Bond security, Investing and Leverage

Question 1

What is bond security?

Answer 1

• Security refers to the guarantee provided to the investor that the bond will be repaid.

Question 2

What are the different types of bond security?

Answer 2

• Fixed Charge
• Floating Charge
• Third Party Guarantee

Question 3

Fixed Charge

Answer 3

A specific asset, such as the head office of the company, or a particular factory, provides the security for the loan

Question 4

Floating Charge

Answer 4

General assets of the company are offered as security for the loan, which might include the company’s cash at the bank, trade debtors and unsold stock

Question 5

Third Party Guarantee

Answer 5

A guarantee from another organisation or individual that if the issuer defaults they will repay the bondholder eg A bank

Question 6

What are the advantages for bonds for investors?

Answer 6

• Relative security of capital for more highly rated bonds
• A range of income yields to suit different investment and tax situations
• For many bonds, they have a fixed maturity rate
• A regular and certain flow of income (bonds with a fixed coupon)

Question 7

What are the disadvantages of bonds for investors?

Answer 7

• Inflation Risk, if inflation rises, the real value of the bond’s coupon and redemption payment are eroded
• Liquidity Risk: Some bonds are more easily sold at a fair market price than others
• Exchange Rate Risk: Bonds denominated in a currency different from that of the investor’s home currency are potentially subject to adverse exchange rate movements
• Price/ Market Risk
• Default Risk
• Seniority Risk

Question 8

What is leverage?

Answer 8

• Leverage is the proportion of debt finance compared to equity finance in a company