on 17-Mar-2016 (Thu)

The coupon rate or nominal rate of a bond is the interest rate that the issuer agrees to pay each year until the maturity date. The annual amount of interest payments made is called the coupon. A bond’s coupon is determined by multiplying its coupon rate by its par value. For example, a bond with a coupon rate of 6% and a par value of $1,000 will pay annual interest of $60 (6% × $1,000).

3.1.4. Cash Flow Statement

Although the income statement and balance sheet provide measures of a company’s success in terms of performance and financial position, cash flow is also vital to a company’s long-term success. Disclosing the sources and uses of cash helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial flexibility. Financial flexibility is the ability of the company to react and adapt to financial adversities and opportunities. The cash flow statement classifies all cash flows of the company into three categories: operating, investing, and financing. Cash flows from operating activities are those cash flows not classified as investing or financing and generally involve the cash effects of transactions that enter into the determination of net income and, hence, comprise the day-to-day operations of the company. Cash flows frominvesting activities are those cash flows from activities associated with the acquisition and disposal of long-term assets, such as property and equipment. Cash flows from financing activities are those cash flows from activities related to obtaining or repaying capital to be used in the business. IFRS permit more flexibility than US GAAP in classifying dividend and interest receipts and payments within these categories.

Exhibit 8 presents Volkswagen’s statement of cash flows for the fiscal years ended 31 December 2009 and 2008.

Exhibit 8. Cash Flow Statement of the Volkswagen Group: 1 January to 31 December

€ million	2009		2008
Cash and cash equivalents at beginning of period (excluding time deposit investments)	9,443		9,914
Profit before tax	1,261		6,608
Income taxes paid	–529		–2,075
Depreciation and amortization of property, plant and equipment, intangible assets and investment property	5,028		5,198
Amortization of capitalized development costs	1,586		1,392
Impairment losses on equity investments	16		32
Depreciation of leasing and rental assets	2,247		1,816
Gain/loss on disposal of noncurrent assets	–547		37
Share of profit or loss of equity-accounted investments	–298		–219
Other noncash expense/income	727		765
Change in inventories	4,155		–3,056
Change in receivables (excluding financial services)	465		–1,333
Change in liabilities (excluding financial liabilities)	260		815
Change in provisions	1,660		509
Change in leasing and rental assets	–2,571		–2,734
Change in financial services receivables	–719		–5,053
Cash

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Dollar-weighted and Time-weighted Rates of Return

The dollar-weighted rate of return is essentially the internal rate of return (IRR) on a portfolio. This approach considers the timing and amount of cash flows. It is affected by the timing of cash flows. If funds are added to a portfolio when the portfolio is performing well (poorly), the dollar-weighted rate of return will be inflated (depressed).

The time-weighted rate of return measures the compound growth rate of $1 initial investment over the measurement period. Time-weighted means that returns are averaged over time. This approach is not affected by the timing of cash flows; therefore, it is the preferred method of performance measurement.

Example

Jayson bought a share of IBM stock for $100 on December 31, 2000. On December 31, 2001, he bought another share for $150. On December 31, 2002, he sold both shares for $140 each. The stock paid a dividend of $10 per share at the end of each year.

To calculate the dollar-weighted rate of return, you need to determine the timing and amount of cash flows for each year, and then set the present value of net cash flows to be 0: - 100 - 140/(1 + r) + 300/(1 + r)² = 0. You can use the IRR function on a financial calculator to solve for r to get the dollar-weighted rate of return: r = 17%.

To calculate the time-weighted rate of return:

• Split the overall measurement period into equal sub-periods on the dates of cash flows. For the first year:
  • beginning price: $100
  • dividends: $10
  • ending price: $150
  For the second year:
  • beginning price: $300 (150 x 2)
  • dividends: $20 (10 x 2)
  • ending price: $280 (140 x 2)

• Calculate the holding period return (HPR) on the portfolio for each sub-period: HPR = (Dividends + Ending Price)/Beginning Price - 1. For the first year, HPR₁: (150 + 10)/100 - 1 = 0.60. For the second year, HPR₂: (280 + 20)/300 - 1 = 0.

