Fixed Income Securities Flashcards
Zero- coupon- indexed bonds
pay no coupon, so the inflation adjustment is made
via the principal repayment only: The principal amount to be repaid at maturity
increases in line with increases in the price index during the bond’s life. This
type of bond has been issued in Sweden
Interest- indexed bonds
pay a fixed nominal principal amount at maturity but
an index- linked coupon during the bond’s life. Thus, the inflation adjustment
applies to the interest payments only. This is essentially a floating- rate note
in which reference rate is the inflation rate instead of a market rate such as
Euribor. These have been issued by insurance companies and major commercial
banks but not typically by governments.
Capital- indexed bonds
pay a fixed coupon rate, but it is applied to a principal
amount that increases in line with increases in the index during the bond’s life.
Thus, both the interest payments and the principal repayment are adjusted for
inflation
Indexed- annuity bonds
are fully amortized bonds, in contrast to interest indexed and capital- indexed bonds that are non- amortizing coupon bonds. The
annuity payment, which includes both payment of interest and repayment of
the principal, increases in line with inflation during the bond’s life.
contingency provision
is a clause in a legal document that allows for some
action if the event or circumstance does occur
Call premium
The call premium is the amount over par paid by the issuer if the bond is called
Call protection period
The call protection period prohibits the issuer from calling a bond early in its life and
is often added as an incentive for investors to buy the bond. The earliest time that a
bond might be called is known as the call date
Contingent convertible bonds
bonds with contingent write- down provisions. IN the case of CoCos, conversion is automatic if a specified event occurs
Bonds Tenor
The tenor of the bond is the time remaining until the bond’s maturity date.
Capital Market Security
A capital market security has an original maturity longer than one
year.
Covered Bonds
is a debt obligation backed by a segregated pool of
assets called a “cover pool.” When the assets that are included in the cover pool
become non- performing (i.e., the assets are not generating the promised cash
flows), the issuer must replace them with performing assets.
Open Market Operations
Open
market operations refer to the purchase or sale of bonds, usually sovereign bonds
issued by the national government. By purchasing (selling) domestic bonds, central
banks increase (decrease) the monetary base in the economy.
Fixed- income markets
are dominated by institutional investors in part because of
the high informational barriers to entry and high minimum transaction sizes.
Trading of Bonds
, the issuance and trading of bonds very often
occurs in over- the- counter (OTC) markets.
How retail investors have exposure to fixed income securities
most retail investors prefer to use investment
vehicles, such as mutual funds and ETFs
Primary Bond Markets
Primary bond markets are markets in which issuers initially sell bonds to investors
to raise capital.
secondary bond markets
are markets in which existing
bonds are subsequently traded among investors
firm commitment offering,
the investment bank guarantees the sale of the bond issue at an offering price that is
negotiated with the issuer. Thus, the investment bank, called the underwriter, takes
the risk associated with selling the bonds
best effort offering,
he
investment bank only serves as a broker. It only tries to sell the bond issue at the
negotiated offering price if it is able to for a commission.
The bid–offer spread or bid–ask spread
reflects the prices
at which dealers will buy from a customer (bid) and sell to a customer (offer or ask),
is very often used as an indicator of liquidity.
organized exchange
provides a place
where buyers and sellers can meet to arrange their trades. Although buy or sell orders
may come from anywhere, the transaction must take place at the exchange according to the rules imposed by the exchange.
Settlement
the process that occurs after the trade is made. The bonds are passed
to the buyer and payment is received by the seller
Guaranteed Certificate
This combination of the zero- coupon
bond and the call option can be prepackaged as a structured financial instrument
What protection does a Capital Protected Instruments give
The zero- coupon bond provides the investor capital
protection; at maturity, the investor will receive 100% of the capital invested even if
the call option expires worthless. The call option provides upside potential if the price
of the underlying asset rises and a limited downside if the price of the underlying asset
falls.
Risks of Capital Protected Instruments
Note that the capital protection is only as
good as the issuer of the instrument. Should the issuer of guarantee certificates go
bankrupt, investors may lose their entire capital.
Yield Enhancement Instruments
Yield enhancement refers to increasing risk exposure in the hope of realizing a higher
expected return
Credit Linked Note
a type of bond that pays regular coupons but whose
redemption value depends on the occurrence of a well- defined credit event, such as a
rating downgrade or the default of an underlying asset, called the reference asset
Benefits of CLN’s
If the
specified credit event does not occur, the investor receives the par value of the CLN at
maturity. But if the specified credit event occurs, the investor receives the par value of
the CLN minus the nominal value of the reference asset to which the CLN is linked.
Issuers Benefits of CLN’s
A CLN allows the issuer to transfer the effect of a credit event to investors.
Investors Benefits of CLN’s
. Investors
are willing to buy CLNs because these securities offer higher coupons than otherwise similar bonds. In addition, CLNs are usually issued at a discount.
Participation Instruments
a participation instrument is one that allows investors to
participate in the return of an underlying asset.Most participation instruments are designed to give investors indirect exposure to
a specific index or asset price.
Risks of Participation Instruments
x. In contrast to capital protected instruments that offer equity exposure,
these participation instruments usually do not offer capital protection
Leveraged Instruments
Leveraged instruments are structured financial instruments created to magnify returns
and offer the possibility of high payoffs from small investments. An inverse floater is
an example of a leveraged instrument
Inverse floater coupon rate = C – (L × R)
Deleveraged Inverse Floaters
Inverse floaters with a coupon leverage greater than zero but lower than one
Leveraged Inverse Floaters
Inverse floaters with a coupon leverage greater
than one
shelf registration
is a method for issuing securities in which the issuer files a
single document with regulators that describes and allows for a range of future
issuances. Allows certain authorized issuers to offer additional bonds to the general public without having to prepare a new and separate
offering circular.
auction
is a public offering method that involves bidding, and that is helpful
in providing price discovery and in allocating securities. It is frequently used in
the issuance of sovereign bonds
negotiable certificate of deposit (CD)
allows any depositor (initial
or subsequent) to sell the CD in the open market prior to maturity. A is incorrect because negotiable CDs are mostly available in large (not small) denominations
the option- adjusted spread (OAS)
The option value in basis points per year is subtracted from the Z- spread
Prepayment risk
the uncertainty that the cash flows will be different from the scheduled cash flows as set forth
in the loan agreement because of the borrowers’ ability to alter payments, usually to
take advantage of interest rate movements
