Introduction To Bonds Notes

Corporate Finance: SGS 9: Introduction to Bonds

INDEX OF ABBREVIATIONS

- RIE – Recognised Investment Exchange

- IPO – Initial Public Offering

- PR – Prospectus Rules

- LR – Listing Rules

- DTR – Disclosure Guidance and Transparency Rules

- LP – Listing Principles

- PLP – Premium Listing Principles

- FSMA 2000 – Financial Services and Markets Act 2000

- RAO – Financial Services and Markets Act 2000 Regulated Activities Order 2001

- FPO – Financial Services and Markets Act 2000 Financial Promotions Order 2005

- MAR – Market Abuse Regulations

- CJA – Criminal Justice Act 2002

- FSA – Financial Services Act 2012

- UK CGC – UK Corporate Governance Code

- RCF – Revolving Credit Facility

- LSE – London Stock Exchange

- AIM – Alternative Investment Market

- FCA – Financial Conduct Authority

- MAC - Material Adverse Change

- EoD – Event of Default

NATURE AND CHARACTERISTICS OF BONDS

- Capital Markets – Markets on which capital is raised + where borrower seeking capital is matched with lender willing/able to provide such capital.

- Debt Capital Markets – Markets on which BONDS are bought/sold – increasingly popular source of capital post 2008 financial crisis + due to unpredictability/instability of stock markets.

- Bonds – Form of debt security issued in connection with borrowing arrangement whereby loan advanced for specific term + is repayable on maturity date.

- Borrower (issuer) sells bond certificate to 1/more lenders (investors/bondholders) for specified amount of cash.

- Bond Certificate – States that loan made to issuer for PAR VALUE/PRINCIPAL AMOUNT stated on bond certificate.

- Issuer pays interest (COUPON) over life of bond + when bond matures, issuer must repay par value/principal amount to holder of bond at maturity date.

- Form of Debt – Bond is a form of debt + appears on issuer’s balance sheet as a current liability (maturity date within 1 year) or non-current liability (maturity date over 1 year from date of balance sheet) – do NOT give investor voting/other equity related rights at meetings of issuer’s shareholders.

- ‘Principal Amount’ – Also known as ‘par value,’ ‘nominal value,’ ‘face value’ and ‘redemption value’ – amount stated on bond certificate as the amount repayable under the bond on the maturity date.

- Maturity Date – ‘Final Redemption Date’ – Date on which term of bond lapses + issuer must pay back principal amount borrowed to holder of bond certificate on that date (subject to early redemption at instance of issuer/investor where permitted by terms of the bond).

- Perpetual/Undated Bond – Bond with no maturity/redemption date – investor can only recover principal amount by selling bond to another investor OR if issuer unilaterally elects to redeem the bond.

- Interest/Coupon – Interest paid by issuer to investor in relation to specified interest periods during lifetime of bond – interest expressed as a percentage of the principal amount of the bond – 4 interest rate options possible:

(1) Fixed Rate Bonds – ‘Plain Vanilla Bonds’ – rate of interest fixed at specific percentage of principal amount which CANNOT be changed during term of bond.

(2) Floating Rate Bonds – Interest rate set as aggregate of chosen base rate (e.g. LIBOR) + additional small percentage (investor’s margin) so that rate of interest fluctuates according to changes in chosen base rate whilst preserving investor’s margin.

(3) Variable Rate Bonds – Rates of interest fixed at outset BUT vary in accordance with pre-determined schedule throughout the term of the bond (e.g. 5% for first 2 years, 4% for next 3 years and 3% thereafter until maturity date).

(4) Zero-Coupon Bonds – Bonds sold without agreement for issuer to pay interest on principal amount to investor – bond sold (i.e. amount issuer receives) at a substantial discount to principal amount BUT issuer required to pay full principal amount on maturity date so that investor’s return derived solely from difference between discounted price paid for the bond and the full principal amount received on maturity/redemption date.

- Marketability – How easily/readily bonds may be traded on debt capital markets – if bonds are highly marketable they are low-risk investments as investor knows they can readily/easily realise their investment by selling bond on market, leading to increased demand for bonds and lower interest rates – opposite effect for less marketable bonds (i.e. greater risk due to inability to readily realise investment meaning that investor will demand higher rates of interest in order to purchase bonds).

- Security – Majority of bonds are NOT secured + investors rely on pari passu ranking in order of payment on insolvency + negative pledge clauses for protection against claims of issuer’s other creditors.

- Payments Free of Withholding Tax – Issuer will normally undertake to make all interest payments free of tax.

- Where issuer required by law to withhold tax on interest payment to investor (i.e. pay interest NET of tax), terms of bond will usually require the issuer to GROSS UP interest payment so that investor does not receive less interest than initially agrees as a result of tax deductions.

- Issuers will generally refuse to issue bonds subject to tax laws which require withholding of tax + will demand terms of bond allow for redemption of bond if applicable tax laws change to require withholding of tax due to onerous obligation grossing up places on issuer.

- Quoted Eurobond Exception – Interest can be paid GROSS of tax by UK issuers on quoted Eurobonds (bonds listed on recognised investment exchange).

- Issuers – Borrowers – companies/governments/banks/supranational organisations/public authorities.

- Investors – Lenders – Bonds usually sold on primary debt capital markets to banks underwriting bond issue + then sold on to banks/financial institutions/high-net-worth individuals on secondary market – investors either retain bonds until maturity OR sell bonds on debt capital markets to realise investment prior to maturity date.

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