Corporate Bonds  

Corporate Debt Financing
The Canadian bond market is the major source for raising capital for Canadian corporations interested in borrowing large sums of money for terms longer than one year. Funded debt — that is, debt represented by bonds or other securities which bear regular interest payments and is payable at a fixed future date, provides the company with an uninterrupted injection of capital, as opposed to bank loans which are generally of a more temporary nature.

The magnitude of the funds to be raised and the participants involved are also factors in determining how a company will finance. Typical bond market transactions, which are almost always negotiated deals as there is no trading floor for debt securities, are generally in units of $1 million or more, easily accommodating commonly placed issues totaling $50 million and up. It is because of the large amounts involved that the bond market is dominated by institutional purchasers such as banks, trust companies, mutual funds, pension funds, and insurance companies. In a buyer’s market, however, it is up to the issuing companies to make their securities more saleable, and this is done through various combinations of special features or “sweeteners”.

One such sweetener is the conversion feature, which allows the bondholder to exchange for some other type of security, usually common stock of the company issuing the convertible debt; this option is generally at a pre-stated price during a specified conversion period. Convertible instruments are attractive to the investor because they offer the stability of a fixed interest rate, plus an opportunity for profit should the price of the company’s shares increase. And, because of the conversion feature, a convertible security will usually sell at a higher price than a similar security carrying no conversion rights. The amount of this premium will depend upon a number of factors, including the difference between the current market price for the common stock and the conversion price, the length of time before the conversion right expires, and the economic outlook for the company.

Rising inflation rates of the late 1960s led to the advent of retractable and extendible debt securities, a response to the buyer’s demand for versatility with respect to maturity dates. Variable maturity bonds and debentures allow the holder to choose the time at which he will be repaid his capital investment, thus giving the investor an advantage when interest rates are changing. The option must be made at a specified time, either before a certain date, or between two specified dates.

A security may be issued with a relatively short term maturity date, with the holder given the option of having the maturity date extended. On the other hand, the maturity date may be long term at the time of issue, with the holder having the right to require pre-payment of the principal amount. In either case, the interest rate is the same, be it short or long term. However, some variable maturity securities provide for a change in interest rate dependent on maturity option.

Provisions for redemption and sinking fund are more prevalent characteristics of debt securities but of no less importance. Bond issuers frequently reserve these rights as a means of paying off their debt obligations prior to maturity.

The redemption feature permits the issuer to call the bonds for redemption upon the payment of a small premium over the par value. During a period of lower interest rates, this can be especially advantageous to the borrower. The set prices at which a bond is to be redeemed by the company are sometimes an important factor to be considered by the investor in determining whether that security should be purchased or held. Occasionally, the current market price would be such that if the security were redeemed, the holder would suffer a loss.

A sinking fund is a sum of money set aside in each year, usually out of current earnings, to provide for the retirement of all or part of a bond issue by maturity. The money periodically set aside is frequently invested conservatively, such as in government bonds, and the income from investment is added to the fund. In many cases, the bond issue itself specifies that a sinking fund is to be established to assure payment at maturity.

Although many of these special features were developed to attract and maintain investor confidence in the market place, and at the same time, make the purchase of one bond preferential over another, they are by no means the only criteria to be considered when making an investment decision. The market value of a bond is greatly influenced by the current level of interest rates and is therefore subject to the day-to-day fluctuation of the market place, which in turn, is the final determinant.

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