Corporate Bonds
By: Mrs. Belen Apostol
Corporate Bonds
• Bonds – long term debt of a firm or the government
set forth in writing and made under seal.
- it does not represent equity capital, but
they are long-term liabilities of the company.
- a long-term contract under which a borrower
agrees to make payments of interest and principal
on specific dates, to the holder of the bond.
- unlike long-term loans, it is generally
advertised, offered to the public and sold to many
investors
Kinds of Bonds
1. Government Bonds – issued by the
government to finance its activities
2. Corporate Bonds – issued by private
corporations to finance their long-term
funding requirements.
Bonds as Distinguished from Stocks
Bonds
Stocks
Debt Instrument
Instrument of Ownership
Bondholders have priority over
stockholders when payments are
made by the company
Stockholders shall wait for the
bondholders to be paid
Interest payments due to bonds are
fixed
Dividends are contingent upon
earnings and must be declared by the
board of directors
Bonds have specific maturity date, at
which time, repayment of principal is
due
Stocks are instruments of permanent
capital financing and does not have
maturity dates
Bondholders have no vote and no
Stockholders (common stocks) have
influence on the management of the
the right to vote
firm, except when provisions of the
bond and the indenture agreement are
Alternative Ways of Bond Issuance
• Bonds are issued in the following ways:
1. Public Offering – selling of corporate bonds
to the general public through investment
bankers.
The investment banker provides assistance
in the issuance of bonds by:
1. helping the firm determine the size of
the issue and the types of bonds to be
issued
2. establishing the selling price
3. selling the issue
Alternative Ways of Bond Issuance
• Bonds are issued in the following ways:
2. Private placement – sale of bonds directly to
an institution and is a private agreement
between the issuing company and the
financial institution without public
examination.
Advantages
1. the issue can be tailor-made to fit the
needs of the issuing firm, as well as the
investing firm.
2. the issues does not have to be registered
3. there are no underwriting fees paid by the
issuing firm.
Classes of Bonds
• Three general types
1. By type of security
2. By manner of participation in earnings
3. By method of retirement or repayment
Classification of Bonds as to Type of Security
1. Earnings and general unpledged assets of issuing company
(Debentures)
2. Earnings of issuing company plus pledge of specific
property (mortgage bonds). This is further classified as
follows:
a. Real estate mortgages (senior & junior liens)
i. closed-end issues
ii. Open-end issues
b. Chattel mortgages
3. All or some of original security plus general credit of another
company which may be:
a. assumed bonds
b. guaranteed bonds
4. Combined earnings of allied companies plus collateral
protection in some cases (joint bonds).
Classification of Bonds as to Type of Security
• Debenture bonds – general credit bonds
not secured by specific property. The
earning power of the issuing corporation
provides the protection to the debenture
bondholder. The claim of debenture
bondholders is superior to any stockholder
regarding unpledged property of the
issuing corporation.
Classification of Bonds as to Type of Security
• Mortgage bonds – secured by a lien on
specifically named property such as land,
buildings and other fixed assets. Mortgage
bondholders have a prior claim to the assets
specifically pledged as security.
• The specific property pledged are of two
general types:
1. Real estate – consists of land and property
attached to the land
2. Chattels – consist of personal and movable
property
Classification of Bonds as to Type of Security
• Real estate mortgages may be classified
according to claims:
1. Senior liens (first mortgage bonds)-Having
prior claim to fixed assets pledged as
security.
2. Junior liens (second mortgage or third
mortgage bonds) – having subsequent liens
to fixed assets pledged as security. They
have a subordinated priority claim to senior
liens.
Classification of Bonds as to Type of Security
• Real estate mortgages may be classified according
to type of issue:
1. Closed-end issue – subsequent issues on the
specific property pledged are not allowed.
2. Open-end issue – permits the issuance of
additional bond issues or series to be made under
the original mortgage secured by a single lien.
- characterized by series bonds
(having various maturity dates, principal amounts,
and interest rates but with identical security)
3. Limited open-end issue – allowing additional
bonds to be sold after a maximum amount. The
issue becomes closed when the specified amount
of bonds have been issued.
Classification of Bonds as to Type of Security
• Assumed Bonds – when a corporation
buys another corporation, or merged with
another, the liabilities of the deceased
corporation are “assumed” by the surviving
corporation
• Guaranteed Bond – payment of interest,
principal or both is guaranteed by one or
more individuals or corporations.
• Joint bonds – property owned jointly be
several companies which was used as a
security for a bond issue. The companies
bind themselves jointly as debtors.
Classification of Bonds by Method of
Participation in Earnings
• Bonds may be classified according to the
method of participation in earnings of the
company.
