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AFM 121 > Chapter 6: Fixed Income Securities > Flashcards

Chapter 6: Fixed Income Securities Flashcards

1
Q

What does fixed income include

A
  • bonds
  • debentures
  • mortgages
  • swaps
  • preferred shares
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2
Q

what is fixed income

A
  • fixed stream of cash flows instead of ownership

like:
- Coupon payments over time
- Principal repayment at maturity

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3
Q

what are bonds

A
  • secured by specific assets
  • In the event of default, the bondholder can seize the collateral
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4
Q

what are debentures (debt)

A
  • unsecured
  • There is no collateral beyond the general income and assets of the borrower
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5
Q

what are bond terms

A

described in a Bond Trust, which outlines the legal rights of the borrower (e.g. the company) and the lender (e.g. the investor)

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6
Q

what would be included in bond terms

A
  • Dates of amount coupon payments
  • Date of principal repayment
  • Covenants (restrictions)
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7
Q

what are bond prices like

A
  • they are quoted based on an index with a base value of $100
  • when they are traded at $100, they are trading at par/face value
  • this means it is selling for exactly what its worth, not more or less
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8
Q

what is par/face value of a bond

A
  • like the principal amount that is paid back to you at maturity (of the bond)
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9
Q

what is it called when a bond is trading above face value

A
  • called a premium
  • ex. you pay $104, and get back $100 face value
  • when the bond is selling for more than the face value
  • investors are willing to pay extra because the bond’s interest rate is higher than the current market rate
  • seen as safer/desirable
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10
Q

what is it called when a bond is trading below face value

A
  • called a discount
  • ex. you pay $96, and get back $100 face value
  • happens when the interest rate of the bond is lower than the current market rate or it seems like a risky investment
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11
Q

what is the coupon rate always

A

an annual rate

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12
Q

are price and face value the same thing

A
  • no
  • price is what is paid today
  • face value is what is paid back at the end of maturity
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13
Q

what are discount bonds

A
  • bonds that may not include a coupon payment
  • that’s why they are sold at a discount (“below par”)
  • what is earned is the difference between the price and the face value at maturity (discount bonds are when you are paying less initially and getting a higher face value)
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14
Q

what are price changes of discount bonds considered (aka returns you get on discount bonds; getting a principal amount that is higher than what you initially invested)

A
  • considered interest income for tax purposes (like income)
  • not treated as capital gains
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15
Q

what are the different time frames of bonds

A
  • short term
  • medium term
  • long term
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16
Q

how long are short term bonds

A

1 to 5 years

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17
Q

how long are medium term bonds

A

5 to 10 years

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18
Q

how long are long term bonds

A

over 10 years

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19
Q

what do liquid bonds trade with (think what is considered liquid)

A

(many buyers and sellers)
they trade with a large volume

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20
Q

what are marketable bonds

A

bonds where there is an existing market

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21
Q

what are “on the run” bonds

A

newly issued bonds

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22
Q

what are “off the run” bonds

A

bonds that are older and no longer new

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23
Q

what market is the bond market larger than

A

the equity market (measured by the $ traded)

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24
Q

what does governments issue and dont

A

bonds and not shares

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25
Q

what is a result of there being more bonds than stocks

A

each bond is less liquid

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26
Q

what would governments do when investors no longer want to invest in their bonds

A
  • increase the coupon rate
  • they need the money since they have a deficit
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27
Q

what are the different types of bond coupon rates

A
  • floating
  • fixed
28
Q

what is a floating coupon rate

A
  • a rate that adjusts periodically based on interest rates
  • ex. resetting every 90 days to the government 90 day t-bill yield
29
Q

what is a fixed coupon rate

A
  • a rate that never adjusts
  • the rate is the same for the entire life of the bond
30
Q

what can happen to the maturity date of a bond

A

based on the bond, the original maturity date can be modified by the terms of the bond

31
Q

what are callable bonds

A
  • can be “called” or repurchased by the issuer before the maturity date
  • they would be repurchased at a call price that is usually a premium over par (aka more than the original)
32
Q

what are retractable bonds

A
  • bonds that can be “put” (sold) back to the issuer before maturity
  • bond holders are forced to repurchase
33
Q

what kind of bonds require the issuer to repurchase portions of the bond issue over time

