The bond – great source of capital and investors’ favourite
Bonds issued by governments, corporations, etc are always in investment news.
Why? Because of their relationship to fluctuating market interest rates, credit and investment quality, ability to be bought and sold in a far larger quantities in global capital markets than equity markets.
What is a bond?
We’ll start with an example of a hypothetical growing company needing cash for expansion, but not willing to dilute ownership by issuing additional stock (that’s another topic for another day).
So picture this. You are walking through an old playground.
There is a giant see-saw, you know the ones that have been in playgrounds memorialised since your own childhood.
Sitting in the very pivot point of one of the see-saws is Ed Striver Smith, CEO, of Innovative Carpentry Products, a Nasdaq publicly listed manufacturing corporation.
Ed’s company manufactures wood products, specialising in outdoor furniture. Business has been good, so good, in fact that ICP is expanding into global markets, and needs to raise cash to increase its production. Ed Striver Smith is an astute CEO, manages a profitable fiscally conservative company, employs excellent staff and has a growing consumer base.
ICP has just received an very good credit rating from Moody’s, a credit rating service.
What this little nugget of information signifies to capital market analysts and investment managers, is that the repayment rate on the interest and principal on any security issue (bonds) purchased from this company is almost, but not quite, guaranteed to be repaid for as long as they remain a viable high credit rated stable company.
ICP decides to issue a $100 million bond issue paying a coupon rate of 6 per cent annually, in $1,000 increments, with a maturity date of 2028, but callable in year 2026. They anticipate receiving a good investment grade rating on the bond issuance, reflecting the credit quality rating.
ICP figures this will give them enough additional cashflow to increase market share abroad, plan a five-year operational strategy, and generate far more company revenue than the 6 per cent interest expense they will have to pay each year to every bond holder.
The life of a bond can be broken down into an overview of five basic stages, just in ordinary people’s terms.
Now the individuals and firms that will handle the bond debt product placement need to be selected.
ICP’s CEO and board of directors/company advisers will need to chose a bank – to lead the project – to set out the life of the bond in a chronological sequence that will serve as a guide to doing a bond issue.
Pre-launch: ICP enlists their bank to advise on preliminary matters, help decide what type of bond to issue and how it should be structured.
Credit rating agencies will again enter the picture to verify its rating.
Intensive documentation: lawyers specialising in securities issuances are also needed to construct the bond contract, a lengthy document that must address a myriad of conditional details before the bond can be considered for approval and issue.
Launch and roadshow: the lead manager announces the bond issue publicly and promotes the transaction to prospective investors, inviting them to buy the bonds once they are issued.
This is a significant marketing operation for ICP. They are expected to detail what the company stands for, how it operates, whether they are worth the risk to investors, in short, their entire financial statements will be under scrutiny. The presentations also provide an opportunity to gain interest from investors, whether the rate, pricing, and maturity is amenable and numerous other investment parameters.
And Ed, still sitting on the see-saw, is hoping that after substantial work, scrutiny, expense and more than a bit of stress is hoping that the issuance will be successful.
And, why should not it be? Its coupon rate is conservative compared to some bond offerings, but investors should be interested given the company’s track record and forward sales projections.
Ed has also been pleased to tell every investor – in the ICP roadshow – that no matter which way interest rates and capital markets move, up or down and down or up, he, personally, and his company will still pay your bond coupon interest at an annual return of 6 per cent to you, and when the maturity date is up in 2028, you will be paid back your principal.
Why is Ed still sitting on a the see-saw?
What is a coupon rate?
Who are these investors in a roadshow? Obviously, you haven’t been invited.
If ICP bond launches, how can you buy it, where, and who will hold it for you?
For those reading the column for the first time, and regular readers, hopefully, it should be obvious by now that we are in the pretend mode. Essentially, Ed Striver Smith, CEO, and his company are hypothetical, teaching aids, if you will.
Stay tuned for part two, next month.
Step-by-step guide to issuing a bond, BBVA, Pilar Martínez Fariña
• Martha Harris Myron is a native Bermudian with US connections and the finance journalist (22 years) to The Royal Gazette. Contact her at firstname.lastname@example.org
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