CORPORATE BONDS

CHAPTER 9
TABLE OF CONTENTS
Definitionof Bond
Bond as Distinguished from Stocks
Alternative Ways of Bond Issuance
Classes of Bonds
Reasons for the Use of Bonds
The Indenture and Trustee
CORPORATE BONDS
Bonds constitute the alternative source of long-
term financing. The other means is the stock
which has been discussed in the previous
chapter. Bonds do not represent equity capital,
but they are long-term liabilities of the company
DEFINITION OF BOND
A bond is defined as a long-term debt of a firm or the
government set forth in writing and made under seal.

KINDS OF BOND
These are general kinds of bonds. These are the ff.
1. government bonds
2. corporate bonds
Government bonds are those issued by the government to
finance its activities. Corporate bonds are those issued by
private corporations to finance their long-term funding
requirements. In this chapter, corporate bonds as a source
of long-term financing shall be presented.

Like a long-term loan, a bond is 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, a bond issue is
generally advertised, offered to the public, and actually
sold to many different investors.
BONDS AS DISTINGUISHED FROM
STOCKS
As distinguished from stocks, bonds possess the following
characteristics:
1. A bond is a debt instrument, while stock is an instrument of
ownership;
2 Bondholders have priority over stockholders when payments
are made by the company;
3. Interest payments due to bonds are fixed, while dividends to
stockholders are contingent upon earnings and must be
declared by the board of directors;
4. Bonds have specific maturity date, at which time, repayment of the
principal is due. In contrast, stocks are instruments of permanent capital
financing and does not have maturity dates; and
5. Bondholders have no vote and no influence on the management of the
firm, except when the provisions of the bond and the indenture agreement
are not met.

ALTERNATIVE WAYS OF BOND ISSUANCE

Corporate bonds are generally sold by medium-and-large-sized companies
to finance plant and equipment. Small firms do not usually use this
financing method.
Bonds are issued through any of the following ways:
1. public offering; and
Public offering involves selling of corporate bonds to the general public though
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 type of bonds to be issued;
2. establishing the selling price; and
3. selling the issue.

Private placement is a sale of bonds directly to an institution and is a private

agreement between the issuing company and the financial institution without public
examination.
Private placement offers the following advantages:
1. the issue can be tailor-made to fit the needs of the issuing firm, as well as the
investing firm;
2. the issue does not have to be registered; and
3. there are no underwriting fees paid by the issuing firm.
CLASSES OF BONDS
By major contractual provisions, bonds may be classified into three
general types: (1) by type of security; (2) by manner of participation in
earnings; and (3) by method of retirement or repayment.

Classification of Bonds as to Type of Security

Bonds may be classified according to the type of security offered by the
issuing firm.
These consist of the following:
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:
This is further classified as follows:
a. Real estate mortgages (senior and 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).
Debentures. Debenture bonds are 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.

Mortgage Bonds. Mortgage bonds are those which are secured by a lien on
specifically named property such as land, buildings, equipment, 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-which consists of land and property attached to the land;
2. chattels-which consist of personal and movable property.
Real estate mortgages may also be classified according to
priority of claims:

1. Senior liens. They are those having prior claim to fixed

assets pledged as security. Bonds with senior liens are also
sometimes called first mortgage bonds.
2. Junior liens. They are bonds having subsequent liens to
fixed assets pledged as security. They have a subordinated
priority claim to the senior liens. Bonds with senior liens are
also sometimes called second mortgage or third mortgage
bonds.
Real estate mortgages may also be classified according to the
type of issue:
1. Closed-end issue. This type of issue refers to those wherein
subsequent issues on the specific property pledged as collateral are not
allowed.
2. Open-end issue. This type of bond issue permits the issuance of
additional bond issues or series to be made under the original mortgage
secured by a single lien. Open-end issues are usually characterized by
series bonds (those having various maturity dates, principal amounts,
and interest rates but with identical security).
3. Limited open-end issue. This is an improvement of the open and
closed issues allowing additional bonds to be sold after a maximum
amount. The issue becomes closed when the specified amount of bonds
have been issued.
Assumed Bonds. There are times when a corporation buys another
corporation, or is merged with another. The liabilities of the
deceased corporation are “assumed” by the surviving corporation.
All bonds previously issued by the deceased corporation are also
assumed by the surviving corporation. These bonds, by virtue of
such assumption, are referred to as assumed bonds. They remain
unchanged in form and will continue to enjoy the protection of any
mortgage lien originally given.

Guaranteed Bond. A guaranteed bond is a type of bond in which

the payment of interest, or principal, or both, is guaranteed by one
or more individuals or corporations. The guarantee merely assures
additional protection on the part of the bondholder.
Joint Bonds. There are times when a property is owned jointly by
several companies. The same property may be used as security
for a bond issue. The companies bind themselves jointly as
debtors in this type of issue. Bonds falling under such type of
issue are called joint 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. The classifications are as follows:
1. Bonds with fixed contractual interest rates of which there are
two types:
a coupon bonds; and
2. Bonds with fixed contractual rate with payment
contingent upon earnings (income bonds).

