Corporate Bonds & Investment Strategies

• A corporate bond is a debt security issued by a firm and sold to investors.
• In return for the capital, the investor receives pre-established interest payments at a fixed or variable rate.
• When a bond expires, or reaches maturity, payments cease and the original investment is returned.
• Bonds are a form of long-term debt with a specified principal value and maturity date.
• The principal of a bond is its face value, the amount printed on the face or its par value.
• The company issuing the bond is the debtor, and the investor is the bond holder/creditor.
• Bond holders receive interest, also known as yield, expressed as current yield or yield to maturity.
• Debt instruments contain debtor terms, also called covenants, stated in a legal document known as indenture and may vary based on the borrower's financial condition.
• Failure to make required interest or principal payments results in the bond being in default
• The indenture states what actions investors can take if the issuer defaults.
• A trustee is appointed for publicly held bonds to monitor the indenture terms and work with the firm if intervention is needed.
• Companies often use investment bankers to facilitate the bond issuance process for a fee.
• High-quality corporate bonds are considered relatively safe and conservative investments.
• Investors add bonds to balance portfolios, offsetting riskier investments like growth stocks.
• Corporate bonds are considered to have a higher risk.
• As investors age they add more bonds and fewer risky investments to protect their accumulated capital.
• Retirees invest a larger portion of assets in bands to assure reliable income.

Types of Bonds (According to Type of Security)

• Secured bonds or mortgage bonds are backed by firm-owned property.
• Mortgages are the most common type of secured bonds and are backed by real estate assets.
• Mortgage bonds are secured by a lien on specifically named property like land, buildings, equipment, and other fixed assets specifically pledged as security.
• Specific types include real estate (land and property attached), and chattel (personal and movable property.

Sub-Classes of Mortgages

• Senior liens (first mortgage bonds) have prior claim to fixed assets.
• Junior liens (second or third-mortgage bonds) have subsequent claims to fixed assets.

Real Estate Mortgages Classified by Type of Issue

• Closed-end issue: Subsequent issues on the specific property pledged as collateral are disallowed
• Open-end issue: Permits issuance of additional bonds or a series of issues under the original mortgage secured by a single lien
• Limitied open-end issue: Additional bonds can be sold after the orginal issue but stipulate maximum amount.
• An issue becomes closed when amount is reached.
• Debentures are unsecured long-term bonds of a corporation
• Holders of debentures are paid after secured bond holders are satisfied.

Other Bond Types

• Subordinate debentures have lower payment priority and require higher interest due to higher risk.
• The issuing company can lower the interest on its subordinated debentures by adding a convertibility feature.
• Convertible bonds have a maturity value and coupon rate, and also allow the investor to convert debt to equity at stated times.
• Assumed bonds are absorbed by the surviving corporation and retain the same protection on mortgage lien.
• A guaranteed bond has payments guaranteed by one or more individuals/corporations, assuring additional bondholder protection.
• Joint bonds are owned by several companies using the same property as security, binding themselves jointly as debtors.

Municipal and Government Bonds

• Municipal bonds or government bonds are issued by public entities like countries, cities, municipalities, or authorized public authorities.
• Funds are paid over a period of time as stated in the levy proposal.
• These bonds allow an agency to sell bonds immediately to fund projects.
• Municipal bonds offer a lower interest rate than corporate bonds because the interest income is exempt from income taxes.
• General obligation bonds are backed by the issuer's full faith and credit.
• Revenue bonds derive funds from the income produced by the funded asset.
• Pure discount bonds promise to pay a certain amount in the future.
• Registered bonds identify owners in the company's transfer books.
• Income bonds have a fixed interest rate payable only if earned and declared by the directors.
• Participating bonds stipulate a fixed coupon rate but provide a method for additional income over and above.
• Convertible bonds are generally debenture bonds or junior-lien mortgage bonds.

Bonds with Option to Exchange or Purchase Shares

• Certain bonds allow the owner to exchange their bond for a specified number of shares of common/preferred stock.
• Bonds with warrants provide the option to purchase stock at a stated price during a specified period.
• Detachable warrants can be sold separately from the bond.
• Non-detachable warrants cannot be sold separately.

