Chapter 4 - Bonds Flashcards
What is a Bond?
Simply a loan.
With a bond, an investor lends in return for the promise to have the loan repaid on a fixed date plus (usually) a series of interest payments. Bonds are commonly referred to as loan stock, debt or (in the case of those that pay fixed income) fixed interest securities.
Who issues Government bonds?
- National Government
- Supranational Agencies
- World Bank
Supranational Agencies examples: European Investment Bank, IMF, World Tr
Who can issue a Corporate bonds?
- Large Corportate Listed Companies
- Large Banks
What makes a bond different from most loans?
It is tradable
What is the Nominal of a Bond?
Also known as par or face value or principal of the bond.
The amount of stock purchased. This will be what the interest payment will be based on.
The nominal is not be confused with the amount
invested or the cost of purchase
What is Stock in relation to a Bond?
The name given to identify it.
What is Coupon Rate?
- The nominal interest rate payable on the stock.
- Rate is quoted gross
- Typically pays out equall every half year.
What is the Redemption Date in relation to Bonds?
Also known as Maturity Date
- The year the stock will be repaid.
- The amount repaid will be the nominal amount of stock held
- Repayment will take place at the same time as the final interest payment3.
Repayment will take place at the same time as the final interest payment
In the bond market, what price per nominal is it based on?
£100
Nominal = £10,000
The convention in the bond markets is to quote prices per £100 nominal of stock. So, in this
example, the price is £100.70 for each £100 nominal of stock.
How do you calculate the value of a bond?
price per £100 nominal of stock and scaling up based on the total nominal value held.
Example, the total nominal value is £10,000 and the price per £100
nominal value is £100.70. The total value is, therefore, £10,070.00, calculated as: (£10,000/£100) x
£100.70 = £10,070.00.
What are Gilts?
UK Government Bonds
What are UK Government Bonds called?
Gilts
Who issues Gilts on behalf of the UK Government
The bonds are
issued on behalf of the government by :
- The Debt Management Office (DMO)
- An executive agency of HM Treasury.
What are the two main types of UK Government Bonds
- Conventional Bonds
- Index-Linked Bonds
What are Conventional UK Government Bonds?
Conventional government bonds are instruments that carry a fixed coupon and a single repayment
date.
What are Index-Linked UK Government Bonds?
The coupon and redemption amount for index-linked bonds are increased by the amount of inflation
over its lifetime by linking the payments to some inflation indicator, such as the Consumer Price Index (CPI) or Retail Price Index (RPI).
What main UK Government bond type is favourable in times of uncertain inflation?
Index-linked bonds
- Provides more protection to the investor.
- Long-term investors need to invest their funds and know that the returns will
maintain their real value after inflation so that they can meet their obligations to pay pensions.
What does stripping a Gilt mean?
When a conventional gilt bond is “stripped,” breaking it down into its individual cash flows which can be traded separately as zero coupon gilts.
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What are gilt STRIPs?
A conventional gilt bond that has been stripped into its individual cash flows and sold seperately as zero coupon gilts
What is the name of a bond that is issued by a company of a maturity date over 12 months
Corporate Bond
What is the a bond that is issued by a company that has a maturity date less than 12 months typically reffered as?
Commercial Paper
What is a call provision in a corporate bond
A right that give the issuer the option to buy back all or part of the issue before maturity
What requirement does a company need to issue bonds of over 10 years at an acceptable cost?
- High Credit Rating
Where are Corporate Bonds traded?
Trading mainly occurs Over the Counter (OTC) in developed markets (that is directly between market counterparties) but are also tradable on stock exchanges.
Most are listed on stock exchanges
What is Bond Security?
(Corporate Bonds)
When a company issues bonds and is obliged to offer protection to the investor that gurantees some repayment of the bond if the company defaults.
This can secured through the issuers assets or a third party guarantree e.g. a bank that agrees to pay the investors if the company defaults.
Bondholders have seniority before other creditors on these assets.
