LM 1: Fixed Income Features, Cash Flows, Issuance, & Trading Flashcards
What are fixed-income securities?
Dominant means of raising capital
What are the 2 types of bond issuers? GP
- Government and government-related sector
- Private Sector
What are the 4 different government and government-related sector bond issuers? SSNQ
- Supranational organizations
- Sovereign (national) governments
- Non-sovereign (local) governments
- Quasi-government entities
What are the 2 different private sector bond issuers? CS
- Corporations
- Special purpose entities that issue asset-backed securities
What is a supranational agency?
An international organization that represents a country or more (eg. United Nations)
What are sovereign bonds?
Bonds issued by the national government to fund spending when tax revenues are insufficient.
What are non-sovereign bonds, and what’s another word for non-sovereign bonds?
Bonds issued by states and cities
Often referred to as municipal bonds
What are quasi-government bonds?
Business entity that provides specific governmental services (eg. Federal National Mortgage Association)
What is tenor on bonds?
Time remaining on bond until maturity
What are bonds called that have less than one year until maturity and bonds with more than one year until maturity?
money market securities: bonds with less than 1 year until maturity
capital market securities: bonds with more than 1 year until maturity
What are perpetual bonds maturity?
bonds with no stated maturity
Is current yield higher or lower than the coupon rate when selling at a discount?
Current yield is higher than coupon rate when selling at discount
Is current yield higher or lower than the coupon rate when selling at a premium?
Current yield is lower than coupon rate when selling at a premium.
What type of interest rate does floating rate notes pay?
Interest rate changes based on performance of market reference rate (MRR)
What is a floored floating rate notes?
Note holder gets a minimum payment despite reference rate being below coupon floor. When reference rate is above coupon floor note holders gets coupon at reference rate
What is capped floating rate note?
Note holder receives coupon rate of the reference rate up until maximum point, if reference rate exceeds cap rate then investor recovers only the cap rate.
What is collard floating rate?
Note holder received coupon floor when rate is under coupon floor, when rate is above cap note holder received only the cap, when the reference rate is between both the cap and floor note holder gets reference rate coupon
What are zero coupon bonds?
No coupons paid on bond, investors purchase these bonds at discount and receive par value at maturity
What is the total interest earned formula on zero coupon bonds?
Total interest = par value - issue price
What are any contingency provisions embedded in the bond?
Anything about put options, call options, and convertible options on a bond
What is the relationship between a bond’s price and its yield?
inverse relationship
higher yield results in lower bond price
What 3 conditions must be met to earn the yield to maturity (IRR)? IPI
- issuer makes all payments as scheduled
- payments received before maturity are reinvested to earn the YTM
- investor holds the bond to maturity
What is the yield curve?
visual representation of how much it costs in terms of interest rate to borrow money for different periods of time.
eg. shows interest rates in U.S Treasuries debt at different maturities at a given point in time.
What is the trust deed or the bond indenture?
Describes obligations of bond issuer and rights of bond holder.
What are the 6 items cover in a bond indenture of trust deed? BLSCCC
- Basic bond features
- Legal identity of bond issuer
- Source of repayment proceeds
- Collateral (if any)
- Credit enhancements (if any)
- Covenants (if any)
Who are indentures held by?
Held by a trustee.
What are 3 roles of the trustee? APH
- Act as a fiduciary for bond holders
- Perform administrative duties
- Handle defaults
Whats the different between unsecured bonds and secured bonds?
unsecured bonds backed by issuers operating cash flow
secured bonds back by collateral
What are bond covenants?
Rules agreed at the time of issue
What are affirmative covenants?
Tells you what issuers are required to do and usually administrative
What are negative covenants?
Tells you what issuers are not allowed to do.
What is pari passu?
Equal footing clause in which two or more parties within the same seniority class in a financial contract get treated the same despite maturity & etc
What is cross default?
Bond indenture on loan agreement that puts a borrower in default if the borrower defaults on another obligation
What is negative pledge clause?
agreement between owner of asset and lender of bond stating the owner will not create further security that would be senior to the lender without the agreement of lender.
eg. house cannot be used as collateral for other loan without lender approval.
What is an incurrence test?
restrictions on breaching specific levels of certain leverage or solvency ratios
What are bullet bonds?
Entire principal is paid at maturity with coupon payments paid at regular intervals
What are fully amortized bond (aka conventional bond)?
Provide equal annuity like payments that are split between interest and principal.
What is the annuity formula for a fully amortized loan?
A= r * principal /
(1- (1+r) ^-N)
A= amount of each payment
Principal = face value of loan
r = market interest rate
N = total number of payment periods over the term of the loan
What are partially amortized bonds?
Amortized some principal payments during bond, then makes a final balloon payment.
What is a sinking fund?
A fund containing money set aside or saved to pay off a debt or bond
What is subordination or credit tranching (aka waterfall structure)?
When a bond is divided into tranches where cash flows are paid from highest seniority to lowest seniority. Highest seniority get the least yield and lowest seniority get the most yield for taking in more risk.
