Chapter 6: Fixed Income Securities Flashcards
What does fixed income include
- bonds
- debentures
- mortgages
- swaps
- preferred shares
what is fixed income
- fixed stream of cash flows instead of ownership
like:
- Coupon payments over time
- Principal repayment at maturity
what are bonds
- secured by specific assets
- In the event of default, the bondholder can seize the collateral
what are debentures (debt)
- unsecured
- There is no collateral beyond the general income and assets of the borrower
what are bond terms
described in a Bond Trust, which outlines the legal rights of the borrower (e.g. the company) and the lender (e.g. the investor)
what would be included in bond terms
- Dates of amount coupon payments
- Date of principal repayment
- Covenants (restrictions)
what are bond prices like
- 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
what is par/face value of a bond
- like the principal amount that is paid back to you at maturity (of the bond)
what is it called when a bond is trading above face value
- 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
what is it called when a bond is trading below face value
- 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
what is the coupon rate always
an annual rate
are price and face value the same thing
- no
- price is what is paid today
- face value is what is paid back at the end of maturity
what are discount bonds
- 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)
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)
- considered interest income for tax purposes (like income)
- not treated as capital gains
what are the different time frames of bonds
- short term
- medium term
- long term
how long are short term bonds
1 to 5 years
how long are medium term bonds
5 to 10 years
how long are long term bonds
over 10 years
what do liquid bonds trade with (think what is considered liquid)
(many buyers and sellers)
they trade with a large volume
what are marketable bonds
bonds where there is an existing market
what are “on the run” bonds
newly issued bonds
what are “off the run” bonds
bonds that are older and no longer new
what market is the bond market larger than
the equity market (measured by the $ traded)
what does governments issue and dont
bonds and not shares
what is a result of there being more bonds than stocks
each bond is less liquid
what would governments do when investors no longer want to invest in their bonds
- increase the coupon rate
- they need the money since they have a deficit
what are the different types of bond coupon rates
- floating
- fixed
what is a floating coupon rate
- a rate that adjusts periodically based on interest rates
- ex. resetting every 90 days to the government 90 day t-bill yield
what is a fixed coupon rate
- a rate that never adjusts
- the rate is the same for the entire life of the bond
what can happen to the maturity date of a bond
based on the bond, the original maturity date can be modified by the terms of the bond
what are callable bonds
- 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)
what are retractable bonds
- bonds that can be “put” (sold) back to the issuer before maturity
- bond holders are forced to repurchase
what kind of bonds require the issuer to repurchase portions of the bond issue over time
- sinking fund
- purchase fund
what is a sinking fund
- 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
what are purchase funds
- 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
what are convertible bonds
- 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)
what kind of companies use convertible bonds
- often used by less credit worth companies, to give investors some potential upside
what are protective provisions
- also known as “covenants”
- restricts the borrower’s behaviour
what are some protective provisions
- limits to total debt allowed
- limits to debt/interest as a proportion of revenue/EBITDA/income
- ex. EBIT / interest > 3x
what happens if a covenant on a bond is violated
- 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
what are government bonds called
- 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”
what are the types of government bonds
- treasury bills
- marketable bonds (treasury bonds)
when are government bonds adjusted for canada
face value for coupon and principal payments are adjusted each year based on inflation
in terms of risk, what are government bonds considered
- considered risk free
- they’re backed by the government
due to inflation, what happens to some government bonds
- their return are adjusted
- called real return bonds
- ex. the $100 face value may be adjusted and end up being $110 at maturity
what are marketable bonds
medium and long-term bonds with coupon payments
what are treasury bills
short term discount bonds
what are the different bonds corporations can issue
- Mortgage Bonds
- First Mortgage bonds
- Second Mortgage bonds
- Collateral Trust bonds
- Equipment Trust bonds
what is Collateral Trust bonds
- secured by financial collateral
- other financial assets
- like common shares, bonds, treasury bills
what can real return bonds be used for
- used to discover the market’s inflation expectations
- comparing real return yields to treasury bond yields
what is commercial paper
- issued by corporations to borrow for a short period of time
- like 1 month, or 3-4 weeks
- like treasury bills
what are corporate bonds
- bonds that are secured; all of them have collateral
- bonds issued by corporations
what are Mortgage Bonds
- have a specific asset as collateral
- secured by real property
- like land, buildings, or equipment
what are First Mortgage bonds
have the first claim to the assets
what are Second Mortgage bonds
bonds are paid after all First Mortgage bonds are repaid
what happens if a corporation’s Commercial Paper is guaranteed by a bank
- it becomes a Banker’s Acceptance
- The Commercial Paper now has two company’s responsible for repayment
what are Equipment Trust bonds
secured by equipment collateral
what are corporate debentures
unsecured debt issued by corporations
what kind of rates can corporate bonds and debts have
floating or fixed rates
what is the Credit ratings/worthiness of a company based
- 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
what are Subordinated debentures
- ranked behind other forms of debt
(e.g. only repaid after non-subordinated debt)
what are the different kinds of strip bonds
- interest only
- principal only
what are strip bonds
created by “stripping” a bond of its coupon payments to create a series of discount bonds
what are interest only strip bonds
- “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
what are principal only strip bonds
- consists of the principal repayment
- no coupon payments
since Individual retail investors may not be able to purchased fixed income products directly, what can they invest in
invest in Term Deposits and GICs offered by banks
