VARIATIONS IN CORPORATE BONDS
Most corporate bonds are
similar to the 6 percent Treasury bonds that we examined earlier in the
material. In other words, they promise to make
a fixed nominal coupon payment for each year until maturity, at which
point they also promise to repay the face value. However, you will find that there is greater variety in the design
of corporate bonds. We will return to this issue, but here are a few types of
corporate bonds that you may encounter.
Zero-Coupon Bonds. Corporations sometimes
issue zero-coupon bonds. In this case, investors receive $1,000 face value at
the maturity date but do not receive a
regular coupon payment. In other words, the bond has a coupon rate of zero. You
learned how to value such bonds earlier. These
bonds are issued at prices considerably below face value, and the
investor s return comes from the difference between the purchase price and the
payment of face value at maturity.
Floating-Rate Bonds. Sometimes the coupon rate
can change over time. For example, floating-rate bonds make coupon payments
that are tied to some measure of
current market rates. The rate might be reset once a year to the current Treasury
bill rate plus 2 percent. So if the Treasury bill rate at the start of the year is 6 percent, the bond s coupon
rate over the next year would set at 8 percent. This arrangement means that the
bond s coupon rate always
approximates current market interest rates.
Convertible Bonds. If you buy a convertible
bond, you can choose later to exchange it for a specified number of shares of
common stock. For example, a
convertible bond that is issued at par value of $1,000 may be convertible into
50 shares of the firm s stock. Because convertible bonds offer the opportunity to participate in any price
appreciation of the company s stock, investors will accept lower interest rates
on convertible bonds.
Category: Cash flows
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