Types of Bonds

14/05/2020 2 By indiafreenotes

1. Serial Bonds:

Serial bonds are issued by an organization with different maturity dates. This is done to enable the company to retire the bonds in instalments rather than all together. It is less likely to disturb the cash position of the firm than if all the bonds were retired together.

From the point of view of the bondholder, this gives him a chance to select a bond of the maturity date which would suit his portfolio. He may select a short-term maturity bond if it meets his need or take a bond with a long-term maturity if he already has too many shorter-term investments.

Serial bonds usually do not have the call feature and the company retires the debt when it becomes payable on the maturity date. Such bonds are useful to those companies that wish to retire their bonds in series. Serial bonds, resemble sinking fund bonds and have an effect on the yields of bonds. Bonds with shorter-term maturity have lower yields compared to those of long- term maturities.

2. Sinking Fund Bonds:

Sometimes, an organization plans the issue of its bonds in such a way that there is no burden on the company at the time of retiring bonds. This has the advantage of using the funds are well as retiring them without any excessive liquidity problems.

The company sets apart an amount annually for retirement of bonds. The annual installment is usually fixed and put in a sinking fund through the trustees. The trustee uses his discretion in investing these funds. He may use the fund to call the bonds every year or purchase bonds from them at a discount. Sinking fund bonds are commonly used as a measure of industrial financing.

3. Registered Bonds:

Registered bonds offer an additional security by a safety value, attached to them. A registered bond protects the owner from loss of principal. The bondholder’s bond numbers, name address and type of bond are entered in the register of the issuing company. The bondholder has to comply with the firm’s formalities at the time of transfer of bonds.

While receiving interest, registered bondholders usually get their payment by cheque. The main advantage of registering a bond is that if the bond is misplaced or lost, the bondholder does not suffer a loss unlike the unregistered bonds. However, registered bonds do not offer security of principal at maturity.

4. Debenture Bonds:

Debentures in the USA are considered to be slightly different from bonds. Debenture bonds are issued by those companies who have an excellent credit rating but do not have security in the form of assets to pledge to the bondholders. The debenture holders are creditors of the firm and receive the full rate of interest whether the company makes a profit or not.

In India, debentures can be issued with the specific permission of the Controller of Capital Issues. Bearer debentures are not considered legal and permissible documents in India. Convertible debentures have become popular in recent years.

Convertible debentures have lower rates of interest but the convertible clause makes it an attractive investment. While permission has to be sought for the convertibility clause, it is not necessary if they are solely offered to financial institutions. Debentures can be of different kinds. They may be registered, convertible, mortgage, guaranteed and may also combine more than one feature in one issue.

5. Mortgage Bonds:

A mortgage bond is a promise by the bond issuing authority to pledge real property as additional security. If the company does not pay its bondholders the interest or the principal, when it falls due, the bondholders have the right to sell the security and get back their dues.

The value of mortgage bonds depends on the quality of property mortgages and the kind of charge on property. A first charge is the most suitable and highly secure form of investment, since its claims will be on priority of the asset.

A specific claim on a particular property is also an important consideration compared to a general charge. A second and third charge on security of property is considered to be a weak form of security, and is less sound than a first charge. Sometimes, however, second or third charges prove useful when the quality of the property with a first charge is poor.

This means that a property which is of high value and immediately saleable because of its strategic placement should be considered very valuable even if it offers a second and third charge.

Another property offering no saleable features but giving a first charge may be worthless to the bondholders. The quality of the mortgage is, therefore, an important consideration to the mortgage bondholders. Mortgage bonds may be open end, close end and limited open end.

An open end mortgage bond permits the bond issuing company to issue additional bonds if earnings and asset coverage make it permissible to do so. In close end mortgage bonds, the company can make only one issue of bonds and while those bonds exist, new bonds cannot be issued.

If additional bonds are issued they get the ranking of junior bonds and the prior issue gets the first priority in receiving payments. The limited open end bonds permit the organization to issue specified number of fresh bonds series distributed over a number of years.

