates on these dates.
Security None The bonds are debentures.
Sinking fund Annual, The firm will make annual payments towards
beginning 8/1/05 the sinking fund.
Call provision Not callable The bonds have a deferred call feature.
before 8/1/04
Call price 104.188 initially, After 8/1/04, the company can buy back the
declining to 100 bonds for $1,041.88 per bond, with this
price declining to $1,000 on 8/1/14
Rating Moody’s A2 This is one of Moody’s higher ratings. The
bonds have a low probability of default.CHAPTER 7 Interest Rates and Bond Valuation 213Information on individual
bonds can be found at
http://www.bondsonline.com
and
http://www.bondresources.com.(^3) The words loan agreementor loan contractare usually used for privately placed debt and term loans.
indenture
The written agreement
between the corporation
and the lender detailing
the terms of the debt
issue.