Reading 42 Flashcards
type of bond with contingency provision (embedded option)
- callable bonds
- putable bonds
- convertible bonds
Callable bonds
give the issuer the right to redeem all or part of the bonds before maturity date
- high yield & low price compensate the bondholder for the vale of the call option to the issuer
- provide protection to the issuer in decline interest rate environment
contingency provision is?
clause in legal document that allows for some action if the event does occur
embedded option
various contingency provision found in the indenture
puttale bonds
- put provision
- provide right to the bonholder to sell the bond back to the issuer at a pre-determined price ona specified date
- lower yield on these bonds compensate the issuer for the value of the put option
- pre-specified selling price of putable bond provide benefit to the bondholder
conversion price
price per share - convertible bond can be converted into shares
conversion ratio
number of common shares that each bond can be converted into
conversion value
current share price x conversion ratio
convertible bonds advantage for investors?
- can participate in equity upside
- receive downside protection
- price of convertible bond can’t fall below the price of the straight bond
convertible bond
hybride security with both debt and equity features (bondholder has a right to exchange the bond for specified number of shares in issuing company).
- price of a convertible bond is higher than the price of the bond without this provision
convertible bond may futher include what ?
call provision
tax consideration
- income portion of a bond investment
- capital gain / loss if the price is likely to have changed compared with the purchased price
- different tax rate for long term and short term capital gains in different countries
income portions of a bond investment
- taxed at ordinary income tax rate
- tax-exempt securities (municipal bonds, US TREASURY SECURITIES) is exempt from federal income tax and from the income tax of the state in which the bonds are issued.
principal repayment structures
- bullet, amortization bond (full and partial)
- sinking fund arrangements
bullet bonds
entire principle payment happens at maturity
amortization bond
periodic payment of interest and repayment of principle
partial amortized bond
fixed period payment until maturity & a portion of the principal at maturity date
- ballon payment
ballon payment
payment to retire the bonds outstanding principal at maturity
sinking funds
issuer plan to set aside funds over time to retire the bond
benefitsof sinking fund arrangement
formal plan to retire the debt
disadvantages of sinking fund arrangement
- reinvestment risk
- issuer may have option to repurchase bonds at below market price
bermuda-style call
issuer has the right to call bonds on a species fate following the call protection period
coupon payment structure
- floating rate
- step up coupon bond
- credit link
- payment in kind
- deferred coupon
- index linked
deferred coupon bond
- paid no coupon for the first few years & pays higher than normal coupon for the remainder of its life
- common in project financing
- priced at significant discount to par.
index-linked bond
coupon & or principal repayment are linked to a specific index.
example: inflation-linked bond
- real interest rate= nominal interest rate - inflation
- equity-linked notes
real interest rate formula
nominal interest rate - inflation
equity-linked notes
final payment is based on the return of an equity index.
coupon
interest payment that the bond issuer makes to the bondholders
- usually, coupon is paid semi-annual for sovereign & corporate bond
credit-linked coupon bonds
- coupon rate change when bonds credit rating change
- attractive to investors who are concerned about the future creditworthiness of the issuer
payment-in-kind coupon bond
coupon is paid in the form of additional amounts of the bonds issue rather than as a cash payment
- favored when issuer future cash flow will be questionable
step-up coupon bond
- fixed or floating couping which increase by specified margin at specified dates
- provides some protection against rising interest rates.
floating rate note
- coupon rate is linked to an external reference rate -LIBOR
little interest rate risk
additional features may include floor or cap
- typical coupon rate
- variable rate note
- inverse floater
typical coupon rate
3M libor + … bps(spread)
variable rate note
spread is not fixed
inverse floater
inverse relationship to the reference rate
fixed income security
an instrument that allows gov, companies & other types of issuers to borrow money from investors
- adding fixed securities to portfolio add diversification benefits
adding fixed income securities to a portfolio does what ?
add diversification
maturity date
date when the issuer is obligated to redeem the bond by paying the outstanding principal.