A
  • sinking fund
  • purchase fund
34
Q

what is a sinking fund

A
  • requires the issuer to buy back the bonds over time (not waiting until the lump sum at maturity)
  • helps the issue avoid having to pay the entire amount at maturity
  • not always good for the bond holders if they planned to hold the bond until the maturity date
35
Q

what are purchase funds

A
  • requires the issuer to buy back the bonds over time as long as the bonds are priced below par
  • good for the bond holders since they can get some liquidity and downward price support for the market price
36
Q

what are convertible bonds

A
  • bonds that contain a provision that allows the bond to be converted to shares of the issuer
  • contains a “call option” (buy option) on the issuing company’s shares
  • ex. $1000 face value of bonds = 10 shares
  • once converted, the terms of the bonds (like coupon payments, would be foregone)
37
Q

what kind of companies use convertible bonds

A
  • often used by less credit worth companies, to give investors some potential upside
38
Q

what are protective provisions

A
  • also known as “covenants”
  • restricts the borrower’s behaviour
39
Q

what are some protective provisions

A
  • limits to total debt allowed
  • limits to debt/interest as a proportion of revenue/EBITDA/income
  • ex. EBIT / interest > 3x
40
Q

what happens if a covenant on a bond is violated

A
  • can lead to “technical default”
  • the whole amount borrowed must be given back immediately
  • done even if the borrow never missed an interest or principal payment
41
Q

what are government bonds called

A
  • also known as treasury bonds (mainly for the US)
  • referenced by the name of the issuing country
  • canadian government bonds = “Canadas”
  • german government bonds = “bunds”
  • UK government bonds = “gilts”
42
Q

what are the types of government bonds

A
  • treasury bills
  • marketable bonds (treasury bonds)
43
Q

when are government bonds adjusted for canada

A

face value for coupon and principal payments are adjusted each year based on inflation

43
Q

in terms of risk, what are government bonds considered

A
  • considered risk free
  • they’re backed by the government
43
Q

due to inflation, what happens to some government bonds

A
  • their return are adjusted
  • called real return bonds
  • ex. the $100 face value may be adjusted and end up being $110 at maturity
43
Q

what are marketable bonds

A

medium and long-term bonds with coupon payments

43
Q

what are treasury bills

A

short term discount bonds

43
Q

what are the different bonds corporations can issue

A
  • Mortgage Bonds
  • First Mortgage bonds
  • Second Mortgage bonds
  • Collateral Trust bonds
  • Equipment Trust bonds
44
Q

what is Collateral Trust bonds

A
  • secured by financial collateral
  • other financial assets
  • like common shares, bonds, treasury bills
44
Q

what can real return bonds be used for

A
  • used to discover the market’s inflation expectations
  • comparing real return yields to treasury bond yields
44
Q

what is commercial paper

A
  • issued by corporations to borrow for a short period of time
  • like 1 month, or 3-4 weeks
  • like treasury bills
45
Q

what are corporate bonds

A
  • bonds that are secured; all of them have collateral
  • bonds issued by corporations
46
Q

what are Mortgage Bonds

A
  • have a specific asset as collateral
  • secured by real property
  • like land, buildings, or equipment
46
Q

what are First Mortgage bonds

A

have the first claim to the assets

47
Q

what are Second Mortgage bonds

A

bonds are paid after all First Mortgage bonds are repaid

47
Q

what happens if a corporation’s Commercial Paper is guaranteed by a bank

A
  • it becomes a Banker’s Acceptance
  • The Commercial Paper now has two company’s responsible for repayment
48
Q

what are Equipment Trust bonds

A

secured by equipment collateral

48
Q

what are corporate debentures

A

unsecured debt issued by corporations

48
Q

what kind of rates can corporate bonds and debts have

A

floating or fixed rates

48
Q

what is the Credit ratings/worthiness of a company based

A
  • Credit ratings/worthiness is based on the company’s cash flow and “unencumbered” assets
  • unencumbered assets are assets that are not used as securities (collateral) for other debt obligations
48
Q

what are Subordinated debentures

A
  • ranked behind other forms of debt
    (e.g. only repaid after non-subordinated debt)
49
Q

what are the different kinds of strip bonds

A
  • interest only
  • principal only
49
Q

what are strip bonds

A

created by “stripping” a bond of its coupon payments to create a series of discount bonds

49
Q

what are interest only strip bonds

A
  • “Interest Only” component consists of the coupon payments
  • only get coupon payments and not the principal at maturity
  • Each individual coupon can become its own discount bond
50
Q

what are principal only strip bonds

A
  • consists of the principal repayment
  • no coupon payments
51
Q

since Individual retail investors may not be able to purchased fixed income products directly, what can they invest in

A

invest in Term Deposits and GICs offered by banks

AFM 121 (12 decks)

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