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Chapter 6 Fixed income securities - Coggle Diagram
Chapter 6 Fixed income securities
The fixed-income marketplace
bonds, debentures, money market instruments, mortgages, and preferred shares
The rationale for issuing fixed-income securities
Government
borrow by issuing fixed-income securities
companies
To finance operations or growth
To take advantage of financial leverage
The basic features and terminology of fixed-income securities
Bond: secured by physical assets
Debenture: backed by the general creditworthiness of the issuer (unsecured bond)
Bond terminology
Characteristics of Bond
Par value/ face value (dollar amount per share)
face value (par value) is the amount the bond issuer contracts to pay at maturity
Coupon rate
interest or rate paid by the bond issuer
Most bonds semi-annual coupon payment; some pay annual
not impacted by changes in interest rate
Maturity date
Term to maturity
the time that remains before a bond matures
Bond price
the present discounted value of all the future payments that the bond issuer is obligated to pay the investor
Yield to maturity
Bond features
Interest on bonds
coupon rates can change over time, as with step-up bonds and most saving bonds
interest can be compounded over time and paid at maturity; zero-coupon bond, strip coupons, residuals
interest rate does not have to be applied; in a form of a return based on future factors; (e.g. index-linked notes : hybrid investment product )
Denominations
most common being $1000 and $10,000
Bonds can be purchased only in specific denominations
Bond pricing
quoted price 100 is at par (face value)
discount: bond trading below par: a price of 98 (the bond is trading at 98% of face value)
premium: The amount by which a preferred stock or debt security may sell above its par value.bond trading above par: at a price of 104
Term to maturity
Short-term: more than 1 year, less than 5 years
medium-term: 5 to 10 years
long-term: greater than 10 years
Less than 1 year:
money market securities
That part of the capital market in which short-term financial obligations are bought and sold. These include treasury bills and other federal government securities maturing in three years or less and commercial paper, bankers’ acceptances, trust company guaranteed investment certificates and other instruments with a year or less left to maturity.
Bonds classified as long-term bond when first issued, over time, a medium-term bond, a short-term bond, and, eventually, a money market security
e,g. The Province of Ontario bond at the time of purchase had 10 years to maturity. If that purchase took place six years ago, the bond only has four years left until it matures. Therefore, the bond is now considered a short-term bond.
Liquidity, negotiability, and marketability
Liquid bonds: trade in specific value (e.g. government of Canada bonds have very good liquidity given that there is an active market)
可转让债券Negotiable bonds: can be transferred between investment dealers
Marketable bonds: have a ready market; e.g. a private placement or new issue may have clients to buy because its price and features are attractive
Strip bonds : (zero coupon bond) :
trade at a discount to their par value
The income is considered interest income rather than a capital gain
tax must be paid annually
Usually high quality federal or provincial government bonds where some or all of the interest coupons have been detached and are sold separately.
The dealer acquires a block of high-quality bonds and separates the individual, future-dated interest coupons from the rest of the bond( bond residue)
It is attractive to investors who do not need immediate cash flow and who do not want reinvestment risk or hassle
Callable bonds (redeemable bond)
the issuer give notice of 10 to 30 days
the call price is usually set higher than the par value of the bond
provincial bonds are usually callable at 100 plus accrued interest ( interest that has accumulated since the last interest payment date)
call protection period: before the first possible call date
Extendible and retractable bonds
Extendible bonds
option to extend the investment from short-term (5 years) to long-term
Retractable bonds
have options to redeem early (the maturity date is usually 10years)
Election period
during this period, the holder must notify the trustee or agent of the debt issuer to extend the term of the bond or allow it to mature on the earlier date
convertible bonds and debenture
with the option of exchanging the bond for common shares
conversion privilege
more attractive and saleable
Characteristics: some debenture issues stipulates " no adjustment for interest or dividends"
forced conversion
when market interest rates fall below the bond's coupon rate; when the common shares begin to trade above the conversion price
advantage: relieves the issuer of the obligation to make interest payment on debt; free up room for new debt financing
market behaviour of convertibles
the market price of convertible bonds and debentures is influenced by their investment value as a fixed-income security and by the price of the common shares into which they can be converted.
Sinking funds and purchase funds
sinking fund 偿还基金
set aside sums of money to pay all or part of a debt issue by maturity
A sinking fund will result in a greater proportion of an issue being retired because a specified amount of the bond must be redeemed each year. With a purchase fund, redemptions will only be made if the market price of the bond is at or below a specified price.
