Fixed Income

Front 1

Nonsovereign governments.

Back 1

Issued by government entities that are not national governments, such as the state of California or the city of Toronto.

Front 2

Quasi-government entities

Back 2

Not a direct obligation of a country’s government or central bank. An example is the Federal National Mortgage Association (Fannie Mae)

Front 3

Supranational entities

Back 3

Issued by organizations that operate globally such as the World Bank, the European Investment Bank, and the International Monetary Fund (IMF)

Front 4

money market securities

Back 4

Bonds with original maturities of one year or less

Front 5

Capital market securities

Back 5

Bonds with original maturities of more than one year

Front 6

plain vanilla bond or a conventional bond.

Back 6

A bond with a fixed coupon rate

Front 7

dual-currency bond

Back 7

makes coupon interest payments in one currency and the principal repayment at maturity in another currency

Front 8

currency option bond

Back 8

gives bondholders a choice of which of two currencies they would like to receive their payments in.

Front 9

trust deed (US or Canada) or bond indenture (globally)

Back 9

The indenture defines the obligations of and restrictions on the borrower and forms the basis for all future transactions between the bondholder and the issuer.

Front 10

Negative covenants

Back 10

include restrictions on asset sale, negative pledge of collatera, restrictions on additional borrowing

Front 11

Affirmative covenants

Back 11

do not typically restrict the operating decisions of the issuer. Common affirmative covenants are to make timely interest and principal payments to bondholders, to insure and maintain assets, and to comply with applicable laws

Front 12

domestic bonds

Back 12

Bonds issued by a firm domiciled in a country and also traded in that country’s currency

Front 13

foreign bonds

Back 13

Bonds issued by a firm incorporated in a foreign country that trade on the national bond market of another country in that country’s currency

ex: Examples include bonds issued by foreign firms that trade in China and are denominated in yuan

Front 14

Eurobonds

Back 14

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

ex: A bond issued by a Chinese firm that is denominated in yen and traded in markets outside Japan would fit the definition of a Eurobond.

Front 15

global bonds

Back 15

Eurobonds that trade in the national bond market of a country other than the country that issues the currency the bond is denominated in, and in the Eurobond market

Front 16

Eurobonds reference (yen vs usd vs xyz enominated)

Back 16

Eurodollar bonds are denominated in U.S. dollars, and euroyen bonds are denominated in yen

Front 17

bearer form

Back 17

Ownership of bearer bonds is evidenced simply by possessing the bonds

Front 18

registered bonds

Back 18

ownership of registered bonds is recorded

Front 19

special purpose entities

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An entity created solely for the purpose of owning specific assets and issuing bonds to provide the funds to purchase the assets

SPEs are called bankruptcy remote vehicles or entities because assets supporting the bonds are owned by the SPE and are used to make the payments to holders of the securitized bonds even if the company itself runs into financial trouble

Front 20

securitized bonds

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bonds that have a specific asset or cash flow often issued by a SPE.

Front 21

Unsecured bonds

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represent a claim to the overall assets and cash flows of the issuer.

Front 22

Equipment trust certificates

Back 22

debt securities backed by equipment such as railroad cars and oil drilling rig

Front 23

Collateral trust bonds

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backed by financial assets, such as stocks and (other) bonds.

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debentures

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refers to unsecured debt in the United States

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covered bonds

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similar to asset-backed securities, but the underlying assets (the cover pool), although segregated, remain on the balance sheet of the issuing corporation (i.e., no SPE is created)

Front 26

Credit enhancement

Back 26

internal (built into the structure of a bond issue) or external (provided by a third party)

Front 27

Credit enhancement- cash reserve fund

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cash set aside to make up for credit losses on the underlying assets.

Front 28

Credit enhancement- excess spread account

Back 28

the yield promised on the bonds issued is less than the promised yield on the assets supporting the ABS

Front 29

Credit enhancement- overcollateralization

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collateral pledged has a value greater than the par value of the debt issued

Front 30

Credit enhancement-Surety bonds

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issued by insurance companies and are a promise to make up any shortfall in the cash available to service the deb

Front 31

Credit enhancement- letter of credit

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promise to lend money to the issuing entity if it does not have enough cash to make the promised payments on the covered deb

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amortizing loan.

