4 - Bonds (fin) Flashcards
Bond characteristics
NV - far value/face value - amount issue will pay back @ redemption. coupon expressed as % of this
£100, $1000, 100 yuan, 1000 rand
price - quoted as amount investor would have to pay to buy NV
redemption date/maturity date - when issue will repay NV
coupon - interest that issuer pays to holder (usually semi annual, can be quarterly or annual)
can be 0 for ZCB
fixed for vanilla bonds
index (inflation) linked for ILB - linked to RPI with 8 (issued before jul 2005) or 3 month lag - inflation uplift = RPI now/RPI @ issue
maturity
<7yrs = short 7-15 = med >15 = long
yield - measures return on bond incl coupon and principal
what is a bond
a form of debt whereby borrower issues bond and receives price of bond, over the lifetime of bond pays interest in form of coupons and then at maturity repays lender the principal value of the bond
rank ahead of equity in cases of liquidation - so relatively low risk - so generally lower expected returns
traditionally low correlation to equities
bond yield
= return an investor expects to receive each year over its term to maturitY
In financial media - will see flat yield and GRY (aka YTM)
figure shown = annual
markt val of straight will vary as rates vary - because fixe dcoupon will seem more/less attractive relative to rates
yields can be neg = capital loss (cannot be offset as no CGT on gains)
higher yield = higher risk
risk built up of
risk free rate + credit risk + liquidity risk + currency risk (if in another currency) +maturity
for most govis - yield is just risk free rate + maturity as no credit risk/currency risk
currency risk can be taken on by issuer by denominating bond in another currency
bond features: maturity date
single dated/bullet bonds - vast majority of bonds - single redemption date
irredeemable/perpetual/undated
issuer has no obligation to redeem but may have right to do so after particular date
coupon paid in perpetuity
e.g. war bonds UK 5% war loan 1917
no undated UK gilts in issue
also issued by corps - AT1 bonds are perpetual bonds issued by banks to help fulfil cap reqs
most corp perpetuals are convertible
callable bonds - can be redeemed by issuer between call date and maturity date
- if rates fall - call back and refinance at lower rate
higher coupons for investor
e.g. UK double dated gilt - last one redeemed in 2013
putable bonds
can be redeemed early by holder
- if rates rising - redeem and buy new bond @ higher rate
lower coupon
both call and put bonds hard to analyse price - dissuades investors
Coupons
most bonds = fixed rate coupon = ‘straights’
frequency = market driven
semi annual usually- UK, US, Japan, Italy
annual - Germany, France
ILB - coupon and redemption linked to inflation index (currently RPI) via uplift (or down if no deflation floor)
FRN - coupons linked to ref interest rate e.g. SONIA, ESTR, SARON, SOFR
ZCB - no coupon. issued at discount to face val and the gain provides the required GRY - will be subject to income tax as yield is considered to have accrued over life of bond
- UK govs dont issue these but can be created via STRIPS
step up coupons - % increases annually
Credit ratings
Credit rating agencies provide a benchmarking system for government and corporate bonds.
-Moody’s, Fitch, S&P
IG - least likley to default, highest liquidity
speculative/high yield/junk/non IG - more likely to default, compensated for with higher coupons and higher YTM
PostGFC scrutiny - competitive pressure to lower standards, bias towards clients with more issues with ratings agencies
Credit ratings - Moody, fitch, s&p
spreads
difference between yield avail on 1 instrument vs another - usually as bps
e.g.
same instrument different maturities
2yr gilt vs 10 yr gilt
corp vs gov
- 10 yr appl vs 10 year treasury
different countries
10yr gilt vs 10 year treasury
used as indicators of risk sentiment - wider spread vs govi = greater perceived risk
can also be vs rate benchmarks eg SONIA, ESTR, SOFR etc
als bond yields vs equity yields - observed as indicators of changing sentiments and relative val
bond covenants
baso just conditions that protect holders
covenants limiting further debt and priority -
negative pledge clause
- prevent issuer from reducing val of bond by issuing additional debt @ higher priority or
pari passu clause
- only allowing debt to be issued at higher priority is existing bonds are upgraded to have equal priority
covenants restricting divi payment
- excessive divis could negatively impact bond value - covenants frequently restrict payment of cash divi based on earnings and cash
- can also restrict buyback facility
covenants restricting sale of assets
- to prevent val falling due to asset sale - often assets only permitted for sale if proceeds used to buy new fixed assets or retire debt
- can prohibit transfer of whol bis or require new owner to assume all obligations of bond
breach of covenants is a default event - if no solution is found afer engagment period post default - bond becomes immediately repayable
Susuk
Islamic financial instruments - similar to bond s- compliant with Shariah law (interest forbidden)
works on basis of risk sharing -customer and bank share risk of investment and divide profit between them
susuk = instruments of equal val representing common share in ownership of UL
baso - issuer sells investor group a certificate (susuk) and uses proceeds to buy asset -investor group has direct partial ownership in asset
issuer must also promise to buy back certificate at future date @ par
severaldifferent structures
Ijarah Susuk
Ijarah = lease
company owns asset
SPV issues susuk and uses proceeds to buy asset from company
leases asset back to company
lease payments passed back through to investors
@end - comp buys back assets and SPV buys back susuks from investors
Intifa susuk
similar to Ijarah but investors have right to use,own, develop asset over period
issuer divides right sof assets into units and transfers to investors
investors have right to benefit like a time share
salam susuk
similar to forward contract
issuer issues susuk and promises to delivery commodity on future date
price paid in advance via susuk
usually ST finance
perpetual susuk
susuk without specific maturity date
may be redeemed or amortised wholly or partially @ any time @ issuer discretion or within specific period
gov, ministries, instiution and public authorities can issue perpetual susuk
convertible susuk
gives holder right to convert into shares of issuer at future date
price of susuk cannot be below par val of shares
green bonds?
