The key points for you to know are (1) the federal bankruptcy statutes govern both
reorganization and liquidation, (2) bankruptcies occur frequently, and (3) a priority
of the specified claims must be followed when distributing the assets of a liquidated
firm.
Differentiate between mortgage bonds and debentures.
Name the major rating agencies, and list some factors that affect bond
ratings.
Why are bond ratings important both to firms and to investors?
For what purposes have junk bonds typically been used?
Differentiate between a Chapter 7 liquidation and a Chapter 11 reorganization.
When would each be used?
List the priority of claims for the distribution of a liquidated firm’s assets.
Bond Markets
Corporate bonds are traded primarily in the over-the-counter market. Most bonds are
owned by and traded among the large financial institutions (for example, life insurance
companies, mutual funds, and pension funds, all of which deal in very large blocks of
securities), and it is relatively easy for the over-the-counter bond dealers to arrange
the transfer of large blocks of bonds among the relatively few holders of the bonds. It
would be much more difficult to conduct similar operations in the stock market, with
its literally millions of large and small stockholders, so a higher percentage of stock
trades occur on the exchanges.
Information on bond trades in the over-the-counter market is not published, but a
representative group of bonds is listed and traded on the bond division of the NYSE
and is reported on the bond market page of The Wall Street Journal. Bond data are also
available on the Internet, at sites such as http://www.bondsonline.Figure 4-6 reports
data for selected bonds of BellSouth Corporation. Note that BellSouth actually had
more than ten bond issues outstanding, but Figure 4-6 reports data for only ten bonds.
The bonds of BellSouth and other companies can have various denominations, but
for convenience we generally think of each bond as having a par value of $1,000—this is
how much per bond the company borrowed and how much it must someday repay.
However, since other denominations are possible, for trading and reporting purposes
bonds are quoted as percentages of par. Looking at the fifth bond listed in the data in
Figure 4-6, we see that the bond is of the series that pays a 7 percent coupon, or
0.07($1,000) $70.00 of interest per year. The BellSouth bonds, and most others, pay
interest semiannually, so all rates are nominal, not EAR rates. This bond matures and
must be repaid on October 1, 2025; it is not shown in the figure, but this bond was is-
sued in 1995, so it had a 30-year original maturity. The price shown in the last column is
expressed as a percentage of par, 106.00 percent, which translates to $1,060.00. This
bond has a yield to maturity of 6.501 percent. The bond is not callable, but several oth-
ers in Figure 4-6 are callable. Note that the eighth bond in Figure 4-6 has a yield to call
of only 3.523 percent compared with its yield to maturity of 7.270 percent, indicating
that investors expect BellSouth to call the bond prior to maturity.
Coupon rates are generally set at levels that reflect the “going rate of interest” on
the day a bond is issued. If the rates were set lower, investors simply would not buy the
bonds at the $1,000 par value, so the company could not borrow the money it needed.
Thus, bonds generally sell at their par values on the day they are issued, but their
prices fluctuate thereafter as interest rates change.
Bond Markets 179
Bonds and Their Valuation 175
