Chapter 6 | Fixed Income Flashcards
NOTE ONLY / FIXED INCOME
Fixed-income securities represent debt of the entity that issues them. As such, you will often hear the term debt securities to describe them.
The terms of a fixed-income security include a promise by the issuer to repay the maturity value, or principal, on the maturity date, and to pay interest either at stated intervals over the life of the security or at maturity. In most cases, if the security is held to maturity, the rate of return is fairly certain.
Fixed-income securities trading in today’s markets come in many varieties, including bonds, debentures, money market instruments, mortgages, and even preferred shares. The various types reflect widely different borrowing needs and investor demands.
Issuers of fixed-income securities can modify the terms of a basic security to suit both their needs and costs, and to provide acceptable terms to various lenders.
NOTE ONLY / FIXED INCOME
Fixed-income securities represent debt of the entity that issues them. As such, you will often hear the term debt securities to describe them.
The terms of a fixed-income security include a promise by the issuer to repay the maturity value, or principal, on the maturity date, and to pay interest either at stated intervals over the life of the security or at maturity. In most cases, if the security is held to maturity, the rate of return is fairly certain.
Fixed-income securities trading in today’s markets come in many varieties, including bonds, debentures, money market instruments, mortgages, and even preferred shares. The various types reflect widely different borrowing needs and investor demands.
Issuers of fixed-income securities can modify the terms of a basic security to suit both their needs and costs, and to provide acceptable terms to various lenders.
NOTE ONLY /
Two examples of financing operations or growth:
A company wants to invest and expand its current operations so that it can meet the increasing demand for its product lines. The company decides to announce a new bond issue for “general corporate purposes”.
A corporation is interested in purchasing a company that specializes in making paper bags for grocery store chains. The cost of the purchase is $3 million. The corporation does not want to spend any of its available cash on the purchase, so instead it issues $3 million in bonds. The proceeds from the bond issue are used to complete the purchase, and the borrowing costs are paid out from the corporation’s revenue stream.
NOTE ONLY / FINANCIAL LEVERAGE
An example that takes advantage of financial leverage:
A company wants to open a new plant to increase its production capacity. The company issues $1 million in bonds at 10% interest, at a cost of $50,000 a year after tax.
The expanded capacity is expected to increase after-tax profits by more than $100,000 a year. The company proceeds with the project because it can increase the return on shareholders’ equity by borrowing the money.
In other words, the expected return from investing the borrowed funds is greater than the cost of borrowing. When the return from borrowing is higher than the borrowing cost, the result is financial leverage.
FIXED INCOME SECURITIES
Bonds are considered fixed-income securities because they impose fixed financial obligations on issuers—that is, the payment of regular interest payments and the return of principal on the date of maturity.
TRUST DEED
The details of a bond issue are outlined in a trust deed and written into a bond contract. If the issuer can no longer meet the fixed obligations, the bond goes into default. When that happens, the provisions of the trust deed allow the bondholders to seize specified physical assets and sell them to recover their investment.
DEBENTURES
A debenture is a type of bond that is secured by something other than a specified physical asset, typically by a general claim on residual assets. Therefore, the debenture is backed by the general creditworthiness of the issuer.
For this reason, debentures are also referred to as unsecured bonds. Aside from this difference, debentures are similar to bonds, and as such, they promise the payment of regular interest and the repayment of principal at maturity.
GOVERNMENT BONDS
Government bonds are never secured by physical assets, and so technically they are debentures; in practice, however, they are always referred to as bonds.
PAR VALUE
The par value of a bond (also called face value) is the principal value amount the bond issuer contracts to pay at maturity to the bondholder.
A bond is issued and matures at its par value.
COUPON RATE
The coupon rate, or simply the coupon, is the interest or rate paid by the bond issuer relative to the bond’s par or face value over the term of the bond.
The coupon represents the regular interest the bond issuer is obliged to pay to the bondholders. Most bonds are coupon bonds, paying fixed coupon rates.
Most bonds make semiannual coupon payments; some bonds pay coupons on an annual basis.
MATURITY DATE
The maturity date is the date at which a bond matures, when the date principal amount of the loan is paid back to the investor holding the bond.
TERM TO MATURITY
The term to maturity is the time that remains before a bond maturity
