Chapter 4: Bonds Flashcards
How are bonds split?
Between government (issued by national governments) and corporate (issued by companies) bonds.
How does a bond work?
An investor lends in return for the promise to have the loan repaid on a fixed date plus a series of interest payments. Bonds can be commonly referred to as LOAN STOCK, DEBT or FIXED INTEREST SECURITIES.
The 6 features of a bond:
- Nominal - the amount of stock purchased. The amount on which interest will be paid. Also known as par amount.
- Stock - name given to identify
- Coupon - e.g 0.375%, it is the nominal interest rate payable on the stock. Rate is quoted gross will be paid in two separate half yearly interest payments.
- Redemption date - e.g 2030, it is the year the stock will be repaid, also known as maturity date.
- Price.- of stock
- Value
UK government bonds are also known as what? Who are they issued by?
Known as gilts. They are issued by the Debt Management Office (DMO).
Two types of government bonds:
- Conventional bonds - instruments that carry a fixed coupon and a single repayment date.
- Index linked bonds - coupon and redemption amount are increased by amount of inflation over its lifetime (more attractive for long term investments)
What is ‘stripping’?
Conventional bonds can be stripped into their individual cash flows - stripping refers to individual cash flows which can be traded separately as zero coupon gilts.
Other types of government bonds:
Dual dated - carry a fixed coupon bud show two dates they can be repaid.
Undated.
Features of corporate bonds:
- Bond security: is a form of charge over the issuers assets so that if issuer defaults, the bond holders have a claim on those assets before other creditors. Security can be FIXED or FLOATING.
- Redemption provisions - issuer has option to buy back all or part of the issue before maturity.
What is a sinking fund requirement?
Type of call provision where there may be a requirement for the issuer to redeem a specified amount regular intervals.
What’s a puttable bond?
Gives the bondholder the right to require the issuer to redeem early, on a set date or between specific dates.
Types of corporate bonds:
- Medium term notes (MTNs): are standard corporate bonds with maturities up to five years. They are offered to investors continually over a period of time by an agent of the issuer, instead of in a single tranche of one sizeable underwritten issue.
- Fixed rate bonds: fixed coupons which are paid either half yearly or annually.
- Floating rate notes (FRNS’s): variable rates of interest. The rate will be linked to a benchmark such as SONIA or SOFR
- Permanent interest bearing shares (PIBS): they are issued by building societies and carry fixed coupons and are irredeemable.
- Convertible bonds: gives investor 2 choices - collect interest payments and then the repayment of the bond on maturity AND to convert bond into a predefined number of ordinary shares in the issuing company
Attractions: 1) if company prospers, share price will rise, capital gains. 2) if company hits problems the investor can retain the bond. - Zero-coupon bonds (ZCBs): a bond that pays no interest.
What are the two geographic bonds?
- Domestic bond: issued by a domestic issuer into the domestic market
- Foreign bond: issued by an overseas entity into a domestic market and is denominated in the domestic currency
What are Eurobonds? Where’d they come from? Key factor:
Are large international bond issues often made by governments and multinational companies.
Market devolved in 1970’s to accommodate the recycling of OPEC US dollar revenues from Middle East oil sales.
They are denominated in a currency different from that of the financial centre or centres in which they are issued.
What is a ‘negative pledge’ clause?
Prevents company from subsequently making any secured bond issues, or issues which confer greater seniority or entitlement to the company’s assets.
Advantages of Eurobonds:
- a choice of innovative products to more precisely meet issuers needs
- the ability to reach potential lenders internationally
- anonymity to investors as issues are made in bearer form
- gross interest payments to investors
- less regulation
What are Eurobonds issued as?
Conventional bonds (straights) with a fixed nominal value, fixed coupon and known redemption date.
What are asset backed securities?
ABS - these are bundled securities, so called because they are marketable securities that result from the bundling or packaging together of a set of non marketable assets.
The Assets range from mortgages and credit card debt to accounts receivable.
What’s the largest ABS market?
It’s for mortgage-backed securities.
Mortgage backed bonds are created by bundling together a set of mortgages and then issuing bonds that are backed by these assets. These bonds are sold on to investors who receive interest payments until they are redeemed - securitisation
Advantage of ABS
They bring together a pool of financial assets that otherwise could not easily be traded in their existing form. The pooling together of a large portfolio of these illiquid assets converts them into instruments that may be offered and sold freely in capital markets.
What is a covered bond?
A variation of ABS. Issued by financial institutions and are corporate bonds that are backed by cash flows from a pool of mortgages of public sector loans.
What’s the differences between asset backed securities and covered bonds?
- They remain on the issuers balance sheet
- The asset pool must provide sufficient collateral to cover bond holder claims throughout the whole term of the covered bond
- Bondholders must have priority claim on the cover asset pool in case of default of the issuer
Advantages of investing in bonds:
- For fixed interest bonds you get a regular and certain flow of income
- For most bonds you have a fixed maturity date
- A range of income yields to suit different investment and tax situations
Disadvantages of investing in bonds:
- The real value of the income flow is eroded by the effects of inflation
- Bonds carry various elements of risk.
Risks of holding bonds:
- Corporate bonds have default risk and price risk
- Government bonds are said to have price risk
- Early redemption - risk that the issuer may invoke a call provision
- Seniority risk
- Inflation risk
- Liquidity risk
- Exchange rate risk
