Collateral Trust Bond: What it is, How it Works, Example

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Updated April 21, 2022

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What Is a Collateral Trust Bond?

A collateral trust bond, also known as collateral trust certificate or collateral trust note, is a bond that is secured by one or more financial assets—such as shares of stock or other bonds—that is deposited and held by a trustee for the holders of the bond. The bond is ꦍperceived as a safer investment than an unsecured bond since the assets could be sold to pay the bondholder, if necessary.

Key Takeaways

A collateral trust bond is a type of secured bond, in which a corporation deposits stocks, bonds, or other securities with a trustee so as to back its bonds.
The collateral has to have a market value at the time the bond is issued that is at least equal to the value of the bonds.
The value of the collateral is periodically reassessed to make sure it still matches the value initially pledged.
If over time, the value of the collateral falls below the agreed-upon minimum, the issuer has to put up additional securities or cash as collateral.
This kind of bond is considered safer than an unsecured bond; however, the tradeoff with greater safety is a lower yield and therefore lower payout.

Understanding Collateral Trust Bonds

A corporate bond is a bond issued by a company to raise capital for its sh👍ort-term debt obligations or long-term capital projects. In return for the loan provided by investors, the company pays periodic interest to bondholders🍎 and, upon maturity of the bonds, repays the principal investment.

Because companies prefer to issue debt with as low an interest rate as possible, they will seek out ways to reduce their 澳洲幸运5官方开奖结果体彩网:cost of borrowing. One way to do this is by securing the bond issued with 澳洲幸运5官方开奖结果体彩网:collateral through a security called a collateral trꦍust bond.

Fast Fact

I𝕴f a corporation goes bankrupt or defaults on its debt, bondholders get paid back first, and holders of secured bonds get paid back before holders of unsecured bonds.

A collateral trust bond has a claim against a security or basket of securities. These bonds are typically issued by holding companies since they usually have little to no real assets to use as collateral. Instead, holding companies have control over other companies, known as subsidiaries, by owning stock in each of the subsidiaries. A holding coജmpany will thus issue a collateral trust bo𝄹nd against securities of its subsidiary firms.

The collateralized securities pledged to secure the bond are transferred to a trustee to manage on behalf of the bondholders. Even though the trustee has custody of the pledged assets, the 澳洲幸运5官方开奖结果体彩网:voting rights granted by these🍨 securities will remain with the corporate issu🐷er.

For the securities to be eligible for collateral, their market values must be higher than the amount of the outstanding bonds by a certain percentage. The value of pledged securities will be regularly reevaluated and 澳洲幸运5官方开奖结果体彩网:marked to market to reflect their current market value. If during the life of the bond, the market value of the collateral falls below the stipulated minimum highlighted on the 澳洲幸运5官方开奖结果体彩网:trust indenture, the issuer must pledge additional securities or cash as collateral🍬.

Important

Buying a secured bond such as a collateral trust bond is safer than bu🎶ying an unsecur🦂ed bond, but the extra safety has a price—a lower interest rate than what you would receive if you had bought a comparable unsecured bond.

Example of Collateral Trust Bond

If the issuing company were to default on the debt obligation, the debt holders would receive the securities held in trust, just like collateral for a loan. For example, say Company A issues a collateral trust bond, and as collateral for the bond, it includes the right to Company A shares held by a trust company. If Company A were to default on the bond payments, the bondhoꦯlders would be entitle🅘d to the shares held in trust.

Furthermore, if the issuer defaults on its payments, the voting rights of the shares held by the trustee will be transferred to the trustee which hꩵas the option of selling the securities to pay the bondholders.

Collateral trust bonds have lower yields than unsecured bonds since they are perceived to be less risky due to the collateral held by the trustee. Investors will be willing to accept a lower yield on these bonds in return for a guaranteed stream of income and preserved principal investm꧑ent.

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