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Types and Ratings of Bonds - 673
ISSUING BONDS
A bond arises from a contract known as a bond indenture. A bond represents a promise
to pay: (1) a sum of money at a designated maturity date, plus (2) periodic interest at a spec-
ified rate on the maturity amount (face value). Individual bonds are evidenced by a paper
certificate and typically have a $1,000 face value. Companies usually make bond interest
payments semiannually, although the interest rate is generally expressed as an annual rate.
The main purpose of bonds is to borrow for the long term when the amount of capital
needed is too large for one lender to supply. By issuing bonds in $100, $1,000, or $10,000
denominations, a company can divide a large amount of long-term indebtedness into many
small investing units, thus enabling more than one lender to participate in the loan.
A company may sell an entire bond issue to an investment bank which acts as a sell-
ing agent in the process of marketing the bonds. In such arrangements, investment banks
may either underwrite the entire issue by guaranteeing a certain sum to the company, thus
taking the risk of selling the bonds for whatever price they can get (firm underwriting).
Or they may sell the bond issue for a commission on the proceeds of the sale (best-efforts
underwriting). Alternatively, the issuing company may sell the bonds directly to a large
institution, financial or otherwise, without the aid of an underwriter (private placement).
TYPES AND RATINGS OF BONDS
Below, we define some of the more common types of bonds found in practice. OBJECTIVE 2
Identify various types of
TYPES OF BONDS bond issues.
SECURED AND UNSECURED BONDS. Secured bonds are backed by a pledge
of some sort of collateral. Mortgage bonds are secured by a claim on real estate.
Collateral trust bonds are secured by stocks and bonds of other corporations.
Bonds not backed by collateral are unsecured. A debenture bond is unsecured.
A "junk bond" is unsecured and also very risky, and therefore pays a high inter-
est rate. Companies often use these bonds to finance leveraged buyouts.
TERM, SERIAL BONDS, AND CALLABLE BONDS. Bond issues that mature
on a single date are called term bonds; issues that mature in installments are
called serial bonds. Serially maturing bonds are frequently used by school or san-
itary districts, municipalities, or other local taxing bodies that receive money
through a special levy. Callable bonds give the issuer the right to call and retire
the bonds prior to maturity.
CONVERTIBLE, COMMODITY-BACKED, AND DEEP-DISCOUNT BONDS.
If bonds are convertible into other securities of the corporation for a specified
time after issuance, they are convertible bonds.
Two types of bonds have been developed in an attempt to attract capital in
a tight money market-commodity-backed bonds and deep-discount bonds.
Commodity-backed bonds (also called asset-linked bonds) are redeemable in
measures of a commodity, such as barrels of oil, tons of coal, or ounces of rare
metal. To illustrate, Sunshine Mining, a silver-mining company, sold two issues
of bonds redeemable with either $1,000 in cash or 50 ounces of silver, whichever
is. greater at maturity, and that have a stated interest rate of 8% percent. The
accounting problem is one of projecting the maturity value, especially since sil-
ver has fluctuated between $4 and $40 an ounce since issuance.
JCPenney Company sold the first publicly marketed long-term debt securi-
ties in the United States that do not bear interest. These deep-discount bonds,
also referred to as zero-interest debenture bonds, are sold at a discount that pro-
vides the buyer's total interest payoff at maturity.-
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Types and Rating of Bonds, chapter, 2007; (https://texashistory.unt.edu/ark:/67531/metadc1452074/m1/1/: accessed May 20, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu; crediting UNT Libraries Special Collections.