fixed income Flashcards
zero-coupon bond
promises to pay a stipulated principal amount at a future maturity date, but it does not promise to make any interim interest payments. The value of a zero-coupon bond increases overtime, and approaches par value at maturity. The return on the bond is the difference between what the investor pays for the bond at the time of purchase and the principal payment at maturity. The implied interest rate is earned at maturity.
floating-rate security
oupon rate = reference rate + quoted margin.
Examples of reference rates are LIBOR, U.S. Treasury yields.
The quoted margin is the additional amount that the issuer agrees to pay above the reference rate. It is a constant value and can be positive or negative. It is often quoted in basis points.
The coupon rate is determined at the coupon reset date but paid at the next coupon date.
maturity date
is the date when the bond issuer is obligated to pay the outstanding principal amount. It defines the remaining life of the bond.
It defines the time period over which the bondholder can expect to receive interest payments and principal repayment.
It affects the yield on a bond.
It affects the price volatility of the bond resulting from changes in interest rates: the longer the maturity, the greater the price volatility.
Source of Repayment Proceeds
Supranational bonds: repayment of previously loans, or the paid-in capital from members
Sovereign bonds: taxing authority and money creation
Non-sovereign government bonds: general taxing authority of the issuer, project cash flows, and special taxes
Corporate bonds: the issuer’s operating cash flows
Securitized bonds: cash flows from the underlying financial assets
Source of Repayment Proceeds
Supranational bonds: repayment of previously loans, or the paid-in capital from members
Sovereign bonds: taxing authority and money creation
Non-sovereign government bonds: general taxing authority of the issuer, project cash flows, and special taxes
Corporate bonds: the issuer’s operating cash flows
Securitized bonds: cash flows from the underlying financial assets
A special-purpose vehicle/entity (a separate legal entity) can issue bonds collateralized by
assets transferred from its sponsor. If bankruptcy occurs, the sponsor’s creditors cannot go after such assets; this is known as bankruptcy remote.
Covered bonds
debts issued by banks that are fully collateralized by residential or commercial mortgage loans or by loans to public sector institutions.
Internal credit enhancement considerations include:
Tranche structure. The senior tranches get paid first, and the subordinated tranches get paid only if there are enough funds left. The subordinated tranches absorb the credit risk, making the senior tranches less risky.
Overcollateralization. The amount of overcollateralization can be used to absorb losses. If the liability of the structure is $100 million and the collateral’s value is $105 million, then the first $5 million loss will not result in a loss to any of the tranches.
Excess spread. Underlying assets support a higher level of payment than that promised to security holders.
External credit enhancements are
financial guarantees from third parties. Examples include surety bonds, bank guarantees, and letters of credit. If the third-party defaults, the external credit enhancement will fail. A cash collateral account can mitigate this concern.
Affirmative covenants
Paying interest and principal on a timely basis
Paying taxes and other claims when due
Keeping assets in good conditions and in working order
Submitting periodic reports to a trustee so that the trustee can evaluate the issuer’s compliance with the indenture
Negative covenants
Limitations on the borrower’s ability to incur additional debt unless certain tests are met
Limitations on dividend payments and stock repurchases
Limitations on the sale of assets
bond indenture
contract between the issuer and the bondholder specifying the issuer’s legal requirements. It contains the promises of the issuer and the rights of the holder of the bond.
a surety bond is issued by
an insurance company
for external credit enhancement, an investor would most likely pick ___ to counter third party risk
cash collateral ccount
for external credit enhancement, an investor would most likely pick ___ to counter third party risk
cash collateral ccount
covered bond assets remain on the issuer’s consolidated balance sheet because
the security is not transferred to a third party like securitised bonds are
which type of secured bond is issued to take advantage of tax benefits of leasing
equipment trust certificates
collateral trust bonds provide
bondholders a lien on stocks, bonds, other securiites on firm
secured debt
tax exemption for municipal securities applies to
interest income
Bullet bond.
issuer pays the full principal amount at the maturity date.
Amortizing bond
payment schedule requires periodic payment of interest and repayment of principal. If the entire principal is not amortized over the life of the bond, a balloon payment is required at the end of the term.
sinking fund arrangement
allows a bond’s principal outstanding amount to be repaid each year throughout the bond’s life or after a specific date.
call provision
right of the issuer to retire the issue prior to the stated maturity date. When only part of an issue is called, the bond certificates to be called are selected randomly or on a pro rata basis.
cap / floor / collar
A cap is the maximum coupon rate of a floater. It is an attractive feature for the issuer since it limits the coupon rate. A floor is the minimum coupon rate, and it is an attractive feature for the investor. A collar is a floater with both a cap and floor.
inverse floater
coupon rate moves in the opposite direction from the change in the reference rate: coupon rate = K - L x reference rate, where K and L are constant values set forth in the prospectus for the issue. To prevent a negative coupon rate there is a floor imposed.
