More On Bond Features

In this section, we continue our discussion of corporate debt by describing in some detail the basic terms and features that make up a typical long-term corporate bond. We discuss additional issues associated with long-term debt in subsequent sections.

Securities issued by corporations may be classified roughly as equity securities and debt securities. At the crudest level, a debt represents something that must be repaid; it is the result of borrowing money. When corporations borrow, they generally promise to make regularly scheduled interest payments and to repay the original amount borrowed (that is, the principal). The person or firm making the loan is called the creditor, or lender. The corporation borrowing the money is called the debtor, or borrower.

From a financial point of view, the main differences between debt and equity are the following:

1. Debt is not an ownership interest in the firm. Creditors generally do not have voting power.

Ross et al.: Fundamentals III. Valuation of Future 7. Interest Rates and Bond © The McGraw-Hill of Corporate Finance, Sixth Cash Flows Valuation Companies, 2002

Edition, Alternate Edition

212 PART THREE Valuation of Future Cash Flows

Information for bond 2. The corporation's payment of interest on debt is considered a cost of doing business investors can be found at . www.investinginbonds.com.

investors can be found at . www.investinginbonds.com.

and is fully tax deductible. Dividends paid to stockholders are not tax deductible. Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued.

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