1. Bonds with fixed contractual interest rates
of which there are two types
a. Coupon bonds
b. Registered bonds
2. Bonds with fixed contractual rate with
payment contingent upon earnings
(income bonds)
Classification of Bonds by Method of
Participation in Earnings
• Bonds may be classified according to the
method of participation in earnings of the
company.
1. Bonds with fixed contractual rate with
participating feature of which there are
four types:
a. Participating bonds
b. Convertible bonds
c. Bonds with warrants
d. Bonds with junior security attached.
Classification of Bonds by Method of
Participation in Earnings
• Coupon bonds – having attachments of a
series of postdated certificates (coupons)
payable to the bearer for the interest over
the life of the bonds (bearer bonds).
• Registered bonds – names of owners are
recorded on the transfer books of the
company. The owners receive payment for
interest and principal by checks drawn in
their favor
Classification of Bonds by Method of
Participation in Earnings
• Income bonds – debt instruments with a
fixed rate of interest payable only if earned
and declared by the Board of Directors.
• Participating bonds – bonds which
stipulate a fixed coupon rate but which
also provide a method of receiving
additional income over and above this
minimum sum. This additional income
comes from the corporate earnings then
available and paid out as dividends.
Classification of Bonds by Method of
Participation in Earnings
• Convertible bonds – debenture bonds or
junior-lien mortgage bonds wherein the
owner has the option to exchange his
bond to a specified number of shares of
common stock, preferred stock (less
frequent), or other types of bonds.
• Bonds with Warrants – warrants
attached to bonds, having an option or a
right to purchase stock at a stated price
during a stipulated period of time
Classification of Bonds by Method of
Participation in Earnings
• Warrants may be detachable (sold or
exercised apart form the bond) or nondetachable(cannot be sold separately from
the bond)
• Bonds with Junior Security Attached –
issued along with some share of stock in a
package sale or block sale. Bondholders
may share with stockholders with
dividends declared.
Bonds Classified by Method of Retirement
• Serial bonds – mature semi-annually or
annually instead of a single date. Matured
in series because of its staggered
repayment schedule.
• Sinking Fund Bonds – retired with the
provision of a sinking fund. The provision
requires the issuer to deposit annually
certain sums of money with the trustee of
the issue for the retirement of the part of
the issue before maturity. (periodic
repayments)
Bonds Classified by Method of Retirement
• Callable bonds – the terms of the issue
can be cancelled or called. The call
privilege enables the issuing company to
pay off a bond issue prior to maturity.
• Convertible bonds – bonds exchange for
common stock of the issuing company at a
fixed price, at a pre-determined
redemption date, and at the option of the
bondholder. Once converted, it is
considered as retired.
Bonds Classified by Method of Retirement
• Perpetual bonds – cannot be redeemed
by demanding repayment. Used in public
finance in which the debtor (government),
is assumed to have permanent existence.
Reasons for the Use of Bonds
1. When a franchise or a license is issued to
a corporation providing a guarantee of a
return on capital investments
2. When economic conditions allow the
payment of interest at a rate lower than
what is paid to common stock in the form
of dividends
3. When the present owners of the
corporation want to retain their share of
the voting power.
Reasons for the Use of Bonds
4. When investor resistance to the purchase
of common stock is very strong; and
when such resistance is not found in the
sale of bonds.
5. When the degree of safety offered by the
issuer attracts investors.
6. When tax advantages are derived from
the exercise
7. When there is a sufficient demand from
institutional investors like banks,
insurance companies, and pre-need
firms.
Indenture
• Indenture – contract between the corporation
and the trustee on behalf of the bondholders.
– Contains the terms of the bond issue, the manner
of its fulfillment, rights and responsibilities of
bondholders and duties of the trustee.
– Contents of the indenture:
1. The amount, duration, and denomination of the
bond issue
2. If applicable, the serial issues and size of each
issue
Indenture
Contents of the indenture:
3. The rate of interest, terms of payment,
designated place of collection
4. The rights, privileges, limitations attached to the
issue
5. Type of security and its terms
6. Terms and conditions of mortgage or pledge of
securities.
7. The manner of redemption
8. Remedies available to bondholders in case of
default of the issuing corporation
9. Replacement of mutilated or lost bond certificate
10. Duties and remunerations of the trustees
Trustee
• Person who handles the money or
property on behalf of another in a trust.
• The role of trustee in a bond issue is to
see that the issuing corporation complies
with the provision of the indenture.
• Duties include:
1. To represent the bondholder in case of
default
2. To make payment of interest and
principal
Trustee
• Duties include:
3. To take care of the sinking fund
4. To report annually to the bondholders on his
operations and the condition of the bond issue and
its pledged security;
5. To supply lists to bondholders to any bondholder,
enabling the bondholders to form special
committees to protect their interest at any time
6. To notify the bondholder of any default
7. To inform bondholder of any loans by the trustee
to the corporation