fixed income

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Features of Debt
Securities

1

Introduction to Fixed Income
Securities
Fixed Income Security is a financial obligation of
an entity (known as issuer) that promises to pay a
specified sum of money at specified future dates.
Categories of Fixed Income Securities:

Debt Obligation

2

Indentures and Covenants
Bond Indenture: Details of the promises by issuer and rights
of bondholders are furnished in bond indenture.
Trustee: A third party in the bond or debt contract between
the issuer and the bondholder. As per the indenture, the
trustees are the representatives of the bondholders.
Affirmative covenants as per the indenture:
• Borrower pays the interest and principal on time.
• Borrower pays all taxes when due.
• Borrower keeps the assets that are used or useful, in good
condition and working order.
• Submission of report to trustee about the borrowers
compliance with the loan agreement.
Negative covenants as per the indenture:
• Certain limitations and restrictions on borrower like imposing
limitations on the borrowers ability to incur additional
debt.
3

Maturity
It is the number of years remaining for the final
principal payment.
Reasons for importance of Bond maturity:
1. It indicates the time span for which the
bondholder will get the interest on bond.
2. Yield offered on bond is dependent on the term
of maturity.
3. Price volatility of a bond is a function of its
Note:
maturity.
Longer the maturity of bond, greater will be the price
volatility resulting from changes in interests rates.

4

Par Value
It is the amount the issuer agrees to repay to the
bondholder on the maturity date. It is also termed
as face value, maturity value, redemption value, or
principal.
Facts:
1. Bonds can have different par value.
2. Price of the bond is quoted as a percentage of its
par value. For e.g. If the par value of a bond is
Rs.1000 and it said to be selling at 90, it means
that price of the bond is 90% of Rs.1000 i.e.
Rs.900.
3. A bond may trade above (premium) or below
5
(discount) its par value.

Coupon Rate
Coupon Rate: It is the interest rate that the issuer
of the bond agrees to pay each year to the
bondholder.
Coupon: It is the amount of interest paid by the
issuer every year to the bondholder.
Calculation of coupon:
Coupon = Coupon Rate x Par Value.

Note:
While describing a bond of an issuer, the coupon rate is mentioned
along with the maturity date.
For e.g. “7 of 01/04/2020 trading at 94” means that a bond with coupon rate of 7% and maturity date of 01/04/2020 is trading at 94% of its par
value.
Higher the coupon rate, lower is the risk of decrease in price in response to a change in interest rates.

6

Coupon Rate
Zero coupon bonds
– These bonds are not contracted to make periodic
coupon payments.
– Holder purchases the bond at a price lower than the
par value and the interest is the difference between
the par value (which he gets at the maturity date)
and the purchase price.

Step-Up Notes
– These are securities whose coupon rate increases
over time.
– If only one change in coupon rate, it is known as
single step-up note. If more than one change in
coupon rate, it is known as multi step-up note.
7

Coupon Rate
Deferred Coupon Bonds
– Interest payments are deferred for a specified number of
years.
– Periodic interest payment after the deferred period till the
bond maturity.
– Interest payments post the deferred period is higher than
the promised interest payment as to compensate the loss of
interest payment in deferred period.

Floating-Rate Securities
– In these type of securities, the coupon rate is not fixed and
varies according to some reference rate.
– Coupon Rate = Reference rate + Quoted Margin (can be
positive or negative).
– E.g. Coupon Rate = 1-month LIBOR + 50 basis points. If 1month LIBOR is 6%, then the coupon rate is 6.5%.
8

Coupon Rate - Floating-Rate
Securities
CAP: The maximum coupon rate that can be paid at
any reset date by the floated is called a Cap.
Eg. The coupon rate is calculated by formula:
Coupon rate = 10-year Treasury rate + 100
basis points,
and the cap is 7.5%. If the 10-year Treasury rate is
7%, the coupon rate by the formula would be 8%.
But as the cap is at 7.5%, the coupon rate paid will
A ‘CAP’
is unattractive
for investors as it
be 7.5%
instead
of 8%.
restricts the coupon rate from increasing
9

