What are the different types of bonds you will encounter?

Mortgage bonds and collateral.

Collateral is an important aspect of bonds. In today’s home-buying market, people borrow money from banks and use their homes as collateral. If homeowners fail to re-pay loans, banks kick them out, repossess their homes, and sell the real estate to try to recover as much of their original loans as possible.

Like homeowners, railroads usually offered collateral when they borrowed money from investors. They often guaranteed their mortgage bonds with all conceivable combinations of land, equipment, locomotives, and rolling stock as collateral. When companies failed to repay their bonds, courts forced them to liquidate their holdings in order to re-pay their investors.

Just like the modern home loan market, railroad companies often raised extra money with second, and even third, mortgages. First mortgage bonds constitute a little more than two-thirds of all bonds currently known. Second mortgage bonds are much less common. Currently only seven varieties of third mortgage bonds have been identified on the collectible stock and bond market.

Debentures.

Some railroads did not bother with collateral. They did not secure their loans at all. They guaranteed nothing. Such loans are called debentures. Instead of being secured by property, debentures are secured by company reputations and nothing else. A convertible debenture allowed investors to convert bonds into stock under specific circumstances. Only about 6% of collectible bonds are debentures.

Sinking fund bonds.

In financial jargon, floating loans means initiating loans. Extending the metaphor, sinking loans means paying off loans. Companies sometimes established special savings funds, earmarked solely for sinking loans. The idea was to allow companies to use those funds to redeem high-interest loans prematurely, especially if prevailing interest rates ever fell. About 8% of surviving collectible bonds are labeled as sinking fund bonds.

Consolidated bonds.

Companies often borrowed money in several series of loans over several years. If companies needed money at inopportune times, they wound up paying higher interest rates than they wanted. When prevailing interest rates dropped to acceptable levels, companies often floated new bond issues to consolidate and redeem older loans. Today's analogy is the practice of re-financing homes in order to pay off automobile loans and high-interest credit card bills.

Land grant bonds.

The Railroad Act of 1862, and its later modification by the Pacific Railroad Act of 1864, granted land to railroads to entice them to lay tracks across the West. In some cases, the U.S. granted as much as 50 square miles of land per mile of track laid. Once they owned the land, companies raised money for rail building by selling land. A few companies sold bonds and used their land grants as collateral. Fewer than forty varieties of land grant bonds appear in this catalog. Click here to learn more about land grants.

Government aid bonds

This catalog lists approximately 175 bonds issued by public entities to aid the building of railroads. While the wording and purposes of these kinds of bonds varied from place to place, the concept was fairly simple. If people wanted to get rail service into remote towns, cities, townships, counties, and states, they made deals with railroad companies. The public entities would pay for railroad building, if the companies would agree to provide service.

Equipment trusts

Large companies often used equipment trusts to finance their purchases of rolling stock. Most trusts were party arrangements somewhat separate from railroad companies. Large trust companies administered trusts and the trusts owned rolling stock instead of railroad companies. Trusts in turn leased equipment to a like-named railroad companies.

From companies' perspectives, leasing equipment through trusts is substantially more advantageous than buying equipment through ordinary loans. The economic rationale lies with the complicated relationship between interest rates, inflation rates, and tax rates. In short, companies may deduct all their equipment lease payments made to trusts. Conversely, they can only deduct interest payments made on ordinary bonds. And the higher the prevailing inflation rates, the more advantageous equipment trusts become.

Equipment trusts functioned in the middle ground between stocks and bonds. The certificates themselves resemble vertical format bonds. Equipment trusts were often sold in 'shares' of $1000. Instead of interest payments, they paid 'dividends.' The dividends, though, were offered in percentages just like typical bonds.

Most equipment trusts had specific terms, usually ten years or less. Most trusts sold issues in series, each varying in percentage rates and terms. Many equipment trusts sold serial certificates that became payable over a period of years instead of all at once. This allowed companies even greater flexibility in controlling both the amount of debt and the amount of money borrowed.

Experts could legitimately argue that equipment trusts are entities separate from both stocks and bonds. For the purposes of this price guide, though, that they are best lumped with bonds for ease of discovery.