tenor
time remaining until maturity
money market securities
maturities at insurance of 1 year or less
capital market securities
fixed securities with maturity more than 1 yr
3 important elements of bond investing
- the bonds features
- legal, regulatory & tax consideration
- contingency provision
par value
principal or par value amount that the issuer agrees to repay the bondholder on maturity date
credit risk
risk of loss resulting from the issuer failing to make full & timely payment of interest/ principal
major type of bond issuer are:
- supranational organization (IFM, world bank)
- quasi-gov bonds
- corporate issuers
- non-sovereign gov bonds (cities)
- sovereign gov bonds (fed)
current denomination
- dual currency bonds
- currency option bonds
dual currency bonds
pay interest in one currency & principal in another currency
currency option bonds
single currency bond + foreign currency option
coupon rate and frequency
- coupon/ nominal rate
- plain vanilla bond
- floaters
- zero coupon bonds
zero coupon bonds
issued at discount to par & reddem at par
floaters
bonds with floating rate coupon
plain vanilla bond
fixed rate bond
coupon/ nominal rate
interest rate that the issuer agrees to pay every year until maturity
yield to maturity
internal rate of return on bonds expected cash flow
- lower interest rate scenario anticipation, lower yield to maturity demand
current or running yield
bonds annual coupon / bonds price
bond indentures
- trust deed (indenture)
- collateral
- credit enhancement
- covenants
indenture (trust deed)
legal contract that describe:
- bond form
- issuer obligation
- bondholder rights
collateral
assets or financial guaranteed above & beyond the issuer promise to pay
credit enhancement
provision to reduce the credit risk of the bond issue
covenants
clauses that define bondholders right and an issuer’s actions
bonds issuer is legally obligated to make what kind of payment?
contractual payments
source of repayment proceeds
- supernational organization
- sovereign bonds
- non-sovereign gov debt (bond)
- corporate bonds
- securitization
securitization
cash flow generated by one or more underlying financial assets
corporate bonds
issuer ability to generate cash flow from operations
non-soveriegn gov debt (bond)
- tax
- special tax or fees
- cash flow of project (financed with bond issue)
supranational organization
either the repayment or previous loans or the paid-in-capital from its members
sovereign bonds
tax revenue & print money is the major source of repayment
credit enhancement
- internal credit enhancement (subordination)
- > junior tranche
- > excess spread
- external credit enhancement
- > surety bond
- > letter of credit
credit enhancement
variety of provision that can be used to decrease the credit risk of a bond issue
surety bond
issued by a rated & regulated insurance company
letter of credit
provide by a financial institution
-> less common form
internal credi enhancement (subordination)
ordering of claim priorities for ownership or interest in an asset
junior tranche
function as credit protection for senior tranche
excess spread
difference between cash flows received from the assets used to secure issue & the interest paid to investors
euro bonds
bond issued & traded on euro bond market
- bearer bond
- registered bond
bearer bonds
trustee does not keeep records of bonds ownerships
registered bonds
ownership is recorded by either name or serial number
national bond market
bond that are issued & traded in a specific country
legal & regulatory concerning fixed income?
fixed income securities are subject to legal and regulatory requirement
seniority ranking
- secured bonds
- debentures
- unsecured bonds
secured bonds
backed by asset or financial guarantees pledge to ensure debt repayment in case of default
debenture
types of bonds that can be unsecured
unsecured bonds
no collateral bond
covenants
- bonds covenants
- affirmative covenants
- negative covenants
bond covenants
legally enforceable rules that borrowers & lenders agree on at the time of a new bond issue
affirmative covenants
what issuer are required to do (admin nature)
negative covenants
what issuer are prohibited from doing (costly & do materially constrain the issuer potential business decision)
example: restriction on debt, negative pledges. restriction on prior claims restriction on investments
types of collateral backing
- collateral trust bonds
- equipments certificates
- mortgage backed securities
- covered bonds
collateral trust bonds
secured by securities such as shares other bonds or financial assets
equipment trust certificates
bonds secured by specific types of equipments or physical assets
mortgage-backed securities
debt obligations that represent claims to the cash flow from pools of mortgage loans
covered bonds
debt backed by a segregated pool of asset called cover pool.
