When amortization is necessary, however, owing to the fact that the bonds are based upon wasting assets, or that the business of the company is of a temporary or hazardous nature, what form should it take? Let us examine in a general way and without regard to the many exceptions which might be advanced, the ap plications of the five considerations above stated to the various general forms of amortization that have been mentioned.
8. Serial bonds.--Bonds which mature serially are objectionable from the standpoint of their effect upon the market for the issue, and usually also because they do not, as applied in practice, properly distribute the burden of amortization for the company. Take, for instance, a bond issue of $1,000,000, maturing at a rate of $100,000 a year. If this issue bears five per cent interest, the company will have to pay, at the end of the first year, interest and sinking-fund charges aggregating $150,000, while at the end of the tenth year these will amount to only $105,000. These charges are not evenly distributed and fall upon the company most heavily during the earlier years, when it is least able to bear the burden.
Of course, these payments could be averaged so that the sinking fund payments would be lighter in the earlier years, the interest and sinking-fund pay ments together equaling ten even annual instalments. But in practice this is not done, because serial bonds are issued, as a rule, only against equipment which depreciates at a horizontal or constant rate, and is therefore thought to demand equal annual payments upon the principal of the bonds. The rate of depre ciation will not adjust itself to the financial conveni ence of the corporation. The writer doubts the wis dom and necessity of this practice. The investor should realize the fact that his principal and his in terest come from the same pocket, are equally impor tant to him, and bear equally hard upon the corporate finances.
Obviously, the various maturities, when the issue is offered in the market, will appeal to different classes of investors and will sell at different prices. Why this is so has already been made plain in the early part of this chapter. At first glance, it might seem that the various maturities, by appealing to different classes of investors, would tend to broaden the mar ket for serial bonds. On the contrary, they tend to
restrict the market, for the reason that there will be ten different prices and ten different market quota tions for the same issue of bonds. Even figured out on the basis of yield, the quotations will differ, because the short-term issues will sell more nearly on the basis of commercial paper, whereas the longer maturities will be taken up by regular bond investors. This is probably one reason for the slow awakening of the public to the high investment merits of equipment trust bonds, which are as a class one of the best, if not the very safest, of American securities.
9. bonds payable by annual allot repayment of bonds by annual allotment has at least the advantage over serial bonds of permit ting one quotation for the entire issue. The uncer tainty attending time of payment, however, renders them distasteful to the permanent bond investor, who desires a continuous income that will not disturb his principal. He is put to some inconvenience, and per haps loss of interest, in changing his investment, and the company must therefore offer a premium to make such bonds look attractive in the market. The trust deed may direct the trustee to purchase annually, by allotment, a certain portion of the issue at 105, or some other stated premium. This premium lends to the issue a speculative element that oftentimes more than compensates in the market for the otherwise unfavorable terms of payment. Of course, the pre mium adds to the expense of the company, and thus increases the actual interest rate which it pays for the loan.
A fixed redemption price in the trust deed prevents any speculative loss or gain by the company in re deeming its bonds by allotment. When the market price is lower than the fixed price, the trustee will of course purchase in the open market, if that right has been reserved to him, thus saving something to the company and avoiding the necessity of making an allotment. Any buying by the trustee, whether in the open market or by allotment, tends to strengthen the market. It is usually considered better financial policy to retire bonds annually by allotment than by serial maturity, for reasons just stated.