Ch 3. Long Term Debt Products Flashcards
Long term debt market: 2 segments:
- Fixed Interest Market (govvies and semis)
2. Debt capital markets (debt issued by non government issuers
Government Securities
- CGS issued by AOFM on competitive tender basis & settled by RBA
- Tenders conducted on outright basis
- May also do conversions
Annuity
- series of periodic cashflows that occur for a fixed period of time
- standard formula assumes the amount is $1 and is based on using the compound interest calculations
RBA bond formula, broken into components:
Total Price = Capital price + accrued interest component
Accrued interest is the pro rata coupno received between coupon dates.
FRN: 2 margins
1, Coupon margin: set at issue as a margin relative to an index
2. Trade margin: adjustment to the interest margin (plus or minus) to reflect the credit spread margin
Zero Coupon bonds
- long term discount securities
- no interim cashflows, all interest and principal is paid on maturity
- therefore interest is large compared to face value, as such these are known as dep discount bonds
- taxed as an accrual rather than cash basis
Capital Indexed Bonds
- periodic interest coupons are paid on an indexing principal.
- principal grows in line with movements in CPI
- fixed coupon rate of interest is applied to calculate coupon payments
- indexed principal itself is repaid at maturity
- provide inflation protection
Interest Indexed bonds:
- interest payment has a fixedx rate comp;onent (coupon payment) and floating component which is added to the fixed coupon payment.
- The floating component varies with indexation adjustment
- principal is repaid at maturity at the original face value
Medium Term Note
- Debt obligation of issuer
- issued in a series, each series may comprise 1 or more tranches issued on different dates
- subsequent series may be fungible
- fixed or floating
Asset Backed Securities
- backed by asset pools and their respective cashflows that service interest payments on the debt issued
ABS: securitisation process
- assets sold to special purpose vehiclew, which is a separate company specifically created for the transaction
- SPV is controlled by a trustee, which issues new securities backed by assets in the SPV
- A guarantee from a bank covering the SPV is often put in place to enhance marketability
- A manager is appointed to carry out administration functions
MBS
- define
- bullet vs pass through
- most common form of ABS in Aus
- claim on cashflows from pools of mortgages
- bullet: repayment of all capital at maturity
- pass through: periodic payments of capital as the mortgaes are paid off (prepayment risk for investor)
Hybrids - Reset Securities
- reset mechanism at predetermined date allowing issuer to change key terms (eg coupon / dividend rate, equity participation, next reset date)
- Holders have te right to accept new terms or refuse and exit.
- Exit - could convert into ordinary shares
Hybrids: Convertible bonds
- Debt instruments with embedded options
- holder has right to convert to equity in the future, according to predetermined ratio
- most are callable (issuer can repurchase outstandings at certain price & date)
- equiv to bond with an equity call
Hybrids: Warrants
- contain an option for the holder to convert the bond and receive redemption proceeds in another form.
- May be issued with a bond, from which they can be detached and exercised, or traded separately from the bond
CDOs
- debt securities that are exposed to credit risk of a number of corporate borrowers.
- reference pools = variety of corrower types and credit ratings
Eurobonds
- bonds issued in the international market
- Fixed rate of interest, generally paid annually in arears (zero coupon also available)
- tend to be 30/360
- yields generally expressed as annual effective yields (due to annual payment) so need to adjust to compare with semi annual bond in Aus mkt
Debentures
- document evidencing acknowledgment of a debt a company has created to raise capital
- payments are secured by a charge over ussing company’s unpledged assets and/or specific revenues
- unsecured notes - issued on unsecured basis
- usually transferable
CALCULATIONS:
- Compound interest: Future value and present value
- Annuity
- Simpler Annuity Formula
- RBA Bond Formula
- Short Dated bond pricing
- FRN
- Compound interest: Future value and present value
- Annuity
- Simpler Annuity Formula
- RBA Bond Formula
- Short Dated bond pricing
- FRN
Calcs: Fixed interest securities are priced on xxx while discounts are priced onxxx
Fixed Interest: Compound interest
Discounts: Simple interest
Compound interest calcs
Watch compounding period -
Compounding period:
eg 7% quarterly; over 2 years:
FV = PV x (1+ 0.07/4)^8
Calc trap compound interest
- watch FV vs PV
- eg “A company needs to borrow $500K FOR 2 years” (ie PV = 500K
- eg “an investment of $200K is to mature in 3 years time (calculate PV, but read question)
Calculating bond prices using fin calc:
- watch: “Price” is cap price; need to add this with “accrued” for the total
