The following types of long-term debt are covered here:

1. Term loans

2. Bonds

3. Debentures

4. Mortgage bonds

5. Convertible bonds

6. Senior debt

7. Subordinated debt

8. Junk bonds

Term Loans. This is the form of long-term debt most frequently used by businesses. It is a loan from a bank to a company that is used to finance expansion efforts. It has a fixed maturity date, frequently five to seven years from the date of the loan. The company will repay the loan in monthly installments of principal and interest. Spreading the payments of the principal over the life of the loan is called loan amortization. The monthly payments of principal and interest are called debt service. The amortization of the principal can take place over a period that is longer than the loan period. With this arrangement, the remaining principal is due at the end of the loan period. That ending balance is called a balloon payment.

Bonds. A bond has many characteristics similar to those of a term loan. The differences are:

1. A bond is a negotiable instrument that can be bought and sold like common stock.
2. A bond is usually sold to the public through a public offering registered with the Securities and Exchange Commission.

Bonds are usually sold in units of $1,000. A bond that is selling at its face value is said to be selling at par. The interest rate is called the coupon. After these securities are issued, their prices fluctuate in accordance with economic conditions. The prices of many of these securities are quoted daily in all major financial publications. Bonds are usually interest payments only with principal repaid at maturity.

Debentures. A debenture is a bond with only ‘‘the full faith and credit’’ of the company as collateral. Other than the credit rating and creditworthiness of the debtor, there is no specific collateral. The owners of these bonds, therefore, are classified as unsecured creditors.

Mortgage Bonds. A mortgage bond differs from a debenture only in that there is specific collateral to back up the security. Owners of these bonds are known as secured lenders. Because of this collateral, the interest rate should be lower than that on a debenture.

Convertible Bonds. This is a type of debenture with a very interesting feature. If a company does not have a high credit rating and therefore does not qualify for a reasonable interest rate, it would be prohibitively expensive for that company to sell bonds. Remember that investors and lenders have very different risk/ reward relationships. An investor may take a very high risk in the hope of experiencing a very high reward. A lender can never make more that the interest rate, and thus a lender that takes a very high risk may lose everything without having the prospect of a high reward. The convertible bond changes the risk/reward relationship for the lender.

The bond is sold at a relatively low interest rate, perhaps 7 percent rather than the 12 percent that the company would otherwise have to pay. The owner of the bond has the right to convert the bond into shares of common stock at a later date. The company enjoys an affordable interest rate and can now expand its business. The owners of the convertible bonds get some interest and share in the rewards of success if the company does well and the price of the stock increases to above a predeter mined threshold price called the strike price. Prices of convertible bonds are listed in the bond price tables in major financial publications with the extra symbol CV.

Senior Debt. This is a debenture issue that gives its holders priority over the holders of all other debenture issues in receiving interest payments and access to the company’s assets in case of a bankruptcy.

Subordinated Debt. Holders of this type of debt have priority below that of the holders of senior debt. Because of this secondary position and the resulting higher risk position, holders of this debt will receive a higher interest rate than the holders of senior debt.

Junk Bonds. The creditworthiness of most companies and their securities is rated by various agencies such as Standard & Poor’s and Moody’s. Generally bonds with the three or four highest ratings are classified as investment grade. Bonds in this category are recommended for pension funds and very conservative investors.

Bonds that do not qualify for these high ratings have a much smaller pool of available buyers. As a result, they must pay considerably higher interest rates, and so they are classified as ‘‘high yield.’’ As a company’s creditworthiness declines, the yield on its bonds increases at an increasing rate because of the incrementally greater risk. When bonds reach a very-high-yield, lowerquality status, they are known as ‘‘junk’’ bonds.

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