fixed income securities ch1
Terms
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- private placements
- bonds sold to one or only few buyers
- General obligation bonds
- backed by full faith, credit, and taxing power of the issuing government unit
- revenue bonds
- safety, or credit worthiness that depends upon the vitality and success of the entity (toll roads) issuing the bond.
- maturity
- the date on which the debt will cease and the borrower will redeem the issue by paying the face value
- term to maturity
- number of years until the maturity
- term bonds
- issues that have a single maturity
- call privilege
- permits the issuer to redeem the bond before the scheduled maturity under certain conditions
- sinking fund provisions
- mandates that the firm retire a substantial portion of the debt, in a prearranged schedule, during its life and before the stated maturity
- serial bonds
- typically municipal bonds that are bundles of bonds with differing maturities.
- short-term bonds
- bonds with maturity 1 to 5 years
- notes
- bonds with maturity 5 and 12 years
- long-term bonds
- greater than 12 years.
- coupon
-
periodic interest payment made to owners during the life of the bond.
coupon * principal (par value) = dollar value of coupon payment. - bearer bonds
- investors clip coupons and send them to the obligor for payment
- registered bonds
- bond owners receive the payment automatically at the appropriate time. All new bond issues must be registered.
- income bonds
-
contain a provision permitting the firm to omit or delay the payment of interest if the firm's earnings are too low.
(issued as part of bankruptcy reorganizations or to replace preferred-stock offering of the issuer) - deferrable bonds
- deeply subordinated debt instruments that give the issuer the option to defer coupon payment up to five years in the event of financial distress.
- inflation-indexed bonds
- coupon payments are tied to an inflation index
- TIPS
- Treasury Inflation-Protection Securities.
- step-up notes
- coupon rate "steps up" over time.
- ratchet bonds
- coupon rate that can decrease over time but never increase. (putable automatic-reset securities). This was designed as substitutes for callable bonds.
- floater
- coupon rate varies over the instrument's life. The coupon rate is reset at designated dates based on the value of some reference rate adjusted for a spread.
- price of bond
-
quoted as percentages of par (or face value).
Dollar price of quote = quote / 100 * principal - advantage of call provision
-
permits the borrower, should market rates fall, to replace the bond issue with a lower-interest-cost issue.
or to use unexpectedly high levels of cash to retire outstanding bonds or might wish to restructure their balance sheets. - disadvantage of call provision
-
investors run the risk of losing a high-coupon bond when rates begin to decline.
prospect of a call limits the appreciation in a bond's price that could be expected when interest rates decline. - noncallable (NC)
- during the deferment period, the borrower cannot retire the debt
- nonrefundable (NF)
- can be called if funds used to retire the issue are obtained from internally generated funds.
- bullet bonds
- noncallable for life.
- "make-whole" call provision
- redemption amount is typically the sum of present values of the remaining coupon payments and principal discounted at a yield on a Treasury security that matches the bond's remaining maturity plus a spread.
- advantage of sinking fund provision from investor perspective
-
1. ensures an orderly retirement of the debt so that the finaly payment, at maturity will not be too large.
2. enhances the liquiditiy
3. prices are stable becomes issuer can become an active participant on the buy side when prices fall. - putable bond
- grants the investor the right to sell the issue back to the issuer at par value on designated dates.
- hard put
- security must be redeemed by the issuer only for cash
- soft put
- issuer has the option to redeem the security for cash, common stock, another debt instrument or combination of three.
- convertible bond
- can be exchanged for specified amounts of common stock in the issuing firm. Conversion cannot be reversed, and the terms of conversion are set by the company in the bond's indenture.
- exchangeable bond
- can be exchanged for the common stock of corporation other than the issuer of bond
- liquid yield option note (LYON)
- a zero coupon, convertible, callable, and putable bond
- medium-term notes
- noncallable, unsecured, senior debt securities with fixed coupon rates that carry an investment grade credit rating.
- mortgage pass through security (pass-through)
- one or more holders of mortgages form a collection of mortgages and sell shares in the pool. Payments are made to security holder each month.
- collateralized mortgage obligation (CMO)
- structured so that several classes of bond holders with varying maturities. (tranches).