CHAPTER 6
FINANCING S&S AIR’S EXPANSION
PLANS WITH A BOND ISSUE
A rule of thumb with bond provisions is to determine who benefits by the provision. If the company
benefits, the bond will have a higher coupon rate. If the bondholders benefit, the bond will have a
lower coupon rate.
2. The more senior the bond is, the lower the coupon rate. Senior bonds get full payment in bankruptcy
proceedings before subordinated bonds receive any payment. A potential problem may arise in that
the bond covenant may restrict the company from issuing any future bonds senior to the current bonds.
3. A sinking fund will reduce the coupon rate because it is a partial guarantee to bondholders. The
problem with a sinking fund is that the company must make the interim payments into a sinking fund
or face default. This means the company must be able to generate these cash flows.
6. A make-whole call provision should lower the coupon rate in comparison to a call provision with
specific dates since the make-whole call repays the bondholder the present value of the future cash
flows. However, a make-whole call provision should not affect the coupon rate in comparison to a
plain vanilla bond. Since the bondholders are made whole, they should be indifferent between a plain
7. A positive covenant would reduce the coupon rate. The presence of positive covenants protects
bondholders by forcing the company to undertake actions that benefit bondholders. Examples of
positive covenants would be: the company must maintain audited financial statements; the company
must maintain a minimum specified level of working capital or a minimum specified current ratio; the
company must maintain any collateral in good working order. The negative side of positive covenants
is that the company is restricted in its actions. The positive covenant may force the company into
actions in the future that it would rather not undertake.
9. Even though the company is not public, a conversion feature would likely lower the coupon rate. The
conversion feature would permit bondholders to benefit if the company does well and also goes public.
The downside is that the company may be selling equity at a discounted price.