Section 3Function 3: Investment Products, Recommendations & Records
Corporate bonds
51 min read
· Lesson 3 of 19
About This Lesson
Now the bond fundamentals from Chapter 9 get applied to the biggest issuer class: corporations. The chapter has two centers of gravity. The first is structure: what backs the bond (collateral or just a promise), and what options ride along (calls, puts, sinking funds, conversion). The second is arithmetic: parity, quote math in eighths, and OID accretion. The structures tell you who gets paid in a bankruptcy; the arithmetic shows up as straight calculation questions.
What you'll cover
bond structures and the indenture: secured versus unsecured, call and put features, sinking funds
convertible bonds: parity, the conversion premium, and antidilutive adjustments
ratings and the six-step liquidation priority, quote math (eighths versus Treasury 32nds), the yield hierarchy, and taxation including OID phantom income
A corporate bond is a debt obligation — the issuer borrows money and promises
to repay the principal at maturity plus periodic interest payments. Understanding the
basic mechanics and legal structure is the foundation for everything else in this chapter.
Par value (face value)
Definition
Principal repaid at maturity; typically $1,000 per bond
Exam note
Prices quoted as % of par (95 = $950; 105 = $1,050)
Coupon rate
Definition
Stated annual interest rate applied to par value
Exam note
6% on $1,000 = $60/yr ($30 semi-annually)
Maturity date
Definition
Date the issuer repays par; bond ceases to exist
Exam note
Short ≤3y, Medium 3–10y, Long 10y+
Indenture
Definition
Legal contract between issuer and bondholders
Exam note
Administered by trustee on behalf of all bondholders
Trustee
Definition
Bank appointed to enforce the indenture on bondholders' behalf
Exam note
Can declare default and accelerate repayment if covenants breached
Covenants are promises embedded in the indenture that restrict or require
certain actions by the issuer. Affirmative covenants require the issuer to do something
(maintain insurance, file financial statements). Negative (restrictive) covenants
prohibit certain actions (paying excessive dividends, taking on additional debt beyond a
specified ratio).
Corporate Bond Types
Secured bonds
Backed by specific collateral pledged to bondholders. In default, bondholders have a priority claim on the pledged asset.
Mortgage bond — backed by real property
Collateral trust bond — backed by securities held in trust
Equipment trust certificate — backed by specific equipment (railroads, aircraft)
Unsecured bonds (debentures)
Backed only by the issuer's general credit and promise to pay. No specific collateral pledged. Higher credit quality issuers use debentures because their creditworthiness is sufficient.
Debenture — senior unsecured, paid before subordinated
Subordinated debenture — junior unsecured; paid after senior debentures
Convertible bonds
Holder may convert each bond into a fixed number of common shares at the conversion price. Offers bond safety with equity upside. Because of this option, convertible bonds carry lower coupon rates than equivalent straight bonds.
Lower coupon in exchange for conversion option
Zero-coupon bonds
Issued at a deep discount to par; pay no periodic interest. Investor profit comes entirely from price appreciation to par at maturity. The implied interest (OID — original issue discount) is taxed annually as ordinary income even though no cash is received.
Phantom income tax on OID each year
Income bonds (adjustment bonds)
Pay interest only if the issuer has sufficient earnings to do so. Typically issued as part of a bankruptcy reorganization. Failure to pay interest does not constitute a default — making them the weakest form of corporate bond.
No guarantee of interest payment
Guaranteed bonds
Principal and/or interest is guaranteed by a third party (often a parent company guaranteeing a subsidiary's debt). The guarantee improves the bond's credit quality and reduces its yield.
Third-party guarantee reduces credit risk
Call Provisions, Put Features, and Sinking Funds
Call Provisions
A callable bond hands the issuer the exit: the right to redeem before maturity at a preset call price. Issuers use it when rates fall, refinancing the way a homeowner does, and the refinancing happens at exactly the moment you least want your money back. That is reinvestment risk, and three terms organize it:
Call price: Usually par plus a call premium (e.g., 102 = $1,020 per
$1,000 face). The premium compensates bondholders for losing a high-coupon bond
Call protection period: Most callable bonds cannot be called for
5 to 10 years after issuance, giving the investor a guaranteed period of cash flow
Yield to call (YTC): The yield if the bond is called on the first
possible call date. When a bond is trading at a premium, YTC is typically lower than YTM
Put Features
A putable bond flips the option to the holder: the right to sell the bond back to the issuer at par before maturity, protection that matters when rates rise. Because the put benefits the investor, putable bonds pay lower yields than equivalent straight bonds.
