The corporations of America raise funds for operational purposes by retaining internally generated funds (profits) by issuing stock and by issuing bonds.
Bonds mean indebtedness; the bondholder is a creditor. The buyer loans the corporation money for a certain period of time (the maturity), at fixed rate of interest (the coupon). The corporation agees to pay the purchaser the amount of money (principal) that was loaned plus a rate of interest on that money as long as the loan or bond is outstanding. All the terms are stated in the bonds indenture which is the place to look if there are ever any questions concerning the claims the buyer might have on the issuer.
Bonds may be backed or secured by rolling stock (railroads), natural resources (mining companies), securities (collateral trust notes), or in the case of most public utilities, by a lien on specific property (a mortgage).However, bonds may be issued without any backing (unsecured) except for the good name or the credit of the corporation. This type of debt is called a debenture.
All of the pertinent information about a new issue is available either in a "red herring" prior to an offering or in the prospectus once the offering has been completed.
Corporate bonds are sold to the public in one of two basic ways. They are either negotiated by a single syndicate or bid for competitivevely by several syndicates. In either case, a syndicate made up of various brokerage houses and headed by a lead underwriter markets the issue. A secondary trading markets the issue. A secondary trading market is maintained by many brokerage hourses after issues are marked. Matuities
Until the early '70s', most corporate bonds were of long-term maturity. (20 to 30 years). However, with the excessively high interest rates of 1972 through 1974, issuers began selling intermediate bonds of 5-, 7- and 10-year duration. These bonds became especially appealing to individuals and trust departments.
Of prime importance in purchasing a bond is the ability of the issuer to pay the semi-annual interest and to repay the principal at maturity. This ability can be equalated with risk, which is expressed in the rate of return or interest paid or yield on a particular bond. The poorer the credit rating of a company, the greater the risk, and consequently the greater the yield or return on the bond. Conversely, the better the ability to pay the interest and principal, the less return or interest.
Call protect is an important consideration especially when a bond is purchased when interest rates are at a high level. Call protection is the length of time that exists before the issuing company may 'call in', or pay off an outstanding issue.
For example, if you buy a new issue with an 8.75 per cent coupon at par, you would like to keep that 8.75 per cent as long as possible. If, in a few years, interest rates were 7 per cent, it would be to the advantage of the issuing corporation to pay off the 8.75 per cent issue and replace it with a 7 per cent issue (if legally possible). Their ability to call in the 8.75 per cent bond could by stymied if the bonds are non-callable for ten years. A good rule of thumb for the investor is that the higher the interest rates, the more call protection should be sought. Tyle of Corporate Bonds
The major types of corporate bonds are public utility, railroad and industrial bonds, which now have approximately $225 billion in straight debt outstanding.
Of these, public utility issues far outpace the oters with about $120 billion outstanding. Telephone, electric, and other energy companies make up the utility spectrum. Amercian Telephone & Telegraph does the most financing and is considered top AAA paper. Most telephone and electric issues are non-callable for five years and are sold with intermediate and long maturities. Rating-wise, the investor should stick to the top four categories (AAA-BAA), parade of new and different issues are constantly before the investor. These securities are issued in minimum denominations of $1,000 in registered form only. Industrial Bonds Industrials do not come that frequently to the market place, but when they do, they range in size from $50 million to $500 million. The main features are ten-year call pretection and sinking funds. Most industrials are in the AA and A class although some AAA and several BAA are marketed, all industrials are negotiated issues. Railroad Bonds
The great majority of railroad bonds are equipment trust certificates that are issued by the roads and collateralized by the equipment itsel. These are sold in serial form, that is, an issue will have maturities running annually from one to fifteen years. They are non-callable and the longer maturities are in great demand. Depending on the particular issue, equips may come in registered or coupon form and in denominations as small as $1,000. These securities are mostly AA- and A-rated. Finance Companies
Finance companies frequently sell a long and an intermediate security together. The longer issues generally have ten-year call-protection.