Comparing Secured Notes by Collateral Income and Bond Coupon
Summary
The document explains why secured 7% notes could be more valuable than a company's 5% bonds when both traded at the same price. The notes were backed by a larger face amount of the 5% bonds than the notes' own face value. Interest paid on that collateral was passed to noteholders, giving them income calculated from the collateral amount rather than solely from the notes' stated coupon. The example therefore emphasizes the economic value of collateral coverage and cash flows, not a comparison of the two coupon percentages in isolation.
The discussion is a historical illustration from Graham's Security Analysis, with the figures and circumstances tied to the cited securities in 1933. It does not present a general valuation model or account for all legal, credit, liquidity, or recovery risks. Collateral income and contractual rights can support value, but an investor must assess the security documents and enforceability in each case.
Key ideas
- A secured note's collateral can provide cash flows beyond those implied by its stated coupon alone.
- The example compares notes backed by a larger face amount of 5% bonds with the notes' own face value.
- Interest received from the collateral was distributed to the noteholders, increasing their effective current income.
- The historical illustration does not replace analysis of legal rights, credit risk, or collateral value.
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Full text
# Comparing Values of 5s and 7% Notes (Security Analysis by Benjamin Graham) # Comparing Values of 5s and 7% Notes (Security Analysis by Benjamin Graham) I was reading Security Analysis by Benjamin Graham (Sixth Edition). Page 63, last paragraph says: > A third kind of analytical conclusion may be illustrated by a comparison of Interborough RapidTransit Company First and Refunding 5s with the same company’s Collateral 7% Notes, when both issues were selling at the same price (say 62) in 1933. The 7% notes were clearly worth considerably more than the 5s. Each \$1,000 note was secured by deposit of \$1,736 face amount of 5s; the principal of the notes had matured; they were entitled either to be paid off in full or to a sale of the collateral for their benefit. The annual interest received on the collateral was equal to about $87 on each 7% note (which amount was actually being distributed to the note holders), so that the current income on the 7s was considerably greater than that on the 5s. Whatever technicalities might be invoked to prevent the note holders from asserting their con- tractual rights promptly and completely, it was difficult to imagine conditions under which the 7s would not be intrinsically worth consid- erably more than the 5s. The 1,736 statement puzzled me. Is it a statement or a quick calculation? I assume that `5%` and `7%` is referring to the annual yield rate. Thus, if the latter is bought for $\$1000$, then after a year it will grow to $\$1070$. To have the same result, the former should be bought as $\$1070\div 1.05\approx\$1019 $, which is nowhere near the value in the statement. ## Answer by user39645 (score 1) https://quant.stackexchange.com/a/45070 A &5 note of worth \$1000, is issued against a collateral of 5% bond of worth \$1736. Now yearly interest of \$1736 at a rate of 5% comes \$87. This interest is distributed among note holders. So note holder effective get a interest of 8.7% (=87/1000 x 100) which is much better than 7% as per contract. This is the advantage note holders were getting ------I think this will clarify your query : Kashinath
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