Understanding Bond Prospectus

One of the basic tasks to be done before investing in any asset is to understand the contractual terms of the asset transfer. Be it land, gold, equity or bonds. In case of bonds, similar to equity shares, bond issuers file bond prospectus with the regulatory authorities stating the terms of agreement. When the bonds are offered to the public, bond issuers submit the offer documents comprising latest financial statements, offering memorandum or prospectus with the regulatory authorities which can be accessed by general public.

Investors may find two types of bond prospectus, which are typically issued in two stages: preliminary prospectus and final prospectus. Preliminary prospectus which is also called draft or red-herring does not contain the pricing details and size of the bonds offers. Once the road show is completed and a final price is set, a final prospectus is published with all the details. Since some of the terms in draft prospectus are printed in red, it is called as red-herring prospectus. The draft prospectus may go through several iterations based on the demands from the market before a final price is set.

Typically the bonds offered under REGS or 144A rule contain the following information: details of issuers and guarantors, terms of the bonds, risk factors, use of proceeds, pro forma capitalisation structure, corporate structure, description of existing debt, description of notes or bonds offered, details of the underwriters, arrangers, and trustees of the bond. It also gives the legal information such as the governing law of the agreement, validity of the securities, enforceability of the civil liabilities and general information on bond listing, clearing. The latest financial statements are also attached with the prospectus, also with the details of the industry dynamics and overview of issuers business and credit profile.

The main advantage of familiarizing with the terms of the bonds is it keeps investors informed of all the parties related to the bonds. The corporate structure laid out in the prospectus will give a clear view of the related parties and helps investors clearly understand the bearing of the liability (such as guarantee, collateral) on each of these parties. At times when market reacts to negative news about any issuer, a well-informed bond investor can assess the impact of the news on each of these parties. He/she has the opportunity to act on the information available rather than on false alarms about the issuer. For example, consider a coal mining company which has issued bonds against collateral of assets held in North America and certain assets held in China. Unless, investors know which assets in China are secured, he will react on any negative news regarding Chinese coal mining sector. Similarly, bond investors must also know the rights and protection available to them as per the agreement. In case of default, bankruptcy or other credit events, investor who is aware of the legal implications of the enforceability of their rights and protection gains competitive advantage over other investors.

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