Sinking Fund
A sinking fund makes the issuer retire part of the issue on a schedule instead of facing one massive payment at maturity, which lowers credit risk for everyone still holding. The issuer satisfies the requirement by buying bonds in the open market or calling them at par by lottery.
Concept Check
Which type of corporate bond pays interest only when the issuer has sufficient earnings, and where failure to pay interest does not constitute an event of default?
Income bonds (also called adjustment bonds) pay interest only if the issuer has sufficient earnings to do so. Unlike all other bond types, a missed interest payment does not trigger a default. They are typically issued as part of a corporate bankruptcy reorganization in exchange for existing debt. This makes them the weakest form of corporate bond from an investor protection standpoint — the income stream is contingent rather than contractual.
Concept Check
An indenture trustee represents the interests of bondholders in a corporate bond issue. Which of the following best describes the trustee's primary function?
The indenture trustee (typically a bank or trust company) is appointed to represent the collective interests of all bondholders. The trustee's primary role is to ensure the issuer complies with the terms of the trust indenture — including making timely interest and principal payments, maintaining required financial ratios, and adhering to covenants. If the issuer defaults, the trustee can take legal action on behalf of bondholders. The trustee does not set terms, underwrite, or provide credit ratings.
Concept Check
A corporate debenture is issued with the backing of
A debenture is an unsecured corporate bond backed only by the general credit and promise to pay of the issuing corporation — no specific assets are pledged as collateral. Real estate pledges back mortgage bonds; equipment pledges back equipment trust certificates; the ability to levy taxes is a characteristic of municipal general obligation bonds, not corporates. Higher-rated corporations often issue debentures because their creditworthiness is sufficient that investors do not require collateral. Lower-rated corporations typically must issue secured debt to attract buyers at acceptable yields.
Concept Check
Which of the following corporate debt securities is the LEAST suitable recommendation for a customer whose primary objective is steady current income?
Income bonds, also called adjustment bonds, pay interest only if the issuer has sufficient earnings to make the payment. Failure to pay interest does not constitute a default — making them the weakest form of corporate bond and unsuitable for any customer whose objective is reliable, steady income. Income bonds are typically issued as part of a bankruptcy reorganization, when the company cannot commit to fixed payments. Senior debentures, negotiable CDs, and Treasury bonds all commit to scheduled coupon payments backed either by the issuer’s general credit or by FDIC insurance and are appropriate steady-income recommendations.
Section 2 of 5~10 min · 2 concept checks
Convertible Bonds
Convertible Bond Parity
A convertible bond carries a conversion ratio, the number of common shares one bond becomes, and a conversion price, the implied per-share cost of getting stock that way. Four formulas connect everything the exam asks:
Conversion ratio = Par value ÷ Conversion price Parity price of bond = Stock price × Conversion ratio Conversion value = Market price of stock × Conversion ratio Conversion premium = Bond market price − Conversion value
Example: a $1,000 par convertible has a conversion price of $25, so the ratio is $1,000 ÷ $25 = 40 shares. With the stock at $30, conversion value = $30 × 40 = $1,200, and the bond must trade at or above $1,200 to shut off arbitrage. That is its parity price.
When the bond trades above conversion value, the gap is the conversion premium: the market paying up for the fixed-income floor and the option's time value. When it trades below, arbitrageurs buy the bond, convert, and sell the shares until the discount disappears.
Worked Example: Convertible Bond Parity
Problem: A convertible bond has a par value of $1,000 and a conversion price of $40. The bond is currently trading at $1,100. The underlying stock is trading at $46.
Calculate: (a) the conversion ratio, (b) the parity price of the stock, (c) the parity price of the bond, and (d) whether an arbitrage opportunity exists.
1
Conversion ratio = Par value ÷ Conversion price $1,000 ÷ $40 = 25 shares Each bond converts into 25 shares of common stock.
2
Parity price of the stock = Bond market price ÷ Conversion ratio $1,100 ÷ 25 = $44.00 For the bond to be fairly priced relative to the stock, the stock would need to trade at $44.00.
3
Parity price of the bond = Stock price × Conversion ratio $46 × 25 = $1,150 At the current stock price of $46, the bond's conversion value is $1,150.
