Debentures, Mortgage Bonds & Commercial Paper

Quick comparison of all types

Commercial paper

• Commercial paper, sometimes described as a type of promissory note, is short-term, corporate zero coupon debt. Corporations use it to raise money for short-term needs.
• Investors buy commercial paper at a discount, and the issuer repays par value at maturity.
• 🔑 The maximum maturity for commercial paper is 270 days. That number ties directly to securities registration rules.

Why 270 days? (the registration exemption)

• In the laws and regulations unit, you’ll cover the Securities Act of 1933 and the Uniform Securities Act. These laws regulate the sale of new issues.
• In general, issuers must register securities with the Securities and Exchange Commission (SEC) and/or the state administrator before selling them to the public. Registration is designed to require disclosure of important (material) information so investors can make informed decisions.

Definitions

• Registration can be expensive and time-consuming. Issuers typically hire lawyers, accountants, and other professionals to prepare the required filings, and they also pay filing fees to regulators. Because of that cost, issuers generally register only when they must.
• Both the SEC and state administrators offer exemptions (exceptions) from registration. There are several exemptions you’ll learn later. For now, focus on this one:

Why regulators allow the exemption

• Short-term debt generally carries less risk than long-term debt. For an investor to lose the entire investment, the issuer would have to go bankrupt within the next 270 days. For the typical issuers of commercial paper — large, well-established companies — that outcome is less likely.

Practical characteristics

Debentures

• A debenture is a long-term, unsecured (naked) corporate bond.
• 📌 This definition matters on this material and tends to show up in multiple contexts.

Sidenote — “Naked” debentures

The term ‘naked’ can sometimes be used as a substitute for unsecured. Whether a bond is referred to as ‘naked’ or ‘unsecured,’ it is not backed by any pledged collateral.

• In terms of risk, debentures are riskier than secured corporate bonds because there is no collateral backing them.
• Debentures are full faith and credit bonds: the issuer is legally obligated to repay, but bondholders don’t have a specific pledged asset to claim if the corporation goes bankrupt.
• Because investors take on more risk, debentures generally offer higher coupons and trade at higher yields (lower prices).
• A debenture is one of many forms of long-term corporate debt, which is sometimes called funded debt. The term reflects that the corporation has a long period of time to use the borrowed funds.

Guaranteed bonds

• In finance, the word “guarantee” is usually used cautiously — investments rarely come with true guarantees. However, guaranteed bonds do exist.
• To understand them, you need the idea of a subsidiary: a company owned and controlled by a larger parent company.
  • For example, Crest Toothpaste, Head & Shoulders, and Pampers are subsidiaries of Procter & Gamble.
• When a subsidiary issues a bond, the parent company may agree to act like a co-signer. If the subsidiary can’t repay the bond, the parent becomes responsible for repayment.
  • For example, if Pampers issues a guaranteed bond, Procter & Gamble “guarantees” it by obligating itself to pay if Pampers can’t.

• The term guaranteed bond can also apply to bonds insured by third parties, most commonly municipal bonds. For example, if the city of Denver issues a bond insured by Ambac, the bond is considered “guaranteed.”

Bottom line — any bond backed by a third party (whether a parent company or an insurance company) is considered a guaranteed bond.

Income bonds

• Income bonds, sometimes called adjustment bonds, are high-risk bonds that come out of bankruptcy.
• Suppose a corporation issues bonds and later defaults, meaning it can’t make the required interest and principal payments. Bondholders may sue and push the issuer into bankruptcy court.

🔑 Bondholders generally have two paths in bankruptcy court:

• If bondholders believe the business won’t recover, they may seek liquidation. When liquidation payouts are made, payments are prioritized to specific parties as discussed earlier in this chapter.
• If bondholders believe the issuer might recover, they may allow the company to restructure its debt.

How income bonds work

• In the restructuring process, the issuer effectively replaces the old defaulted bonds with new income bonds.
• 🔑 These new bonds pay interest only if the company has sufficient earnings.
• Income bonds may also have different features, interest rates, and par values than the original bonds.
• After bankruptcy court, the issuer continues operating. If it becomes profitable again, it may begin making interest payments to income bondholders. If the turnaround succeeds, both the business and the bondholders benefit.
• However, many issuers that restructure never return to sustained profitability. In that case, income bonds may never pay interest or principal, and they can become worthless.
• Income bonds are generally poor investments and are typically appropriate only for the most risk-tolerant investors. They trade at very high yields (low prices) in the market.

📌⚠️ Exam relevance: If you see a suitability question on the exam, income bonds are almost always the wrong answer. Adjustment bonds are suitable only in rare situations for aggressive, risk-tolerant investors willing to take a speculative risk. The name can be misleading: “income” sounds like reliable interest payments, but these bonds often pay nothing.

Mortgage bonds

• Mortgage bonds are the first type of secured (collateralized) bond covered in detail.
• When a corporation issues a mortgage bond, it pledges real estate as collateral. Examples of collateral include factories, equipment, and corporate real estate.

Why issuers use them

• Issuers use mortgage bonds to reduce their cost of borrowing. With debentures, investors take on more risk because there is no collateral, so they demand higher interest rates.
• By pledging real estate, the issuer can usually borrow at a lower interest rate — but it risks losing the pledged property if it can’t repay the bond.
• Utility companies are common issuers of mortgage bonds. These companies often own valuable property that can be pledged as collateral, such as factories, electrical grids, and power plants.

First vs. second mortgage bonds

Equipment trust certificates (ETCs)

• Equipment trust certificates (ETCs) are also secured bonds.
• If a corporation issues bonds backed by the equipment it owns, it has issued ETCs.
• Collateral can include vehicles, construction equipment, or airplanes.
• For example, Delta Airlines can issue bonds and pledge some of its airplanes as collateral. Interestingly enough, their bond ratings have declined due to COVID-19’s effect on the value of airplanes.

Collateral trust certificates (CTCs)

• Collateral trust certificates (CTCs) are bonds secured by marketable assets owned by the corporation.
• Marketable assets could include a portfolio of investments or a subsidiary.
• For example, PepsiCo could issue a bond and pledge Gatorade (a subsidiary of theirs) as collateral. If PepsiCo doesn’t make the required bond payments, Gatorade becomes the property of the bondholders. In most cases, Gatorade would be liquidated (sold), and the proceeds would be used to repay bondholders.

Key points

Commercial paper

• Short-term zero coupon corporate debt
• 270-day maximum maturity
• Exempt from SEC registration
• Typically sold in large denominations ($100,000+)
• Sold to raise short-term cash

Debentures

• Long-term unsecured corporate bonds
• Also known as full faith and credit bonds
• Riskier than secured bonds

Funded debt

• General term for long-term corporate debt

Guaranteed bonds

• Backed by a third party’s promise to pay interest and/or principal in case of default
• Typical third parties:
  • Parent companies
  • Insurance companies
• Considered unsecured bonds

Income (adjustment) bonds

• Issued after company defaults on debt
• Only pay interest when the issuer meets the earnings test
• High risk securities

Mortgage bonds

• Secured by corporate real estate
• Commonly issued by utility companies

Liquidation priority

• First mortgage bondholders receive liquidation proceeds first
• Second mortgage bondholders receive leftover liquidation proceeds

Equipment trust certificates (ETCs)

• Secured by corporate equipment
• Issued in serial form

Collateral trust certificates (CTCs)

• Bonds secured by marketable corporate assets

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.