FIN30021 Fixed Income and Debt Markets Topic 7 Suggested Solutions Question 7.5 8. Answer the below questions. (a) What is the difference between refunding protection and call protection? Unlike call protection, refunding protection prevents redemption only from certain sources, namely the proceeds of other debt issues sold at a lower cost of money. The holder is protected only if interest rates decline and the borrower can obtain lower-cost money to pay off the debt. (b) Which protection provides the investor with greater protection that the bonds will be acquired by the issuer prior to the stated maturity date? Call protection is much more absolute than refunding protection. Although there may be certain exceptions to absolute or complete call protection in some cases (such as sinking funds and the redemption of debt under certain mandatory provisions), it still provides greater assurance against premature and unwanted redemption than does refunding protection. 9. Answer the below questions. (a) What is a bullet bond? Beginning in early 1986 a number of industrial companies issued long-term debt with extended call protection, not refunding protection. In Wall Street, these noncallable- for-life issues are referred to as bullet bonds. (b) Can a bullet bond be redeemed prior to the stated maturity date? Some bullet bonds are noncallable for the issue's life as the prospectus expressly Module 7 Solutions Page 1
FIN30021 Fixed Income and Debt Markets prohibits redemption prior to maturity. Other issues carry limited call protection and can be called after a period of time. Question 7.6 14. What is a payment-in-kind bond? In an LBO or a recapitalization, the heavy interest payment burden that the corporation assumes places severe cash flow constraints on the firm. To reduce this burden, firms involved in LBOs and recapitalizations have issued bonds with deferred coupon structures that permit the issuer to avoid using cash to make interest payments for a period of three to seven years. There are three types of deferred coupon structures: deferred-interest bonds, step-up bonds, and payment-in-kind bonds. Payment-in-kind (PIK) bonds give the issuer an option to pay cash at a coupon payment date or give the bondholder a similar bond (i.e., a bond with the same coupon rate and a par value equal to the amount of the coupon payment that would have been paid). The period during which the issuer can make this choice varies from 5 to 10 years. Question 7.7 16. Answer the below questions. (a) In what ways does an MTN differ from a corporate bond? There are four ways that MTN differ from a corporate bond. First, corporate bonds generally have a longer maturity than a medium term note (MTN). With shorter maturities and an upward sloping yield curve, MTNs tend to have lower coupon rates if everything else is equal. Second, medium-term notes differ from corporate bonds in the manner in which they are distributed to investors when they are initially sold. Although some investment-grade corporate bond issues are sold on a best-efforts basis, typically they are underwritten by