4
Arbitrage check: Bond is trading at $1,100 but the conversion value is $1,150. $1,150 − $1,100 = $50 arbitrage profit per bond An investor could buy the bond at $1,100, immediately convert it into 25 shares, and sell those shares at $46 each for $1,150 — locking in a $50 profit before transaction costs.
Answers: (a) Conversion ratio = 25 shares. (b) Parity price of stock = $44.00. (c) Parity price of bond = $1,150. (d) Yes, arbitrage exists — the bond trades below its conversion value by $50.
Exam trap: The bond is trading at $1,100. The stock is at $44. Is the bond trading at parity, above parity, or below parity?
1
Parity price of stock = $1,100 ÷ 25 = $44.00
2
Stock is trading at exactly $44.00 = parity price. The bond is trading at parity — no arbitrage opportunity.
Rule: If stock price > parity price of stock → bond trades below conversion value → arbitrage opportunity (buy bond, convert, sell stock). If stock price = parity price → no arbitrage. If stock price < parity price → no advantage to converting.
Antidilutive Protection for Convertible Bonds
The conversion ratio is fixed at issuance, so any corporate action that changes the share count would quietly shrink the conversion privilege unless the contract pushed back. Standard convertible indentures push back with antidilutive provisions that adjust the ratio automatically, and the exam tests which events trigger the adjustment:
Events That Trigger Adjustment
Adjustment Triggered
Conversion ratio increases
Stock splits (forward and reverse)
Stock dividends
Spin-offs and rights offerings (sometimes)
No Adjustment
Conversion ratio unchanged
Cash dividends
Share buybacks (typically)
Ordinary trading-driven price changes
Worked example — 2-for-1 stock split: A convertible bond
has a conversion ratio of 40 shares (par $1,000 / conversion price $25). The
issuer declares a 2-for-1 stock split.
After the split:
• Conversion ratio: 40 × 2 = 80 shares
• Conversion price: $25 ÷ 2 = $12.50
• Par value of the bond is unchanged at $1,000
Verification: $1,000 par ÷ $12.50 conversion price = 80 shares. The
bondholder’s economic position is preserved — the doubled share count is
offset by the halved per-share value.
Cash dividend trap: cash dividends trigger nothing. A cash dividend drains the company's cash but leaves the share count, and the bondholder's per-share claim on conversion, untouched. The trigger the exam wants you to spot is a change in share count or per-share equity claim, never a return of capital to shareholders.
Tool Card: Convertible Parity Calculator
Use this interactive tool to explore how convertible bond parity works —
adjust the stock price, conversion ratio, and bond price to see the parity
relationship, conversion premium, and arbitrage signals in real time.
A $1,000 par convertible bond has a conversion price of $40. The company's common stock is currently trading at $50. What is the parity price of the bond?
Conversion ratio = $1,000 par ÷ $40 conversion price = 25 shares. Parity price = stock price × conversion ratio = $50 × 25 = $1,250. The bond must trade at at least $1,250 to prevent arbitrage — if it traded below this, investors would buy the bond, convert to 25 shares worth $1,250, and profit on the difference. The conversion premium, if any, is the amount above this parity price.
Concept Check
A convertible bond has a conversion ratio of 50 shares. Which of the following corporate actions would NOT trigger an adjustment to the conversion ratio under standard antidilutive provisions?
Cash dividends do not trigger antidilutive adjustment to a convertible bond’s conversion ratio. The logic: a cash dividend reduces corporate cash but does not change the share count or the per-share equity claim a converting bondholder would receive. Stock splits (forward or reverse) and stock dividends do trigger adjustment because they change the number of shares outstanding and would otherwise dilute the bondholder’s conversion privilege. The exam test: if the action changes share count or per-share equity claim, adjust; if not (cash dividend, market-price buyback), no adjustment is required.
Section 3 of 5~8 min · 2 concept checks
Bond Ratings and Credit Risk
Bond Ratings and the Investment-Grade Threshold
Credit rating agencies (Moody's, S&P, Fitch) assess the creditworthiness of bond
issuers. Ratings drive yields — lower-rated bonds must offer higher yields to
compensate investors for taking on more default risk.
Investment grade
Low default risk — suitable for most investors
S&P / Fitch: AAA, AA, A, BBB
Moody's: Aaa, Aa, A, Baa
Many institutional investors (pension funds, insurance companies) are restricted by charter to investment-grade only
Below investment grade (high yield / "junk")
Significant default risk — higher yields required
S&P / Fitch: BB, B, CCC, CC, C, D
Moody's: Ba, B, Caa, Ca, C
"D" (S&P) or "C" (Moody's) = in default
The investment-grade threshold:
BBB− (S&P) and Baa3 (Moody's) are the lowest investment-grade ratings.
