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CFA Level 1 > Fixed Income > Flashcards

Fixed Income Flashcards

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CFA flashcards
1
Q

bond indenture / trust deed

A

The legal contract between the bond issuer (borrower) and bondholders (lenders)

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2
Q

Negative covenants

A

restrictions on asset sales (the company can’t sell assets that have been pledged as collateral), negative pledge of collateral (the company can’t claim that the same assets back several debt issues simultaneously), and restrictions on additional borrowings (the company can’t borrow additional money unless certain financial conditions are met).

Negative covenants serve to protect the interests of bondholders and prevent the issuing firm from taking actions that would increase the risk of default. At the same time, the covenants must not be so restrictive that they prevent the firm from taking advantage of opportunities that arise or responding appropriately to changing business circumstances.

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3
Q

Affirmative covenants

A

do not typically restrict the operating decisions of the issuer. Common affirmative covenants are to make timely interest and principal payments to bondholders, to insure and maintain assets, and to comply with applicable laws and regulations.

Two examples of affirmative covenants are cross-default and pari passu provisions. A cross-default clause states that if the issuer defaults on any other debt obligation, they will also be considered in default on this bond. A pari passu clause states that this bond will have the same priority of claims as the issuer’s other senior debt issues.

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4
Q

foreign bonds

A

firm trades bonds in another county

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5
Q

Eurobonds/global bonds

A

bonds traded across the globe in a separate currency

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6
Q

Bearer bond

A

better for tax than registered bond

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7
Q

Collateral trust bonds

A

securities held by trustee

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8
Q

Equipment trust certificate

A

physical assets owned by trust, leased to firm
Secured bonds have seniority over unsecured bonds

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9
Q

Securitised bonds:

A
  • Issued by a SPE/SPV
  • Firm sells assets to SPV
  • Assets cash flow make payments to bondholders
  • Assets separate from firm, safe form firm problems
  • Created to reduce borrowing costs
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10
Q

Covered Bonds:

A
  • Primarily issued by financial firms
  • Firm must augment assets whenever they are insufficient to support the covered bonds
  • Bond holders effectively have resource to firm as well as the segregated financial assets
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11
Q

Credit enhancement (external):

A
  • Bank guarantee
  • Surety bond
  • Letter of credit
  • Cash collateral account
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12
Q

Credit enhancement (internal):

A
  • Overcollateralization – collateral value is greater than amount borrowed
  • Excess spread – underlying asset return greater than bond cost
  • Tranches – waterfall to insulate risks
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13
Q

Tax considerations:

A
  • Interest typically taxed as ordinary income
  • Interest on municipal bonds (U.S.) exempt from taxes
  • Some domestic bonds pay interest net of tax
  • For bonds sold prior to maturity, may be capital gains or losses if yield has changed
  • Long-term capital gains (and capital gains in general) often taxed at a lower rate
    Zero coupon bond = weird stuff because no tax flow but still get taxed
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14
Q

balloon payment

A

final payment includes a lump sum in addition to the final period’s interest

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15
Q

Sinking fund provisions

A

must retire a certain amount of principal from a set time

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16
Q

Step-up coupon

A

increases on a schedule + call feature

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17
Q

Credit linked coupon

A

coupon rate increases if credit rating decreases, decreases if credit rating increases

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18
Q

Payment-in-kind

A

Issuer may make coupon payments by increasing principal amount

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19
Q

Deferred (split) coupon

A

Coupon payments do not begin until a period after issuance

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20
Q

Index link bonds

A

inflation, equity linked, commodity linked bonds (changes face value which flows through to coupon payments)

21
Q

Inflation linked bonds (linkers

A

interest indexed = coupon rate adjusted, capital-indexed = par value adjusted

22
Q

Indexed annuity bonds

A

fully amortised, payments adjusted

23
Q

Principal-protected

A

pay original face value if index decreases over life of bond

24
Q

Contingency provisions

A

are actions the issuer or bondholders may take

25
Q

Callable bonds

A

issuer may redeem bonds before maturity on scheduled call dates at specific prices

26
Q

Make-whole clause

A

includes PV of future coupons

27
Q

Putable bonds

A

bondholder may sell bond back to issuer typically for par value

28
Q

Contingent convertibles or Cocos

A

convert to common stock automatically if specified event occurs (bank with minimum equity percentage this automatically increases equity

29
Q

Global bond markets can be classified by several bond characteristics

A
  • Type of issuer
  • Credit quality
  • Original maturities
  • Coupon structures – (market reference rate + margin = floating vs fixed)
  • Currency denomination
  • Geography (developed markets or emerging markets)
  • Indexing
  • Tax status
30
Q

Describe the use of interbank offered rates as reference rates in floating-rate debt

A

Move away from using London Interbank Offered Rate (LIBOR) because it has been manipulated previously. Banks no longer required to report using LIBOR. In USA they are now using secured overnight financing rate (SOFR)

31
Q

grey market

A

when issued basis (before they go public)

32
Q

US treasury securities

A

single price auctions with primary dealers

33
Q

Shelf registration

A

bonds issued overtime as required

34
Q

Corporate bonds settle on

A

T+2 or T +3

35
Q

Government bonds settle on

A

T+1

36
Q

Liquid markets indicator

A

10 to 12 basis point spread

37
Q

on-the-run bonds and also as benchmark bonds

A

Trading is most active and prices most informative for the most recently issued government securities of a particular maturity.

38
Q

Bond tenure

A

Short term < 5 years, 5 -12 years = medium term, 12+ years = long term

39
Q

Yield enhancement instruments

A

credit-linked note (CLN)

40
Q

Capital protected instruments

A

A capital protected instrument offers a guarantee of a minimum value at maturity as well as some potential upside gain

41
Q

Participation instruments

A

A participation instrument has payments that are based on the value of an underlying instrument, often a reference interest rate or equity index

42
Q

Leveraged instruments

A

An inverse floater is an example of a leveraged instrument

43
Q

Describe short-term funding alternatives available to banks

A
  • certificates of deposit (CDs)
  • central bank funds market
  • interbank funds
44
Q

Repo agreements

A

an arrangement by which one party sells a security to a counterparty with a commitment to buy it back at a later date at a specified (higher) price. The repurchase price is greater than the selling price and accounts for the interest charged by the buyer, who is, in effect, lending funds to the seller with the security as collateral. The interest rate implied by the two prices is called the repo rate

45
Q

Repo rate calc

A

(repo price/original purchase price) – 1

46
Q

Repo margin or haircut

A

(market value/ originating repo price)-1

47
Q

Repo agreement dynamics

A

The repo rate is:
* Higher, the longer the repo term.
* Lower, the higher the credit quality of the collateral security.
* Lower when the collateral security is delivered to the lender.
* Higher when the interest rates for alternative sources of funds are higher.
The repo margin is influenced by similar factors. The repo margin is:
* Higher, the longer the repo term.
* Lower, the higher the credit quality of the collateral security.
* Lower, the higher the credit quality of the borrower.
* Lower when the collateral security is in high demand or low supply.

48
Q
A

CFA Level 1 (9 decks)

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