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(think automobile loans and home loans), same payment each year, some interest some principal

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partially amortizing

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balloon payment at bond maturity, just as with a bullet structure. However, unlike a bullet structure, the final payment includes just the remaining unamortized principal amount rather than the full principal amount.

Front 34

Sinking fund provisions

Back 34

provide for the repayment of principal through a series of payments over the life of the issue

ex: 20-year issue with a face amount of $300 million may require that the issuer retire $20 million of the principal every year beginning in the sixth year.

Often have the ability to repay par early

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reference rate

Back 35

On a FRN you pay pay the reference rate plus some interest margin

Front 36

variable-rate note

Back 36

margin above the reference rate is not fixed.

Front 37

Step-up coupon bonds

Back 37

structured so that the coupon rate increases over time according to a predetermined schedule.

Front 38

credit-linked coupon bond

Back 38

carries a provision stating that the coupon rate will go up by a certain amount if the credit rating of the issuer falls and go down if the credit rating of the issuer improves.

Front 39

payment-in-kind (PIK) bond

Back 39

allows the issuer to make the coupon payments by increasing the principal amount of the outstanding bonds, essentially paying bond interest with more bonds

Front 40

deferred coupon bond, also called a split coupon bond

Back 40

regular coupon payments do not begin until a period of time after issuance

Front 41

index-linked bond

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oupon payments and/or a principal value that is based on a commodity index, an equity index, or some other published index number

ex: inflation linked bonds

Front 42

Capital-indexed bonds

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This is the most common structure. An example is U.S. Treasury Inflation Protected Securities (TIPS). The coupon rate remains constant, and the principal value of the bonds is increased by the rate of inflation (or decreased by deflation).

Front 43

contingency provision

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an action that may be taken if an event (the contingency) actually occurs

Front 44

Bermuda style

Back 44

the bonds can be called on specified dates after the first call date, often on coupon payment dates.

Front 45

put option on bonds

Back 45

gives the bondholder the right to sell the bond back to the issuing company at a prespecified price, typically par.

Front 46

Conversion price

Back 46

the price per share at which the bond (at its par value) may be converted to common stock.

Front 47

Conversion ratio

Back 47

Equal to the par value of the bond divided by the conversion price

ex: if a bond with a $1,000 par value has a conversion price of $40, its conversion ratio is 1,000/40 = 25 shares per bond.

Front 48

Conversion value

Back 48

This is the market value of the shares that would be received upon conversion

A bond with a conversion ratio of 25 shares when the current market price of a common share is $50 would have a conversion value of 25 × 50 = $1,250.

Front 49

warrants

Back 49

Warrants give their holders the right to buy the firm’s common shares at a given price over a given period of time

Front 50

Contingent Convertible Bonds

Back 50

bonds that convert from debt to common equity automatically if a specific event occurs. This type of bond has been issued by some European banks. Banks must maintain specific levels of equity financing.

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underwritten offering

Back 51

the entire bond issue is purchased from the issuing firm by the investment bank, termed the underwriter in this case

Front 52

best efforts offering.

Back 52

the investment banks sell the bonds on a commission basis. Unlike an underwritten offering, the investment banks do not commit to purchase the whole issue (i.e., underwrite the issue).

Front 53

primary dealers

Back 53

participate in single price auctions for USTs

Front 54

shelf registration

Back 54

a bond issue is registered with securities regulators in its aggregate value with a master prospectus. Bonds can then be issued over time when the issuer needs to raise funds.

Front 55

bilateral loan

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When the loan involves only one bank

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syndicated loan

Back 56

when a loan is funded by several banks. there is a secondary market in syndicated loan interests that are also securitized, creating bonds that are sold to investors.

Front 57

commercial paper

Back 57

short-term debt securities- the interest cost of commercial paper is less than the interest on a bank loan

Front 58

bridge financing

Back 58

Debt that is temporary until permanent financing can be secured

Front 59

Commercial Paper length USA

Back 59

commercial paper is issued with maturities of 270 days or less, because debt securities with maturities of 270 days or less are exempt from SEC registration.

