Types of Corporate Bond | Long-Term Debt Instruments | Financial Management
A bond is a long-term contract under which a borrower agrees to make payments of interest and principal on specific dates to the holders of the bond. It is long-term debt security or long-term promissory note having a maturity period of more than one year. Bonds are issued by corporations and government agencies that are looking for long-term debt capital. The borrower of the securities promises to pay fixed periodic interest till the maturity period and at the end maturity value or face value as well.
The interest payment is called coupon payment. In the issuance of a bond the legal document indenture is prepared which specifies the right and duties and all the terms and conditions related to bonds. The indenture also specifies the rights and responsibilities of the trustee.
Types of Corporate Bond
There are various types of corporate bonds in practice. Some of them are as follows;
A Mortgage Bond is a type of bond that is issued using specific assets as collateral for the security of the bond. It is also called a secured bond since at the time of default of the bond interest and redemption that specific asset is sold to satisfy their claims. If those specific assets cannot cover the amount of the bond outstanding, the bondholder becomes general creditors for the residual amount.
A company may have more than one bond issue secured by the same property. A bond issue may be secured by a second mortgage on property already used to secure another bond issue under a first mortgage. In the event of foreclosure, the first mortgage bondholders must be paid the full amount owed them before there can be any distribution to the second mortgage bondholders.
Debentures are unsecured long-term debt issued by the company without pledging any specific assets. Debenture holders are the general types of creditors in case of liquidation if a firm fails to pay the interest and meet the principal amount. The debenture holders invest in the debentures by analyzing the profitability future growth rather than the specific collateral. These debts can be secured with the help of covenants in indenture. Debentures are more risk than mortgage bonds. Generally, debenture has a call provision that also adds a risk of calling the bond when market interest decreases.
A subordinated debenture is a long-term, unsecured debt instrument with a lower claim on assets and income than other classes of debt; known as junior debt. Generally, subordinate debentures have a higher rate of return than mortgage bonds and debentures. Frequently, subordinate bonds are issued with convertible features for better marketability.
An Income bond pays interest only if a company earns sufficient income to pay the obligation otherwise interest will be accumulated for up to three years. A company can pay the accumulated interest to the income bondholder when sufficient income is earned. These bonds are less secured than regular bonds but more secured compared to preference share and common stock. The yields on income bonds should be higher than the regular bonds because of the higher risk.
A Junk Bond is an unsecured, risky bond issued by weak companies that yield higher than all other types of bonds. Junk bonds are rated below investment grade. When a market is unstable and a higher risk exists and firms issue the bonds at a higher rate, those bonds are called junk bonds. Generally, these junk bonds are issued through private placement which means that through direct negotiation between individual investors rather than a formal investment banking process.
A bond, which can be converted into a specified number of common stocks within a specific future date at the investor’s desire is called a convertible bond. Convertible features of bonds may attract the investors of bonds if the company likely to perform well in near future and increase the share price of the company even if the coupon rate is lower than regular bonds. Convertible bonds are a good option for the company too because it reduces the interest expense and flotation cost to issue new common stock in the future.
Callable And Puttable Bonds
Callable bonds are those which can be called by the company before maturity. In contrast to the callable bond, a puttable bond allows the bondholders the option to exchange the bond for cash. Call provision gives the right to the company to call the bonds and puttable bond provision gives the right to the bondholders to exchange the bond for cash.
Zero-Coupon Bond or Zeros
The bond which is issued at discount without any interest payment(less than par value) and paid face value at the maturity is called a Zero-coupon bond. Generally, zero-coupon bonds are issued by companies having irregular cash flow or government. Government bonds and municipal bonds are issued without coupon interest.
Floating Rate Notes/Bonds
Under floating rate notes, the coupon rate is adjusted according to market interest rate change but the minimum floor rate is often specified. These bonds are less risky than regular bonds because the yield is adjusted according to the market interest rate. From the company (issuer) perspective too, floating-rate notes proved to be beneficial when the market interest rate decrease.