TRADITIONAL TYPES OF BONDS

I. Unsecured bonds

- A bond that has no specified source of collateral. In other words, the bond is only
secured by the bond issuer’s good credit standing. There are no buildings, equipment, vehicles,
or other assets backing up the bond.

- Unsecured bonds are usually only issued by companies or government bodies that
don’t have enough assets to put up for collateral or government bodies.

Example:

• If a company can’t raise enough capital to back a bond issuance, it is usually a

sign of a risky investment. Governments, on the other hand, can always raise
taxes if they need to pay off bond holders. An unsecured bond from a
municipality is usually a safe investment. Even in the rare circumstance that a
governmental body declares bankruptcy; the bonds are usually covered by other
governmental bodies.

-Since unsecured bonds are more risky to investors than secured bonds, unsecured
bond issuers usually have to pay a higher interest rate to the bond holders. Depending on the
company or governmental organization, the interest rate could be one percent or ten percent.
This rate difference largely depends on how trustworthy and financially stable the company or
governmental organization is.

A. DEBENTURES
- These bonds are backed only by the issuer’s good word and written agreement (the
indenture) stating that the issuer will pay the investor interest when due (usually
semiannually) and par value at maturity.
- It has usually has a term greater than 10 years.
- When issuing a debenture, first a trust indenture must be drafted. The first trust is an
agreement between the issuing corporation and the trustee that manages the interest of
the investors.
- The company's credit rating and ultimately the debenture's credit rating impact the
interest rate that investors will receive. Credit-rating agencies measure the
 creditworthiness of corporate and government issues. These entities provide investors
with an overview of the risks involved in investing in debt.

Risks to Investors
- Debenture holders may face inflationary risk. Here, the risk is that the debt's interest
rate paid may not keep up with the rate of inflation. Inflation measures economy-based
price increases. As an example, say inflation causes prices to increase by 3%, should
the debenture coupon pay at 2%, the holders may see a net loss, in real terms.
- Debentures also carry interest rate risk. In this risk scenario, investors hold fixed-rate
debts during times of rising market interest rates. These investors may find their debt
returning less than what is available from other investments paying the current, higher,
market rate. If this happens, the debenture holder earns a lower yield in comparison.
- Debentures may carry credit risk and default risk. As stated earlier, debentures are
only as secure as the underlying issuer's financial strength. If the company struggles
financially due to internal or macroeconomic factors, investors are at risk of default on
the debenture. As some consolation, a debenture holder would be repaid before
common stock shareholders in the event of bankruptcy.

Example of Debenture:
An example of a government debenture would be the U.S. Treasury bond (T-bond). T-
bonds help finance projects and fund day-to-day governmental operations. The U.S.
Treasury Department issues these bonds during auctions held throughout the year.
Some Treasury bonds trade in the secondary market. In the secondary market through a
financial institution or broker, investors can buy and sell previously issued bonds. T-
bonds are nearly risk-free since they're backed by the full faith and credit of the U.S.
government. However, they also face the risk of inflation and interest rates increase.

B. SUBORDINATED DEBENTURES
- Subordinated debt (also known as a subordinated debenture) is an unsecured loan or
bond that ranks below other, more senior loans or securities with respect to claims on
assets or earnings. Subordinated debentures are thus also known as junior securities. In
the case of borrower default, creditors who own subordinated debt will not be paid out
until after senior bondholders are paid in full.
 - Subordinated debt offers higher yields than all other debt instruments due to their
inherent subordination risk.
- Subordinated debt is any debt that falls under, or behind, senior debt. However,
subordinated debt does have priority over preferred and common equity. Example of
subordinated debt is mezzanine debt, which is debt that also includes an investment.

C. INCOME BONDS
- These bonds are the riskiest of all. The issuer promises to pay par value back at
maturity and will make interest payments only if earnings are high enough.
Companies in the process of reorganization usually issue these bonds at a deep
discount.