Front 60

Eurocommercial paper (ECP)

Back 60

issued in several countries with maturities as long as 364 days. Commercial paper is issued with maturities as short as one day (overnight paper), with most issues maturing in about 90 days.

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backup lines of credit

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The bank agrees to provide the funds when commercial paper matures, if needed, except in the case of a material adverse change (i.e., when the company’s financial situation has deteriorated significantly).

Front 62

serial bond issue

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bonds are issued with several maturity dates so that a portion of the issue is redeemed periodically

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term maturity structure

Back 63

A bond issue that does not have a serial maturity structure

Front 64

medium-term notes

Back 64

MTNs are issued in various maturities, ranging from nine months to periods as long as 100 years. Issuers provide maturity ranges (e.g., 18 months to two years) for MTNs they wish to sell and provide yield quotes for those ranges. Investors interested in purchasing the notes make an offer to the issuer’s agent, specifying the face value and an exact maturity within one of the ranges offered. The agent then confirms the issuer’s willingness to sell those MTNs and effects the transaction.

Front 65

Negotiable certificates of deposit

Back 65

Large denomination (typically more than $1 million) negotiable CDs are an important funding source for banks. They typically have maturities of one year or less and are traded in domestic bond markets as well as in the Eurobond market.

Front 66

central bank funds market

Back 66

source of short-term funding for banks. Either post or receive funds depends on if you meet RR

Front 67

repurchase (repo) agreement

Back 67

arrangement by which one party sells a security to a counterparty with a commitment to buy it back at a later date at a specified (higher) price

The interest rate implied by the two prices is called the repo rate

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repo margin or the haircut

Back 68

percentage difference between the market value and the amount loanedin a repo

ex: Bond has mkt value $80, loaned for 90 days for $70 to be repurchased at $73. Repo rate is 73/70 -1 (annualized). repo margin in 80/70-1 (annulaized)

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reverse repo agreement

Back 69

refers to taking the opposite side of a repurchase transaction, lending funds by buying the collateral security rather than selling the collateral security to borrow funds.

Front 70

yield-to-maturity or redemption yield.

Back 70

The market discount rate appropriate for discounting a bond’s cash flows

Front 71

bond between coupon payment date calculation

Back 71

price at last coupon payment × (1+ YTM)^(t/T) where

t= the number of days from the last coupon payment date until the date the bond trade will settle

T= number of days between the last coupon payment and the next

Front 72

flat price to full price

Back 72

full price = flat price + accrued interest

flat price of the bond is also referred to as the bond’s clean price

full price is referred to as the dirty price

Front 73

Matrix pricing

Back 73

method of estimating the required yield-to-maturity (or price) of bonds that are currently not traded or infrequently traded

Front 74

Linear interpolation

Back 74

4 yr = 5%

9yr = 8%

solve for 6 yr

5% +(6-4)/(9-4) *(8%-5%) = 6.2%

Front 75

Estimating yields by spread

Back 75

Instead of averaging just the yields, do it by averaging spread to equivalent USTs

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effective yield

Back 76

depends on how many coupon payments are made each year and is simply the compound return

Front 77

Currently semiannual, compare to quarterly yield

Back 77

3% semiannual vs 3% quarterly

3/2 = 1.5%

(1.015^1/2) -1 = .747% x4 = 2.988

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street convention

Back 78

Bond yields calculated using the stated coupon payment dates

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true yield

Back 79

yield adjusted for holidays weekends etc

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Current yield

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annual cash coupon / bond price

does not consider capital gains/losses

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simple yield

Back 81

Takes a discount or premium into account by assuming that any discount or premium declines evenly over the remaining years to maturity.