The greater the security offered, the lower the cost of borrowing should be
What is the difference between a fixed-rate security and a floating-rate security?
(Corporate Bonds)
- Fixed security implies that specific assets (eg, a building) of the company are charged as security for the loan
- A floating charge means that the general assets of the company are offered as security for the loan; this might include cash at the bank, trade debtors and stock.
What are 2 features of a corporate bond that help define them
- Bond Security
- Redemption Provisions
What are the 7 types of corporate bonds?
- Medium-Term Notes (MTNs)
- Fixed-Rate Bonds
- Floating-Rate Bonds
- Permanent Interst-Brearing Shares (PIBS)
- Convertable Bonds
- Preffered Bonds
- Zero Coupon Bonds
What is a Medium-Term Notes Corporate Bond?
MTNs
- Medium-term notes (MTNs) are standard corporate bonds with maturities up to five years.
- They are continually offered to investors over a period of time by an agent of the issuer.
The term can also applied to instruments with maturities as long as 30 years.
What is a puttable bond
(put option bond, put bond, put provision bond)
A put option on a bond, also known as a put provision, gives the holder the right to demand the issuer pay back the principal before the bond matures, for whatever reason.
This is the opposite of a callable bond, in which the issuer may redeem an outstanding bond before it reaches maturity.
What is a call provision in a corporate bond
(callable bonds)
Gives the issuer the option to buy back
all or part of the issue before maturity.
Provides oppertunity for the issuer to refinance it at a lower rate.
What is a sinking fund requirement
(Corporate Bonds)
When there is a requirement that the issuer redeems a specified amount at regular intervals
What is a corporate fixed-rate bond?
A fixed rate bond is a bond that pays the same level of interest over its entire term.
What is a Floating Rate Note Corporate (FRNs)?
(Also known as Variable Rate Bonds or Floating rate Bonds)
- Floating rate notes (FRNs) are usually referred to as FRNs and are bonds that have variable rates of interest.
- The rate will be linked to a benchmark
- An FRN will usually pay interest at the benchmark rate plus a quoted margin or spread.
SONIA is the rate of interest at which banks will lend to one another in London
What is a Permanant Interest-Bearing Share Corporate Bond (PIBS)
- Irredeemable Fixed Coupon Bonds issued by Building Societies
- Typical to see in the UK Sterling Market
You should note that the name ‘shares’ is a misnomer. It is in fact a bond, pays interest, and is taxable as such despite its name
What is a Convertable Corporate Bond?
A bond issued by Companies that give the investor two options:
1. Collect interest payments and then repayment of bond on maturity
2. Convert bond into a predefined number of ordinary shares in the issuing company on a date or dates or between set dates or before bond maturity.
- Conversion may lead to capital gains if the company does well.
- Investor can retain the bond and interest payments if company does poorly, and in bankrupcy it has seniority (may not be paid if its unsecured but less likely than a shareholder).
- The prospect of dilution of current
shareholder interests, as convertible bondholders exercise their options, has to be borne in mind.
What is a Preferred Corporate Bond?
Also known as preferreds
- They are essentially bonds that have equity-like features and are generally issued by large banks and insurance companies.
- Undated/perpetual and carry callable rights for the issuer within the first five to ten years of issuance
- They pay dividends and not coupons (seniority is between other bonds and shareholders)
Has the potential to offer investors higher yields than holding the company’s ordinary shares or bonds.
What is a Zero Coupon Corporate Bond (ZCBs)
Coupon’ is an alternative term for the interest payment on a bond
- A bond that pays no interest
- Are issued at a discount to their par value (nominal value) and are redeemed at their nominal value.
3.
The return is provided in the form of capital growth rather than income and, as a result, it may be treated differently for tax purposes.
What currency is a bond in
Whatever currency the the investors domestic market is in. I.e a German bond issuer has issued a bond into the UK market will be denoted in Pound Sterling and not Euro.
What is a Eurobond
-Large international bonds created by governments and multinational companies.
