Investments, tenth edition

  Dividend Restrictions 

  

Covenants also limit the 

dividends firms may pay. These limitations protect the 

bondholders because they force the firm to retain assets 

rather than paying them out to stockholders. A typical 

restriction disallows payments of dividends if cumulative 

dividends paid since the firm’s inception exceed cumula-

tive retained earnings plus proceeds from sales of stock.  

  Collateral   

Some bonds are issued with specific col-

lateral behind them.    Collateral    is a particular asset that the 

bondholders receive if the firm defaults on the bond. If the 

collateral is property, the bond is called a  mortgage bond.   If 

the collateral takes the form of other securities held by the 

firm, the bond is a  collateral trust bond.  In the case of equip-

ment, the bond is known as an  equipment obligation bond.  

This last form of collateral is used most commonly by firms 

such as railroads, where the equipment is fairly standard and 

can be easily sold to another firm should the firm default. 

 

Collateralized bonds generally are considered safer 

than general  

  debenture   

 bonds, which are  

unsecured,  

meaning they do not provide for specific collateral. Credit 

risk of unsecured bonds depends on the general earning 

power of the firm. If the firm defaults, debenture owners 

become general creditors of the firm. Because they are 

safer, collateralized bonds generally offer lower yields 

than general debentures. 

 

 

Figure  14.10 

 shows the terms of a bond issued by 

Mobil as described in  Moody’s Industrial Manual.   The 

 Figure 14.10 

Callable bond issued by Mobil 

  Source:  Mergent’s Industrial Manual,  Mergent’s Investor 

Services, 1994. Reprinted with permission. All rights reserved.