(Annual coupon payment + straight-line amortization of a discount ) / flat price

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yield-to-call

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The yield if the bond was called at any of the callable dates

Front 83

yield-to-worst

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The lowest of yield-to-maturity and the various yields-to-call

Front 84

option-adjusted yield

Back 84

Calculated by adding the value of the call option to the bond’s current flat price. The value of a callable bond is equal to the value of the bond if it did not have the call option, minus the value of the call option

Front 85

quoted margin

Back 85

difference between reference rate and yield on FRN

"libor +200" 200 = quoted margin

Front 86

required margin (also called the discount margin)

Back 86

margin required to return the FRN to its par value. different from Quoted margin when the credit quality has changed

Front 87

Pricing a floating-rate note on a reset date where required margin is different than quoted margin

Back 87

N=n

PMT= par*(required-quoted)

I/Y= ref+req margin

FV = Par Solve for PV

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Money Market yields

Addon yield

Back 88

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Front 89

Relationship Between Short-Term Forward Rates and Spot Rates

Back 89

(1 + S3)^3 = (1 + S1)(1 + 1y1y)(1 + 2y1y)

Front 90

benchmark spread.

Back 90

A yield spread relative to a benchmark bond

A yield spread over a government bond is also known as a G-spread.

Front 91

I-spreads

Back 91

Yield spreads relative to swap rates in the same currency are known as interpolated spreads or I spreads

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Z Spread

Back 92

Bond Price = pmt 1 / (G%1 +ZS)^1 + pmt 2 / (G%3 +ZS)^2 +... pmt n / (G%n +ZS)^n

Front 93

option-adjusted spread

Back 93

used for bonds with embedded options.

OAS = Z-spread – option value

Front 94

loan-to-value ratio

Back 94

the percentage of the value of the collateral real estate that is loaned to the borrower

Front 95

index-referenced mortgage

Back 95

Type of Asjudtable rate mortage where its based on a market rate (LIBOR for example)

Front 96

convertible mortgage

Back 96

one for which the initial interest rate terms, fixed or adjustable, can be changed at the option of the borrower, to adjustable or fixed, for the remaining loan period.

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fully amortizing

Back 97

each payment includes both an interest payment and a repayment of some of the loan principal so there is no loan principal remaining after the last regular mortgage payment.

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interest-only mortgage,

Back 98

there is no principal repayment for either an initial period or the life of the loan

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non-recourse loans

Back 99

the lender has no claim against the assets of the borrower except for the collateral property itself

Front 100

mortgage pass-through securities.

Back 100

Agency RMBS-

Each mortgage pass-through security represents a claim on the cash flows from a pool of mortgages. Any number of mortgages may be used to form the pool, and any mortgage included in the pool is referred to as a securitized mortgage

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weighted average maturity

Back 101

the weighted average of the final maturities of all the mortgages in the pool, weighted by each mortgage’s outstanding principal balance as a proportion of the total outstanding principal value of all the mortgages in the pool.

Front 102

conforming vs non conforming loans

Back 102

Conforming loans have characteristics like max LTV, documents, higher down payment %, etc. They can be in Agency RMBS. Non conforming loans dont, and they must be in private non-agency RMBS

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pass-through rates

Back 103

the coupon rate on the MBS, also called its net interest or net coup

Front 104

Mortgage Pass-through Cash Flow

Back 104

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Front 105

extension risk vs contraction risk.

Back 105

The risk that prepayments will be slower than expected

risk that prepayments will be more rapid than expected

Front 106

conditional prepayment rate (

Back 106

is an annualized measure of prepayments.

Front 107

Public Securities Association (PSA) prepayment benchmark

Back 107

The PSA benchmark is expressed as a monthly series of CPRs. If the prepayment rate (CPR) of an MBS is expected to be the same as the PSA standard benchmark CPR, we say the PSA is 100 (100% of the benchmark CPR

Front 108

Collateralized mortgage obligations (CMO

Back 108

securities that are collateralized by RMBS.

Front 109

Sequential Pay CMO

Back 109

consider a simple CMO with two tranches. Both tranches receive interest payments at a specified coupon rate, but all principal payments (both scheduled payments and prepayments) are paid to Tranche 1 (the short tranche) until its principal is paid off. Principal payments then flow to Tranche 2 until its principal is paid off.

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planned amortization class (PAC) tranches

Back 110

A PAC tranche is structured to make predictable payments, regardless of actual prepayments to the underlying MBS.

reduced contraction risk and reduced extension risk

Front 111

initial PAC collar.