• Calculate the time-weighted rate of return:
  • If the measurement period < 1 year, compound holding period returns to get an annualized rate of return for the year.
  • If the measurement period > 1 year, take the geometric mean of the annual returns.
    
    

    Learning Outcome Statements

    d. calculate and compare the money-weighted and time-weighted rates of return of a portfolio and evaluate the performance of portfolios based on these measures;

Money market instruments are low-risk, highly liquid debt instruments with a maturity of one year or less. There are two types of money market instruments: interest-bearing instruments (e.g., bank certificates of deposit), and pure discount instruments (e.g., U.S. Treasury bills).

Pure discount instruments such as T-bills are quoted differently than U.S. government bonds. They are quoted on abank discount basis rather than on a price basis:

• r_BD = the annualized yield on a bank discount basis
• D = the dollar discount, which is equal to the difference between the face value of the bill, F, and its purchase price, P
• t = the number of days remaining to maturity
• 360 = the bank convention of the number of days in a year.

Bank discount yield is not a meaningful measure of the return on investment because:

• It is based on the face value, not on the purchase price. Instead, return on investment should be measured based on cost of investment.
• It is annualized using a 360-day year, not a 365-day year.
• It annualizes with simple interest and ignores the effect of interest on interest (compound interest).

Holding period yield (HPY) is the return earned by an investor if the money market instrument is held until maturity:

• P₀ = the initial price of the instrument
• P₁ = the price received for the instrument at its maturity
• D₁ = the cash distribution paid by the instrument at its maturity (that is, interest).

Since a pure discount instrument (e.g., a T-bill) makes no interest payment, its HPY is (P₁ - P₀)/P₀.

Note that HPY is computed on the basis of purchase price, not face value. It is not an annualized yield.

The effective annual yield is the annualized HPY on the basis of a 365-day year. It incorporates the effect of compounding interest.

Money market yield (also known as CD equivalent yield) is the annualized HPY on the basis of a 360-day year using simple interest.

Example

An investor buys a $1,000 face-value T-bill due in 60 days at a price of $990.

• Bank discount yield: (1000 - 990)/1000 x 360/60 = 6%
• Holding period yield: (1000 - 990)/990 = 1.0101%
• Effective annual yield: (1 + 1.0101%)^365/60 - 1 = 6.3047%
• Money market yield: (360 x 6%)/(360 - 60 x 6%) = 6.0606%

If we know HPY, then:

• EAY = (1 + HPY)^365/t - 1
• r_MM = HPY x 360/t

If we know EAY, then:

• HPY = ( 1 + EAY)^t/365 - 1
• r_MM = [(1 + EAY)^t/365 - 1] x (360/t)

If we know r_MM, then:

• HPY = r_MM x (t/360)
• EAY = (1 + r_MM x t/360)^365/t - 1
  
  

  Learning Outcome Statements

  e. calculate and interpret the bank discount yield, ho

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Statistics can refer to numerical data (e.g., a company's average revenue for the past 20 years). It can also refer to methods of collecting, classifying, analyzing, and interpreting numerical data. Statistical methods provide a powerful set of tools for making decisions in business and other fields.

Statistics involves two different processes:

• Describing sets of data. Descriptive statistical methods can be used to describe the important aspects of data sets that have been collected. This reading will focus on the use of descriptive statistics to consolidate a mass of numerical data into useful information.
• Drawing conclusions (making estimates, judgments, predictions, etc.). Inferential statistical methods can be used to draw conclusions about a large group from a smaller group actually observed.

