Types of Bonds

A. Unsecured Long- Term Bonds

1. Debentures- these are unsecured long-term debt and backed only by the reputation and financial
stability of the corporation. The earning ability of the issuing corporation is a great concern to the
bondholder.
2. Subordinated Debentures- claims of bondholders are honored only after the claims of secured debt
and unsubordinated debentures have been satisfied.
3. Income Bonds- requires interest payments only if earned and non-payment of interest does not lead to
bankruptcy. Usually issued during the reorganization of a firm facing financial difficulties, these bonds
have longer maturity.

B. Secured Long-Term Bonds

Mortgage Bonds- secured by a lien on real property. Typically, the market value of the real property is
greater than that of the mortgage bonds issued. This provides the mortgage bondholders with margin of
safety in the event that the market value of the secured property declines.

a. First Mortgage Bond- have senior claim on the secured assets if the same property has been
pledged on more than one mortgage bond.
b. Second Mortgage Bond- have second claim on assets and are paid only after the claims of the first
mortgage bonds have been satisfied.
c. Blanket or General Mortgage Bonds- all assets of the firm are used as security for this type of
bonds.
d. Closed-end Mortgage Bonds- forbid the further use of the pledged assets security for other bonds
e. Open-end Mortgage Bonds- allow the issuance of additional mortgage bonds using the same
secured assets as security.
f. Limited Open-end Mortgage Bonds- allow the issuance of additional bonds up to a limited amount
at the same priority level using the already mortgaged assets as security.

C. Other Types of Bonds

1. Floating Rate or Variable Rate Bonds- one which the interest payment changes with market conditions.
A common feature is that an attempt is being made to counter uncertainty by allowing the interest rate
to float.
2. Junk or Low-Rated Bonds- rated BB or below. The major participants of this market are new firms that
do not have an established record of performance, although in recent years junk bonds have been
increasingly issued to finance corporate buyouts.
3. Eurobonds- payable or denominated in the borrowers currency, but sold outside the country of the
borrower, usually by an international syndicate of investment bankers.
4. Treasury Bonds- carry the full-faith-and-credit backing of the government and investors consider
them among the safest fixed-income investments in the world. BSP uses treasury securities to
implement monetary policy.

Prepared by: JLM-SY Page 1

Bond Features and Prices

Par Value- the face value of the bond that is returned to the bondholder at maturity.

Coupon Interest Rate- the percentage of the par value of the bond that will be paid out annually in
the form of interest.

Maturity- the length of time until the bond issuer returns the par value to the bondholder and
terminates the bond

Indenture- the agreement b/w the firm issuing the bonds and the bond trustee who represents the
bondholders. It provides the specific terms of the loan agreement, including the description of the
bonds, the rights of the bondholders, the rights of the issuing firm and the responsibilities of the
trustee.

Current Yield- refers to the ratio of the annual interest payment to the bonds market price.

Yield to Maturity- refers to the bonds internal rate of return. It is a discount rate that equates the
present value of the interest and principal payments with the current market price of the bonds.

Credit Quality Risk- the chance that the bond issuer will not be able to make timely payments.
Bond Ratings- involve a judgement about the future risk potential of the bond provided by rating
agencies.

Factors that may affect Bond Ratings

a. A low utilization of financial leverage

b. Profitable Operations
c. A low Variability of the past earnings
d. Large firm size
e. Little use of subordinated debt

*** The poorer the bond rating, the higher the rate of return demanded in the capital markets.

Prepared by: JLM-SY Page 2

 Credit Ratings- provide an indicator of default risk that in turn affects the rate of return that must be paid on
borrowed funds.

Credit Risk Credit Rating Description

Highest Quality AAA The issuers capacity to meet its

financial commitment on the
obligation is extremely strong

High Quality AA Capacity is very strong

Upper Medium Grade A Capacity is still strong, though

somewhat susceptible to the adverse
effects of changes in circumstances
and economic conditions

Medium Grade BBB The issuer exhibits adequate

protection. However, adverse
economic conditions or changing
circumstances are more likely to lead
a weakened capacity to meet its
financial commitment

Below Investment Grades

Somewhat Speculative BB Faces major on-going uncertainties or
exposure to adverse business,
financial or economic conditions w/c
could lead to the obligors inadequate
capacity to meet its financial
commitment.

Speculative B adverse business, financial or

economic conditions will likely impair
the issuers capacity or willingness to
meet financial obligations

Highly Speculative CCC Currently vulnerable to non-payment,

and is dependent upon favourable
business, financial , and economic
conditions for the issuer to meet its
obligation

Most Speculative CC Currently highly vulnerable to non-

payment

Imminent Default C Used to cover a situation where a

bankruptcy petition has been field or
similar action taken, but payments on
this obligation are being continued

Default D Obligations are in default or the filing

of bankruptcy petition has occurred
and payments are jeopardized

Prepared by: JLM-SY Page 3

Prepared by: JLM-SY Page 4