purchase fund 用于回购债券的基金
retire a specified amount of the outstanding bonds or debentures through purchases in the market
the price must be at or below a stipulated price
Protective provisions of corporate bonds
security
details of assets that support the debt
negative pledge
will not pledge any assents if the result in less security for the debt holder
limitation on sale and leaseback transaction
sale of assents or merger
dividend test
establish the rules for the payment of dividends
debt test
limit the amount of additional debt; maximum debt-to-asset ratio
additional bond provisions
which circumstances allow the firm to issue additional debt
sinking or purchase fund and call provisions
specific dates and price at which the firm can call the debt
Government of Canada Securities
Bonds
has specific maturity date and coupon/ interest rate
transferable (can be traded in the market)
noncallable (cannot call them before maturity)
Treasury bills
short-term
denominations from $1000 up to $1 million
do not pay interest; sold at a discount ( below par) and mature at 100
The government deems that the difference between your purchase price and maturity price is considered interest income, and is taxed at your regular income tax rate
Canada saving bonds ( CSBs) and Canada premium bonds (CPBs)
discontinued in Nov. 2017
not transferable (have no second market)
can be redeemed by investors throughout the year
Real return bonds
inflation compensation
the coupon payments and principal repayment are adjusted for inflation
e.g. the rate of inflation is 1.5% over the first 6 months, therefore, the value of a $1000 real return bond at the end of 6 months was $1015; the interest payment for the half-year were based on $1015
Provincial and municipal government securities
simply promises to pay (actually are debentures)
bond quality is determined by 2 primary factors: credit quality and market conditions
guaranteed bonds
extend guarantees to cover municipal loans and school board costs
borrow in international markets
provincial securities
offer their own savings bonds: can be purchased only by residents of the residence; only at a certain time of the year; are redeemable every 6 months ( in Quebec any time)
municipal securities
instalment debenture (serial bond) : a bond issue in which a predetermined amount of principal matures each year
non-callable
Types of corporate bonds
mortgage bonds
pledge real property as security for a loan
the lender cannot take ownership of the properties unless the borrower fails to satisfy the terms of the loan
first mortgage bonds are the senior securities of a company / the best security
after-required clause: all assents can be used to secure the loan, even those acquired after the bonds were issued
floating-rate securities (variable-rate securities)
automatically adjusts to changing interest rates
popular because they offer an advantage to investors during periods of rising interest rates
domestic, foreign and eurobonds
foreign bond: issued outside of the issuer's country and denominated in the currency of the country in which they are issued
E.g. : Canadian dollar- denominated bond issued by a U.S. company in Cananda
bonds issues in the United States called Yankee bonds
bonds issues in Japan called Samurais
foreign pay bonds : other bonds pay interest in one currency and the principal in another
Eurobonds
EuroCanadian bonds
Issue Eurobonds denominated in Canadian dollars
Eurodollar
Eurobonds denominated in U.S. dollars
other types of corporate debt issued in the market place
Collateral trust bond 质押债券
secured by a pledge of securities 公司的其他有价证券作为担保
Collateral trust bonds are issued by holding companies. These companies usually do not own many fixed assets. They own securities in subsidiaries that can be pledged to secure bonds.
Equipment trust certificate 设备信托债券
发行公司购买设备后，即将设备所有权转交给受托人，再由受托人将设备出租给发行公司； 发行公司支付租金 （常用与铁路， 航空和运输部门）
Subordinated debentures 次级债券
Junior to other securities
Corporate notes
short-term unsecured promise made by a corporation
high-yield bonds
non-investment grade
lower credit-quality bonds have a higher risk of default
Other fixed-income securities
bankers' acceptances
commercial draft drawn by a borrower for payment on a specified date
sold at a discount and mature at their face value
trade in multiples of $1000; minimum initial investment of $25000
generally have a term to maturity of 30 to 90 days
offer a higher yield than Government of Canada T- bills
can be sold before maturity
commercial paper
unsecured promissory note issued by a corporation
asset-backed security backed by a pool of underlying financial assets
sold at a discount and matures at face value
higher yield than government of Canada T-bills
can be sold in a secondary market
term deposit
offer a guaranteed rate for a short-term deposit ( up to one-year)
a penalty normally applier for withdrawing funds before a certain period
Guaranteed investment certificates (GIC)
offer fixed rates of interest for a specific term
redeemable GICs are lower than non-redeemable GICs
banks can customize their GICs to provide more choices ( e.g. a brief term; the frequency of interest payments)
CDIC does not cover GICs with a term of more than five years
types of GICs
Escalating rate GIC
the interest rate increases over the GIC's term
Laddered GIC
GICs is evenly divided into multiple-term lengths; it can be reinvested or redeemed when matures ; the diversification of terms reduces interest rate risk
instalment GIC
invest $5000 in GIC and arrange to have an additional $100 monthly from bank account to buy GICs
index-linked GIC
return: initial investment; some exposure to equity markets
indexed to domestic or global indexes
interest-rate linked GIC
offer interest rates linked to the change in other rates such as the prime rate, the bank's non-redeemable GIC interest rate, or money market rates
fixed-income mutual funds and exchange-traded funds
the demand for both has grown significantly
easy access to a diversified portfolio of debt securities
attractive features: professional investment management, liquidity, and low investment costs; attractive to investors who have limited amount of money
How to read bond quotes and ratings
issuing company, the coupon rate, the maturity date, the bid and ask price and the yield on the bond
ask 99.85: can be bought for $99.75
bid 99.25: can be sold for 99.25
DBRS, Moody's and S&P provide rating service
from company's point of view, a high rating benefit: set lower interest rates on issues of new securities
a downgrading will lead to lower price on bond; riskier, then investors ask for higher yield, the bond price goes down ( pay less for a bond)