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24 views17 pages

Fis C1

.

Uploaded by

Muhammad Saad Umar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 17

FIXED INCOME SECURITIES:

DEFINING ELEMENTS
1 Chapter 1
OVERVIEW OF A FIXEDINCOME
SECURITY
 bond is a contractual agreement between
the issuer and the bondholders.
 There are three important elements that an

investor needs to know about when investing


in a bond:
 Bond’s features
 Legal, regulatory, and tax considerations
 Contingency provisions

2
BASIC FEATURES OF A BOND
 Issuer
 Maturity

 Par Value

 Coupon Rate and Frequency

 Currency Denomination

3
YIELD MEASURES
 The current yield or running yield is equal
to the bond’s annual coupon divided by the
bond’s price, expressed as a percentage.
 The yield to maturity is the internal rate of

return on a bond’s expected cash flows—that


is, the discount rate that equates the present
value of the bond’s expected cash flows until
maturity with the bond’s price.
 The yield to maturity can be considered an

estimate of the bond’s expected return; it


reflects the annual return that an investor
will earn on a bond if this investor purchases 4

the bond today and holds it until maturity.


LEGAL, REGULATORY, AND TAX
CONSIDERATIONS
 The trust deed is the legal contract that
describes the form of the bond, the
obligations of the issuer, and the rights of the
bondholders. Market participants frequently
call this legal contract the bond indenture.
 Legal Identity of the Bond Issuer and Its Legal
Form
 Source of Repayment Proceeds
 Asset or Collateral Backing
 Seniority Ranking
 Types of Collateral Backing

 Collateral trust bonds

 Equipment trust certificates 5


 Covered bond
LEGAL, REGULATORY, AND TAX
CONSIDERATIONS
 Credit Enhancements
 Internal Credit Enhancement
 Subordination
 Overcollateralization
 Reserve accounts
 External Credit Enhancement
 Bank guarantees and surety bonds
 Letter of credit
 Cash collateral account
 Covenants
 Bond covenants are legally enforceable rules that borrowers
and lenders agree on at the time of a new bond issue.
 An indenture will frequently include affirmative (or positive)
and negative covenants.
 Affirmative covenants enumerate what issuers are required
to do, whereas negative covenants specify what issuers are 6
prohibited from doing.
LEGAL AND REGULATORY
CONSIDERATIONS
 Eurobonds are typically less regulated than
domestic and foreign bonds because they are
issued outside the jurisdiction of any single country.
 They are usually unsecured bonds and can be
denominated in any currency, including the issuer’s
domestic currency.
 In the past, Eurobonds typically were bearer
bonds , meaning that the trustee did not keep
records of who owned the bonds; only the clearing
system knew who the bond owners were.
 Nowadays, Eurobonds as well as domestic and
foreign bonds are registered bonds for which
ownership is recorded by either name or serial 7
number.
TAX CONSIDERATIONS
 The income portion of a bond investment is
taxed at the ordinary income tax rate, which is
typically the same tax rate that an individual
would pay on wage or salary income.
 Tax-exempt securities are the exception to this

rule.
 The tax status of bond income may also depend

on where the bond is issued and traded.


 The tax rate for long-term capital gains is lower

than the tax rate for short-term capital gains,


and the tax rate for short term capital gains is
equal to the ordinary income tax rate, although 8
there are exceptions.
STRUCTURE OF A BOND’S CASH
FLOWS
 Principal Repayment Structures
 Bullet, Fully Amortized, and Partially Amortized
Bonds
 Sinking Fund Arrangements
 The term sinking fund refers to an issuer’s plans to set
aside funds over time to retire the bond.
 Coupon Payment Structures
 Floating-Rate Notes
 Step-Up Coupon Bonds
 Credit-Linked Coupon Bonds
 Payment-in-Kind Coupon Bonds
 Deferred Coupon Bonds
9
 Index-Linked Bonds
10
11
12
13
BONDS WITH CONTINGENCY
PROVISIONS
 A contingency refers to some future event or
circumstance that is possible but not certain.
 A contingency provision is a clause in a

legal document that allows for some action if


the event or circumstance does occur.
 For bonds, the term embedded option

refers to various contingency provisions


found in the indenture.
 These contingency provisions provide the

issuer or the bondholders the right, but not


the obligation, to take some action.
14
 These rights are called “options.”
BONDS WITH CONTINGENCY
PROVISIONS
 A callable bond gives the issuer the right to
redeem all or part of the bond before the
specified maturity date.
 Putable bonds are beneficial for the

bondholder by guaranteeing a pre-specified


selling price at the redemption dates.
 A convertible bond is a hybrid security with

both debt and equity features. It gives the


bondholder the right to exchange the bond
for a specified number of common shares in
the issuing company
15
KEY TERMS REGARDING THE
CONVERSION PROVISION
 Conversion price
 Conversion ratio
 Conversion value
 Conversion premium
 Conversion parity

16
BONDS WITH CONTINGENCY
PROVISIONS
 A warrant entitles the holder to buy the
underlying stock of the issuing company at a
fixed exercise price until the expiration date.
 Contingent convertible bonds ,

nicknamed “CoCos,” are bonds with


contingent write-down provisions.
 If the bank experiences losses that reduce its

equity capital below the minimum


requirement, CoCos are a way to reduce the
bank’s likelihood of default and, therefore,
systemic risk—that is, the risk of failure of
the financial system. 17

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