Chapter 5: Q8DQ (page 524)

Under what circumstances would a call on a bond be exercised by a corporation? What is the purpose of a deferred call? (LO16-3)

Short Answer

Expert verified

A corporation exercises a call on a bond in case of repayment before the maturity date.

On the other hand, a deferred call ensures that bondholders will not surrender their securities before 5 to 10 years.

Step by step solution

Call on a bond

A call on a bond is one of the features of repayment of bonds that facilitates the corporation to retire the bonds before their due date.

Purpose of a deferred call

The corporations exercise call on a bond when interest rates on new securities are lower than the previously issueddebt.

The primary purpose of a deferred call is to ensure that bondholders will not ask for the retirement of their dues for at least initial 5 or 10 years.

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Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	\(8,500,000

Under what circumstances would a call on a bond be exercised by a corporation? What is the purpose of a deferred call? (LO16-3)

Short Answer

Step by step solution

Call on a bond

Purpose of a deferred call

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