Long Term Debt The Basics

Ultimately, all long-term debt securities are promises made by the issuing firm to pay principal when due and to make timely interest payments on the unpaid balance. Beyond this, there are a number of features that distinguish these securities from one another. We discuss some of these features next.

The maturity of a long-term debt instrument is the length of time the debt remains outstanding with some unpaid balance. Debt securities can be short-term (with maturities of one year or less) or long-term (with maturities of more than one year).1 Short-term debt is sometimes referred to as unfunded debt.2

Debt securities are typically called notes, debentures, or bonds. Strictly speaking, a bond is a secured debt. However, in common usage, the word bond refers to all kinds of secured and unsecured debt. We will therefore continue to use the term generically to refer to long-term debt.

The two major forms of long-term debt are public issue and privately placed. We concentrate on public-issue bonds. Most of what we say about them holds true for private-issue, long-term debt as well. The main difference between public-issue and privately placed debt is that the latter is directly placed with a lender and not offered to the public. Because this is a private transaction, the specific terms are up to the parties involved.

'There is no universally agreed-upon distinction between short-term and long-term debt. In addition, people often refer to intermediate-term debt, which has a maturity of more than 1 year and less than 3 to 5, or even 10, years.

2The word funding is part of the jargon of finance. It generally refers to the long term. Thus, a firm planning to "fund" its debt requirements may be replacing short-term debt with long-term debt.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

III. Valuation of Future Cash Flows

7. Interest Rates and Bond Valuation

© The McGraw-Hill Companies, 2002

CHAPTER 7 Interest Rates and Bond Valuation

There are many other dimensions to long-term debt, including such things as security, call features, sinking funds, ratings, and protective covenants. The following table illustrates these features for a bond issued by May Department Stores. If some of these terms are unfamiliar, have no fear. We will discuss them all presently.

Features of a May Department Stores Bond

Term

Explanation

Amount of issue

$200 million

The company issued $200 million worth of bonds.

Date of issue

8/4/94

The bonds were sold on 8/4/94.

Maturity

8/1/24

The principal will be paid 30 years after the issue date.

Face value

$1,000

The denomination of the bonds is $1,000.

Annual coupon

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