- A Eurobond issued by a company does not often provide underlying collateral but are almost always credit-rated by a credit rating agency.
Is the worlds largest with the most activity in London
What are the advantages (7) for for being in the Eurobond Market? (Opposed to being in the domestic bond market )
- Innovative products to precisely meet investors need
- Ability to reach potential lenders internationally
- Anonymity to investors as issues are made in bearer form
- Gross Interest Payments to investors
- Lower funding costs due to competitive nature and greater liquidity of the market
- Ability to issue bonds in short notice
- Less Regulation
What is an Asset Backed Secuirty (ABSs)
Corporate Bonds
Non-Marketable Assets bundled together to make it more profitable.
Creating a bond in this way is known as securitisation
Think of Mortgage Backed Securities (MBS) or Subprimes that caused the 2008 crash but for non mortgage assets.
What is the term for creating an ABS bond by bundling non-marketable assets together
Securitisation
What are covered bonds?
Corporate Bonds
A variation of ABSs (bundled together non-marketable assets) backed by a cash flow of mortgages or public sector loans.
They remain on the issuers balance sheet
Bondholders have priority claim on the cover asset pool in the case of default.
What are the 4 advantages of investing in the Bond Market?
- Regular and certain cash flow of income (For Fixed-Interest Bonds)
- Fixed Maturity date (for most)
- Range of income yields to suit most investors and tax situations.
- Relative secuirty of capital for more highly rated bonds
What are the disadvantages of investing in the bond markets?
risks incl.
- The real value of income flow is eroded by the effects of inflation (execpt for index linked bonds)
- Default Risk (Mianly for Corporate Bonds)
- Price (Market) Risk for Gov and Corp Bonds
- Early Redemptions
- Seniority Risk (Corp)
- Inflation Risk
- Liquidity Risk
- FX RIsk
Highly-rated government bonds are said to have only price risk.
In relation to bonds, typically what happens to the bond price when interest rates increase and vice versa?
If interest rates increase, bond prices will decrease.
If interest rates decrease, bond prices will increase.
How is flat yield of a bond calculated?
( Annual Coupon / Bond Price ) x 100
The bond’s price is typically stated as the price payable to purchase £100 nominal value.
A bond with a coupon of 1%, issued by XYZ plc, redeemable in 2030, is currently trading at £100
per £100 nominal. The flat yield is the coupon divided by the price expressed as a percentage, ie:
£1/£100 x 100 = 1%.
What is Credit Risk?
The probability of the issuer defaulting on their payment obligations.
What are the two distinct catagories that you get in credit ratings
Investment Grades and Non-Investment Grade (High Yield, Junk Bonds)
4¾% Treasury Gilt 2030 is an example of which type of government bond?
Exam Question
Index linked gilts (due to it being so high)
Which type of government bond would you expect to be the most attractive during a period of
rising inflation?
Exam Question
Index-Linked Bonds
What is the function of a call provision when attached to a bond?
Exam Question
Gives the issuer the right to buy back all or part of the issue before maturity.
What is the typical maturity period for a medium-term note (MTN)?
Exam Question
5 years
What options does a convertible bond give to an investor?
Exam Question
To convert it to shares
What type of bond does not pay interest?
Exam Question
Zero-Coupon Bonds
Which types of assets might you see pooled together to provide the backing for an assetbacked
security (ABS)?
Exam Question
Non-Marketable Securities
What will be the impact of a fall in interest rates on bond prices?
Exam Question
Bond price will rise
You have a holding of £1,000 Treasury 1.75% stock 2028 which is priced at £117. What is its
flat yield?
Exam Question
1.496%
What credit rating should be looked for in a bond when seeking the greatest liquidity and
certainty of repayment?
Exam Question
Investment Grade
What is a dual dated govenment bond?
One that has two possible redemption rates that the government can choose from.
What is a negative pledge cause in a Eurobond?
Prevents a company from issuing secured bonds or greater seniority assets.
What kind of assets are included in an ABS?
Mortgages and Credit Card Debt.
Usually the former.
