Fixed-Income Securities Defining Elements Part 5 Flashcards
Contingency provision
A clause in a legal document that allows for some action if the event or circumstance does occur
embedded option
Callable Bond
Give the right to redeem all or part of the bond before the specified maturity date
Face reinvestment risk
Higher yield, sell lower
Why issue callable bonds
To protect the issuer when market interest rates drop
the credit quality of the issuer improves
Companies issue them to signal the market about their credit quality
Details of callable Bond
Call price
call Premium
call schedule
call protection period
Call date
Call price
Price paid by the issuer to the bondholder when the bond is called
Call Premium
The amount paid on top of the face value as compensation to bondholders as they will have to reinvest proceeds at a lower rate
Call schedule
The dates and prices at which the bond may be called
Call protection period
The lockout period, deferrment, or cushion period
the early days of a bond’s life to encourage investors to invest in the issue
Call date
The earliest date at which the bond may be called
Types of callable bonds
American call
European call
Bermuda-style call
American call
The issuer has the right to call the bond ANY TIME after the first call date
European call
The issuer has the right to call the bond ONLY ONCE after the call date
Bermuda style call
The issuer has the right to call the bond on specific dates after the call protection period
Putable Bond
Gives the bondholder the right to sell the bond back to the issuer at a predetermined price on specific days
Lower yield, sell higher
Benefits of putable Bond
When interest rates rise, bond prices fall
cash can be reinvested at higher rates
Details of putable Bond
Redemption date
selling price
how many times the issue allows bondholders to sell the Bond
One-time Put
multiple Put
One-time put
Gives bondholders a single sellback opportunity
Multiple put
More than one sellback opportunity is available
priced higher than one-time put bonds
Types of putable bonds
American put
European put
Bermuda-style put
American put
Bondholder has the right to sell the bond back to the issuer ANY TIME after the first put date
European put
Bondholder has the right to sell the bond back to the issuer ONLY ONCE at the put date
Bermuda-style put
Bondholder has the right to sell the bond back to the issuer only on specified dates
Convertible Bond
A hybrid security with both debt and equity features
Advantages of convertible bonds for investor
Opportunity to convert into equity if share prices are increasing (upside)
Downside protection if share prices are falling
Advantages of convertible bonds for issuer
Reduced interest expense lower yield because of the conversion provision given to bondholders
elimination of debt if conversion option is exercised
usually callable
Conversion price
Price per share at which the convertible bond can be converted into shares
Warrant
An attached option not an embedded option
Contingent convertible bonds
Bonds with contingent write-down provisions
can be converted into equity contingent to a specified condition
