The manner in which convertible bonds stay up at bond levels when stock prices fall very low, but join in a rise of stocks above the converting ratio may be illustrated by the accompanying table.
In this table the value of the conversion privilege of the lowest November stock price is indicated in brackets. The Atchison, Topeka and Santa Fe con vertible bond could be exchanged at par. Its con version price in November, 1907, indicated a value of 66%, but it remained up at 80. The Delaware and Hudson convertible could be turned into common stock at 200. Its conversion price in November, 1907, was 62, but it did not go below 88. The Penn sylvania R. R. convertible could be changed into stock at $70, which means, since the par of Pennsyl vania stock is $50 per share, at the rate of $140 stock for $100 bonds. The conversion ratio in November, 1907, indicated 74, while the bond did not fall below 84. The Union Pacific convertible could be ex changed at $175. Its conversion value in November, 1907, was 61, but it did not pass below 79. Thus the principle controlling bond values came into action.
In the high market of December, 1909, the Penn sylvania bond had a conversion value of 100: 140:: x: 138 = 98.5. The bond came within two points of its conversion value. The Union Pacific bond at the highest point in December, 1909, had a conversion value of 100: 175: :x : 204Y2= 117. It will be seen that it reached approximately this price.
'Great profits have been made in convertibles by those who invested in them years ago when railway shares were at lower prices. Carefully chosen, they commend themselves as purchases for panic periods.
12. Short-term notes.—Short-term notes are de bentures of short life, which are more formally drawn than commercial paper and almost invariably secured by the deposit of collateral. American railways have issued them recently by the hundreds of millions, par ticularly in the year 1907 and the period inclusive. The term averages from two to five years. They are absorbed chiefly by the banks.
The significance of this security in finance is that when interest rates are high and long-term obligations of low income are salable only at a sacrifice, borrow ers are facing an unfavorable market. They there fore resort to a temporary loan, pledging as collateral the bonds they would have preferred to issue, with the hope that at maturity they can refund with those bonds on a more favorable market. The Michigan Central Railway in 1910 tried to sell long-term 4 per cent bonds, but receiving no bid better than 87, they sold in France one-year notes bearing 4V2 per cent interest.
The appeal of short-term notes is to liquidate bank ing capital. They serve the banks as a portion of the large secondary reserve which it has heretofore been necessary to provide because of the undeveloped character of our machinery for rediscounting. As they do not pass from the banks to investors in any large measure they absorb funds which otherwise would be available for call loans or for three, six and nine-months' paper, and so they serve directly to tighten the money market.
From the investor's point of view it may be said that short-term notes are seldom issued except by railroad corporations of excellent standing. The value of the notes depends upon the quality of the collateral pledged, upon the protection of the trust deed clauses prohibiting the issue of other obligations during their life, and upon the surplus of current earnings above prior charges. The notes invite con fidence because of the definiteness with which rail road corporation incomes for a short period may be forecasted. Furthermore, their price cannot fall much below par under the pressure of a high prevail ing rate for money, because the date of repayment is so close. They are vigorously bid up against the private investor by banks, trust companies and in surance companies, so that their chief appeal is to serve as "time-money" investments when a general decline in the security market is imminent.
A typical market list of short-term notes, abbre viated from the circular of Bull and Eldredge of New York City of August 14, 1916, is as follows: 13. Receivers' certificates.—When a corporation falls into the hands of receivers, especially if it is a railway or a public utility corporation which must be kept as a going concern, the officer in charge may, with the approval of the court, issue certificates to provide necessary funds. Most of the market supply comes from railway receiverships. There were large issues in 1893 and in 1899. Receivers' certificates are short-term formal obligations and are usually secured. By reason of necessity and by provision of law they rank ahead of the bonds of a system, but not ahead of the bonds of the subsidiary or separable properties of which it is composed. In other words, they rank be hind taxes, wages, open accounts for supplies, current expenses and mechanic's liens.