Bond Classifications by Retirement Method

• When bonds mature principal and interest are paid at a definite time and place, but classification may change based on retirement period.
• Serial bonds mature semi-annually or annually, and are paid on staggered bases.
• Sinking fund bonds require the issuer to deposit a specific sum of money annually with a trustee for retirement of part of the issue.
• Callable bonds allow for the issuer to cancel/call the issue, enabling them to pay off a bond issue before maturity.
• Perpetual bonds don't redeem payment; used in public finance where the government has permanent existence as the debtor.

Bonds Classified by Value

• Bonds can be classified as premium, par, or discount bonds, depending on whether their current price exceeds, equals, or is less than the face value.
• If a bond is selling at a premium, its price will fall as maturity approaches, regardless of interest rates.
• If a bond is selling at a discount, its price rises as it approaches maturity, regardless of interest rates.
• The effect of interest rates is affected by the maturity of the bond, the coupon rate and the level of interest rates at the time of the change in rates.
• Corporate bonds are a major source of capital, along with equity, bank loans, and lines of credit.
• Debt financing is sometimes preferable to issuing stock (equity financing) because it is typically cheaper without giving up ownership.
• Companies need consistent earnings potential to offer debt securities at a favorable coupon rate. .
• High credit quality allows more debt at lower rates.
• When corporations need short-term boosts they sell commercial paper, which is similar to a bond and matures in 270 days or less.

Corporate Bonds vs. Equities (Stocks)

• A corporate bond investor lends money to the company. A stock investor is buying a share of company ownership.
• Stock value rises and falls, increasing or decreasing the investor's stake.
• Stock investors may earn money by selling stocks at a higher price or by collecting dividends.
• Bond investors are paid interest rather than profits.
• The original investment is only at risk if the company collapses.
• A bankrupt company must pay bondholders and other creditors before stock owners.
• Bonds are an instrument of debt, while stock is an instrument of ownership in the business.
• Bondholders have payment priority over stockholders.
• Bonds have maturity dates. Stock does not.
• Bondholders typically have no voting rights, while common stock have voting rights.

Features of Long-Term Bonds

• New bond rates (coupon rates) are fixed according to market rates on bonds of comparable quality/maturity so that the bonds sell near par value
• Some bonds reset the coupon rates periodically (twice a year) depending on market rates
• Long term debt typically have a maturity of 20-30 years.
• Call feature and bond refunding allow the isuing company to redeem or call a debt issue prior to its maturity date
• The put option entitles the bondholder to sell the bond back to the issuer before maturity at a predetermined price
• Sinking funds provide for a gradual retirement of bond issues.
• Equity-linked debt has a conversion ratio to determine converted shares.
• An indenture is a contract between the corporation and the trustee on behalf of the bondholders which contains the terms of the bond issue.
• It covers the obligations of the corporation, the manner of its fulfillment, the rights, and responsibilities of bondholders, and duties of the trustee.
• Items included: amount, length of time, denomination of the bond issue
• Items included: Serial issues and the size of each issue
• Items included: Rate of interest, terms of payment, and designated place of collection Rights, privileges/limitations attached to issue
• Items included: Security type and its terms
• Items included: Mortgage/pledge of securities, if any
• Items Included: manner of redemption
• Items Included: Remedies available to bondholders in case of default Replacement procedure of mutilated or lost bond certificate
• Items Included: Duties and Remunerations of Trustees
• A trustee is the person/entity that handles monies/property on behalf of another in trust.
• Trustees ensure that issuing corporations comply with the provisions in the indenture.
• Duties include representing the bondholder in case of default, making principal/interest payments, and managing the sinking fund
• Duties include reporting annually to bondholders results of operations.
• Bond Trustee: will check the condition of the bond issue and pledged security.
• The bond trustee will provide bondholder lists to form special committees to protect their interests.
• The bond trustee will notify the bondholders of any default.
• The bond trustee will provide information to the bondholders of any loans by the trustee to the corporation

Explore the role of high-quality corporate bonds in balanced portfolios and how investment strategies evolve over an investor's lifetime. Differentiate between secured bonds and debentures. Also explains open-end issue mortgage bonds.