15_FixIncome - Features of Debt Securities Indentures and...

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Features of Debt Securities - Indentures and Covenants: The promises of the issuer and the rights of the bondholders are set forth in great detail in a bond’s indenture. As part of the indenture there are affirmative covenants and negative covenants. Affirmative covenants set forth activities that the borrower promises to do. Negative covenants set forth some limits and restrictions on borrower’s activities. - Maturity: The term to maturity of a bond is the number of years the debt is outstanding or the number of years remaining prior to final principal payment. - Par Value: The par value of a bond is the amount that the issuer agrees to repay the bondholder at or by the maturity date. - Coupon Rate: This is the interest rate that the issuer agrees to pay each year. o Zero Coupon Bonds or Accrual Bonds o Step Up Notes: Coupon rate that increases over time o Deferred Coupon Bonds: Interest payments are deferred for a specified number of years. There is no interest payment during the deferred period o Floating Rate Securities: Coupon Rate = Reference rate + quoted margin Inverse Floaters: Coupon rate moves in the opposite direction from the change in the reference rate. K- Lx (reference rate) Accrued Interest: Bond price plus the accrued interest is called the full price (or dirty price). - In the US, bonds trade with the next coupon attached, which is termed as cum coupon. A bond traded without the right to the next coupon is said to be trading at ex-coupon. - Provisions for Paying off Bonds: o Call and Refunding Provision: Nonrefundable bonds prohibit the call of an issue using the proceeds from a lower coupon bond issue. Thus a bond may be callable but not refundable. When bonds are called through a call option or a sinking fund, the bonds are said to be redeemed. If a lower coupon issue is sold to provide the funds to call the bonds, the bonds are said to be refunded. o Call Price Single Call price regardless of call date: Call price based on call schedule Call price based on make whole premium: This provides a formula for issuer to determine the premium. A make whole premium does so by setting an amount for the premiums, such that when added to the principal amount and reinvested at the redemption date in US Treasury securities having the same remaining life, it would provide a yield equal to the original issue’s yield. The premium plus the principal at which the issue is called is referred to as the make-whole redemption price. o Noncallable vs. nonrefundable bonds: Refunding protection merely prevents redemption from certain sources, namely the proceeds of other debt issues sold at a lower cost of money.
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o Regular vs. Special Redemption Prices: A concern of an investor is that an issuer will use all means possible to maneuver a call so that the special redemption price applies. o
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15_FixIncome - Features of Debt Securities Indentures and...

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