Chapter 6: Debt: Types and Features

Question 1

Difference between a bond and a bill?

Answer 1

• Bonds typically have maturity for longer than a year whereas bills are short-term securities maturing in less than one year

Question 2

Who issues UK gov gilts and treasury bills and what is the usual method used for this?

Answer 2

• The Debt Management Office (DMO)
• An Auction

Question 3

Features of gilts

Answer 3

• A name
• An interest rate (coupon)
• A redemption date

Question 4

What does the quoted coupon of a gilt represent?

Answer 4

• the annual amount of interest paid per £100 nominal value

Question 5

How often are gilt coupons typically paid?

Answer 5

• Semi-Annually, on fixed days 6 months apart ex. 25th Jan & 25 July

Question 6

Short, medium and blond conventional gilts time

Answer 6

• Shorts – remaining life < 7 years
• Mediums – remaining life 7 - 15 years
• Longs – remaining life > 15 years

Question 7

What are Index-Linked Bonds?

Answer 7

• have coupon and redemption values linked to the UK retail price index
• each index-linked payment is related to the RPI three months prior to the months payment –> the investor will know what the next coupon will be due to the lag

Question 8

2 Unusual features of Floating rate gilts

Answer 8

• Pay variable coupons, set by reference to a predetermined market interest rate at the beginning of each interest payment period
• Pay interest four times a year instead of semi annually

Question 9

What are STRIPS and who are they carried out by?

Answer 9

• gilts that can be stripped into their coupons and a redemption amount and traded separately
• Carried out by financial institutions

Question 10

Gilt Repo

Answer 10

A transaction where one party sells gilts to another, agreeing at the same time to repurchase the equivalent securities at an agreed price and on an agreed date in the future (repo = re-purchase)

Question 11

What is the indenture?

Answer 11

The terms and conditions of a bond

Question 12

What does a fixed charge bond mean?

Answer 12

It is secured against specific company assets ex. a building
* Mortgage bonds

Question 13

Loan Stock

Answer 13

• Unsecured corporate debt securities

Question 14

Debentures

Answer 14

• A bond that is a floating charge over assets secured against a ‘class’ of assets, ex. machinery or fixtures

Question 15

Collateralized debt obligations (CDOs)

Answer 15

• secured by cash flow from a pool of bonds, loans and other assets
• asset backed security
• repackage the bonds, enabling the issuing company to create a separate legal entity from the original owner of the underlying assets, leaving them unaffected by any bankruptcy risk in the original owner

Question 16

Conversion value calculation

Answer 16

Current share price x conversion ratio

Question 17

Calculate the theoretical price of a convertible bond

Answer 17

• done by comparing a similar bond and an American call option with the same strike and expiry date, taking into account the dilution effect of the calculation
• Convertible price = Straight bond + ((Option premium/1 + Dilution) x Conversion ratio)

Question 18

Contingent convertible bonds (CoCos)

Answer 18

• bonds that are converted into shares automatically is a trigger is met
• mechanical trigger = based on bank’s capital ratio, if falls below a set level, will trigger a conversion to prevent the bank becoming insolvent
• discretionary trigger = based on a regulator’s opinion of a bank’s solvency
• a market event is also a trigger

Question 19

What are call provisions for bonds?

Answer 19

• allows the issuer of the bond to pay off the obligations of the bond early, before maturity
• typically used by issuers when interest rates fall as they can re-issue the bond at lower coupon costs

Question 20

What are put provisions for bonds?

Answer 20

• allows the holder of the bond to force the issuer to redeem early

Question 21

Order of repayment

Answer 21

• all classes of debt rang more highly than equity
• senior debt is the priority