3. Bonds with fixed contractual rate with participating

feature of which there are four types:
a. participating bonds;
b. convertible bonds;
C. bonds with warrants; and
d. bonds with junior security attached.
Coupon Bonds. These are bonds having a series of postdated certificates
(coupons) payable attachments of a ser interest over the life of the bond.
These bonds are also referred to as bearer bonds.

Registered Bonds. These are bonds wherein the names of the owners are
recorded on the transfer books of the company. The owners of such bonds
receive payment for interest and principal by checks drawn in their favor.

Income Bonds. These are debt instruments with a fixed rate of interest
payable only if earned and declared by the board of directors. Should the
income of the company be insufficient to provide for the full contractual
Participating Bonds. These are bonds which stipulate a fixed
coupon rate but which also provide a method of receiving
additional income over and above this minimum sum. The
additional income comes from the corporate earnings then
available and paid out as dividends.

Convertible Bonds. Convertible bonds are generally debenture

bonds or junior-lien mortgage bonds wherein the owner has
options to exchange his bond for a specified number of shares
of common stock, or less frequently, preferred stock, or other
types of bonds.
Bonds with Warrants. Bonds may also have warrants, attached to them.
The warrant is an option or a right, exercisable by its holder, to purchase
stock at a stated price during a stipulated period of time.

Warrants may be detachable or non-detachable. Detachable warrants

are those which may be sold or exercised apart from the bond.
Non-detachable warrants cannot be sold or exercised separately from
the bond.

Bonds with Junior Security Attached. These are bonds which are issued
along with some shares of stock in a package kage or block sale. The
effect of this arrangement is that the bondholders have the opportunity of
sharing with the stockholders whatever dividends are declared.
Bonds Classified by Method of
Retirement
Bonds may also be classified according to the method of
retirement. The standard arrangement is for the bond to
mature and the principal be repaid in whole at a definite
place and date. There are some deviations from this
arrangement, however. These deviations have produced
some types of bonds with identifiable titles.
Serial Bonds. A serial bond is one among a group of bonds a part of
which mature semi-annually or annually instead of all on a single date.
The effect of maturity in series is the staggered repayment schedule of
the obligation. In some cases the arrangement is advantageous to the
borrowing firm.

Sinking Fund Bonds. Bonds may also be gradually retired with the
provision of a sinking fund. This 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. This arrangement has
the effect of periodic repayments of the obligation.
Callable Bonds. These are bonds with provisions that 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. These are bonds which may be exchanged for the
common stock of the issuing corporation at a fixed price, at a pre-
determined redemption date, and at the option of the bondholder. Bonds
converted into common stocks are then considered retired.

Perpetual Bonds. These are bonds which cannot be redeemed by

demanding repayment. This type of bond has no place in the finance of
private businesses. It is primarily suited to the field of public finance
where the debtor, the government, may be assumed to have a
permanent existence.
REASONS FOR THE USE OF BONDS
Bonds are used as instruments of long-term financing for any of the following reasons:

1. When a franchise or a license is issued to a corporation providing a guarantee of a certain

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;
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; and
7. When there is a sufficient demand from institutional investors like banks, insurance
companies, and pre-need firms.
THE INDENTURE AND TRUSTEE
In the study of bond issue, two terms are important: (1) the indenture; and
(2) the trustee. Both perform the common function of protecting the
bondholders.

The Indenture
The indenture is a contract between the corporation and the trustee on
behalf of the bondholders. The indenture contains the terms of the bond
issue covering the obligations of the corporation, the manner of its
fulfillment, the rights and responsibilities of the bondholders, and the duties
of the trustee.
The specific contents of the indenture are the following:
1. the amount, duration, and denomination of the bond issue;
2. if applicable, the serial issues and the size of each issue;
3. the rate of interest, the terms of payment, and the designated place of collection;
4. the rights, privileges, or limitations attached to the issue;
5. the type of security and its terms;
6. the terms and conditions of mortgage or pledge of securities, if any;
7. the manner of redemption;
8. the remedies available to bondholders in case of default of the issuing
corporation;
9. the replacement of mutilated or lost bond certificate; and
10. the duties and remunerations of the trustees.
The Trustee
behalf of another in a trust. The role of the trustee in a bond issue is
monies or to see that the issuing corporation complies with the
provisions in the indenture.

The duties of the trustee are the following:

1. to represent the bondholder in case of default;
2. to make payment of interest and principal;
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 of bondholders to any bondholder, enabling the
THANK YOUUU!
BY: NICOLETTE L. , APRIL C. AND RICA R.