A downgrade below this threshold to "junk" status is called a "fallen angel" and
typically triggers forced selling by institutional investors restricted to investment-grade,
causing sharp price declines. This threshold is the most tested rating concept on the Series 7.
Liquidation Priority: The Six-Step Sequence
When a corporation liquidates, the law pays claims in a fixed sequence, each tier in full before the next sees anything. The exam returns to this sequence constantly, so learn it as a story: the proceeding pays for itself first, then collateral, then promises, in descending order of seniority:
1
Wages and Administrative Claims
Unpaid employee wages and the costs of administering the bankruptcy itself — attorneys, trustees, court fees, property appraisers. These claims do not arise from owning securities but are paid first because they fund the proceeding.
2
Secured Bondholders
Holders of mortgage bonds, equipment trust certificates, and collateral trust bonds. They receive proceeds from the specific assets pledged as collateral. If the collateral is insufficient to satisfy their claim, the deficiency drops to the next tier as a general unsecured claim.
3
General (Senior) Unsecured Creditors
Senior debentures, promissory notes, trade creditors, and any unsecured deficiency claims from Tier 2. Paid pro rata if assets are insufficient to satisfy the full tier.
4
Subordinated Debt Holders
Subordinated debentures and similar junior unsecured debt. Paid only after senior unsecured creditors have been satisfied in full.
5
Preferred Stockholders
First class of equity holders. Receive their stated par value if any assets remain. Within preferred, senior preferred is paid before junior preferred.
6
Common Stockholders
Last in line. Receive whatever is left, which in many bankruptcies is nothing. Common stockholders bear the residual risk in exchange for residual upside in healthy companies.
Promissory notes vs. mortgage bonds:
A common exam trap pits a promissory note against a mortgage bond. The mortgage
bond is secured (Tier 2), the promissory note is general unsecured (Tier 3) —
the mortgage bond holder is paid first regardless of which was issued earlier or
carries a higher coupon.
Concept Check
A publicly traded corporation declares bankruptcy. Holders of which of the following securities would be most likely to recover the greatest amount of their investment?
Collateral trust certificates are secured bonds backed by securities held in trust for bondholders. In bankruptcy, secured creditors occupy the second priority tier (after wages and administrative claims) and have first claim on the proceeds from their pledged collateral. Senior debentures fall into the next tier as general unsecured creditors. Preferred and common stock are equity claims paid only after all creditor classes have been satisfied — common stockholders are last in line and frequently receive nothing. The collateral pledge gives bondholders priority access to specific assets, producing the highest recovery among the choices.
Concept Check
A corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. In the event of bankruptcy, the order of payment against claims would be
Mortgage bonds are secured debt and occupy the second priority tier behind wages and administrative claims, giving them first claim among the four instruments listed. Promissory notes are general unsecured debt and rank in the third tier, behind secured creditors. Preferred stock follows in the fifth tier as a senior equity claim, and common stock is last as the residual claim. The full priority sequence — wages, secured, senior unsecured, subordinated, preferred, common — governs all corporate liquidations. Promissory notes are unsecured loans and consistently rank below secured bondholders regardless of which instrument was issued first.
Section 4 of 5~9 min · 3 concept checks
Pricing, Quotes, and Yield
Reading Corporate Bond Quotes: Percentages of Par
A corporate bond quote is a percentage of par, and par is $1,000 unless the question says otherwise, so converting a quote to dollars is one multiplication:
Quote
Decimal
Dollars per Bond
100
100.000%
$1,000.00 (par)
98⅝
98.625%
$986.25
101¼
101.250%
$1,012.50
105½
105.500%
$1,055.00
110¾
110.750%
$1,107.50
Eighths and Quarters
The historical eighths convention still drives the fractions you will see. Knowing these cold converts quote questions into free points:
⅛ = 0.125 = $1.25 per bond
¼ = 0.250 = $2.50 per bond
⅜ = 0.375 = $3.75 per bond
½ = 0.500 = $5.00 per bond
⅝ = 0.625 = $6.25 per bond
¾ = 0.750 = $7.50 per bond
⅞ = 0.875 = $8.75 per bond
Treasuries use 32nds, not eighths. A Treasury quoted 99-16 means 99 and 16/32, which is 99.500, or $995.00 per $1,000 bond. The exam plants this mixed convention deliberately: corporates in eighths, Treasuries in 32nds.