6. Collateral Trust Bonds:

A collateral trust bond is issued generally when two companies exist and are in the relationship of parent and subsidiary. The collateral that is provided in these bonds is the personal property of the company which issues the bonds. A typical example of such bonds is when a parent company requires funds, it issues collateral bonds by pledging securities of its own subsidiary company.

The collaterals are generally in the form of intangible securities like shares or bonds. These bonds have a priority charge on the shares or bonds which are used as collaterals. The quality of the collateral bonds is determined by the assets and earning position of both the parent as well as the subsidiary company.

7. Equipment Trust Bonds:

In the USA, a typical example of Equipment Trust Bonds is the issue of bonds with equipment like machinery as security. The property papers are submitted to trustees. These bonds are retired serially.

The usual method of using these bonds was to issue 20% equity and 80% bonds. The equity issue is like a reverse to protect the lender in cases where the value of the asset falls in the market. The trustee also has the right to sell the equipment and pay the bondholders in case of default.

8. Supplemental Credit Bonds:

When additional pledge is guaranteed to the bondholders their bonds are categorized as supplemental by an additional non-specific guarantee. Such bonds are classified as: Guaranteed Bonds, Joint Bonds and Assumed Bonds.

9. Guaranteed Bonds:

Guaranteed Bonds are issued as bonds secured by the issuing company and they are guaranteed by another company. Sometimes, a company takes assets through a lease. The leasing company guarantees the bonds of the bond issuing company regarding interest and principal amount due on bonds.

10. Joint Bonds:

Joint bonds are guaranteed bonds secured jointly by two or more companies. These bonds are issued when two or more companies are in need of finance and decide to raise the funds together through bonds. It serves the purpose of the company as well as the investor.

The company raises funds at reduced cost. Since funds are raised jointly, dual operations of advertising and the formalities of capital issues control are avoided. The investor is in a favourable position as he has security by pledge of two organizations.

11. Assumed Bonds:

These bonds are the result of a decision between two companies to amalgamate or merge together. For example, Company-X decides to merge into Company-Y. X’s issue of bonds prior to merger then becomes the obligation of Company-Y when merger is effected.

These are called assumed bonds as Company-Y did not originally issue them but as a result of merger the debt was passed on to them. The bondholder receives an additional pledge from Company-Y. He is more secured as his bonds due to merger get the safety of both Companies X and Y.

12. Income Bonds:

Such bonds offer interest to the bondholders only when the firm earns a profit. If profit is not declared in a particular year, interest on bonds is cumulated for a future period when the company can sufficiently earn and make a profit.

Income bonds are frequently issued in case of reorganization of companies. When income bonds arise out of reorganization they are called adjustment bonds. They are also used to recapitalize the firm and take the benefit of deduction of tax by changing preference shares with income bonds.

13. Bonds with Warrants:

Bonds with warrants are also called Warrant Bonds. Each bond has one warrant attached to it and it gives the right to the bondholder to pay a subscription price and exchange the bonds for equity shares. This right is given, for a limited period of time. Usually, a time period is put up in a legal document with the trustee.

Warrant bonds may be detachable or non-detachable. Detachable warrants are used by the investor (a) to sell the warrant during price increase in the market, and (b) to buy stock at an option price and to be sold at market value. A non-detachable bond is slightly more complicated. It has to be sent to the company’s trustee at the time of exercising an option. The warrant is detached by the trustee and sent to the investor.

Warrant bonds like convertible bonds offer a chance to the investor to share in the growth of the company, but convertible bonds are more popular than warrant bonds.

In India, convertible debenture bonds are also relatively new and not as popular as equity issues. The warrant bond gives the right to its holder to sell a warrant if the price increases in the market and retain the bond. If the price does not increase, the bondholder may retain the bond with a warrant.

14. Foreign Bonds:

Bonds raised in India by foreign companies but for Indian investor will he called a ‘foreign bond’. A foreign bond, for example, an American Bond or Japanese Bond in India may be very attractive to investors because (a) the dollar yield is much higher than the rupee, (b) deposits in dollars are considered a good investment, and (c) risk on the portfolio is diversified.

Having described the different kinds of bonds, let us find out the objective of issuing such bonds as well as evaluate bonds as an investment.