Fixed-Income Securities Defining Elements Part 2

Question 1

Bond indenture

Answer 1

A written legal agreement between the bond issuer and the Investor

Question 2

Information included in indenture

Answer 2

Name of the issuer
All the terms of a bond issue, such as the type of bond
its features
issuer’s obligation
bondholders rights
if the bonds are secured or not
covenants
contingency provisions like call options

Question 3

Collateral

Answer 3

Assets or financial guarantees offered by the issuer for the underlying debt issue

Question 4

Credit enhancement

Answer 4

Provision used by a company to improve its creditworthiness or reduce the credit risk of the bond issue

Question 5

Covenant

Answer 5

Clauses that state what an issuer can and can not do
specifies the rights of bondholders

Question 6

Trustee

Answer 6

A financial institution that holds the indenture

Question 7

Aspects an investor must review

Answer 7

Legal identity of the bond issuer and its legal form
source of payment proceeds
asset or collateral backing
credit enhancement
Covenant

Question 8

Legal identity of the bond issuer and it’s legal form

Answer 8

Bond issuer has the legal obligation to pay the interest and principal and is identified in the indenture by its legal name

Question 9

Source of repayment proceeds

Answer 9

How the issuer intends to make interest payments and repay the Principal

Question 10

Categories of repayments sources

Answer 10

Supernational bonds: from repayment of previous loans
sovereign bonds: tax revenues and printing more money
non sovereign debt issues: the taxing authority of the issuer
corporate bonds: cash flow generated by companies operations
securitized bonds: cash flows generated by the underlying assets

Question 11

Asset or collateral backing

Answer 11

Collateral reduces credit risk
secured vs. unsecured Bond
seniority ranking
debenture

Question 12

Secured versus unsecured bonds

Answer 12

In secured bonds, assets are pledged as collateral to ensure the payment
unsecured bonds have no collateral

Question 13

Seniority ranking

Answer 13

The investors are repaid based on seniority

Question 14

Debentures

Answer 14

A type of Bond that can be secured or unsecured

Question 15

Types of collateral backing

Answer 15

Collateral Trust Bond
equipment Trust certificates
mortgage-backed Securities
covered Bond

Question 16

Collateral Trust bonds

Answer 16

Bonds that are secured by a financial asset
deposited by the issuer and held by the trustee

Question 17

Equipment Trust certificates

Answer 17

Bond secured by physical assets or equipment

Question 18

Mortgage-backed Securities

Answer 18

Backed by a pool of mortgages
interest and principal payments are used to pay the bond holders

Question 19

Covered Bond

Answer 19

Debt securities that are backed up by a “cover pool” of assets (mortgage loans/public sector loan)

Question 20

Internal credit enhancement

Answer 20

No external instrument is used to increase the credit quality

Question 21

Included in internal credit enhancement

Answer 21

Senior/junior
overcollateralization
excess spread

Question 22

Senior/Junior

Answer 22

Debt is segregated into different tranches with different priority based on seniority

Question 23

Overcollateralization

Answer 23

The process of posting more collateral than is required to obtain financing

Question 24

Excess spread

Answer 24

The difference between the interest rate increase on the underlying asset and coupon rate paid to investors

Question 25

External credit enhancement

Answer 25

Relies on a third-party for a guarantor to provide a guarantee

Question 26

Included in external credit enhancement

Answer 26

Surety Bond/bank guarantees
letter of credit

Question 27

Surety bonds

Answer 27

A bond that guarantees to pay the Investor if the issuer default

Question 28

Letter of credit

Answer 28

A document or a letter from a financial institution
guarantees the payment of interest and principal if the if the issuer unable to pay

Question 29

Bond covenants

Answer 29

Legally enforceable rules that borrowers and lenders agree on at the time of a new bond issue
Affirmative or negative

Question 30

Negative covenants

Answer 30

Indicate what the issuer must not do

Question 31

Examples of negative covenants

Answer 31

Restrictions on debt
negative pledges
restrictions on prior claims
restriction on distribution to shareholders
restrictions on asset disposals
restrictions on investments
restrictions on mergers and acquisitions

Question 32

Affirmative Covenant

Answer 32

Indicate what the issuer must do

Question 33

Examples of affirmative Covenant

Answer 33

Make interest and principal payments on time
comply with all laws and regulations
maintain current lines of business
insure and maintain assets
pay taxes on time
Pari pasu or cross-default

Question 34

Pari pasu

Answer 34

Ensures that a debt obligation is treated the same as the borrower’s other senior debt instruments

Question 35

Cross-default

Answer 35

Specifies that a borrower is considered in default if they default on another debt obligation