Chapter 6: Fixed Income Securities Flashcards
Fixed Income includes:
bonds, debentures, mortgages, swaps, preferred shares
Fixed stream of cash flows
- Coupon payments over time
- Principal repayment at maturity
- In some cases the “fixed” stream is variable (E.g. “fixed” at a bank’s prime rate)
Bonds VS Debentures
- Bonds are secured by specific assets
- In the event of default, the bondholder can seize the collateral
- Debentures are unsecured
- There is no collateral beyond the general income and assets of the borrower
- The terms are commonly interchanged, and you often hear the term “debt” (short for debenture)
Bond terms are described in a….
Bond Trust
Bond Trust
outlines the legal rights of the borrower (e.g. the company) and the lender (e.g. the investor)
- Dates of amount coupon payments
- Date of principal repayment
- Covenants (restrictions)
Premium VS Discount Bond
Based on par or face value of $100 (or $1,000)
- E.g. Price per $100 of face value of the bond
Premium
- Pay $104 for $100 of face value
Discount
- Pay $96 for $100 of face value
Short-term bonds mature…
in 1 to 5 years
Medium Term mature…
in 5 to 10 years
Long-term mature…
over 10 years from now
Liquid bonds trade with…
large volume
“On-the-run” bonds are
newly issued
“Off-the-run” bonds are
older, no longer “new”
Floating Rate
Adjusts periodically, such as resetting every 90-days to the government 90-day T-bill yield
Fixed Rate
Never adjusts, the coupon rate is the same for the entire life of the bond
Callable bonds can be…
“called” or repurchased by the issuer before the maturity date (price of repurchase set out in the bond trust)
Retractable bonds can be…
“put” back to the issuer (bond holders force the repurchase)
Sinking Fund requires…
the issuer to buy back the bonds over time (not waiting until the lump sum at maturity)
Purchase Fund requires…
the issuer to buy back the bonds over time as long as the bonds are priced below par
Covenants
Restrict the borrower’s behavior
- Limits to total debt allowed
- Limits to debt/interest as a proportion of revenue/EBITDA/Income
Violating a covenant can lead to “technical default” even though the borrower may not miss an interest or principal payment
Treasury Bills
Short-term discount bonds
Marketable Bonds
Medium and Long-term bonds with coupon payments
Government bonds are considered…
“risk-free”
Corporate bonds and debentures can be…
floating or fixed rate
Commercial Paper
Corporations can borrow for short periods of time by issuing Commercial Paper (similar to Treasury Bills)
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
Strip Bonds are created by…
“stripping” a bond of its coupon payments to create a series of discount bonds
“Interest Only”
component consists of the coupon payments
- Each individual coupon can become its own discount bond
“Principal Only”
component consists of the principal repayment
Real Return Bonds
Can be used to discover the market’s inflation expectations
- Comparing Real Return yields to Treasury Bond yields
Some government bonds adjust their return…
based on the rate of inflation.
- For Canada, the face value for coupon and principal payments is adjusted each year based on inflation (E.g. $100 of face value may be $110 of face value at maturity)