GBP?
conventional debt where proceeds used to finance/refinance new/existing green projects
- w/ positive environmental or climate benefits e.g. energy efficiency, transportation
additional transaction costs - issuer must track, monitor and report on funds
- issuers think this is offset by benefits (diversifying investor base, highlighting greenness etc)
lack of standardization as to what makes a green bond - can lead to greenwashing, green label can confer pricing advantage
GBP - green bonds principal dev by ICMA - completely voluntary recommendation of guidelines + transparency and disclosure, promoting integrity etc
fall from green grace - bonds losing green status -reputational and price damage - could put cap at risk due to downward pressure.
canlead to ‘green default’ - investors seeking penalties for breaking green clauses even if bond is paid in full
green bonds?
GBP?
conventional debt where proceeds used to finance/refinance new/existing green projects
- w/ positive environmental or climate benefits e.g. energy efficiency, transportation
additional transaction costs - issuer must track, monitor and report on funds
- issuers think this is offset by benefits (diversifying investor base, highlighting greenness etc)
lack of standardization as to what makes a green bond - can lead to greenwashing, green label can confer pricing advantage
GBP - green bonds principal dev by ICMA - completely voluntary recommendation of guidelines + transparency and disclosure, promoting integrity etc
fall from green grace - bonds losing green status -reputational and price damage - could put cap at risk due to downward pressure.
canlead to ‘green default’ - investors seeking penalties for breaking green clauses even if bond is paid in full
what is greenwashing
practise of comps making misleading environmental claims for marketing purposes - with aim of improving rep, to attract environmentally aware customers and increase profits
social bonds
bond with proceeds used to fund projects with non environmental but beneficial theme - typically with social objectives in mind
e.g. basic infrastructure, affordable housing, health services - particularly to benefit those livign below poverty line
first ever - Asia 2018 - to provide stable LT housing in Korea
like green bonds - ICMA has issues SBP (social bond principles) - voluntary guidelines where issuers may align framework to market expectations = market confidence
sustainability bonds
funds used to finance or refinance combo of green and social project - ICMA has issued SBG - sustainability bond guidelines - promoting integrity etc, voluntary
sustainability linked bonds (SLBs)
any bond instrument where financial and structural characteristics vary depending on whether issuer has achieved ESG/sustainability objectives
more flexi than green/social/sustainability bonds which can only be used to finance specific projects
- no specific use of proceeds - but issuer must define/commit to sustainability path over years
ICMA has vol SLBP guidelines = sets out best practise for launching credible slb
SLBs are complimentary financing to green/social/sustainability bonds
blue bonds
proceeds used for protection and conservation of marine ecosystems
generally issued by low-income countries that are heavily reliant on oceans and their resources
first sovereign blue bond: 2018 Republic of Seychelles - $15mn to support expansion of marine protected areas, fisherie governance
coupons partically guaranteed by world bank and concessional loan from GEF
social impact bonds
main goal is to achieve social objectives not investmentreturns
very diff from conventional bonds - focus is on social benefit > investment potential
payouts based on specific social criterias being met
dont offer fixed return
used by govt to address issues e.g. homelessness, youth unemployment, children in care etc
BASO
contract with GOV/pub sector issue, whereby it pays for better social outcomes + passes on part of the savings achieved to investors.
factors affecting bond price
rates (up P down) - investors need higher ROR as rates rise
inflation (up price down) - investors need higher ROR as inflation rises, for ILB price tends to rise as higher inflation expected - both prevailing and expected rates impact
liquidity - more liquid = more expensive
exchange rates
issuer specific factors
- credit rating - higher = higher price - lower yield
- structure and seniority of bond - higher = higher price
bond derivs