Fixed-Income Securities Defining Elements Part 2 Flashcards
Bond indenture
A written legal agreement between the bond issuer and the Investor
Information included in indenture
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
Collateral
Assets or financial guarantees offered by the issuer for the underlying debt issue
Credit enhancement
Provision used by a company to improve its creditworthiness or reduce the credit risk of the bond issue
Covenant
Clauses that state what an issuer can and can not do
specifies the rights of bondholders
Trustee
A financial institution that holds the indenture
Aspects an investor must review
Legal identity of the bond issuer and its legal form
source of payment proceeds
asset or collateral backing
credit enhancement
Covenant
Legal identity of the bond issuer and it’s legal form
Bond issuer has the legal obligation to pay the interest and principal and is identified in the indenture by its legal name
Source of repayment proceeds
How the issuer intends to make interest payments and repay the Principal
Categories of repayments sources
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
Asset or collateral backing
Collateral reduces credit risk
secured vs. unsecured Bond
seniority ranking
debenture
Secured versus unsecured bonds
In secured bonds, assets are pledged as collateral to ensure the payment
unsecured bonds have no collateral
Seniority ranking
The investors are repaid based on seniority
Debentures
A type of Bond that can be secured or unsecured
Types of collateral backing
Collateral Trust Bond
equipment Trust certificates
mortgage-backed Securities
covered Bond
Collateral Trust bonds
Bonds that are secured by a financial asset
deposited by the issuer and held by the trustee
Equipment Trust certificates
Bond secured by physical assets or equipment
Mortgage-backed Securities
Backed by a pool of mortgages
interest and principal payments are used to pay the bond holders
Covered Bond
Debt securities that are backed up by a “cover pool” of assets (mortgage loans/public sector loan)
Internal credit enhancement
No external instrument is used to increase the credit quality
Included in internal credit enhancement
Senior/junior
overcollateralization
excess spread
Senior/Junior
Debt is segregated into different tranches with different priority based on seniority
Overcollateralization
The process of posting more collateral than is required to obtain financing
Excess spread
The difference between the interest rate increase on the underlying asset and coupon rate paid to investors
External credit enhancement
Relies on a third-party for a guarantor to provide a guarantee
Included in external credit enhancement
Surety Bond/bank guarantees
letter of credit
Surety bonds
A bond that guarantees to pay the Investor if the issuer default
Letter of credit
A document or a letter from a financial institution
guarantees the payment of interest and principal if the if the issuer unable to pay
Bond covenants
Legally enforceable rules that borrowers and lenders agree on at the time of a new bond issue
Affirmative or negative
Negative covenants
Indicate what the issuer must not do
Examples of negative covenants
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
Affirmative Covenant
Indicate what the issuer must do
Examples of affirmative Covenant
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
Pari pasu
Ensures that a debt obligation is treated the same as the borrower’s other senior debt instruments
Cross-default
Specifies that a borrower is considered in default if they default on another debt obligation
