Chapter 6: Fixed Income Securities

Question 1

Fixed Income includes:

Answer 1

bonds, debentures, mortgages, swaps, preferred shares

Question 2

Fixed stream of cash flows

Answer 2

• 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)

Question 3

Bonds VS Debentures

Answer 3

• 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)

Question 4

Bond terms are described in a….

Answer 4

Bond Trust

Question 5

Bond Trust

Answer 5

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)

Question 6

Premium VS Discount Bond

Answer 6

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

Question 7

Short-term bonds mature…

Answer 7

in 1 to 5 years

Question 8

Medium Term mature…

Answer 8

in 5 to 10 years

Question 9

Long-term mature…

Answer 9

over 10 years from now

Question 10

Liquid bonds trade with…

Answer 10

large volume

Question 11

“On-the-run” bonds are

Answer 11

newly issued

Question 12

“Off-the-run” bonds are

Answer 12

older, no longer “new”

Question 13

Floating Rate

Answer 13

Adjusts periodically, such as resetting every 90-days to the government 90-day T-bill yield

Question 14

Fixed Rate

Answer 14

Never adjusts, the coupon rate is the same for the entire life of the bond

Question 15

Callable bonds can be…

Answer 15

“called” or repurchased by the issuer before the maturity date (price of repurchase set out in the bond trust)

Question 16

Retractable bonds can be…

Answer 16

“put” back to the issuer (bond holders force the repurchase)

Question 17

Sinking Fund requires…

Answer 17

the issuer to buy back the bonds over time (not waiting until the lump sum at maturity)

Question 18

Purchase Fund requires…

Answer 18

the issuer to buy back the bonds over time as long as the bonds are priced below par

Question 19

Covenants

Answer 19

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

Question 20

Treasury Bills

Answer 20

Short-term discount bonds

Question 21

Marketable Bonds

Answer 21

Medium and Long-term bonds with coupon payments

Question 22

Government bonds are considered…

Answer 22

“risk-free”

Question 23

Corporate bonds and debentures can be…

Answer 23

floating or fixed rate

Question 24

Commercial Paper

Answer 24

Corporations can borrow for short periods of time by issuing Commercial Paper (similar to Treasury Bills)

Question 25

If a corporation’s Commercial Paper is guaranteed by a bank…

Answer 25

it becomes a Banker’s Acceptance

- The Commercial Paper now has two company’s responsible for repayment

Question 26

Strip Bonds are created by…

Answer 26

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

Question 27

“Interest Only”

Answer 27

component consists of the coupon payments

- Each individual coupon can become its own discount bond

Question 28

“Principal Only”

Answer 28

component consists of the principal repayment

Question 29

Real Return Bonds

Answer 29

Can be used to discover the market’s inflation expectations

- Comparing Real Return yields to Treasury Bond yields

Question 30

Some government bonds adjust their return…

Answer 30

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)