Financing J&J Airs Expansion Plans With a Bond Issue

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Secured bonds enable bondholders to demand collateral even when a company goes bankrupt. Such bonds are commonly collateralized by equipment or real estate. Since J&J Air is an airline company, this means that it possesses both equipment and property and, hence, its bonds have collateral (Chaney, Sraer, & Thesmar, 2012). The advantage of secured bonds is that they are more likely to be purchased. Besides, this means that J&J Airs bonds have a high rate of seniority. The fact that the bonds are secured and marked with high seniority rates lowers the bonds coupon rate. A sinking fund refers to money that is set aside to pay off the debt. The advantage of a sinking fund is that it protects creditors and attracts investments in the company. Simultaneously, such a fund means for the bondholders a possible loss of money. A call provision increases the coupon rate because it limits bondholders possibilities. When interest rates decline, a call provision enables a borrower to pat off a bond before maturity. But call provision decreases the issue price of the bonds. A deferred call accompanying the call provision provides bondholders with certainty and protection and, thus, lowers the coupon rate. Still, a deferred call prevents a company from returning the bond in advance. A make-whole call provision allows borrowers to repay the debt in advance. This call provision is preferred by investors and is rarely exercised by issuers. Positive covenants reduce the coupon rate by obliging a company to act in favor of its bondholders. J&J Air might consider keeping the audited financial statements. Negative covenants also reduce the coupon rate because they restrict a company from doing actions detrimental to the bondholders. For example, J&J Air could not sell its property and equipment. A conversion feature enhances the security of the bonds and reduces the coupon rate. However, in the case of bankruptcy, convertible bonds also mean risk for the bondholders. Finally, the problem with floating rate coupon is that it brings profit only when interest rates are increasing.

Reference

Chaney, T., Sraer, D., & Thesmar, D. (2012). The collateral channel: How real estate shocks affect corporate investment. American Economic Review, 102(6), 2381-2409.

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