In the same way, equipment bonds vary as to stability of market price. Compared with other classes of railroad issues, equipment bonds are all relatively stable, but the stability is especially marked in the shorter maturities.
Equipment bonds possess little prospect of appreciation in value.
The attentive reader who has carefully followed the foregoing description of equipment bonds, may have noticed a special adaptability on their part to the requirements of a business surplus. Broadly speaking, for such investment, a security is required which will combine perfect safety of principal and interest, a good rate of income, ready convertibility into cash, and unyielding stability of market price. The necessity for insistence upon these requirements in the investment of a business surplus will appear upon a moment's reflection. Safety is required in all forms of investment, but is particularly important in the handling of business funds; a good rate of income is always desirable; convertibility is necessary for a business surplus so that the reserve funds may be converted into cash at any time; and it is of the utmost importance that the security should not shrink materially in quoted price, no matter what changes may take place in financial and business conditions, so that if the need should arise for realizing on the reserve fund, it would be found unimpaired in amount. As explained in a former chapter, this point can not be covered by the selection of securities perfectly safe as to principal and interest, but only by the purchase of short-term obligations.
The point may be illustrated as follows: Let it be supposed that a firm or company has decided to invest $100,000 in the 5-per-cent equipment bonds of a good railroad maturing in three years, which can be obtained at par, merchant's paper then commanding about 5½ per cent. After two years it becomes necessary for the firm to realize on its investment at a time when commercial paper is floated with difficulty on a 6½-per-cent or 7-per-cent basis. Under such money conditions the equipment bonds could be sold on about a 6-per-cent basis, which would mean a price of 99 for a 5-per-cent bond with one year to run. The firm, in liquidating its investment, would therefore lose 1 per cent in principal, but would have received 5 per cent interest for two years, making the net return 4½ per cent. Compare this showing with the result if the bonds when originally bought had had ten years to run instead of three.
After two years, when the firm wished to dispose of its bonds it might experience some difficulty in doing so in the stringent money market which has been supposed, but even if it succeeded in selling them upon a 6-per-cent basis, that would mean a price of only 93¾ and would represent 6¼-per-cent loss in principal. If it were necessary to sell the bonds upon a higher basis or if the firm had purchased a bond with more than ten years to run, the relative disadvantage of the longer bond would be still more apparent. These points sufficiently demonstrate the importance of buying only short-term securities for the investment of a business surplus. Of course, if money conditions improve instead of becoming worse between the dates of purchase and sale, then a greater profit would be made with the longer-term bond. This, however, should not be allowed to influence the choice, first because it is not the object of a reserve fund to make a speculative profit, and secondly because a firm or corporation is only likely to want to realize upon its reserve fund when money is hard to obtain otherwise, and that is precisely the time when any long-term bond would be apt to show considerable depreciation.
The foregoing considerations indicate a special adaptability on the part of equipment bonds to the usual requirements of a business surplus. The points have been brought out at some length because of the importance of the subject to the average business man. The purpose in concentrating attention upon a single instance has been to illustrate more clearly the principles involved and at the same time to acquaint the business man with details of a highly desirable and somewhat unfamiliar form of security.