The Yield Hierarchy: Which Yield Is Highest When a Bond Trades at a Discount?
When a bond trades at a discount, the yields rank from lowest to highest:
Coupon rate < Current yield < Yield to maturity (YTM)
At a premium, the order flips:
Coupon rate > Current yield > Yield to maturity
If the bond is callable, slot in YTC:
YTC < YTM (at a premium) YTC > YTM (at a discount)
The memory hook: a discount bond is giving you more than the coupon admits, so every calculated yield beats the stated rate. You met the full four-yield ranking in Chapter 9; this is the same ladder from the corporate side.
Concept Check
A 6% coupon bond is currently trading at 94 ($940). Which of the following correctly ranks this bond's yields from lowest to highest?
When a bond trades at a discount (below par), all calculated yields exceed the coupon rate because the investor receives more than the coupon — they also gain the difference between the discounted purchase price and par at maturity. The ranking is: coupon rate < current yield < YTM. Current yield = $60 / $940 = 6.38%, which is above the 6% coupon but below YTM, which also captures the price appreciation to par.
Concept Check
An investor buys a corporate bond at a discount. Which of the following correctly describes the relationship between the bond's coupon rate, current yield, and yield to maturity?
For a bond trading at a discount (below par), all yield measures are higher than the coupon rate because the investor earns not only the coupon payments but also a price gain as the bond approaches par at maturity. The hierarchy is always: coupon rate < current yield < YTM. Current yield measures only the coupon relative to the current price; YTM also captures the accretion of the discount to par. For a premium bond, the order reverses: coupon > current yield > YTM.
Concept Check
A corporate bond is quoted at 98⅝. Assuming standard $1,000 par value, the dollar price per bond is
A corporate bond quote is a percentage of par value. 98⅝ converts to 98.625% (since ⅝ equals 0.625), and 98.625% of $1,000 par is $986.25 per bond. The other choices reflect common arithmetic errors: $985.00 treats ⅝ as 0.50 instead of 0.625; $985.80 incorrectly multiplies fractional dollars; $986.50 rounds to a half rather than computing the eighth precisely. Memorize the eighth conversions: ⅛ = $1.25, ¼ = $2.50, ⅜ = $3.75, ½ = $5.00, ⅝ = $6.25, ¾ = $7.50, ⅞ = $8.75. These appear repeatedly in corporate-bond pricing questions.
Section 5 of 5~7 min · 1 concept check
Taxation
Corporate Bond Taxation: Interest, Capital Gains, and OID Accretion
Three tax events punctuate a corporate bond's life: coupon interest arrives, a sale books a gain or loss, and, for bonds issued at a discount, OID accretes every year whether or not cash moves. The exam leans hardest on the third.
Interest Income
Coupon interest is ordinary income at the federal, state, and local levels, no preferential rate. Hold that against the comparisons coming later in the module: municipal interest is federally exempt, Treasury interest is state-exempt, and corporate interest is exempt from nothing.
Capital Gains and Losses
Sell the bond for something other than its adjusted basis and the difference is capital gain or loss, under the same holding-period rules as any security: more than one year for long-term treatment, one year or less for short-term.
OID Accretion: Phantom Income
Buy a bond at original issuance below par and the discount, par minus issue price, is original issue discount. The IRS makes you accrete it: recognize a slice as ordinary income each year with no cash attached, which is why it is called phantom income. Each year's accretion also raises your cost basis.
Worked example: An investor purchases a corporate
zero-coupon bond at $510 with seven years to maturity. Four years later, the
investor sells the bond at $690.
Step 1: OID at issuance = $1,000 par − $510 cost = $490 Step 2: Annual accretion = $490 ÷ 7 years = $70 per year
(using straight-line; constant-yield method is also acceptable) Step 3: Adjusted basis after 4 years = $510 + (4 × $70) = $790 Step 4: Sale proceeds = $690 Step 5: Result = $690 sale price − $790 adjusted basis = $100 capital loss
Note that the investor has already recognized $280 of phantom income over the
four-year holding period (4 × $70). The $100 capital loss on sale is in
addition to that ordinary income recognition.
Corporate OID vs. municipal OID: the accounting is identical, the tax treatment is opposite. Corporate OID accretion is taxable ordinary income every year; municipal OID accretion is tax-exempt, inheriting the muni coupon's federal exemption.
