Bond Investing

SECURITY OF INCOME

1. Amount Received: High rate of income and security of principal do not go hand in hand. They are frequently inversely related. The* periodical income received by the investor is generally larger when the security of principal is meager than when it is very firm. Investment income ordinarily represents two elements of compensation; one element is known as "compensation for risk," the other is called "pure interest" and constitutes the payment for the use of money or its equivalent.

SECURITY OF PRINCIPAL

1. Responsibility of Borrower: Of the factors entering into the security of principal, the foremost is the financial responsibility of the borrower or user of the funds advanced. Both present and potential financial responsibilities are important considerations. The amount of the borrower's wealth and its availability to meet the principal sum when due are the gauges for determining the degree of the security of the principal. Proper use of borrowed funds is another factor the lender must consider.

Investment Fundamentals

There are two fundamental considerations entering into the making of an investment: the security of principal, and the security of income. The security of the principal implies the certainty of the sum of money surrendered being returned or recovered. Such sum of money is termed the "principal" of the investment.

Rise of Industrial Corporations

It was not, however, until the early part of the nineteenth century that certain developments increasing both the supply of public investments and the demand for them became dominant factors. Wealth accumulated very rapidly in the period following the Napoleonic Wars. Machinery displaced hand labor in many industries, and with this development the size of industrial undertakings expanded on an ever-increasing scale. The wealth of a single individual or of a small group of individuals was often insufficient to supply all the capital needed for an enterprise.

Early Fields of Investment

During the eighteenth century, investment as it is known today developed rapidly. This was due chiefly to two circumstances: the increase in the size of business organizations, and the growth of national indebtedness.

Modern Investment

Transactions that may be termed "investments" are comparatively recent in human history. They are a characteristic of modern business. In ancient and medieval times investments were infrequent because business men controlled the use of their own property and bartered it in business dealings, just as merchants nowadays do. The earliest forms of wealth were mainly land and precious metals, i.e., coins. Intangible forms of wealth, such as bonds, notes, bills of exchange, or paper money, were almost unknown until modern times.

Adequacy of Working Assets

A common method of determining the relative adequacy of the working assets is by contrasting these items with the corresponding working liabilities, or current obligations on the opposite side of the general balance sheet, which generally comprise all the liabilities in the general balance sheet except capital stock, funded debt, reserves, and surplus. This comparison may be done in the following manner:

Working Assets

The relative amount and kind of the free "working," or "liquid" assets, i.e., cash or cash equivalents, of any organization, requires in many cases closer observation and analysis than the property accounts, or fixed assets. It is with the current assets that an enterprise meets its current needs, paying its current expenses and obligations. If the working assets do not suffice for this purpose the company must be able to borrow additional funds to avoid financial embarrassment.

Valuation of Fixed Assets

Fixed assets, as a rule, are valued in the balance sheet at cost, regardless of their intrinsic value. The reason for this is obvious. They have been acquired and are retained, not with a view to being sold at a profit in the ordinary course of business, but to being used in operating the business until they are worn out or discarded for some other reason. Fluctuations in value of fixed assets need only be considered when there is a change of ownership of the business. A revaluation is then in order.

Model Balance Sheet

Following is a model balance sheet. Apart from the item of deferred charges, the assets are grouped into two classes, fixed and current, and the items in each class are arranged in the order of their relative liquidity, or the ease with which they can be turned into cash, beginning with the least liquid. Not all concerns follow this order, some preferring to arrange the assets in sequence according to the relative convertibility into cash through sale or exchange. The latter plan is particularly desirable when winding up the concern's affairs or otherwise liquidating its property.