What are step-up bonds?
Bond that pays coupons that increase periodically based on a set schedule.
What are call provisions on bonds?
Provision on bond that allows issuer to repurchase and retire its bonds.
What are sustainability-linked bonds?
bond that pays a stepped-up coupon rate if the issuer fails to meet the environmental performance targets listed in the indenture
What is a credit-linked coupon bond?
Bonds where coupons change when issuers credit rating changes.
What is a payment in kind (PIK) bond?
A bond that allows issuer to pay coupons with more bonds rather than cash.
What is an index linked bond?
Bond with coupons tied to a specific index.
What are deferred coupon bonds (aka split coupon bonds)?
Bonds that allows issuer to pay no coupons in the early years and larger coupon payments in the later years.
What are callable bonds?
Bonds that give the issuer the right to buy bonds back prior to maturity
What is a call protection period?
A period when the issuer of a bond is not allowed to exercise its call option
What are putable bonds?
Gives bondholder right to sell bonds back to issuer prior to maturity.
What is a European-style put option?
a put option that allows the bondholder to sell the bond back to the issuer prior to maturity on one specific date.
What is a Bermuda-style put option?
Offer multiple dates for investors to sell bond back to issuer
What are convertible bonds?
Allow lenders (bondholders) the right to convert bonds into a specified number of common shares.
What is the conversion price?
The share price at which bonds can be converted
What is conversion ratio and formula?
The number of common shares that will be received for each convertible bond.
PAR value/ conversion price
What is conversion value formula and use?
Value if converted immediately
Current share price • conversion ratio
What is conversion premium?
The difference between the convertible bonds price and the current price of stock
What are warrants?
like an option contract, warrant grants the holder the right to purchase the issuer’s shares at a pre-specified price.
What is contingent convertible bonds?
Bonds that automatically convert to equity if a certain trigger is reached.
What are Eurobonds?
bonds traded on the Eurobond market and less regulated because they are beyond the jurisdiction of any single country.
What is a global bond?
bond issued simultaneously in the Eurobond market and in at least one domestic bond market.
Type of bond issued and traded outside the country where the currency of the bond is denominated
What are bearer bonds?
bonds where only the clearing system knows who owns the bonds
How are bonds taxed?
The income portion of bonds are taxed at the ordinary income tax rate at maturity
For Standard & Poor’s credit rating which ratings are considered to be default risk-free, investment grade, and high yield?
- Default risk-free: typically rated AAA
- Investment grade: issuers rated BBB- or higher
- High Yield: Corporate issuers rated BB+ or lower
What are fallen angels?
bonds that previously had an IG rating, but were downgraded below IG forcing investors to liquidate
What are primary bond markets?
Market in which the issuer first sells bonds to investors to raise capital
What are shelf registrations in primary bond markets?
provision that allows an issuer to register a new issue of securities without having to sell the entire issue at once. The issuer can sell portions of the bonds over three years.
What are underwritten offerings?
When an investment bank underwrites a bond and agrees to purchase any bonds that can not be sold to investors
What are best-efforts offering?
When investment banks’ involvement is only as a broker
What are secondary markets?
Markets in which existing bonds are subsequently traded among investors
How are bonds traded in the secondary bond markets?
Over the counter between institutional investors, financial intermediaries, and central banks
What is the bid-offer spread?
difference between the prices at which a dealer will buy and sell a bond
What is distressed debt?
bonds of companies near or already in bankruptcy generally trade at prices that reflect the expected recovery rate
What is nominal rate on bond?
Nominal rate is coupon rate
What are dual currency bonds?
When principal is paid in a different currency than interest piad
What are bond features?
Important information about bonds issued, maturity, par value, etc.
What is credit risk?
Risk issuer may not pay the required principal and interest payments or fulfill their obligation
What are 2 ways bonds are categorized based on credit risk?
- Investment grade bond
- Non-investment grade bond
What are investment grade bonds?
Bonds with less risk for default or less credit risk
What are non-investment grade bonds?
Bonds with more credit risk or higher chance for default
What is another word for conventional bonds?
Plain vanilla bonds
What kind of things does the bond indenture specify?
Principal value, coupon rate, maturity date, covenants, collateral, etc.
What are debentures?
Type of bond or debt instrument that is unsecured by collateral
What is a foreign bond?
bonds issued outside the countries domestic market
What is a domestic bond?
bond issued in a company’s domestic market.
What kind of bonds are tax exempt?
municipal bonds
How are unsecured bonds and corporate bonds similar?
the source of repayment is the companies operating cash flows
What are 2 characteristics of privately paced bonds?
- They are not underwritten
- They are unregistered
What is the difference between Eurobonds and foreign bonds?
Eurobonds: uses companies domestic currency then issued outside country’s domestic market
Foreign Bonds: use the currency it’s being issued. ex. British company issued debt in the US with principal & interest payments denominated in dollars.
What is reopening of a bond?
increasing the size of an existing bond with a price significantly different from PAR.