Why zeros live in tax-deferred accounts: phantom income is a tax bill with no cash to pay it, so individual investors hold corporate zeros inside IRAs and similar accounts, where the annual accretion generates no current tax.
Concept Check
An investor purchases a corporate zero-coupon bond at a price of $510. The bond matures in seven years. Four years later, the bond is sold at $690. What are the tax consequences of the sale?
OID accretion adjusts the cost basis upward each year. Original OID = $1,000 par minus $510 cost = $490. Annual straight-line accretion = $490 ÷ 7 years = $70 per year, which the investor has been recognizing as ordinary phantom income each year. After four years, accumulated accretion = 4 × $70 = $280, raising the adjusted basis to $510 + $280 = $790. The sale at $690 produces $690 minus $790 = a $100 capital loss. The $310 distractor incorrectly uses the original $510 cost without accretion adjustment. The $180 distractor uses the same flawed unadjusted basis with the wrong sign.
SummaryExam-day review · 2 essentials blocks
Chapter Summary — Exam Essentials
Ch 10 Exam Essentials — Corporate Bonds
Yield hierarchy for bonds: Discount bond: coupon rate < current yield < YTM < YTC (if callable and rates fell). Premium bond: coupon rate > current yield > YTM. Par bond: all three yields are equal.
Secured vs. unsecured: Mortgage bonds (secured by real property) → equipment trust certificates → debentures (unsecured, backed by general creditworthiness) → subordinated debentures. Priority in bankruptcy follows this order.
Call provisions: Callable bonds pay higher yields (call premium) because the issuer can redeem early when rates fall, creating reinvestment risk for the investor. Call protection period = cannot be called during initial years.
Convertible bonds: Conversion ratio = par value / conversion price. Parity price of stock = bond market price / conversion ratio. If stock trades above parity, convert; below parity, hold the bond.
Indenture trustee: Represents bondholder interests, ensures issuer compliance with covenants, and can take legal action on bondholders' behalf in default. Not the underwriter — a separate entity (usually a bank).
Corporate Bond Exam Traps — Consolidated
Twelve corporate-bond traps with a track record. Run the list the night before; each entry resolves a question pattern the exam actually uses:
1. Liquidation priority order: wages/admin → secured → senior
unsecured → subordinated → preferred → common.
Memorize the six-step sequence. Each tier paid in full before the next.
2. Mortgage bond beats promissory note in bankruptcy. Secured
debt (Tier 2) is always paid before general unsecured debt (Tier 3) regardless
of issuance dates or coupon rates.
3. Income bonds are unsuitable for steady income. They pay
interest only if the issuer has earnings. Failure to pay does not constitute
default. Recommend Treasury bonds, CDs, or investment-grade debentures for
steady-income objectives.
4. Antidilution: stock splits and stock dividends adjust the conversion
ratio. Cash dividends do NOT. The trigger is a change in share count
or per-share equity claim, not a return of capital.
5. Bond quotes are percentages of par. 98⅝ = 98.625% =
$986.25. Memorize the eighth conversions: ⅛ = $1.25, ¼ = $2.50,
⅜ = $3.75, ½ = $5.00, ⅝ = $6.25, ¾ = $7.50,
⅞ = $8.75.
6. Treasuries quote in 32nds, not eighths. A Treasury at
99-16 means 99 and 16/32 = 99.500% = $995.00. Don’t apply the eighths
convention to Treasuries.
7. Corporate OID accretion = ordinary income annually (phantom income).
Basis increases by the accreted amount each year. Sale below the adjusted basis
produces a capital loss; sale above produces a capital gain.
8. Corporate OID is taxable; muni OID is tax-exempt. Same
mechanic, opposite treatment. The muni OID retains the underlying bond’s
federal tax-exempt character.
9. Zero-coupon bonds are typically held in tax-deferred accounts.
Phantom income creates tax without cash; IRAs and similar shelter the annual
accretion from current taxation.
10. Convertible bondholders give up yield in exchange for upside.
The conversion option allows convertible coupon rates to be lower than equivalent
straight bonds. The investor accepts lower current income in exchange for the
embedded equity option.
11. Debentures are backed by the general credit of the issuer.
No collateral is pledged. Subordinated debentures rank below senior debentures
within the unsecured tier.
12. Guaranteed bonds carry the credit of the guarantor. A
parent company guarantees a subsidiary’s bond, raising credit quality and
lowering yield. The guarantee does not change the issuer — only the credit
support.