Learn Features of Bonds and Notes Completely

A2 Assess debt features and their implications.

This section describes common features of debt securities.

Secured or Unsecured Secured bonds Bonds that have specific assets of the issuer pledged as collateral. (and notes) have specific assets of the issuer pledged (or mortgaged) as collateral. This arrangement gives holders added protection against the issuer’s default. If the issuer fails to pay interest or par value, the secured holders can demand that the collateral be sold and the proceeds used to pay the obligation. Unsecured bonds Bonds backed only by the issuer’s credit standing; almost always riskier than secured bonds; also called debentures. (and notes), also called debentures, are backed by the issuer’s general credit standing. Unsecured debt is riskier than secured debt. Subordinated debentures are liabilities that are not repaid until the claims of the more senior, unsecured (and secured) liabilities are settled.


Term or Serial Term bonds Bonds scheduled for payment (maturity) at a single specified date. (and notes) are scheduled for maturity on one specified date. Serial bonds Bonds consisting of separate amounts that mature at different dates. (and notes) mature at more than one date (often in series) and thus are usually repaid over a number of periods. For instance, $100,000 of serial bonds might mature at the rate of $10,000 each year from 6 to 15 years after they are issued.

Many bonds are sinking fund bonds Bonds that require the issuer to make deposits to a separate account; bondholders are repaid at maturity from that account., which to reduce the holder’s risk require the issuer to create a sinking fund of assets set aside at specified amounts and dates to repay the bonds.

Registered or Bearer Bonds issued in the names and addresses of their holders are registered bonds Bonds owned by investors whose names and addresses are recorded by the issuer; interest payments are made to the registered owners.. The issuer makes bond payments by sending checks (or cash transfers) to registered holders. A registered holder must notify the issuer of any ownership change. Registered bonds offer the issuer the practical advantage of not having to actually issue bond certificates. Bonds payable to whoever holds them (the bearer) are called bearer bonds Bonds made payable to whoever holds them (the bearer); also called unregistered bonds. or unregistered bonds. Sales or exchanges might not be recorded, so the holder of a bearer bond is presumed to be its rightful owner. As a result, lost bearer bonds are difficult to replace.

Many bearer bonds are also coupon bonds Bonds with interest coupons attached to their certificates; bondholders detach coupons when they mature and present them to a bank or broker for collection.. This term reflects interest coupons that are attached to the bonds. When each coupon matures, the holder presents it to a bank or broker for collection. At maturity, the holder follows the same process and presents the bond certificate for collection. Issuers of coupon bonds cannot deduct the related interest expense for taxable income. This is to prevent abuse by taxpayers who own coupon bonds but fail to report interest income on their tax returns.

Convertible and/or Callable Convertible bonds Bonds that bondholders can exchange for a set number of the issuer’s shares. (and notes) can be exchanged for a fixed number of shares of the issuing corporation’s common stock. Convertible debt offers holders the potential to participate in future increases in stock price. Holders still receive periodic interest while the debt is held and the par value if they hold the debt to maturity. In most cases, the holders decide whether and when to convert debt to stock. Callable bonds Bonds that give the issuer the option to retire them at a stated amount prior to maturity. (and notes) have an option exercisable by the issuer to retire them at a stated dollar amount before maturity.
 

Decision Insight
Munis More than a million municipal bonds, or “munis,” exist, and many are tax exempt. Munis are issued by state, city, town, and county governments to pay for public projects including schools, libraries, roads, bridges, and stadiums.