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What are the advantages and disadvantages of a call provision from the viewpoints of both a firm and its bondholders? If you were the CEO of a firm, would you recommend a call provision for a new bond issue? Why or why not? Can you identify a recent bond issue that has a call provision fund?

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Patrina Schowalter
Patrina SchowalterLv2
13 Aug 2019

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You must read the case below (Financing Tuxedo Air’s Expansion Plans with a Bond Issue) carefully. Various assigned readings in this course lean toward value investing. Concepts related to financial statements and long-term financial planning (chapter 3) and valuation and future cash flows (chapter 7) will help you analyze the cases. Preparing the Case Analysis Step 1. Define the problem (15% of assignment grade) Be sure to identify the problem and not the symptom of a problem. For example, a decline in sales is a symptom of a problem; you must identify the actual cause of the decline in sales.

Step 2. Formulate alternative solutions to the problem (20% of assignment grade) It may be helpful to brainstorm as many solutions as you can and then narrow your list down to three or four solutions you feel are the strongest.

Step 3. Evaluate and compare the alternative solutions (35% of assignment grade) To evaluate alternative solutions you should consider their strengths (e.g., increased productivity) and their weaknesses (e.g., increased cost).

Step 4. Recommend and justify an effective solution (30% of assignment grade) Be sure to record the reasons why the chosen solution is most effective. In your analysis you must provide a recommendation that is supported by your analysis. Note: Your analysis may require that you identify more than one problem and develop a set of recommendations.

THE MINI CASE

Financing Tuxedo Air’s Expansion Plans with a Bond Issue

Mark Taylor and Jack Rodwell, the owners of Tuxedo Air, have decided to expand their operations. They instructed their newly hired financial analyst, Ed Cowan, to enlist an underwriter to help sell $35 million in new 10-year bonds to finance construction. Chris has entered into discussions with Suzanne Lenglen, an underwriter from the firm of Raines and Warren, about which bond features Tuxedo Air should consider and what coupon rate the issue will likely have. Although Ed is aware of the bond features, he is uncertain about the costs and benefits of some features, so he isn’t sure how each feature would affect the coupon rate of the bond issue. You are Suzanne’s assistant, and she has asked you to prepare a memo to Ed describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature:

1. The security of the bond—that is, whether the bond has collateral.

2. The seniority of the bond.

3. The presence of a sinking fund.

4. A call provision with specified call dates and call prices.

5. A deferred call accompanying the call provision.

6. A Canada plus call provision.

7. Any positive covenants. Also, discuss several possible positive covenants Tuxedo Air might consider.

8. Any negative covenants. Also, discuss several possible negative covenants Tuxedo Air might consider.

9. A conversion feature (note that Tuxedo Air is not a publicly traded company).

10. A floating-rate coupon.

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

True

False

The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

True

False

You have the following data on three stocks:

Stock Standard Deviation Beta
A 0.15 0.79
B 0.25 0.61
C 0.20 1.29

As a risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

A; B.
C; A.
B; C.
C; B.

Please discuss all questions and explain. Thank you!

How do optional call provisions in a securitization differ from that of a call provision in a standard corporate bond questions relate to auto loan-backed securities.

(a) What is the cash flow for an auto loan-backed security?

(b) Why are prepayments of minor importance for automobile loan-backed securities?

(c) How are prepayments on pools of auto loans measured?

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