Debenture Bonds

Not infrequently a strong corporation employs its credit as the sole security for an issue of bonds. At other times, in addition to pledging its credit, other collateral may be added. Where such bonds are issued they are termed debenture bonds. In reality they are but a note like the plain merchant's note, such as banks discount every day without calling upon the borrower for any other security than his name affixed to his note, accepting his credit rating as sufficient guarantee that the note will be paid when it matures. If the bank is not wholly satisfied with the standing of the maker of the note, it will demand, for added security, that the note be endorsed by one or more persons satisfactory to the bank. In the debenture bonds, a corporation, instead of going to the banks for a loan, approaches investors whom it is prepared to pay a fixed rate of interest for a term of years, for the use of their capital. Such bonds should be appraised by the rule applied to a merchant's note - on the credit standing of the maker, and this is usually determined by the periodical statements of earnings issued, indicating the profits in excess of all operating costs.

Convertlblb Bonds

In the convertible bond modern finance has evolved a device to tempt forth the capital of investors who, while still wishing to maintain their position as creditors of a corporation, desire a speculative opportunity to share in the future prosperity of the business. The convertible bond serves this end. Such bonds carry a call upon another security at a given price, usually considerably in excess of the market value at the time the bonds are issued. When the convertible price is reached, the holders of the bond may exercise the privilege of exchanging their bonds into the other security. The convertible bonds of the Union Pacific issued some years ago brought a round profit to those who held them until the company's shares reached their conversion price. The Atchison is another road where this happened. Among the industrial corporations a striking example is the American Telephone & Telegraph Company, whose shares advanced to where it became profitable for the holders of an early issue of convertible bonds to exchange them for the com-, pany 's stock, which was receiving 8 per cent in dividend, in contrast to the smaller interest received from the bonds.

Quite a number of our corporations have resorted to convertible bonds as an expedient to make loans, but the successes attendant upon some of these issues by no means mark these securities with the character of unusual investments. On not a few of this class of bonds, the convertible privileges represent a forlorn hope that an opportunity of making a profitable exchange may present itself. Seldom are there any assets of a tangible character pledged behind the convertible bond. If such exist, their character is stipulated in the mortgage. Such bonds are considered as coming within a semi-speculative class of investments, and for that reason they should be carefully scrutinized by investors. Their safety largely depends upon the issuing company's continued prosperity.

With a description of a few more securities included in the definition of bonds of a general character, I shall close this section.

Short-Term Notes

The most important of the securities which still remain to be described is the short-term note - a useful financial expedient in periods when there is a scarcity of capital and, because of this condition, exacting interest rates. To meet this situation, corporations borrow capital for their pressing needs for only a short term of years by means of notes running for a brief period, and agree to pay interest on them in accordance with the current money rate. In hard times it would be folly for a corporation to make a long-term loan for two reasons. One is that such a loan, at the current high rates, would prove unusually expensive if spread over a long time, and the other and more important reason is the disastrous influence likely to follow in depressing the price of the outstanding bonds which a corporation has sold when there was a plethora of money and interest rates were low.

If the holder of a 4 per cent bond having still ten years to run, saw an opportunity to replace it for a 5 per cent bond of his corporation which would not mature before his security matured, the natural inclination would be to exchange the one for the other. It is to equalize the interest with the bonds already outstanding, that short-term notes are employed. This class of securities crowd upon the market in panic years and in the years of depression which follow. Other securities may mature in these abnormal periods which must be taken care of, or capital may be needed for other purposes.

The late H. H. Rogers, rich as he was, found himself in a tight corner in the panic of 1907. He was just finishing the Virginian Railroad and needed a few million dollars hurriedly. It was out of question to raise this money by offering first mortgage bonds, especially on an incompleted railroad. The banks were not lending any money except on gilt-edged collateral. Mr. Rogers could not allow his cherished ambition to fail in this critical period without suffering a great loss in prestige. He was forced to issue short-term notes carrying 6 per cent interest and had to pledge to insure their security a large part of his investments in Standard Oil, and shares in banks and gas companies - in all over $18,000,000, the income on which provided for the interest on the notes several times over. Mr. Rogers' experience illustrates that periods are reached in nearly every rich man's career when borrowing money is not an easy matter.

Nor do corporations escape the exactions placed upon them by hard times. Municipalities enjoying in normal times the best of credit, are forced to pay large interest to borrow what money they need. A case in point is that of the city of New York, which at one time, only a few years previous to the 1907 panic, readily sold 3½ per cent bonds at a premium, but was forced to raise its interest rate to 4½ per cent.

By the use of short-term notes corporations finance their needs to bridge a period of tight money, depending upon their ability with the return of easier conditions to refund these obligations with a security which calls for a more reasonable interest rate. Most of the large railroads and industrial corporations have found these short-term obligations a great convenience in trying times.