Chapter 24 The Many Different Kinds of Debt 619
bre44380_ch24_618-651.indd 619 10/09/15 09:29 PM
24-1 Long-Term Bonds
Bond Terms
To give you some feel for the bond contract (and for some of the language in which it is
couched), we have summarized in Table 24.1 the terms of a bond issue by J.C. Penney. The
bond was a plain vanilla issue; in other words, it was pretty well standard in every way. We
will look in turn at its principal features.
The J.C. Penney bond was issued in 1992 and is due to mature 30 years later in 2022. It
was issued in denominations of $1,000. So at maturity the company will repay the principal
amount of $1,000 to the holder of each bond.
The annual interest or coupon payment on the bond is 8.25% of $1,000, or $82.50. This
interest is payable semiannually, so every six months the bondholder receives interest of
82.50/2 = $41.25. Most U.S. bonds pay interest semiannually, but in many other countries it
is common to pay interest annually.^2
(^2) If a bond pays interest semiannually, investors usually calculate a semiannually compounded yield to maturity on the bond. In other
words, the yield is quoted as twice the six-month yield. When bonds pay interest annually, it is conventional to quote their yields to
maturity on an annually compounded basis. For more on this, see Section 3-1.
● ● ● ● ●
We should point out that many debts are not shown
on the company’s balance sheet. For example, companies
have occasionally disguised the debt by establishing special-
purpose entities (SPEs), which raise cash by a mixture of
equity and debt and then use that cash to help fund the par-
ent company. By making use of SPEs, Enron kept a large
amount of its debt off-balance-sheet, but that did not stop
the company from going bankrupt. Since the Enron scandal,
accountants have moved to tighten up the rules on disclosing
SPE debt.
Companies have other important long-term liabilities that we
do not discuss in this chapter. For instance, long-term leases
are very similar to debt. The user of the equipment agrees to
make a series of lease payments and, if it defaults, it may be
forced into bankruptcy. We discuss leases in Chapter 25.
Postretirement health benefits and pension promises can
also be huge liabilities. For example, in 2003 General Motors
had a pension deficit of $19 billion. To reduce this deficit,
GM made a large issue of bonds and invested the majority
of the proceeds in its pension fund. You could say that the
effect was to increase the company’s debt, but the economic
reality was that it substituted one long-term obligation (the
new debt) for another (its pension obligation). Management
of pension plans is outside the scope of this book, but finan-
cial managers spend a good deal of time worrying about the
pension “debt.”
◗ FIGURE 24.1 The principal species of corporate debt and the sections of this chapter in which
they are discussed.
Convertible
Bonds
(24-2)
Exotic
Bonds
(24-2)
Bank
Loans
(24-3)
Straight
Bonds
(24-1)
Commercial
Paper and
Medium-Term
Notes (24-4)
Long-Term
Debt
Shorter-Term
Debt