Fixed Income I

Reading 42. Fixed-Income Securities: Defining Elements

Learning Outcome Statements

a. describe basic features of a fixed-income security;

CFA Curriculum, 2020, Volume 5

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### Subject 1. Basic Features of a Fixed-Income Security

A fixed income security is a financial obligation of an entity (the issuer) that promises to pay a specified sum of money at specified future date.

Issuers of bonds include supranational organizations, sovereign governments, non-sovereign governments, quasi-government entities, and corporate issuers. The risk of the issuer failing to make full and timely payments of interest and/or repayment of principal is called credit risk. Credit risk is inherent in all debt investments.

The maturity date is the date when the bond issuer is obligated to pay the outstanding principal amount. It defines the remaining life of the bond.

• It defines the time period over which the bondholder can expect to receive interest payments and principal repayment.
• It affects the yield on a bond.
• It affects the price volatility of the bond resulting from changes in interest rates: the longer the maturity, the greater the price volatility.

The par value (principal, face value, redemption value, or maturity value) is the amount that the issuer agrees to repay the bondholder on the maturity date.

• Bonds can have any par value, though a par value of \$1,000 is the most common.
• The price of a bond is typically quoted as a percentage of its par value. For example, a value of 90 means 90% of the par value.

The interest rate that the issuer agrees to pay each year is called the coupon rate (or nominal rate). The coupon is the annual amount of the interest payment: par value x coupon rate.

In the U.S. most issuers pay the coupon semi-annually.

If you have a "6.5 of 12/1/2019 trading at 97," you have a bond that has a 6.5 coupon rate, matures on 12/1/2019 and is selling for 97% of its par value.

A floating-rate security's coupon payments are reset periodically according to some reference rate. The typical coupon formula is: coupon rate = reference rate + quoted margin.

• Examples of reference rates are LIBOR, U.S. Treasury yields.
• The quoted margin is the additional amount that the issuer agrees to pay above the reference rate. It is a constant value and can be positive or negative. It is often quoted in basis points.
• The coupon rate is determined at the coupon reset date but paid at the next coupon date.

A zero-coupon bond promises to pay a stipulated principal amount at a future maturity date, but it does not promise to make any interim interest payments. The value of a zero-coupon bond increases overtime, and approaches par value at maturity. The return on the bond is the difference between what the investor pays for the bond at the time of purchase and the principal payment at maturity. The implied interest rate is earned at maturity.

For example, if an investor purchases a zero-coupon bond for \$60 with a par value of \$100, the investor will earn \$40 of interest over the life of the bond. The investor receives no payments until maturity of the bond when he or she will receive \$100.

Bonds can be issued in any currency. If an issue has coupon payments in one currency and principal payments in another currency, it is called dual-currency issue. The holders of currency option bonds can choose the currency in which coupons and principals are paid.

###### sarath

Dollar dominated - payments in dollars

Nondollar-denominated - payments NOT in dollars

Dual-currency issue - payment of coupon payments and principal payments in different currencies...

###### CFAnext

MAturity defines the time period, defines the volatility of the bond and bond yield

bonds normally have a determined par value, price of bond is given as percentage of par value and may be traded at above or below par value

###### etlynleon

may i know what is bond yield?

###### manyu

O bond yield is the net true return from the acquistion of the bond i.e internal rate of return of a bond.

###### jgraham6

"The coupon has nothing to do with the bond price."
How can this be true??? Isn't the coupon important for valuing the price of a bond?

###### samudra

The coupon has nothing to do with the bond price..but vice-versa is not true..bond price is affected by coupon and market interest rate..
The coupon is fixed for the tenure of the bond (assuming fixed coupon bond)

###### mixer

what is par value

###### zubayer

these are all school level education. we need something more advance.

###### moneyguy

be careful what you ask for, zubayer

###### jonan203

zubayer:

did you read any of the modules prior to this one?

###### gill15

I swear all these short term notes, intermediate bonds and long term are changing their maturity everywhere I go....I've read short term is less then 2 years, long term is 10 years with intermediates not existing....

just pick one...

###### Shaan23

Gill - You're right.

In the first unit of the equity section it sates short term fixed income securites = 1-2 years

cutoff for bonds and notes is 10 years.

###### To-be-CFA

Issuers of bonds:
- Corporations
- Sovereign national governments
- Non-sovereign governments - Revenue bonds
- Quasi-government entities - Not a direct obligation of a country's government
- Supranational entities - WTO, IMF

Important terms:
- Term-to-maturity/Tenor - Time remaining until maturity.
- Perpetual Bonds - Bonds that have no maturity.
- Money Market Securities - Original maturities of < 1 year.
- Capital Market Securities - Original maturities of > 1 year.
- Plain Vanilla/Conventional - Bonds with a fixed coupon rate.
- Zero-coupon/Pure Discount - Bonds with no interest prior to maturity.
- Dual-currency Bond - Interest payments in one currency and principal payments in another currency.
- Currency Option Bond - Bondholders has a choice of which two currencies to receive their payments in.

###### farhan92

To be CFA - summarising the summarised notes are we

###### standaert

This is short, direct, precise and straight to the point