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Not only is this tax saving of great value, but quality municipal bonds are regarded as among the choicest and safest investments in the world. In selecting municipal bonds for permanent investment income, maturities of twenty years or longer are recommended and the bonds should have a quality rating of AA or better. Consult your broker for municipal bonds; he can help you secure the best yield values at the time of your purchase. It must be borne in mind, however, that municipal bonds are not actively traded and all of them are bought, sold and quoted over-the counter.
Stock Corporations and the Securities They Issue
Stock corporations may raise money both by borrowing and by selling stock. Corporate borrowing has certain advantages: (1) It permits the use of a specific sum of money for a definite period of time at a stated rental (the interest rate); (2) Interest is deductible as a business cost before calculation of net profits; (3) The borrowed money adds substantially to the total capital on which a profit may be earned, and often accelerates the acquisition of new equipment. The disadvantage of corporate borrowing is that the interest must be paid and the money paid back to the investors, or they may, by enforcing their claims as creditors, take over the company.
Types of Corporation Bonds
When a company borrows, it has a wide selection of obligations to choose from. It may issue short-term notes—five years or less. Or it may issue bonds. There, in turn, are several varieties of these. The oldest is the first mortgage bond. The corporation, in this security, promises to repay the borrowed funds at some remote future date—10, 15, or 50 years away—and for the protection of investors pledges its property under a first mortgage or lien. Northern Pacific Prior Lien 4's, and
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West Shore Railroad 1st Mortgage 4's are good examples.
If, later on, a company fails to pay interest on its mortgage bonds, the bondholders have the legal right to foreclose, i.e., take over the mortgaged property, and either sell it or operate it to satisfy their claims against the borrower.
There are some other types of bonds you should know about. There's the collateral trust bond wherein specific assets, usually securities (either bonds or stocks), may be pledged to assure payment of principal and interest. There are debentures which are long-term, unsecured promissory notes; and there are subordinated debentures which come after existing debentures or other indebtedness in the corporate structure. And there are bonds convertible into other securities.
Finally, there is the income bond differs from others in that interest can be skipped without penalty. This is the weakest sort of bond. Income bonds, in most cases, came into being as the result of a corporate organization. They pay interest only if it is earned. If the issuing company has a bad year, it may pay no interest at all, although there is usually a provision that if interest payment is omitted in one year, it will become cumulative and be paid later on when earnings may permit. The disadvantage of the income bond lies in this uncertainty of interest payment.
Summary about Bonds
Bonds, whether of the mortgage or debenture variety, are pretty well standardized. They come in $1,000 denominations (sometimes $500 and $100 as well); they pay interest semi-annually by coupons attached to each bond. All you do is clip the coupons when due and present them to any bank for collection and payment. Many investors find this coupon-clipping a pleasant pastime! (Some bonds may be registered, in which case the interest is paid by check.)
You must remember, however, that as a bondholder you are always a creditor. Your bond income is limited
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to the stated rate, and the payment at maturity is at the face amount. Bonds (except convertible ones which well go into in a later chapter) are seldom bought for speculation. If you buy a bond at a great discount from its face amount, it may be because there is considerable doubt about continuity of interest.
Uses of Bonds
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