CH.6- Fixed-Income Securities: Features and Types Flashcards
FIXED INCOME SECURITIES
debt of issuing security
-promise to pay maturity value or principal on maturity date
○ Pay interest in intervals over life of security or at maturity
Rationale for borrowing
○ Finance operations or growth
Take advantage of operating leverage
rationale for issuing fixed income securities
- to finance growth
- to add to or expand companies current operations or to buy other companies
- s also borrow to take advantage of operating leverage ( greater return on cash invested in their business than it would cost to borrow money)
Bond
long term fixed obligation debt security that is secured by physical assets
-Pmt of regular interest pmts, return of principal on date of maturity
Debenture
type of bond that promises pmt of regular interest and re-pmt of principal at maturity, may be secured by something other than physical asset (also called Unsecured Bonds)
face vale/par value
principal amt bond issuer contract to pay at maturity to bond holder
Coupon rate
rate at which bond issuer pays regular interest
Maturity Date AND term to maturity
date at which bond matures and principal amt of loan paid back to investor holding bond
term to maturity: amt of time from beginning to maturity
yield
bond yield is approx. measure of annual return on bond if held to maturity
-yield NOT SAME AS COUPON RATE
floating rate securities
bonds with variable coupon rates typically referred to as Floating rate securities
amount of interest at each pmt date
coupon rate / # pmts in year
Yield and coupon rate relationship
○ If yield MORE than coupon rate = discount
○ If yield = coupon rate= PAR
○ If yield LESS than coupon rate= Premium
categorizing bonds
Money market Up to 1 yr term to maturity
Short term bonds More than 1 -5 yr remaining to maturity
Medium term bonds 5-10 yr remaining to maturity
Long Term Bonds More than 10 yrs remaining to maturity
liquid bonds
trade in significant volumes and for which it is possible to make medium and large trades quickly without making significant sacrifice on the price
negotiable bonds
bonds that can be trf because they are in deliverable form
( ○ Certificates not torn, power of attorney has been signed
)
marketable bonds
bonds for which there is a ready market
Strip Bonds (zero coupon bonds)
when dealer acquires block of high quality bonds and separates individual future dated interest coupons from rest of bond (underlying bond residue)
- • Sells each coupon and residue separately at significant discounts to future value
- ○ Holders don’t get interest pmts- strips bought at discount price that provides compounded rate of return when they mature at par
Callable bonds
bond issuers can pay off bond before maturity- to take advantage of lower interest rates, or to reduce their debt when they have excess cash
- ○ Allows issuer to call bonds for redemption at specified price on specific dates or during specific intervals over life of bond
○ Price usually set higher than par value of bonds– premium pmt for holder
accrued interest
interest that has accumulated since the last interest payment date, belongs to holder of bond
call protection period (on callable bonds)
interest that has accumulated since the last interest payment date, belongs to holder of bond
Extendible Bonds and debentures
issued with short maturity term (i.e. 5yrs), with option for investor to exchg the debt for identical amt of longer term debt
- ○ Maturity date of the bond can be extended so that the bond changes from short term bond to long term bond
retractable bonds
issued with long maturity term (min 10yrs), investors have right to turn in the bond foe redemption at par sooner (i.e 5 yrs), by retraction date
why are convertible bonds issued
- Conversion privilege makes bond more saleable or attractive to investors
- Lowers cost of the money borrowed + enable a company to raise equity capital indirectly on terms more favourable
- § Permits holding of a 2 way security
Combines much of the safety and certainty of income earned on bond with option to convert it to C/S
- § Appeals to investors who:
□ Wants share in company growth and avoid substantial risk
□ Willing to accept lower yield of convertible in order to Have call on C/S
characteristics of convertible bonds
○ Conversion price gradually raised over time to encourage early conversion
○ If c/s shares split, conversion privilege adjusted accordingly- protection against dilution
SINKING FUND
sums of money set aside out of earnings each year to provide repayment of all or part of debt issue by maturity
PURCHASE FUND
to retire at specified amount of the outstanding bonds or debentures through purchases in market
Protective provisions (COVENANTS)
safeguards In the bond contract to guard against any weakening in the security holders position
