Talk:Mortgage bond

Mortgage Bonds

With a mortgage bond, the corporation pladges certain assets as security for the bond. To illustrate, in 2005 Scobes Corporation needed $10 million to build a major regional distribution center. Bonds in the amount of $4 million, secured by a mortgage on the property, were issued. (The remaining $6 million was financed with equity capital.) If Scobes defaults on the bonds, the bond holders can foreclose on the property and sell it to satisfy their claims. If Scobes chooses to, it can issue second mortgage bonds secured by the same $10 million plant. In the event of liquidation, the holders of these second mortgage bonds would have claim against the property, but only after the first mortgage bondholders have been paid off in full. Thus, second mortgages are sometimes called junior mortgages (debt), of first mortgage bonds. All mortgage bonds are written subject to an indenture, which is a legal document that spells out in detail the rights of both the bondholders and the corporation (bond issuer). Indentures generally are "open ended", meaning that new bonds might be issued from time to time under the existing indenture. However, the amount of new bonds that can be issued almost always is limited to a specific percentage of the firm's total "bondable property", which generally includes all plant and equipment. For example, Bartow Electric Company can issue first mortgage bonds totaling up to 60% of its fixed assets. If its fixed assets totaled $1 billion, and if it had $500 million of first mmortgage bonds outstanding, it could, by the property test, issue another $100 million of bonds (60% of $1 billion = $600 million)

source: Essentials of Managerial Finance, 13th ed.; Weston, Besley, Bricham