A bond represents a contract whereby the issuing agency borrows money and stands behind such a loan by a pledge of property, so that each bond commonly represents a portion of a mortgage.
One might be tempted to think that all bonds are backed by mortgages and are therefore necessarily the best form of investment. This does not follow, because the general reputation of the company, coupled with its over-all financial standing, is of the utmost importance. It is quite conceivable that a company may have the necessary properties to pledge in order to float a bond issue, but the bonds may, at the same time, be very difficult to sell because of the poor operating results and indifferent management of the company. The mere existence of proper backing of a bond by assets is no guarantee that it is of high grade.
On the other hand, there is a type of bond called a debenture which is merely a promise to pay, but, because of the high financial rating of the issuing company, may actually be of better quality than many of the true bonds. For example, the debentures issued over several decades by the American Telephone and Telegraph Company have always enjoyed a high rating, even though they do not carry a mortgage security behind them, as is the case with true bonds.
This may be partially explained by the fact that A.T. & T. is one of the industrial giants in our country, has an excellent financial rating, suffers little from competition, has a long and unbroken record of payments on its common stock, and is one of the best-known enterprises in the nation. In addition, debentures may be convertible, that is, the holder of such a debenture may, at his discretion, surrender it with a specified amount of additional cash and receive shares of common stock in exchange; such exchange must be made within a specified time period and is not a perpetual right. It is obvious that such a conversion may prove quite profitable if A.T. & T. stock is selling on the open market for considerably more than the total amount involved in making the conversion; if, on the other hand, we are in the midst of a low or a declining market so that stock prices are somewhat depressed, it may not pay to make the conversion and the debenture may then be held until redeemed.
Although the afore-mentioned convertible debentures are well known and have proved to be generally satisfactory, this is not the case with many others. If the market price of the common stock, as reflected in its appraisal by the investing public, remains well depressed, the conversion feature may never become of any value to the holder.
Bond investment has always been considered as part and parcel of any program; indeed, as has already been made abundantly clear, the purchase of bonds may be termed the cornerstone of investment. Good-grade bonds, carrying a relatively low rate of return, have had and will continue to possess a high degree of investment stability.