This case raises many interesting questions concerning the record setting issuance of corporate debt by WorldCom, Inc. (“WorldCom”). Both the surprisingly voluminous structure of the proposed issuance and the foreboding macro-economic climate in which it was slated spark concerns over the risk and cost of the move. One of the first questions that must be addressed is whether WorldCom’s timing was appropriate. Next, the company’s choice of structure for the bond issuance must be analyzed. Finally, the cost of issuing each tranche of debt must be estimated in order to determine how much WorldCom is actually giving up to achieve the $6 billion in funds.
Timing of the Bond …show more content…
WorldCom could also choose to increase its bank loan use. However, use of a direct bank loan has associated with it several drawbacks for an issuer. First, WorldCom (or any corporate issuer) is often required to post collateral. Second, banks often require restrictive covenants which can be either positive or negative; for example, requiring a company to maintain a certain rate-setting procedure (positive), or preventing a company from engaging in a leveraged buyout transaction (negative).
Estimated Cost of the Issuance
From the covenants contained we can see that there are no embedded options in WorldCom’s proposed bonds. Thus, we can use the conventional 3-step approach to price the bonds. The first step is to estimate the cash flow that WorldCom could expect to receive over the life of the bonds. If the coupon rate is equivalent to the yield required by the market, then the bond will sell at par value. Thus, we set the coupon rate equivalent to the yield required by the market because we believe the bonds would sell at par. The next step is to determine the appropriate interest rate. Investors will require a yield premium over the U.S. Treasury security (Exhibit 1). This yield premium reflects the additional risks that investors will accept.