We use statistical methods to analyze the results of data. Since the amount of information available may be vast, it may be extremely time-consuming and expensive to collect all the necessary data. For instance, suppose we are interested in the durability of tennis balls. Theoretically, in order to carry out an accurate assessment, we would need to collect large quantities of all different makes of tennis balls from all over the world. Clearly, this is not practical; aside from taking up lots of time, it would be cost-prohibitive to purchase all the balls we would need for our study. A more practical solution would be to use a sample.

A population consists of an entire set of objects, observations, or scores that have something in common. It comprises every possible member of the specified group. In our example above, the population of tennis balls consists of every tennis ball that has ever been manufactured anywhere in the world. This is a huge number of tennis balls. Another example of a population would be all males between the ages of 15 and 18.

A sample is a subset of a population. The sample is comprised of some of the members of the population. Since it is usually impractical (or too expensive or time-consuming) to test every member of a population, using data gathered from a sample of the population is typically the best approach available for describing that population.

In our example above, a sample might be a selection of 1,000 tennis balls of various makes collected from different sources. It would be a virtually impossible task to collect every possible tennis ball in the world; this same size provides a manageable number to work with as well as a substantial amount of possible data.

Before we move on, there are several points worth noting:

• Don't be fooled by the word "population." This does not necessarily refer to people. As with the example above, we can have a population of tennis balls. A population can consist of anything, living or not.
• Although populations are often vast, they can also be of manageable size. For example, the population of even numbers between 1 and 9 would comprise the numbers 2, 4, 6 and 8. In this case, it is possible to sample the entire population and get accurate results. This is rare, however, and for your purposes, populations can generally be considered to be vast.
• In general, the bigger the sample, the better your results will be (because you are using data from more of the population for analysis). However, this point can present difficulties, as you will see when we study variance and standard deviation later.
• The ideal process would be to select a sample that is "representative" of the population (a sample that takes into account extreme values on both sides but contains many "average" values). In this way, the results that we get will be more meaningful. Because we frequently don't know about the exact values of a population (which is why we sample in the first place), we will never really know if our sample is truly representative or not. It's a

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The operating activities section of Volkswagen’s cash flow statement begins with profit before tax,6 €1,261 million, subtracts actual income tax payments, and then adjusts this amount for the effects of non-cash transactions, accruals and deferrals, and transactions of an investing and financing nature to arrive at the amount of cash generated from operating activities of €12,741 million. This approach to reporting cash flow from operating activities is termed the indirect method.

The direct method of reporting cash flows from operating activities discloses major classes of gross cash receipts and gross cash payments. Examples of such classes are cash received from customers and cash paid to suppliers and employees.

The indirect method emphasizes the different perspectives of the income statement and cash flow statement. On the income statement, income is reported when earned, not necessarily when cash is received, and expenses are reported when incurred, not necessarily when paid. The cash flow statement presents another aspect of performance: the ability of a company to generate cash flow from running its business. Ideally, for an established company, the analyst would like to see that the primary source of cash flow is from operating activities as opposed to investing or financing activities.

In Bonds, Collateral backing is a way to alleviate credit risk.

Secured bonds are backed by assets or financial guarantees pledged to ensure debt repayment in the case of default.

unsecured bonds are paid after secured bonds in the event of default.

By lowering credit risk, collateral backing increases the bond issue’s credit quality and decreases its yield.

A bond’s collateral backing might not specify an identifiable asset but instead may be described as the “general plant and infrastructure” of the issuer. In such cases, investors rely on seniority ranking—that is, the systematic way in which lenders are repaid in case of bankruptcy or liquidation. What matters to investors is where they rank compared with other creditors rather than whether there is an asset of sufficient quality and value in place to cover their claims. Senior debt is debt that has a priority claim over subordinated debt or junior debt. Financial institutions issue a large volume of both senior unsecured and subordinated bonds globally; it is not uncommon to see large as well as smaller banks issue such bonds. For example, in 2012, banks as diverse as Royal Bank of Scotland in the United Kingdom and Prime Bank in Bangladesh issued senior unsecured bonds to institutional investors.

seniority ranking—that is, the systematic way in which lenders are repaid in case of bankruptcy or liquidation.