II. Secured Bonds

A. MORTGAGE BONDS
- is a bond in which holders have a claim on the real estate assets put up as its
collateral. A lender might sell a collection of mortgage bonds to an investor, who then
collects the interest payments on each mortgage until it's paid off. If borrowers
cannot repay their debts, bondholders can sell the underlying assets to cover the
payments that they should receive according to the contract terms.
B. COLLATERAL TRUST BONDS
- A collateral trust bond is a bond that is secured by the issuer's own security
investments. These investments are deposited with a trustee, who holds them on
behalf of the bond holders. If the issuing entity defaults on its bond obligation, the
bond holders receive the securities held by the trustee.
C. EQUIPMENT TRUST CERTIFICATES
- An equipment trust certificate (ETC) refers to a debt instrument that allows a company
to take possession of and enjoy the use of an asset while paying for it over time. The
debt issue is secured by the equipment or physical asset. During this time, the title for
the equipment is held in trust for the holders of the issue. After the debt is satisfied, the
asset's title is transferred to the company.

- ETCs are now used in the sale and purchase of aircraft and shipping containers.
CONTEMPORARY TYPES OF BONDS

I. Zero (or low) Coupon Bonds

- A zero-coupon bond is a debt security instrument that does not pay interest but
instead trade at deep discounts, offering full face value (par) profits at maturity
- The difference between the purchase price of a zero-coupon bond and the par value
indicates the investor's return.
II. Junk Bonds
- A bond is a debt or promises to pay investors interest payments and the return of
invested principal in exchange for buying the bond. Junk bonds represent bonds
issued by companies that are struggling financially and have a high risk of defaulting
or not paying their interest payments or repaying the principal to investors.
- For example, a bond that has a 5% annual coupon rate means that an investor who
purchases the bond earns 5% per year. So, a bond with a $1,000 face—or par—
value will receive 5% x $1,000 which comes to $50 each year until the bond matures.
III. Floating-rate Bonds
- A floating-rate note is a bond that has a variable interest rate. The interest rate is tied
to a short-term benchmark rate. Since the bond's rate can adjust to market
conditions, an FRN's price tends to have less volatility or price fluctuations. If market
interest rates fall, the FRN rates may fall as well.
- FRNs can have default risk if the issuing company or corporation can't pay back the
principal.
- Term or maturity of two years
IV. Extendible Notes
- An extendable bond (or extendible bond) is a long-term debt security that includes an
option to lengthen its maturity period. Because these bonds contain an option to
extend the maturity period that may call for a possibility for a higher return, these
bonds sell at a higher price than non-extendable bonds.
- A bondholder has purchased $10,000 worth of extendable bonds, with a fixed
interest rate of 1.25% per year and a three-year term, from a bond issuer. After those
three years pass, if the rate is still favorable, the investor decides to extend the
bond's term for three more years to lock in that rate.
 V. Putable Bonds
- is a type of bond that provides the holder of a bond (investor) the right, but not the
obligation, to force the issuer to redeem the bond before its maturity date. it is a bond
with an embedded put option, if exercised, the bondholder receives the principal
value of the bond at par value.
- The relationship between interest rates and the price of bonds is inversed. Since the
value of the bonds declines as interest rates rise, they provide investors with
protection from potential interest rate increases. At the same time, the bond issuers
reduce their cost of debt by providing lower yields on the bonds. Investors accept
lower yields in exchange for the opportunity to exit the investments in case of
unfavorable market conditions.
- Example, https://corporatefinanceinstitute.com/resources/knowledge/trading-
investing/putable-bond/

CORPORATE BONDS

- A corporate bond is a type of debt security that is issued by a firm and sold to
investors. The company gets the capital it needs and in return the investor is
paid a pre-established number of interest payments at either a fixed or
variable interest rate. When the bond expires, or "reaches maturity," the
payments cease and the original investment is returned.
- The backing for the bond is generally the ability of the company to repay,
which depends on its prospects for future revenues and profitability. In some
cases, the company's physical assets may be used as collateral.

I. INTERNATIONAL BOND ISSUES

- An international bond is a debt obligation that is issued in a country by a non-
domestic entity. Generally, it is denominated in the currency of its issuer's
native country. Like other bonds, it pays interest at specific intervals and pays
its principal amount back to bondholder at maturity.

VALUATION
- Cash flow is the net amount of cash and cash-equivalents being transferred
into and out of a business. At the most fundamental level, a company’s ability
to create value for shareholders is determined by its ability to generate
positive cash flows, or more specifically, maximize long-term free cash flow
(FCF).
The Three Key Inputs to Valuation Process:
1) what the future cash flows (CF) will be,
2) when the future cash flows will be,
3) the rate at which time affects value (e.g., the costs per time period, or the
magnitude [the size or amount] of the effect of time on value).