Principles of Managerial Finance

that the first three types—debentures, subordinated debentures, and income

bonds—are unsecured, whereas the last three—mortgage bonds, collateral trust

bonds,and equipment trust certificates—are secured.

Table 6.4 describes the key characteristics of five contemporary types of

bonds: zero-coupon or low-coupon bonds, junk bonds, floating-rate bonds,

extendible notes,and putable bonds.These bonds can be either unsecured or

secured. Changing capital market conditions and investor preferences have

spurred further innovations in bond financing in recent years and will probably

continue to do so.

International Bond Issues

Companies and governments borrow internationally by issuing bonds in two prin-

cipal financial markets: the Eurobond market and the foreign bond market. Both

give borrowers the opportunity to obtain large amounts of long-term debt financ-

ing quickly, in the currency of their choice and with flexible repayment terms.

CHAPTER 6 Interest Rates and Bond Valuation 279

zero- (or low-) coupon bonds
junk bonds
floating-rate bonds
extendible notes
putable bonds
See Table 6.4

TABLE 6.3 Characteristics and Priority of Lender’s Claim of Traditional

Types of Bonds

Bond type Characteristics Priority of lender’s claim

Unsecured Bonds

Debentures Unsecured bonds that only creditworthy firms Claims are the same as those of any general

can issue. Convertible bonds are normally creditor. May have other unsecured bonds

debentures. subordinated to them.

Subordinated Claims are not satisfied until those of the Claim is that of a general creditor but not as good

debentures creditors holding certain (senior) debts have been as a senior debt claim.

fully satisfied.

Income bonds Payment of interest is required only when Claim is that of a general creditor. Are not in

earnings are available. Commonly default when interest payments are missed,

issued in reorganization of a failing firm. because they are contingent only on earnings

being available.

Secured Bonds

Mortgage bonds Secured by real estate or buildings. Claim is on proceeds from sale of mortgaged

assets; if not fully satisfied, the lender becomes a

general creditor.The first-mortgageclaim must be

fully satisfied before distribution of proceeds to

second-mortgageholders, and so on. A number

of mortgages can be issued against the same

collateral.

Collateral trust Secured by stock and (or) bonds that are owned Claim is on proceeds from stock and (or) bond

bonds by the issuer. Collateral value is generally 25% to collateral; if not fully satisfied, the lender becomes

35% greater than bond value. a general creditor.

Equipment trust Used to finance “rolling stock”—airplanes, trucks, Claim is on proceeds from the sale of the asset; if

certificates boats, railroad cars. A trustee buys such an asset proceeds do not satisfy outstanding debt, trust

with funds raised through the sale of trust cer- certificate lenders become general creditors.

tificates and then leases it to the firm, which,

after making the final scheduled lease payment,

receives title to the asset. A type of leasing.

debentures
subordinated debentures
income bonds
mortgage bonds
collateral trust bonds
equipment trust certificates
See Table 6.3