Senior debt is debt that has a priority claim over subordinated debt or junior debt. Financial institutions issue a large volume of both senior unsecured and subordinated bonds globally; it is not uncommon to see large as well as smaller banks issue such bonds. For example, in 2012, banks as diverse as Royal Bank of Scotland in the United Kingdom and Prime Bank in Bangladesh issued senior unsecured bonds to institutional investors.

Debentures are a type of bond that can be secured or unsecured. In many jurisdictions, debentures are unsecured bonds, with no collateral backing assigned to the bondholders. In contrast, bonds known as “debentures” in the United Kingdom and in other Commonwealth countries, such as India, are usually backed by an asset or pool of assets assigned as collateral support for the bond obligations and segregated from the claims of other creditors. Thus, it is important for investors to review the indenture to determine whether a debenture is secured or unsecured. If the debenture is secured, debenture holders rank above unsecured creditors of the company; they have a specific asset or pool of assets that the trustee can call on to realize the debt in the event of default.

Credit enhancements refer to a variety of provisions that can be used to reduce the credit risk of a bond issue. Thus, they increase the issue’s credit quality and decrease the bond’s yield.

There are two primary types of credit enhancements: internal and external. Internal credit enhancement relies on structural features regarding the bond issue. External credit enhancement refers to financial guarantees received from a third party, often called a financial guarantor.

The most common forms of internal credit enhancement are subordination, overcollateralization, and reserve accounts.

Subordination , also known as credit tranching , is the most popular internal credit enhancement technique. It relies on creating more than one bond class or tranche and ordering the claim priorities for ownership or interest in an asset between the tranches. The cash flows generated by the assets are allocated with different priority to tranches of different seniority. The ordering of the claim priorities is called a senior/subordinated structure, where the tranches of highest seniority are called senior followed by subordinated or junior tranches.

In Subordination or credit tranching, if the issuer defaults, losses are allocated from the bottom up—that is, from the most junior to the most senior tranche. The most senior tranche is typically unaffected unless losses exceed the amount of the subordinated tranches, which is why the most senior tranche is usually rated Aaa/AAA.

The subordinated tranches function as credit protection for the more senior tranches, in the sense that the most senior tranche has the first claim on available cash flows. This type of protection is also commonly referred to as a waterfall structure because in the event of default, the proceeds from liquidating assets will first be used to repay the most senior creditors

Overcollateralization refers to the process of posting more collateral than is needed to obtain or secure financing. It represents a form of internal credit enhancement because the additional collateral can be used to absorb losses. For example, if at issuance the principal amount of a bond issue is $100 million and the value of the collateral is $110 million, the amount of overcollateralization is $10 million.

Over time, the amount of overcollateralization changes, for instance as a result of amortization, prepayments or defaults in the case of MBS. A major problem associated with overcollateralization is the valuation of the collateral. For example, one of the most significant contributors to the 2007–2009 credit crisis was a valuation problem with the residential housing assets backing MBS. Many properties were originally valued in excess of the worth of the issued securities. But as property prices fell and homeowners started to default on their mortgages, the credit quality of many MBS declined sharply. The result was a rapid rise in yields and panic among investors in these securities.

Reserve accounts or reserve funds are another form of internal credit enhancement, and come in two forms: a cash reserve fund and an excess spread account. A cash reserve fund is a deposit of cash that can be used to absorb losses. An excess spread account involves the allocation into an account of any amounts left over after paying out the interest to bondholders.

An excess spread account involves the allocation into an account of any amounts left over after paying out the interest to bondholders. The excess spread, sometimes called excess interest cash flow, is the difference between the cash flow received from the assets used to secure the bond issue and the interest paid to bondholders. The excess spread can be retained and deposited into a reserve account that serves as a first line of protection against losses. In a process called turboing, the excess spread can be used to retire the principal, with the most senior tranche having the first claim on these funds.

