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Chapter 5: Q8DQ (page 524)

Under what circumstances would a call on a bond be exercised by a corporation? What is the purpose of a deferred call? (LO16-3)

Short Answer

Expert verified

A corporation exercises a call on a bond in case of repayment before the maturity date.

On the other hand, a deferred call ensures that bondholders will not surrender their securities before 5 to 10 years.

Step by step solution

01

Call on a bond

A call on a bond is one of the features of repayment of bonds that facilitates the corporation to retire the bonds before their due date.

02

Purpose of a deferred call

The corporations exercise call on a bond when interest rates on new securities are lower than the previously issueddebt.

The primary purpose of a deferred call is to ensure that bondholders will not ask for the retirement of their dues for at least initial 5 or 10 years.

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Most popular questions from this chapter

What was the primary purpose of the Securities Act of 1933?

What is the difference between a bond agreement and a bond indenture? (LO16-1)

In which foreign industry has privatization been most important?

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

c. Calculate the net present value.

Question: The trustee in the bankruptcy settlement for Titanic Boat Co. lists the following book values and liquidation values for the assets of the corporation. Liabilities and stockholders鈥� claims are also shown.

Assets

Book value

Liquidation value

Accounts receivables

\(1,400,000

\)1,200,000

Inventory

\(1,800,000

\)900,000

Machinery and equipment

\(1,100,000

\)600,000

Building and plant

\(4,200,000

\)2,500,000

Total assets

\(8,500,000

\)5,200,000

Liabilities and stockholder鈥檚 claims

Liabilities

Accounts payable

\(2,800,000

First lien, secured by machinery and equipment

\)900,000

Senior unsecured debt

\(2,200,000

Subordinated debenture

\)1,700,000

Total liabilities

\(7,600,000

Stockholder鈥檚 claims

Preferred stock

\)250,000

Common stock

\(650,000

Total stockholder鈥檚 claims

\)900,000

Total liabilities and stockholder鈥檚 claims

$8,500,000

e. List the remaining asset claims of unsatisfied secured debt holders and unsecured debt holders in a manner similar to that shown at the bottom portion of Table16A-3.
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