Coupon Rate - Floating-Rate
Securities
FLOOR: The minimum coupon rate that can be paid
at any reset date by the floated is called a Floor.
Eg. The coupon rate is calculated by formula:
Coupon rate = 10-year Treasury rate - 50
basis points,
and the floor is 7%. If the 10-year Treasury rate is
7%, the coupon rate by the formula would be 6.5%.
But as the floor is at 7%, the coupon rate paid will
be 7%
instead of
A ‘FLOOR’
is 6.5%.
attractive for investors as it
restricts the coupon rate from decreasing.
10

Coupon Rate - Floating-Rate
Securities
Inverse Floaters: These are the issues whose
coupon rate decreases when the reference rate
increases and increases when reference rate
decreases.
Coupon Rate = K – L x Reference
Rate

Where, the values of K and L are mentioned in the
bond prospectus.

11

Accrued Interest
Facts:
• Interest on bonds is paid in many mode i.e.
annually, semi-annually etc.
• For mortgage and asset backed securities, interest
is usually paid monthly.
• Coupon is paid on the coupon date to the
bondholder of record.
• The seller gives up the interest from the time of
the last coupon payment to the time until the bond
is sold. The amount of interest over this period
that will be received by the buyer even though it
was earned by the seller is called accrued interest.
12

Accrued Interest
• In many cases, the buyer of the bond has to pay
the accrued interest to the seller. The amount
that the buyer of the bond pays to the seller is
the agreed upon price for the bond plus accrued
interest and is known as “Full Price”.
• A bond in which the buyer of the bond has to pay
the accrued interest to the seller is said to be
trading cum-coupon (“with coupon”).
• A bond in which the buyer of the bond forgoes the
next coupon payment, the bond is said to be
trading ex-coupon (“without coupon”).
13

Provisions for paying off bonds
Bullet Bonds: In this type of bond, the issuer pays
the full maturity amount on the maturity date.
Amortizing Securities: Fixed income securities which
have schedule of partial principal payments are
known as amortizing securities.
Call Provision: The right of the issuer to retire the
issue fully or partially before the maturity date is
known as ‘Call Provision’.

14

Types of call provisions
1. Call and Refunding Provisions:
•. Callable Bonds: A bond issue that permits the issuer to
call an issue.
•. Call Price: The price which the issuer needs to pay for
earlier retirement of issue is known as call price or
redemption price.
– Single call price regardless of call date.
– Call price based on call schedule.
– Call price based on make-whole premium

2. Prepayments:
Any principal payment prior to the principal payment
date is known as prepayment. It is an option that can be
availed by the borrower.
15

Types of call provisions
3. Sinking Fund Provision:


The amount required for retiring a portion of the
issue each year is known as sinking fund provision.



The vested interest of issuer towards sinking fund
provision is to reduce the credit risk.



Provision can be designed to make the complete
payment of maturity amount by the maturity date
or to pay only a portion of it.



If only a portion is paid, the remaining principal
amount is known as Balloon maturity.
16

Other Features
Conversion Privilege:
– This is a privilege with the bondholder to convert the
bond for a specified number of shares of common
stocks. The bond is called convertible bonds.
– It allows the bondholder to take advantage of favorable
price movements in the price of issuers common stock.

Put Provision:
– This provision gives the right to the bondholder to sell
back the issue to the issuer at a specified price on
specified dates.

Currency Denomination:
– The transaction between the issuer and the bondholder
can be in any currency provided it is mentioned in the
indenture that the issuer can make payment in any
currency.
17

Borrowing funds to purchase
bonds
Margin Buying:
– In this kind of arrangement, the funds that is
borrowed to buy the securities are provided by the
broker and the broker gets the money from a bank.
– The interest that is charged to the broker is known
as call money rate.
– In turn, the broker charges an amount that is a sum
of call money rate and service charges.

Repurchase commitment:
– A sale of securities with a commitment by the seller
to repurchase the same security back from the
purchaser at a specified price on a specified date.
18

Thank You…

19

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