CFA-fixed income

• bondholder: lender; bond issuer: borrower
• The tenor of the bond is the time remaining until the bond’s maturity date.

• redemption value, principal amount, principal value, par value, face value, nominal value

• money market money: bonds with original maturities of one year or less; capital market money: bonds with original maturities of more than one year

• indenture: the legal contract that describes the form of the bond, the obligations of the issuer, and the rights of the bondholders;

• covenants are only one element of a bond’s indenture. Covenants are clauses that specify the rights of the bondholders and any actions that the issuer is obligated to perform or prohibited from performing;
  
  • Negative covenants prevent the issuer from taking actions that could reduce its ability to make interest payments and repay the principal.
  • Affirmative (or positive) covenants enumerate what issuers are required to do and are typically administrative in nature. A common affirmative covenant describes what the issuer intends to do with the proceeds from the bond issue.

• debenture is a type of bond. In many jurisdictions, debentures are unsecured bonds.

• Foreign bond:A bond that is issued in a domestic market by a foreign entity, in the domestic market’s currency.

• Eurobonds are issued outside the jurisdiction of any one country and denominated in a currency different from the currency of the countries in which they are sold.

• Global bonds are bonds that are issued simultaneously in the Eurobond market and in at least one domestic bond market.

• Extension risk is the risk faced that when interest rates rise, fewer prepayments will occur because homeowners will be reluctant to give up the benefits of a contractual interest rate that is now lower than the market rate. As a result, the security becomes longer in maturity than anticipated at the time of purchase.

• Balloon risk is the risk that the borrower will not be able to arrange for refinancing or sell the property to make the balloon payment typically associated with commercial loans backing CMBS. As a result, the CMBS may extend in maturity, implying that balloon risk is a type of extension risk.

• Floating-Rate Notes: pay periodic interest that depends on a current market rate of interest.

• step-up coupon bonds are structured so that the coupon rate increases over time according to a predetermined schedule.

• A sinking fund provision requires retirement of a portion of the bond’s principal every year, rather than retirement of the entire issue at maturity.

• A spot rate is defined as the yield to maturity on a zero-coupon bond maturing at the date of that cash flow.

• internal credit enhancement：

  • Debt surbodination
  • Debt overcollateralization

• external credit enhancement:

  • A letter of credit is a form of external credit enhancement in which a financial institution provides the issuer with a credit line to be used for any cash flow shortfalls related to its debt issue.

• flat price:The agreed-on bond price excluding accrued interest is referred to as the flat price.

• Matrix pricing is most suited to pricing inactively traded bonds and newly underwritten bonds.

Understanding Fixed-Income Risk and Return

• Parallel shift：
  A so-called parallel shift in the yield curve is a when the interest rates on all fixed income maturities - short-term, intermediate, and long-term, increases or decreases by the same number of basis points. For example, if 1-year, 5-year, 8-year, 10-year, 15-year, 20-year, and 30-year bonds all increased by 1.50%, or 150 basis points, over their previous level, this would be a parallel shift in the yield curve because the curve itself didn’t change, rather all data points on it moved to the right of the graph while maintaining its prior slope and shape.

Fundamentals of Credit Analysis

• Credit Risk: the risk of loss resulting from the borrower (issuer of debt) failing to make full and timely payments of interest and/or principal.

  • default risk(probability)
  • loss severity

• Spread risk: the possibility that a bond’s spread will widen due to:

  • credit migration risk / downgrade risk
  • market liquidity risk

• Secured debt: backed by collateral

• Unsecured debt/debentures: a general claim to the issurer’s asssets and cash flows

• Investment grade: ratings of Baa3/BBB- or higher

• non-investment grade/ junk bonds/ high yield bonds: ratings of Ba1/BB+ or lower

• seniority ranking:

  • first lien/first mortgage
  • senior secured debt
  • junior secured debt
  • senior unsecured debt
  • senior subordinated debt
  • subordinated debt
  • junior subordinated debt

• Issuers are rated on their senior unsecured debt

• Notching: the practice by rating agencies of assigning different ratings to bonds of the same issuer

• the four Cs of traditional credit analysis

  • capacity
  • collateral
  • covenants
    
    • a careful credit analysis should include an assessment of whether the covenants protect the interests of the bondholders without unduly constraining the borrowers’ operating activities
  • character

• yield spread=liquidity premium+credit spread

• yield on an option-free coporate bond= real interest rate+the expected inflation rate + a maturity premium+ a liquity premium+ a credit premium