Bond and Interest Rates
- Bond prices will fall if interest rates increase more than expected.
Short Term Cash Flow
- Bonds are long term debt
- Part of capital structure
o Debt and equity
Example: Abc has $100000 in the bank. Their sales in January were $100000. Sales are
growing by $100000 per month. Cost of sales is 70% of sales. Everything is on credit. Pay
suppliers in 30 days and receive cash from customers in 60 days.
- Company growing fast
- Profitable (30% profit margin)
- Insolvent in 3 to 4 months
Cash Jan Feb Mar
Begin 100 100 30
+ Collection 0 0 100
-Payments 0 (70) (190)
End 100 30 (10)
Sales 100 200 300
COGS (70%) 70 140 210
Income 30 60 90
Problem
- Credit Terms (Paying suppliers faster than customers paying you)
- Growing sales too fast
Other Bonds
- Why bonds vs. Bank loan?
o Allow the company to set unique terms based on their circumstances
- Bowie Bonds
o 10 year $50 million bonds
o Collaborated by music royalties
o Rated “Investment grade” at issue
Credit agency BBB
- Callable
o Company can repay bond early
- Strip Bonds
o Do not pay cash interest
Reinvested and compounded
- Real return
o Interest rate is adjusted for inflation
- High Yield
o Not investment grade (Below BBB)
o “Junk” bonds
- Sinking fund
o Issuer sets aside cash each year in a trust account. This is used to repay the face
value on maturity date
- Floating rate
o Variable interest rate that moves with prime rate
Interest = Prime + 0.5%
o Issuer don’t like this cash flow is not stable
- Convertible Bonds
o Convertible into common shares of issuer
o Popular with “growth” companies
