3. Fixed Income Securities Flashcards
Explain what is a bond
Put simply, a loan.
The issuer = the borrower
The bond holder = the lender
The coupon = the interest
The expiry = the date the loan needs to be repaid
A government bond is usually issued by who, in which currency.
National Government - denominated in the country’s own currency
Why do governments issue bonds?
To finance their long term expenditure - finance shortfall between revenues and spending.
What is the shortfall called in the UK?
The PSNCR - the public sector net cash requirement.
Bonds issued by governments in a foreign currency are called what?
Sovereign Bonds
Bonds issued in the home (domestic) market, but denominated in a foreign currency are called?
Eurobonds
Bonds issued in a foreign market, but denominated in the home currency are called?
Foreign bonds
What are UK government bonds known as?
Gilts (Gilt-Edged Securities)
What are government bonds known as in the US?
Treasury Bonds - T-Bonds
What are government bonds known as in Germany?
Bunds
What are government bonds known as in France?
OATs
What are government bonds known as in Italy?
BTPa
What are government bonds known as in Japan?
JGBs
What is the coupon frequency and settlement period for US Treasury Bonds
Semi-Annual
T+1
What is the coupon frequency and settlement period for OATs?
Annual
T+2
What is the coupon frequency and settlement period for bunds?
Annual
T+2
What is the coupon frequency and settlement period for gilts?
Semi-Annual
T+1
Explain the nominal/face/par value of a bond?
It is the amount that will be paid back to the bond holder (from the issuer) at maturity eg £100.
Explain what is the coupon?
It is the interest received by the bond holder.
What happens at maturity?
The nominal/face/par value is repaid plus the final coupon
What are the short, medium and long categorisations for bond maturities defined as?
Short - less than 7 years
Medium - 7-15 years
Long - 15 years plus
What are US Treasury Notes?
US Treasury Securities - 1-10 year maturity.
Bonds with no fixed maturity dates are called what?
Undated/Perpetual Bonds
What are zero coupon bonds?
Bonds that do not pay a coupon, instead they are issued at a discount to their par value and the discount presents the return.
In the UK, inflation linked gilts are linked to which inflation index?
RPI - Retail Price Index (3 mth trailing basis)
In the US, what are inflation protected bonds called?
TIPs Treasury Inflation Protected Securities.
What are corporate bonds?
Bonds issued by corporations.
Generally, what maturity do corporate bonds have?
1 year plus (less is commercial paper).
Can corporate bonds be issued in any currency?
Yes
How does the yield on a corporate bond usually compare with a government bond of the same tenor?
It will be higher, due to the higher risk of default. The markets view is that a government has the best credit.
What benefit do governments have over corporations in respect of money supply?
They have the power to expand the money supply.
What is credit rating important to?
Companies determining the coupon or yield.
Name the three major credit rating agencies?
- Standard & Poors (S&P)
- Fitch
- Moodys
What are the highest rated bonds known as?
Investment grade
Corporate bonds can de divided into two categories, what are they?
- Debentures - secured debt securities
- Loan stock - unsecured debt securities
What are the benefits to the issuer, and the bond holder of secured debt?
Issuer - by offering collateral, the credit risk is less, and they pay less interest.
Bond holder - they take on less credit risk, as have recourse to collateral.
Debentures can be sub divided into what two further categories?
- Fixed Charge - typically over freehold land/property
- Floating charge - typically over inventory/accounts payable
What is an asset backed security (ABS)?
A security whose value and income payments are derived from and collateralised by a specified pool of underlying assets.
What is the process of pooling assets to create an ABS called?
Securitisation
What is created for the purpose of handling the securitisation process of an ABS?
An SPV to create off balance sheet entity
What is a convertible bond?
A bond with an embedded option. The bond holder has the right to convert the bond into shares in the firm, at the conversion ratio.
What is a callable bond?
A bond with an embedded option. It gives the issuer the right to redeem the bond early, for which they have to pay a higher interest rate, for the benefit they receive.
What is liquidity risk with a bond?
Being unable to sell the bond at a fair market value
Explain the relationship between interest rates, and bond prices?
They have an inverse relationship;
- when interest rates go up, bond prices go down.
- when interest rates go down, bond prices go up.
With inflation linked bonds, is the coupon or the principal, or both adjusted?
Both.
Why is it said there is a conflict of interest between corporate issuers, and credit rating agencies?
Because the corporate issuers pay the credit rating agencies to be rated by them.
Investment grade bonds, are bonds with a rating of what and above?
BBB- or above
Conversely, bonds graded BB+ or below are called what?
Speculative grade (non investment grade, or junk bonds)
What is issuer risk?
The risk that the issuer will be unable to meet their obligations, to service the coupon, or repay the principal.
A yield spread is a way of doing what?
Comparing two bonds.
The yield spread between government bonds, and other bonds is a measure of what?
‘Relative’ risk premium demanded by investors
A normal yield curve is what?
Upward sloping. Thus shorter maturities have lower yields, and longer maturities have higher yields.
A normal yield curve is said to capture what?
Investors liquidity preference
An inverted yield curve is drawn how?
Downward sloping.
Explain what an inverted yield curve depicts?
The short term yields are higher than the longer term yields.
When does an inverted yield curve occur?
When there is an expectation of a significant reduction in interest rates at some stage in the future, such as through fears of deflation in the economy.
What is a horizontal yield curve?
When it is a flat line
What does a horizontal yield curve depict?
When short term yields are the same as long term yields. This might happen if the government temporarily raise short term rates while the market doesn’t reflect this in the higher long term yields