The principal amount , principal value , or simply principal of a bond is the amount that the issuer agrees to repay the bondholders on the maturity date. This amount is also referred to as the par value, or simply par, face value, nominal value, redemption value, or maturity value. Bonds can have any par value.

bond prices are quoted as a percentage of their par value. For example, assume that a bond’s par value is $1,000. A quote of 95 means that the bond price is $950 (95% × $1,000). When the bond is priced at 100% of par, the bond is said to be trading at par. If the bond’s price is below 100% of par, such as in the previous example, the bond is trading at a discount. Alternatively, if the bond’s price is above 100% of par, the bond is trading at a premium

The coupon rate or nominal rate of a bond is the interest rate that the issuer agrees to pay each year until the maturity date. The annual amount of interest payments made is called the coupon.

The common characteristic of all negative covenants is ensuring that the issuer will not take any actions that would significantly reduce its ability to make interest payments and repay the principal.

Bondholders, rarely wish to be too specific about how an issuer should run its business because doing so would imply a degree of control that bondholders legally want to avoid.

very restrictive covenants may not be in the bondholders’ best interest if they force the issuer to default when default is avoidable. For example, strict restrictions on debt may prevent the issuer from raising new funds that are necessary to meet its contractual obligations; strict restrictions on asset disposals may prohibit the issuer from selling assets or business units and obtaining the necessary liquidity to make interest payments or principal repayments; and strict restrictions on mergers and acquisitions may prevent the issuer from being taken over by a stronger company that would be able to honor the issuer’s contractual obligations.

A plain vanilla bond or conventional bond pays a fixed rate of interest

The coupon rate of a Floating Rate Note (FRN) includes two components: a reference rate plus a spread. The spread, also called margin, is typically constant and expressed in basis points (bps). The spread is set when the bond is issued based on the issuer’s creditworthiness at issuance: The higher the issuer’s credit quality, the lower the spread. The reference rate, however, resets periodically. Thus, as the reference rate changes, the coupon rate and coupon payment change accordingly

Currency option bonds can be viewed as a combination of a single-currency bond plus a foreign currency option

Currency option bonds give bondholders the right to choose the currency in which they want to receive interest payments and principal repayments. Bondholders can select one of two currencies for each payment.

The most commonly referenced yield measure is known as the yield to maturity , also called the yield to redemption or redemption yield . The yield to maturity is the internal rate of return on a bond’s expected cash flows—that is, the discount rate that equates the present value of the bond’s expected cash flows until maturity with the bond’s price.

There is an inverse relationship between the bond’s price and its yield to maturity, all else being equal. That is, the higher the bond’s yield to maturity, the lower its price. Alternatively, the higher the bond’s price, the lower its yield to maturity. Thus, investors anticipating a lower interest rate environment (in which investors demand a lower yield-to-maturity on the bond) hope to earn a positive return from price appreciation. The reading on understanding risk and return of fixed-income securities covers these fundamentals and more.

Periodic bond yields for both straight and zero-coupon bonds are conventionally computed based on semi-annual periods, as U.S. bonds typically make two coupon payments per year. For example, a zero-coupon bond with a maturity of five years will mature in 10 6-month periods. The periodic yield for that bond, r, is indicated by the equation Price = Maturity value x (1 + r)^-10. This yield is an internal rate of return with semi-annual compounding. How do we annualize it?

The convention is to double it and call the result the bond's yield to maturity. This method ignores the effect of compounding semi-annual YTM, and the YTM calculated in this way is called a bond-equivalent yield (BEY).

However, yields of a semi-annual-pay and an annual-pay bond cannot be compared directly without conversion. This conversion can be done in one of the two ways:

• Convert the bond-equivalent yield of a semi-annual-pay bond to an annual-pay bond.
  

• Convert the equivalent annual yield of an annual-pay bond to a bond-equivalent yield.
  

