Interest Rates and Bond Valuation
Chapter 6 6.2 More on Bond Features
Securities issued by corporations are classified as equity securities and debt securities. A debt in very simple terms represents something that must be paid as a result of borrowing money, when corporations borrow money they make regular interest payments as well as paying the principal amount at the end of the period. There are three main differences between debt and equity, which are: Debt is not ownership; creditors don't have any say in the firm's decisions. Interest is taxable, but dividends are not tax deductible. Unpaid debt is a liability on the firm; if the firm goes bankrupt creditors can legally claim assets of the firm. Debt can result to financial failure, but this is not the case when equity is issued. Is it Debt or Equity? Sometimes it is unclear if what the firm is offering is a debt or equity security. The main purpose behind doing this is so that firms offer debts that are actually equity securities so that they can obtain tax benefits from debts and the bankruptcy benefits of equity. Debt holders are usually paid before equity holders. The rewards for owning a debt is fixed according to the loan's amount, but there is no limit to the available rewards that can be gained from owning equity, the higher the profit the bigger the interest amount. Long-term Debt: The Basics Even though there is no universally agreed –upon period of distinction for debt securities but they can be classified in two categories which are short term securities which last for one year or less they are also referred to as unfunded debt, long term securities duration must be over a year. Long-term debt securities are commonly referred to as bonds, whether they are secured or unsecured. They are also in forms of public issues are privately placed debt. The Indenture The indenture is a written agreement between the corporation and its creditors, it states the...
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