CORPORATE BONDS

Many corporations issue (or float) bonds to borrow money for operations. Bonds are typically issued at $1,000 par. Par is another word for "face amount." Long-term bonds have maturities of 10 to 40 years. They generally pay interest semi-annually. Many bonds may be recalled prior to maturity by the issuer.

If a corporation goes bankrupt, bondholders, as well as stockholders, can make a claim to the corporation's assets. In Bankruptcy proceedings, Bondholders generally receive priority over stockholders.

Some corporations issue bonds for less than their par values. When they repay the bonds at maturity, the investors receive the face values. This is known as discounting the bond.

The interest on bonds is stated as a percentage of the par value.

Bond prices are quoted on $100 even though their face amount is usually $1000. For example, a quote of 85 indicates a bond selling for $850. Amounts less than $10 are quoted in eighths. An eighth is equal to $1.25. A quote of 80 1/8 is $801.25 ($800 + $1.25).

Various rating services rate corporate bonds for their safety, creditworthiness, and likelihood of repayment.

FEATURES OF CORPORATE BONDS

All of these common features of corporate bonds are established at the time of issue.

Callability is the feature of a bond whereby the corporation that issued it can redeem the bond before it matures. Corporations may call their bonds when interest rates drop below their current bond rates. They may then replace high-yielding bonds with lower-yielding bonds. Call provisions must be made clear before a bond is issued. These provisions include the call price, which is the price at which the bond will be bought back from bondholders. The call price is usually above par. The company must also include dates on which it can legally begin to order its bonds redeemed.

A put provision is the privilege whereby the bondholder may redeem a bond at its face value before it matures. Investors may want to do this when interest rates are rising and they can take advantage of higher rates elsewhere. They may not "put" their bonds whenever they choose, however. The issuer assigns dates for this provision, after which the bondholders may then redeem the bonds.

Convertibility is the option of converting a bond into stock. Bonds with this feature are called convertible bonds. They give the investor the option to convert the bond into the issuing company's stock, usually the company's common stock. Conversion must occur at specified times, at specified prices and under specified conditions set in writing at the time of issue. Bonds can be callable and convertible in one. With this provision, the company may have the option to pay investors in stock.

TYPES OF CORPORATE BONDS

Collateral trust bonds are bonds that use other securities as collateral.

Mortgage bonds are backed by mortgages on specific assets or physical property of the company issuing them.

Equipment trust certificates are certificates that offer equipment as backing. Railroads and airlines commonly use them.

Zero coupon bonds are bonds that do not pay periodic interest but are sold at a discount to make up for the lack of interest payments. Instead of receiving interest, the holder receives the full face value of the bond at maturity.

Convertible bonds are bonds that can be converted into other securities of the issuing corporation, generally shares of common stock, though certain provisions regarding conversion are attached to the bond.

MUNICIPAL BONDS

Municipal bonds (nicknamed munis) are bonds issued by states, cities, counties and various districts to raise money to finance their operations or to pay for projects such as hospitals, schools, power plants, etc. Individual investors purchase the majority of municipal bonds. These bonds are usually issued in $5,000 (par) denominations.

Most municipal bonds are free of federal income taxes on interest distributions. Also, they are often free from state and local taxes in the state in which they are issued. These features make them hugely popular among small investors. Municipals are considered relatively safe from default.

There are two types of municipal bonds: general obligation and revenue.

General obligation bonds (GO bonds) are unsecured municipal bonds that finance municipal operations. They have maturities of 10 years or more. The creditworthiness of the issuing city or state is the only "security" they provide. The municipal issuer repays the bonds with funds raised by taxes, fees or property sales.

Revenue Bonds are issued to finance certain projects and assets. The revenues from these projects and assets are used to make interest and principal payments on the bonds. Such revenues include tolls, fees and lease payments. However, the issuer does not have to make interest payments to investors unless there is enough revenue generated.

U.S. GOVERNMENT SECURITIES

The U.S. government issues its own securities from the U.S. Treasury and several government agencies. U.S. government securities are very popular with investors worldwide. They offer fixed interest rates and have durations comparable to corporate bonds. These securities are considered by many to be the safest of all because of the creditworthiness of the U.S. government.

The Treasury also issues Treasury notes and Treasury bills. It sells its securities at regular auctions or from banks or brokerage firms. The income these securities earn is subject to federal taxes, but not state taxes.

Government bonds are quoted on $100 even though their face value (par) may be $1,000. Fractions are given in 32nds. The fraction appears after the decimal point in the quotation. For example, a bond quoted at 88.8 would have a price of $882.50 ($880 + 8/32 of $10).

There are two types of Government securities. Marketable securities can be traded on the secondary market through exchanges or over the counter. Non-marketable securities can only be redeemed back to the government.

MARKETABLE SECURITIES

Treasury notes (T-notes) have maturities ranging from over a year to ten years. They are fixed-income securities that pay interest twice per year.

Treasury bonds (T-bonds) are long-term, non-collateralized bonds whose maturity dates range from 10 to 30 years. Like T-notes, they pay interest twice per year.

Mortgage-backed securities are securities issued by federal agencies to help fund their projects. Two well-known issuers are the Government National Mortgage Association (GNMA-Ginnie Mae) and the Federal National Mortgage Association (FNMA-Fannie Mae).

NON-MARKETABLE TREASURY SECURITIES

Series EE bonds are savings bonds that pay interest when they are redeemed. Investors purchase them for less than their face values and let them build up to full face value at maturity. The maximum face value possible is $30,000. Series EE bonds can be purchased at banks or through payroll deduction plans.

Series HH bonds are savings bonds that are sold at their face values. They pay semi-annual interest. The denominations range from $500 to $10,000. Maturities range from ten to twenty years.

MONEY MARKET SECURITIES

The money market is an investment area where investors can buy short-term debt securities. Money market investments are the short-term debts of governments, banks, financial institutions and corporations. They mature in anywhere from one day to one year. The large majority of investors in these securities are institutions; few are individuals.

Larger securities broker-dealer firms and large commercial banks usually handle money market securities.

For a look at the most popular types of money market investments, read below.

MONEY MARKET INVESTMENTS

Negotiable CD's are a type of CD issued in denominations over $100,000 and sold on the open market. The depositor of a negotiable CD is allowed to negotiate the interest rate with the bank. They have maturities ranging from 30 days to more than one year.

Treasury bills (T-bills) are federal government issues sold for discounts at auctions. They mature in 90, 180 or 360 days. The minimum face value sold is $10,000.

Commercial paper is an unsecured, short-term IOU issued by corporations with good credit. These corporations use them to buy inventories. Companies discount and sell commercial paper to other companies and sometimes to individual investors. Maturities are 270 or fewer days.

Banks that want to finance importing and exporting with firms in foreign countries use banker's acceptances. A bank pays a foreign party on behalf of an importer and assumes liability. Banker's acceptances are usually issued in denominations over $100,000.

A repurchase agreement (repo) is a contract between a buyer and a seller of debt securities, stating that the seller will repurchase the securities after a certain length of time or after certain conditions are met. A bank or dealer sells some of its securities to another party, who buys it back at a higher price. Maturities range from one to 90 days.

Money market mutual funds are pools of money market securities. The funds use money from large numbers of investors to buy these securities. They make investing in this market easy for small investors.

This tutorial provides only a brief overview of debt securities.