Bond Features | Introduction to Corporate Finance | CPA Exam BAR | CMA Exam | Chp 7 p 2

To download the PowerPoints slides and practice quizzes for this video, visit: farhatlectures...
Instagram Account: / farhatlectures
Linkedin: / professorfarhat
Facebook: / accountinglectures
Twitter: / farhatlectures
Email: [e-mail]
#cpaexam #corporatefinance #accountingstudent
In this video, I discuss various bonds features and characteristics.
Securities issued by corporations may be classified roughly as equity securities and debt securities. At the crudest level, a debt represents something that must be repaid; it is the result of borrowing money. When corporations borrow, they generally promise to make regularly scheduled interest payments and to repay the original amount borrowed (that is, the principal). The person or firm making the loan is called the creditor or lender. The corporation borrowing the money is called the debtor or borrower
From a financial point of view, the main differences between debt and equity are the following:
Debt is not an ownership interest in the firm. Creditors generally do not have voting power.
The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible.
Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued.
S IT DEBT OR EQUITY?
Sometimes it is not clear if a particular security is debt or equity. For example, suppose a corporation issues a perpetual bond with interest payable solely from corporate income if and only if earned. Whether this is really a debt is hard to say and is primarily a legal and semantic issue. Courts and taxing authorities would have the final say.
Corporations are adept at creating exotic, hybrid securities that have many features of equity but are treated as debt. Obviously, the distinction between debt and equity is important for tax purposes. So, one reason that corporations try to create a debt security that is really equity is to obtain the tax benefits of debt and the bankruptcy benefits of equity.
As a general rule, equity represents an ownership interest, and it is a residual claim. This means that equity holders are paid after debt holders. As a result of this, the risks and benefits associated with owning debt and equity are different. To give just one example, note that the maximum reward for owning a debt security is ultimately fixed by the amount of the loan, whereas there is no upper limit to the potential reward from owning an equity interest.
LONG-TERM DEBT: THE BASICS
Ultimately, all long-term debt securities are promises made by the issuing firm to pay principal when due and to make timely interest payments on the unpaid balance. Beyond this, a number of features distinguish these securities from one another. We discuss some of these features next.
The maturity of a long-term debt instrument is the length of time the debt remains outstanding with some unpaid balance. Debt securities can be short-term (with maturities of one year or less) or long-term (with maturities of more than one year).1 Short-term debt is sometimes referred to as unfunded debt.
S IT DEBT OR EQUITY?
Sometimes it is not clear if a particular security is debt or equity. For example, suppose a corporation issues a perpetual bond with interest payable solely from corporate income if and only if earned. Whether this is really a debt is hard to say and is primarily a legal and semantic issue. Courts and taxing authorities would have the final say.
Corporations are adept at creating exotic, hybrid securities that have many features of equity but are treated as debt. Obviously, the distinction between debt and equity is important for tax purposes. So, one reason that corporations try to create a debt security that is really equity is to obtain the tax benefits of debt and the bankruptcy benefits of equity.
As a general rule, equity represents an ownership interest, and it is a residual claim. This means that equity holders are paid after debt holders. As a result of this, the risks and benefits associated with owning debt and equity are different. To give just one example, note that the maximum reward for owning a debt security is ultimately fixed by the amount of the loan, whereas there is no upper limit to the potential reward from owning an equity interest.
LONG-TERM DEBT: THE BASICS
Ultimately, all long-term debt securities are promises made by the issuing firm to pay principal when due and to make timely interest payments on the unpaid balance. Beyond this, a number of features distinguish these securities from one another.