Bill and Edna had been married two years and had just reached the point where they had enough savings to start investing. Bill’s uncle Dave told them that he had recently inherited some very rare railroad bonds from his grandmother’s estate. He wanted to help Bill and Edna get a start in the world and would sell them 50 of the bonds at $ 100 each. The bonds were dated 1873, beautifully engraved, showing a face value of $ 1,000 each. Uncle Dave pointed out that “United States of America” was printed prominently at the top and that the U.S. government had established a sinking fund to retire the old railroad bonds. A sinking fund is a fund established for the purpose of repaying the debt. It allows the organization (the U.S. government, in this example) to set aside money over time to retire the bonds. All Bill and Edna needed to do was hold on to them until the government contacted them, and they would eventually get the full $ 1,000 for each bond. Bill and Edna were overjoyed—until a year later when they saw the exact same bonds for sale at a coin and stamp shop priced as “collector’s items” for $ 9.95 each!

Requirements

1. If a company goes bankrupt, what happens to the bonds it issued and the investors who bought the bonds?

2. When investing in bonds, how can you tell whether the bond issue is a legitimate transaction?

3. Is there a way to determine the relative risk of corporate bonds?