What is a 'Collateral Trust Bond'

A collateral trust bond is a bond that is secured by a financial asset - such as stock or other bonds - that is deposited and held by a trustee for the holders of the bond.

A collateral trust bond is also called a collateral trust certificate or collateral trust note.

BREAKING DOWN 'Collateral Trust Bond'

A corporate bond is a bond issued by a company to raise capital for its short-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 that is possible, they will seek out ways to reduce their cost of borrowing. One way to do this is by securing the bond issued with collateral through a security called a collateral trust bond.

A collateral trust bond is a bond with 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 company, therefore, will issue a collateral trust bond 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 voting rights granted by these securities will remain with the corporate issuer. 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 revaluated and marked to market to reflect their market value. If during the life of the bond, the market value of the collateral falls below the stipulated minimum highlighted on the trust indenture, the issuer must pledge additional securities or cash as collateral.

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 bondholders would be entitled 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 has 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 guaranteed stream of income and preserved principal investment.

 

RELATED TERMS
  1. Collateral

    Collateral is property or other assets that a borrower offers ...
  2. Bond Trustee

    A bond trustee is a financial institution with trust powers, ...
  3. Collateralized Debt Obligation ...

    A collateralized debt obligation squared is a special purpose ...
  4. Debt Security

    A debt security is an instrument bought or sold between two parties ...
  5. Collateral Value

    A collateral value is the estimated fair market value of an asset ...
  6. Bond Market

    The bond market is the environment in which the issuance and ...
Related Articles
  1. Personal Finance

    What Is Collateral?

    Collateral is property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup ...
  2. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  3. Investing

    Understand the security types of corporate bonds

    Any investor should be aware of the different security types regarding corporate bonds as well as the direct correlation to potential recovery rates.
  4. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  5. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  6. Investing

    How Interest Rates Impact Bond Values

    The relationship between interest rates and bond prices can seem complicated. Here's how it works.
  7. Investing

    Top 6 Uses For Bonds

    We break down the stodgy stereotype to see what these investments can do for you.
  8. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
RELATED FAQS
  1. What determines bond prices on the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market and why bond prices and yields ... Read Answer >>
  2. How a bond's face value differs from its price

    Discover how bonds are traded as investment securities and understand the various terms used in bond trading, including par ... Read Answer >>
Hot Definitions
  1. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  2. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  3. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  4. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  5. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
  6. Cash Conversion Cycle - CCC

    Cash conversion cycle (CCC) is a metric that expresses the length of time, in days, that it takes for a company to convert ...
Trading Center