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Types of bonds
Here are the most common types of bonds you will encounter
Collateral is an important aspect of bonds. In todays home-buying market, people borrow money from banks and use their homes as collateral. If homeowners fail to re-pay loans, banks evict them, repossess 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 by using 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 investors.
Just like the modern home loan market, railroad companies often raised extra money with second and occasionally third mortgages. A little more than two-thirds of all currently known bonds are first mortgage bonds. Second mortgage bonds are much less common. Currently only fourteen varieties of third mortgage bonds have been identified on the collectible stock and bond market.
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.
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.
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 two or more older and more expensive loans. Today's analogy is the practice of re-financing homes in order to pay off automobile loans and high-interest credit card bills.
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 companies gained title to the land, they attempted to sell land in order to raise money for rail building. A few companies sold bonds and used their land grants as collateral. So far, 69 varieties of land grant bonds appear in this catalog. Click here to learn more about land grants.
This catalog lists approximately 255 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. Public entities agreed to help pay for railroad building if companies agreed to provide service.
Large railroad companies often leased equipment from equipment trusts instead of owning their equipment outright. Equipment trusts were generally two-party arrangements related to but separate from railroad companies. Large trust companies administered equipment trusts and sold shares to investors. The trusts owned rolling stock and leased that equipment to like-named railroad companies. For instance, the Florida East Coast Railway Equipment Trust leased equipment to the Florida East Coast Railway Co.
Equipment trust certificates are sometimes found that seem to have been issued by railroad companies themselves. It is often unclear whether those kinds of equipment trusts were administered with companies' other bonds or not. For the purposes of this guide, equipment trust certificates which carry the word "Company" as part of the title are listed with railroad companies. Otherwise, if lacking the word "Company", certificates are listed as separate equipment trust companies.
From companies' perspectives, leasing equipment through trusts is often substantially more advantageous than buying equipment through ordinary loans. The economic rationale lies with the complicated relationship between interest rates, inflation rates, depreciation and tax law. In short, companies may deduct all their equipment lease payments made to trusts. Conversely, they can only deduct interest payments made on ordinary bonds. The higher the prevailing rate of inflation, the more advantageous equipment trusts become. If visiting railroad history museums, you can often see plaques on locomotives and rolling stock testifying to ownership by equipment trust companies. (The plaque at left was found at the Colorado Railroad Museum in Golden, Colorado.)
Equipment trusts have always functioned in the middle ground between stocks and bonds. Strictly speaking, equipment trusts are organizations completely separate from railroad companies. Equipment trust certificates usually resemble vertical format bonds, but equipment trusts were often sold in 'shares' of $1000. While it seems a semantic argument, equipment trusts paid 'dividends' to investors instead of interest, generally in percentages similar to typical bonds.
Most equipment trusts had specific terms of fifteen years or shorter. Most equipment trusts were generally offered in series, each varying in percentage rates and terms. Many equipment trusts sold serial certificates which allowed the trusts to pay off specific numbers of certificates one or two times a year instead of all at once. This gave companies great flexibility in controlling both the amount of debt outstanding and the prevailing interest rates.
Experts could legitimately argue that equipment trusts are entities separate from both stocks and bonds. For the purposes of easing discovery in this catalog, I decided to list equipment trusts with bonds.
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