Memra

Corporate bonds, covenants and the feature table

◈ 6 cards

The trust deed, the trustee and the covenants — then every feature sorted by whose option it is and whether it raises or lowers the yield: callable, retractable, extendible, convertible, sinking fund, floating rate.

The contract behind the bond

A corporate bond is governed by a trust deed (indenture): the contract between the issuer and a trustee — a trust company acting for all the holders, who could not each enforce a $1,000 claim. The deed sets the coupon, the dates, the security if any, and the covenants: promises the issuer makes for the life of the bond. Negative covenants forbid — no further secured debt, no dividends if coverage falls below a ratio, no sale of the pledged assets. Positive covenants require — keep the plant insured, file audited statements, maintain working capital. Breach a covenant and the trustee can declare default even though every coupon has been paid.

Worked example — Tamarack Foods 6 % debenture

Read Tamarack Foods' 6 % debenture feature by feature, asking the only question that matters: whose option is it? A feature that lets the issuer do something is bad for the holder and raises the yield the market demands; a feature that lets the holder do something is good for the holder and lowers it.

  • Callable at 103 after year 5. The issuer may redeem early at a premium — and will, precisely when rates have fallen and the holder would rather keep the 6 %. Bad for the holder → higher yield. The premium and the call protection (five years) are the compensation.
  • Retractable at par at year 7. The holder may shorten the term — hand the bond back for par early, which is what they want when rates have risen. Good for the holder → lower yield.
  • Extendible. The holder may lengthen the term at the original coupon — valuable when rates have fallen. Good for the holder → lower yield.
  • Convertible into 40 common shares. The holder may exchange each $1,000 into equity; the conversion price is 1,000 ÷ 40 = $25. Good for the holder → lower yield, in exchange for the upside.
  • Sinking fund. The issuer must retire part of the issue each year, by purchase or by lot. Reduces the amount outstanding at maturity — a credit positive — but bonds called by lot are gone at par. Mostly neutral to slightly favourable.
  • A floating-rate cousin resets its coupon to a benchmark (CORRA plus a spread) each period: no interest-rate risk on the price, the holder's income floats instead.

The neighbour trap

The paper's distractors are the adjacent feature: callable (issuer shortens) beside retractable (holder shortens) beside extendible (holder lengthens). Two words share "shorten" and two share "holder" — the question is always which pair. Rank two otherwise-identical Tamarack issues: the one that is callable yields more than the plain one; the one that is retractable yields less. Add both, and they pull in opposite directions.

FeatureWhose optionEffect on yieldConfused withCallableissuer redeemsearlyraisesretractableRetractableholder shortenslowerscallableExtendibleholder lengthenslowersretractableConvertibleholder swaps toshareslowersexchangeableSinking fundissuer must retireyearlyabout neutrala holder putFloating rateneither — couponresetsprice stablevariable-ratepreferredTamarack 6 % debenture: callable at 103 after year 5; retractable year 7; convertible into 40 shares(conversion price $25).
Whose option decides the sign. Issuer options raise the yield the market demands; holder options lower it. The neighbour column is the exam’s distractor.
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