Example

• A Eurobond pays coupon annually. It has an annual-pay YTM of 8%.
• A U.S. corporate bond pays coupon semi-annually. It has a bond equivalent YTM of 7.8%.
• Which bond is more attractive, if all other factors are equal?

Solution 1

• Convert the U.S. corporate bond's bond equivalent yield to an annual-pay yield:
• Annual-pay yield = [1 + 0.078/2]² - 1 = 7.95% < 8%
• The Eurobond is more attractive since it offers a higher annual-pay yield.

Solution 2

• Convert the Eurobond's annual-pay yield to a bond equivalent yield (BEY):
• BEY = 2 x [(1 + 0.08)^0.5 - 1] = 7.85% > 7.8%
• The Eurobond is more attractive since it offers a higher bond equivalent yield.
  
  
  
  
  

  Learning Outcome Statements

  f. convert among holding period yields, money market yields, effective annual yields, and bond equivalent yields.

Periodic bond yields for both straight and zero-coupon bonds are conventionally computed based on semi-annual periods, as U.S. bonds typically make two coupon payments per year. For example, a zero-coupon bond with a maturity of five years will mature in 10 6-month periods. The periodic yield for that bond, r, is indicated by the equation Price = Maturity value x (1 + r)^-10. This yield is an internal rate of return with semi-annual compounding. How do we annualize it?

The convention is to double it and call the result the bond's yield to maturity. This method ignores the effect of compounding semi-annual YTM, and the YTM calculated in this way is called a bond-equivalent yield (BEY).

However, yields of a semi-annual-pay and an annual-pay bond cannot be compared directly without conversion. This conversion can be done in one of the two ways:

• Convert the bond-equivalent yield of a semi-annual-pay bond to an annual-pay bond.
  

• Convert the equivalent annual yield of an annual-pay bond to a bond-equivalent yield.
  

Example

• A Eurobond pays coupon annually. It has an annual-pay YTM of 8%.
• A U.S. corporate bond pays coupon semi-annually. It has a bond equivalent YTM of 7.8%.
• Which bond is more attractive, if all other factors are equal?

Solution 1

• Convert the U.S. corporate bond's bond equivalent yield to an annual-pay yield:
• Annual-pay yield = [1 + 0.078/2]² - 1 = 7.95% < 8%
• The Eurobond is more attractive since it offers a higher annual-pay yield.

Solution 2

• Convert the Eurobond's annual-pay yield to a bond equivalent yield (BEY):
• BEY = 2 x [(1 + 0.08)^0.5 - 1] = 7.85% > 7.8%
• The Eurobond is more attractive since it offers a higher bond equivalent yield.

Periodic bond yields for both straight and zero-coupon bonds are conventionally computed based on semi-annual periods, as U.S. bonds typically make two coupon payments per year. For example, a zero-coupon bond with a maturity of five years will mature in 10 6-month periods. The periodic yield for that bond, r, is indicated by the equation Price = Maturity value x (1 + r)^-10. This yield is an internal rate of return with semi-annual compounding. How do we annualize it?

The convention is to double it and call the result the bond's yield to maturity. This method ignores the effect of compounding semi-annual YTM, and the YTM calculated in this way is called a bond-equivalent yield (BEY).

However, yields of a semi-annual-pay and an annual-pay bond cannot be compared directly without conversion. This conversion can be done in one of the two ways:

• Convert the bond-equivalent yield of a semi-annual-pay bond to an annual-pay bond.
  

• Convert the equivalent annual yield of an annual-pay bond to a bond-equivalent yield.
  

Example

• A Eurobond pays coupon annually. It has an annual-pay YTM of 8%.
• A U.S. corporate bond pays coupon semi-annually. It has a bond equivalent YTM of 7.8%.
• Which bond is more attractive, if all other factors are equal?

Solution 1

• Convert the U.S. corporate bond's bond equivalent yield to an annual-pay yield:
• Annual-pay yield = [1 + 0.078/2]² - 1 = 7.95% < 8%
• The Eurobond is more attractive since it offers a higher annual-pay yield.

