(51) Fixed-Income Securities

Question 1

LOS 51. a: Describe basic features of a fixed-income security.

Answer 1

Basic features of a fixed income security include the issuer, maturity date, par value, coupon rate, coupon frequency, and currency.

Question 2

LOS 51. a: Describe basic features of a fixed-income security. Who are the issuers?

Answer 2

Issuers include corporations, governments, quasi-government entities, and supranational entities.

Question 3

LOS 51. a: Describe basic features of a fixed-income security. Define money market securities & capital market securities

Answer 3

Bonds with original maturities of one year or less are money market securities. Bonds with original maturities of more than one year are capital market securities.

Question 4

LOS 51. a: Describe basic features of a fixed-income security. Define par value, premium, and discount.

Answer 4

Par value is the principal amount that will be repaid to bondholders at maturity. Bonds are trading at a premium if their market price is greater than par value or trading at a discount if their price is less than par value.

Question 5

LOS 51. a: Describe basic features of a fixed-income security. Dine coupons and their payment frequency.

Answer 5

Coupon rate is the percentage of par value that is paid annually as interest. Coupon frequency may be annual, semiannual, quarterly, or monthly.

Question 6

LOS 51. a: Describe basic features of a fixed-income security. Define zero-coupon bonds

Answer 6

Zero-coupon bonds pay no coupon interest and are pure discount securities.

Question 7

LOS 51. a: Describe basic features of a fixed-income security. How do different currencies play a role in bonds being issued?

Answer 7

Bonds may be issued in a single currency, dual currencies (one currency for interest and another for principal), or with a bondholder’s choice of currency.

Question 8

LOS 51. b: Describe content of a bond indenture. Define.

Answer 8

Bond indentures or trust deed is a contract between a bond issuer and the bondholders, which defines the bond’s features and the issuer’s obligations.

Question 9

LOS 51. b: Describe content of a bond indenture. What does an indenture specify?

Answer 9

An indenture specifies:

• the entity issuing the bond
• the source of funds for repayment
• assets pledged as collateral
• credit enhancements, and;
• any covenants with which the issuer must comply.

Question 10

LOS 51. c: Compare affirmative and negative covenants and identify examples of each. Define covenant.

Answer 10

Covenants are provisions of a bond indenture that protect the bondholders’ interests.

Question 11

LOS 51. c: Compare affirmative and negative covenants and identify examples of each. What are negative covenants?

Answer 11

Negative covenants are restrictions on a bond issuer’s operating decisions, such as prohibiting the issuer form issuing additional debt or selling the assets pledged as collateral.

Question 12

LOS 51. c: Compare affirmative and negative covenants and identify examples of each. What are affirmative covenants?

Answer 12

Affirmative covenants are administrative actions the issuer must perform, such as making the interest and principal payments on time.

Question 13

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. List the legal and regulatory matters that affect fixed income securities:

Answer 13

Legal and regulatory matters that affect fixed income securities include:

• the places where they are issued and traded
• the issuing entities
• sources of repayment, and;
• collateral and credit enhancements.

Question 14

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. Define domestic bonds

Answer 14

Domestic bonds trade in the issuer’s home country and currency.

Question 15

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. Define foreign bonds

Answer 15

Foreign bonds are form foreign issuers but denominated in the currency of the country where they trade.

Question 16

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. Define Eurobonds

Answer 16

Eurobonds are issued outside the jurisdiction of any single country and denominated in a currency other than that of the countries in which they trade.

Question 17

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are possible issuing entities of fixed-income securities?

Answer 17

Issuing entities may be:

• a government or agency;
• a corporation, holding company, or subsidiary;
• or a special purpose entity.

Question 18

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are the source of repayment for sovereign bonds?

Answer 18

The source of repayment for sovereign bonds is the country’s taxing authority.

Question 19

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are the source of repayment for non-sovereign government bonds?

Answer 19

For non-sovereign government bonds, the sources may be taxing authority or revenues from a project

Question 20

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are the source of repayment for corporate bonds?

Answer 20

Corporate bonds are repaid with funds form the firm’s operations.

Question 21

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are the source of repayment for securitized bonds?

Answer 21

Securitized bonds are repaid with cash flows from a pool of financial assets.

Question 22

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. When are bonds secured vs. unsecured?

Answer 22

Bonds are secured if they are backed by specific collateral or unsecured if they represent an overall claim against the issuer’s cash flows and assets.

Question 23

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are some internal credit enhancements?

Answer 23

Credit enhancements may be internal, examples include:

• overcollateralization
• excess spread
• tranches with different priority of claims

Question 24

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. What are some external credit enhancements?

Answer 24

Credit enhancements may be external, examples include:

• surety bonds
• bank guarantees
• letters of credit

Question 25

LOS 51. d: Describe how legal, regulatory, and tax considerations affect the issuance of trading of fixed-income securities. How are fixed-income securities normally taxed?

Answer 25

Interest income is typically taxed at the same rate as ordinary income, while gains or losses from selling a bond are taxed at the capital gains tax rate. However, the increase in value toward par of original issue discount bonds is considered interest income. In the United States, interest income from municipal bonds is usually tax-exempt at the national level and in the issuer’s state.

Question 26

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a bond with a bullet structure

Answer 26

A bond with a bullet structure pay coupon interest periodically and repays the entire principal value at maturity.

Question 27

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a bond with an amortizing structure

Answer 27

A bond with an amortizing structure repays part of its principal at each payment date.

Question 28

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a bond with a fully amortizing structure

Answer 28

A fully amortizing structure makes equal payments throughout the bond’s life.

Question 29

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a bond with a partially amortizing structure

Answer 29

A partially amortizing structure has a balloon payment at maturity, which repays the remaining principal as a lump sum.

Question 30

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a bond with a shrinking fund provision

Answer 30

A shrinking fund provision requires the issuer to retire a portion of a bond issue at a specified time during the bonds’ life.

Question 31

LOS 51. e: Describe how cash flows of fixed-income securities are structured. Define a note with a floating-rate

Answer 31

Floating-rate notes have coupon rates that adjust based on a reference rate such as Libor.

Question 32

LOS 51. e: Describe how cash flows of fixed-income securities are structured. What are some over coupon structures?

Answer 32

Other coupon structures include:

• step-up coupon notes
• credit-linked coupon bonds
• payment-in-kind bonds
• deferred coupon bonds, and; (ex. The first payment of $229.25 is the value of the accrued coupon payment for the first year years…)
• index-linked bonds.

Question 33

LOS 51. f: Describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender. Define embedded options. What type of options benefit which party?

Answer 33

Embedded options benefit the part who has the right to exercise them. Call options benefit the issuer, while put options and conversion options benefit the bondholder.

Question 34

LOS 51. f: Describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender. Define call options.

Answer 34

Call options allow the issuer to redeem bonds at a specified call price.

Question 35

LOS 51. f: Describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender. Define put options.

Answer 35

Put options allow the bondholder to sell bonds back to the issuer at a specified put price.

Question 36

LOS 51. f: Describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender. Define conversion options.

Answer 36

Conversion options allow the bondholder to exchange bonds for a specified number of shares of the issuer’s common stock.