A corporation is a peculiar thing. A corporation, at least in the eyes of the law, is actually a legal entity, having been born by virtue of its charter; it has certain rights and privileges which are conferred upon it by the state which issued its charter, which specifies the total capitalization and the amount of stock and/or bonds which may be issued; should any further amounts be required, then the charter must be amended.
Such rights include the right to issue a portion or all of the total authorized stock and/or bonds specified in the charter, the power to incur obligations (debts) and to issue bonds to cover such debts, the right to own property, the right of recourse to law for suit or to be sued in turn.
A bond is basically a contract whereby a corporation may borrow money and, in turn, promises to pay interest at a stipulated rate for a fixed period of time. While the stockholder is a part owner in the business, the bondholder is simply a creditor and as such has a prior claim upon the assets of the corporation.
In the event of failure of the issuer of the bond to carry out the provisions of the contract (commonly known as the indenture), the bondholder is protected by law and may take the necessary steps to recover the principal amount which he has lent; in practice this is done by the appointment of a trustee to act for all bondholders as a group in the event of any legal action.
In case of bankruptcy, the claims of any bondholders are prior to all other claims and must be satisfied before stockholders of any class receive anything. Should more than one bond issue be involved, they are usually satisfied in the order of their rank or issue.
As a guide to the purchase of bonds, there are available what are known as "bond ratings." These are obtainable from such organizations as Moody and Standard & Poor; in order to obtain a reasonable appraisal of the merits of a certain bond, one need only refer to the rating assigned to it by these or some other reliable organization. A portion of the ratings of the above two, as applied to better-grade bonds, is shown below:
Moody S & P Remarks
Aaa Al + Highest grade
Aa Al High grade
A A Upper medium grade
Baa Bl + Medium grade
Lower ratings are available, but the investor of modest means will be well advised to confine himself to the better issues. Bonds of good quality are regarded as having very high investment characteristics, especially with regard to safety of principal.
A bond represents a contract whereby the issuing agency borrows money and stands behind such a loan by a pledge of property, so that each bond commonly represents a portion of a mortgage. One might be tempted to think that all bonds are backed by mortgages and are therefore necessarily the best form of investment. This does not follow, because the general reputation of the company, coupled with its over-all financial standing, is of the utmost importance.
Bond selection is best made with the aid of the rating, as given by one of the investment services, and with the assistance of a broker or investment counsel. Some of the matters which should be borne in mind are: (a) type of business (railroad, manufacturing, public utility) ; (b) bond type (mortgage or debenture) ; (c) term, rate of return, special features (callable, convertible, etc.) ; (d) financial status of issuing company; (e) coverage of interest charges, which should be ample; (f) relationship to other bond issues.
While bonds are quoted on a day-to-day price basis, they do not characteristically fluctuate as widely as common stocks - at least the high-grade bonds do not; the medium- and lower-grade bonds are subject to rather sharp fluctuations, and for this reason are perhaps even inferior to higher grade preferred stocks for the investor of modest means.
Once you have a small nest egg, it may be time to invest in some bonds.
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