Distinguish between the types of bonds
Distinguish between the types of bonds. What factors determine their value? Explain three important relationships that exist in bond valuation.
In our book, it describes five types of bonds: debentures, subordinated debentures, mortgage, euro, and convertible bonds. All of these are long-term bonds, over ten years, that pay interest yearly. A debenture bond is a debt that is unsecured. This means that these types of bonds are risky because it is not secured by collateral of any kind. They are backed by the reputation of the issuer. Subordinated debentures are unsecured debenture bonds that take a back seat to other, more secure, types of bonds. This means that a company will pay off other types of bonds first before they pay off the subordinated debentures. They get their value the same way as normal debentures get theirs, by the reputation of the issuing firm. Mortgage bonds get their value form the property put up for collateral. Typically, the property on lien is worth more than the bond amount. A euro bond is any bond issued in a different company than what currency the issuer is paying. This means that a bond issues in Japan by an American firm would pay out in US dollars instead of paying yen (Japanese currency). These bonds have favorable rates and very little regulations, making them very favorable. These bonds are very valuable because they have small par values and high liquidity. The last type of bond mentioned in the book is the convertible bond. These types of bonds can be paid out in the form of a firm’s stock. They have agreed terms at which stock prices are set and at the date of bond maturity, the bond owner can be paid in equal shares of stock. These type of bonds get their value from how well an issuers stock prices are. If by the date of maturity, the issuer stocks are lower than the value price of the bond, there is no convertion and the owner is stuck with the low returns of the bond.
Three important relationships are “1. The amount and timing of the asset’s expected cash flows 2. The riskiness of these cash flows 3. The investor’s required rate of return for undertaking the investment” (Foundations of Finance).