Chapter 7, Problem 1RQ

Summary Introduction

To discuss: The difference between debentures and mortgage bonds.

Explanation of Solution

The difference between debentures and mortgage bonds are as follows:

A debenture can be termed as any unsecured long-term debt. Because these bonds are unsecured, the earning capacity of the issuing organization is of big worry to the bondholders. They are additionally seen as being extra risky than secured securities and therefore, must furnish the investors with a better return than secured bonds give. Frequently the issuing company tries to give some assurance to the holder through the disallowance of any extra encumbrance of assets.

This disallows the upcoming issuance of secured long-term debt that would additionally connect the company's assets and leave the bondholders fewer secured. In terms of the issuing firm, the main benefit of debentures is that no property must be secured by them. This enables the firm to give debt and still save some future acquiring power.

A mortgage bond is a type of bond that is secured by a lien on real property. Normally, the actual value of the real property is higher than that of the mortgage bonds which are issued. This gives the mortgage bondholders an edge of protection in the occasion the market value of the secured property decreases.

On account of foreclosure, the trustees have the ability to sell the secured property and utilize the returns to pay the bondholders. If the returns from such sale don't cover the bonds, the bondholders become general creditors, like debenture bondholders, for the unpaid segment of the debt.