2.3 Corporate Bonds
Corporate debt issues range from highly secure equipment obligations to speculative junk debentures and hybrid convertible bonds with equity participation upside.
Key FINRA Exam Takeaways
- Secured corporate debt: Mortgage bonds (real property), Collateral trust bonds (securities), Equipment trust certificates (rolling stock/airplanes).
- Unsecured debt: Debentures (backed only by full faith and credit) and Subordinated debentures.
- Convertible bonds: Conversion Ratio = Par ($1,000) ÷ Conversion Price.
- Parity calculations: Parity of Stock = Market Price of Bond ÷ Conversion Ratio; Parity of Bond = Market Price of Stock × Conversion Ratio.
- Trust Indenture Act of 1939 requires corporate debt issues >$50M to have an independent trustee protecting bondholders.
Secured vs. Unsecured Corporate Debt
Equipment Trust Certificates (ETCs) are secured by physical machinery, airplanes, or locomotives, holding high investment-grade ratings. Debentures rely solely on the issuer's general creditworthiness.
Convertible Bonds and Parity Calculations
Conversion Ratio = $1,000 Par ÷ Conversion Price. If Conversion Price is $25, the bond converts into 40 shares ($1,000 / $25). Parity Stock Price = Bond Price ÷ 40. If the bond trades at $1,200, parity stock price is $30.
Convertible Bond Parity Calculation
An investor owns an XYZ Corp 5% convertible bond trading at 108 ($1,080). The conversion price is $20. What is the parity price of the underlying common stock?
- Step 1: Calculate Conversion Ratio = $1,000 Par ÷ $20 Conversion Price = 50 shares.
- Step 2: Calculate Parity of Stock = Current Market Price of Bond ($1,080) ÷ 50 shares.
- Step 3: $1,080 ÷ 50 = $21.60.
An investor owns an ABC Corp convertible debenture with a conversion price of $40. The common stock of ABC is currently trading at $45 per share. What is the parity price of the bond?