Solution 2

• Convert the Eurobond's annual-pay yield to a bond equivalent yield (BEY):
• BEY = 2 x [(1 + 0.08)^0.5 - 1] = 7.85% > 7.8%
• The Eurobond is more attractive since it offers a higher bond equivalent yield.

Periodic bond yields for both straight and zero-coupon bonds are conventionally computed based on semi-annual periods, as U.S. bonds typically make two coupon payments per year. For example, a zero-coupon bond with a maturity of five years will mature in 10 6-month periods. The periodic yield for that bond, r, is indicated by the equation Price = Maturity value x (1 + r)^-10. This yield is an internal rate of return with semi-annual compounding. How do we annualize it?

The convention is to double it and call the result the bond's yield to maturity. This method ignores the effect of compounding semi-annual YTM, and the YTM calculated in this way is called a bond-equivalent yield (BEY).

However, yields of a semi-annual-pay and an annual-pay bond cannot be compared directly without conversion. This conversion can be done in one of the two ways:

• Convert the bond-equivalent yield of a semi-annual-pay bond to an annual-pay bond.
  

• Convert the equivalent annual yield of an annual-pay bond to a bond-equivalent yield.
  

Example

• A Eurobond pays coupon annually. It has an annual-pay YTM of 8%.
• A U.S. corporate bond pays coupon semi-annually. It has a bond equivalent YTM of 7.8%.
• Which bond is more attractive, if all other factors are equal?

Solution 1

• Convert the U.S. corporate bond's bond equivalent yield to an annual-pay yield:
• Annual-pay yield = [1 + 0.078/2]² - 1 = 7.95% < 8%
• The Eurobond is more attractive since it offers a higher annual-pay yield.

Solution 2

• Convert the Eurobond's annual-pay yield to a bond equivalent yield (BEY):
• BEY = 2 x [(1 + 0.08)^0.5 - 1] = 7.85% > 7.8%
• The Eurobond is more attractive since it offers a higher bond equivalent yield.

Restrictions on debt regulate the issue of additional debt. Maximum acceptable debt usage ratios (sometimes called leverage ratios or gearing ratios) and minimum acceptable interest coverage ratios are frequently specified, permitting new debt to be issued only when justified by the issuer’s financial condition.

Negative pledges prevent the issuance of debt that would be senior to or rank in priority ahead of the existing bondholders’ debt.

Restrictions on prior claims protect unsecured bondholders by preventing the issuer from using assets that are not collateralized (called unencumbered assets) to become collateralized.

Restrictions on distributions to shareholders restrict dividends and other payments to shareholders such as share buy-backs (repurchases). The restriction typically operates by reference to the borrower’s profitability; that is, the covenant sets a base date, usually at or near the time of the issue, and permits dividends and share buy-backs only to the extent of a set percentage of earnings or cumulative earnings after that date.

Restrictions on asset disposals set a limit on the amount of assets that can be disposed by the issuer during the bond’s life. The limit on cumulative disposals is typically set as a percentage of a company’s gross assets. The usual intent is to protect bondholder claims by preventing a break-up of the company.

Restrictions on investments constrain risky investments by blocking speculative investments. The issuer is essentially forced to devote its capital to its going-concern business. A companion covenant may require the issuer to stay in its present line of business.

Restrictions on mergers and acquisitions prevent these actions unless the company is the surviving company or unless the acquirer delivers a supplemental indenture to the trustee expressly assuming the old bonds and terms of the old indenture. These requirements effectively prevent a company from avoiding its obligations to bondholders by selling out to another company.

IFRS require companies to present classified balance sheets that show current and non-current assets and current and non-current liabilities as separate classifications.However, IFRS do not prescribe a particular ordering or format, and the order in which companies present their balance sheet items is largely a function of tradition

under IFRS, a company can present a single statement of comprehensive income or as two statements, an income statement and a statement of comprehensive income that begins with profit or loss from the income statement.