This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
The larger an issue of corporate bonds - assuming of course that it is well secured - the greater will be the marketability, and consequently the value of each bond. It is clear that a local corporation which puts out, let us say, one hundred $1,000 bonds, will be able to sell them only in its local market. The issue is too small either to become well known or to be easily salable at a moment's notice. The big bond issues, on the other hand, are being traded in all the time. It is for this reason that the tendency has been strong in the United States toward consolidating the various bond issues of the larger corporations into one issue, under a so-called "blanket" mortgage, thus securing the important advantages of simplicity and of ready salability. $100,000,000 bond issues, which a few years ago were rare, are no longer regarded as uncommon. There are a number of much larger issues, the biggest of all being the recently authorized issue, amounting to $750,000,-000, of the Northern Pacific Railroad Company.
In England this tendency toward large single issues is not nearly so apparent. On the contrary, English practice seems strongly to favor "hand to mouth" financing. Whenever money is needed, a separate security is planned and issued without much reference either to previous security issues or to the future. The result is that many of the English companies have a complex series of small bond issues, the relative claims and value of which can be determined only after competent study. The basic reason is doubtless to be found in the fact that the English investing public is more accustomed to buying and holding securities until their maturity so that there is relatively less trading in the open market than in this country.
The great majority of bonds in the United States are in denomination of $1,000, although $500 is not uncommon. In recent years there has been a widely advertised tendency toward the so-called "baby" bonds of $100 denomination. The chief argument for these bonds is that they make it possible for a small investor, with perhaps only $1,000 to $5,000 available, to diversify his investment just as is commonly done by large investors. This is an important benefit where its effect obviously is to reduce considerably the risk of heavy loss. The disadvantage lies in the increased cost of selling. It costs practically as much for a banker to sell a $100 bond as to sell a $1,000 bond, and his clerical expenses in connection with the transaction are fully as great. Unless he is operating on a larger margin of profit he does not find the small bond business very attractive.
Bonds are frequently expressed in a currency different from that of the country in which they are issued. There are a great many Canadian bonds, for example, that are payable in pounds sterling, with a view to facilitating their sale in the London market. The Pennsylvania Railroad Company, the New York Central and Hudson River Railroad Company, and others, have issues that are payable in francs as well as in sterling. The Brazil Railways Company, an American corporation operating in South America, has a curious medley of issues payable in milreis (Brazilian currency), francs, pounds sterling, and dollars. Before the European War, a stronger and stronger tendency had been evident toward making the larger and more important issues international, and providing for their payment at fixed rates of exchange in the currency of any of the larger commercial countries, at the option of the holder. It is clear that this tendency has been checked.
A great many bonds, especially those of an international character, are specifically payable in gold coin. This is a highly important provision in the countries in which there is fluctuation, or any considerable danger of fluctuation, in the value of the national currency. The European War, for instance, caused a sudden drop in the value of the currencies of Brazil, Chile, and other South American countries, which inflicted serious loss on many holders of securities payable in national currency. On the other hand, corporations suffered serious loss if they were unable to increase their receipts in national currency but at the same time had to pay their obligations in gold. This was one direct cause of the bankruptcy of some large enterprises. During the period of free silver agitation in the United States, prior to 1896, bonds which included the so-called "gold" clause, sold at a considerably better rate than those which were payable in American currency, the value of which it was feared might depreciate.
The life of bond issues naturally varies a great deal, depending upon the prominence of the business and the nature of the assets offered as security. We shall have occasion to discuss this question with more detail in connection with the subject of methods of redemption of bonds. Some issues are perpetual. Among railroads, 100-year bonds have been fairly popular issues. Among those now outstanding which were put out for this period, are Lake Shore and Michigan first 3 1/2's, issued in 1897; Norfolk and Western first consolidated 4's, issued in 1896; Union Pacific, first and refunding 4's, issued in 1908; Manhattan Railway Elevated 4's, issued in 1890; and Reading divisional mortgage issue of 1897. The Northern Pacific has one mortgage for 101 and another for 150 years; the Erie Railroad has two mortgages at 91 years and one at 84 years.
Interest is almost always paid semiannually. The favorite dates are probably January and July, although payments are scattered through the year. On account of the tendency which exists toward reinvesting interest and dividend disbursements in January and June, and the consequent tendency to increase stock-market prices at this time, there is theoretically a slight advantage to the bondholder in getting his interest payments at other periods. This can hardly be called a consideration of much practical weight.
We have already noted in speaking of stock certificates that bond certificates may be either in registered or coupon form. In American practice some bond issues are registered and some are in "bearer" or coupon form. It is becoming more and more the custom with large issues to give the owners of bonds a choice between the two forms. The registered form has the advantage of greater safety and the bearer form the advantage of greater convenience. When the issuing corporation is located at considerable distance or an international market is desired, the bearer form is likely to be preferred. -The favorite plan at the present time is to make bonds registered as to principal so that the transfer of the bond is not fully completed until it is made on the books of the corporation, but to attach coupons covering the interest payments so that coupons - which are practically post-dated checks - may be clipped and deposited as they fall due. This has been demonstrated by long experience to be the simplest and most satisfactory method of collecting interest payments.
It has been assumed so far in this chapter that bonds are always secured by mortgages covering real property. This is not, however, the case. There are three other important types of security: first; bonds, shares, or other securities may be posted as collateral; second a lien on chattel property such as locomotives, rolling stock, and the like may be accepted as security; third, the general credit of a corporation may be the only security.
We shall see plainly, in reviewing these various types of securities and their variations, that it is unsafe to place much dependence upon names. A "general mortgage" may not have a first lien upon anything; "first and refunding" or "first and unifying" and the like may indicate a first mortgage on some small subdivisions of the property and a second, third, or fourth mortgage on the rest of the property. Every bond issue stands by itself and has its own peculiarities. It is unsafe to comment upon it - and it is certainly unsafe in the extreme to buy it - without having first studied with some care the exact terms and extent of its claim upon property and the nature and value of the property itself.