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Chapter 1 - Chapter 1 Features of Debt Securities 1 Plan of...

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1 Chapter 1 Features of Debt Securities
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2 Plan of the lecture Basic features of a bond Bond covenants Coupon rate structures Floating rate securities Accrued interest Options embedded in a bond Borrow funds to purchase bonds
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3 Basic features of a bond In investment management, the most important decision is the allocation of funds across asset classes Two major asset classes are equities (or stocks ) and fixed income securities Alternative asset classes ”: real estate, hedge funds, private equity, and commodities (e.g., crude oil, gold) etc.
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4 Basic features of a bond Fixed income securities (or debt securities ) are securities whose income is literally fixed The issuer (i.e., the borrower ) of a fixed income security promises to pay a specified ( fixed ) sum of money at specified ( fixed ) future dates In contrast, the dividend on an equity is not fixed , but dependent on the issuing firm’s performance
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5 Basic features of a bond Types of fixed income securities Bonds (the most common type, already covered in ADMS3530 ) Mortgage backed securities (see Chapter 10 ) Asset backed securities (e.g., securities backed by auto loans, student loans, credit card receivables …, see Chapter 11 ) Bank loans ……
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6 Basic features of a bond The investor who purchases a debt security is called the lender (or creditor ) compare the lender to the issuer (or borrower ) The payment that an issuer promises to make at specified future dates consist of: interest (or coupon ) and principal payment (i.e., repayment of funds borrowed)
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7 Basic features of a bond The term to maturity (or simply “ maturity or “ term ”) of a bond is the number of years remaining prior to the final principal payment The maturity date of a bond refers to the date that the bond will cease to exist, at which time the issuer will repay the outstanding balance For example, a bond is “due 12/16/2015”
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8 Basic features of a bond Bonds can have any maturity Typically the longest maturity is 30 years But Walt Disney Co. issued an 100-year bond in 1993 Short term ”: a maturity between 1 and 5 years Intermediate term ”: a maturity between 5 and 12 years Long term ”: a maturity of more than 12 years
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9 Basic features of a bond The par value (or principal value , face value , and maturity value ) of a bond is the amount that the issuer promises to repay the bondholder (i.e., lender) at or by the maturity date. It is also the amount borrowed
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10 Basic features of a bond Bonds can have any par value The market practice is to quote the price of a bond as a percentage of its par value Example : suppose a bond has a par value of $1,000
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