Introduction
There are many features of a bond that any investor should evaluate and understand before investing in bonds.
These features offer various benefits in terms of yield, coupon rate, and issue date. Bonds have different limitations and that it’s why it’s essential to understand their features. In our case study, Mark Taylor and Jack Rodwell are the owners of Tuxedo Air. These shareholders wish to expand their operations and are seeking funds from the government. Taylor and Rodwell have specified that they want a 10-year bond but do not understand the features of this fund. As a financial analyst working under Suzanne, I am supposed to inform Ed Cowan about the different features of the 10-year bond. Based on the analysis, an appropriate recommendation will be offered on the critical feature that Tuxedo Air should consider.
The issue
A bond is a form of debt which the holder is supposed to pay annual coupon payments per value. Bonds are considered as fixed income securities whose return is based on the coupon rate. As indicated earlier, Tuxedo Air requires $35 million to expand its operations. The owners of this company do not have knowledge of the bond terms. Without appropriate knowledge, Tuxedo Air may invest in bonds that will deplete its cash flows. This may expose Tuxedo Air to credit risks where it’s unable to pay the principal amount (Wiley, 2013). Many factors should be considered when selling a bond, including a conversion feature, floating rate, the security of the bond, sinking fund, negative or positive covenants, and a Canada plus call provision.
A conversation feature: This may enable Tuxedo Air to enter into the public. This can apply well if the company is doing well financially. This feature gives a company a right to convert a specific investment into another one. For instance, Tuxedo Air may have a chance to switch the bonds into common stock. Additionally, the company may exchange a convertible bond to common stock without incurring any liability. There are situations where the bondholder can convert the variable rate mortgage into a fixed-rate coupon. The conversion feature is in line with the proposed investment of Tuxedo Air.
Positive or negative covenants that the company might consider:
A positive covenant may protect or limit Tuxedo Air from taking specific actions to take on the bond terms (Wiley, 2013). This would reduce the coupon rate that the company would pay on the bond. However, to qualify for this, the company must provide financial statements in good form. Additionally, Tuxedo Air should indicate the financial ratios in the last few years. The main limitation of the covenant is that it minimizes the agency cost imposed on the investors. Due to this, Tuxedo Air may not pledge the securities to other mortgage lenders.
A Canada plus call provision: Under this feature, the bond may compensate Mark Taylor and Jack Rodwell for interest differential (Wiley, 2013). The issuer of the bond may find it unattractive to call the bond. This may increase or lower the coupon rate because Tuxedo Air will have no control over calling the bond in a specific period they would want.
Floating rate coupon: A floating rate is determined by the interest rate or the federal funds rate. This is a bond that has a variable rate and resets periodically. These rates are guidelines financial institutions in making short and long term loans to corporations Wiley, 2013). The main benefit of the floating rate is that the federal fund rate determines interest rate risk.
Recommendations
Based on my evaluation, I would advise Ed Cowan to consider a conversion feature. Under this feature, the company might convert the bond into common stock. The chances of defaulting on the payment are minimized.