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CH 9] Business 101 9-7

Types of Bonds
The potential bondholder has a variety of bonds from which to choose. A secured secured bond
bond is backed by specific pledges of company assets. Just as you may pledge your Bond backed by
house on a house loan, a company may issue mortgage bonds which are secured by the specific pledges of
real estate owned by the firm. When a company pledges the stocks and bonds that it company assets.
holds for its debt this is a collateral trust bond. Equipment trust certificates are issued
by railroads and airline companies, which pledge their locomotives, rail cars and
airplanes as collateral for the debt.
A company may also issue unsecured bonds which are called a debenture. This is debenture
a bond backed only by the reputation of the issuing corporation or governmental unit. Bond backed by the
reputation of the issuing
Only governments and major corporations with extremely sound financial reputations corporation.
can find buyers for their debentures. But then the government has the taxpayer as
collateral for its debts.
A government bond represents funds borrowed by the U.S. government, because government bond
they are backed by the full faith and credit of the federal government (the American Bond issued by the U.S.
taxpayer). Government bonds are considered the least risky of all debt obligations government.
because the taxpayer collateralizes the debt. A mu-nicipal bond is a debt issue of a
county, city, township, or village. Municipal bonds can be classified as general- municipal bond
Debt issue of a state or
obligation bonds or revenue bonds. General‑obligation bonds are backed by the credit political subdivision that
of the issuer—and their ability to generate tax revenues to pay off the bond. Revenue may be a
bonds may be serviced by income produced by such revenue‑generating projects as general-obligation bond or
toll roads, bridges, municipal coliseums, or pub-lic utilities. revenue bond.

Convertible bonds are sometimes issued by corporations. A convertible bond has convertible bond
the option of being converted into a specific number of shares of common stock. The Bond conversion option to
number of shares of stock exchanged for each bond is stated in the bond indenture— a specific number of
the legal contract containing all provisions of the bond. A $1,000 bond might be shares of common stock.

convertible into 100 shares of common stock (the value of the common share being bond indenture
$10 per share). If the current market value of the stock is $8 per share, then the Legal contract containing
conversion privilege is of no value. However, if the stock price is $18 the value of the all provisions of a bond.
bond is now $1,800 a tempting conversion item.
As a reminder, all bonds are loans and are issued with terms. They have a life, a
purchase value, a mature value and a stated interested rate. Convertible bonds
generally offer lower interest rates than those lacking conversion provisions; and some
bond purchasers prefer such bonds, even at lower interest rates, due to the potential of
additional gains if the price of the firm's stock increases.

Figure 9.5. Government bonds

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