Back 111

The upper and lower bounds on the actual prepayment rates for which the support tranches are sufficient to either provide or absorb actual prepayments

Front 112

shifting interest mechanism

Back 112

a method for addressing a decrease in the level of credit protection provided by junior tranches as prepayments or defaults occur in a senior/subordinated structure

Front 113

Commercial mortgage-backed securities (CMBS)

Back 113

backed by income-producing real estate, typically in the form of:Apartments (multi-family).Warehouses etc etc

CMBS mortgages are structured as nonrecourse loans,

ommercial MBS loans are repaid by real estate investors who, in turn, rely on tenants and customers to provide the cash flow

Front 114

Debt-to-service-coverage ratio (DSC)

Back 114

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Front 115

Defeasance (ex of loan-level call protection))

Back 115

should the borrower insist on making principal payments on the mortgage loan, the mortgage loan can be defeased. This is accomplished by using the prepaid principal to purchase a portfolio of government securities that is sufficient to make the remaining required payments on the CMBS.

Front 116

Yield maintenance charge (ex of loan-level call protection)

Back 116

The borrower is charged the amount of interest lost by the lender should the loan be prepaid. Thismake whole charge is designed to make lenders indifferent to prepayment

Front 117

CMBS-level call protection

Back 117

, CMBS loan pools are segregated into tranches with a specific sequence of repayment. Those tranches with a higher priority will have a higher credit rating than lower priority tranches because loan defaults will first affect the lower tranches.

Front 118

collateralized debt obligation

Back 118

A structured security issued by an SPE for which the collateral is a pool of debt obligations.

CDOs do not rely on interest payments from the collateral pool. CDOs have a collateral manager who buys and sells securities in the collateral pool

Front 119

Structured finance CDOs

Back 119

collateral is ABS, RMBS, other CDOs, and CMBS.

Front 120

Synthetic CDOs

Back 120

collateral is a portfolio of credit default swaps on structured securities.

Front 121

market price risk

Back 121

the uncertainty about price due to uncertainty about market YTM

Front 122

reinvestment risk

Back 122

uncertainty about the total of coupon payments and reinvestment income on those payments due to the uncertainty about future reinvestment rates

Front 123

reinvestment risk & market price risk relationship with time

Back 123

short investment horizon: market price risk > reinvestment risklong investment horizon: reinvestment risk > market price risk

Front 124

Duration

Back 124

used as a measure of a bond’s interest rate risk or sensitivity of a bond’s full price to a change in its yield.

Front 125

Macaulay duration.

Back 125

weighted average of the number of years until each of the bond’s promised PV cash flows is to be paid

Front 126

Modified duration

Back 126

calculated as Macaulay duration (MacDur) divided by one plus the bond’s yield to maturity.

approximate percentage change in bond price = –ModDur × ΔYTM

Front 127

Semiannual ModDur formula

Back 127

ModDurSEMI = MacDurSEMI / (1 + YTM / 2)

Front 128

Approximate Modified Duration

Back 128

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Front 129

Effective Duration

Back 129

Notice that its curve not YTM. This is because for things like MBS, it is interest rate path dependent too

Front 130

key rate duration

Back 130

The impact of nonparallel shifts can be measured using a concept known as key rate duration. A key rate duration, also known as a partial duration, is defined as the sensitivity of the value of a bond or portfolio to changes in the spot rate for a specific maturity, holding other spot rates constant

Front 131

portfolio duration calculation

Back 131

portfolio duration = W1 D1 + W2 D2 + … + WN DNwhere:

Wi = full price of bond i divided by the total value of the portfolio

Di = the duration of bond i

N = the number of bonds in the portfolio

Front 132

money duration

Back 132

money duration = annual modified duration × full price of bond position

Front 133

price value of a basis point

Back 133

the money change in the full price of a bond when its YTM changes by one basis point, or 0.01%.

Avg of the two px changes up 1 bp and down 1 bp

Front 134

convexity of Bonds

Back 134

Bonds price changes arent linear. Decrease less quickly as YTM rises. Increase More quickly as YTM falls.

A longer maturity, a lower coupon rate, or a lower yield to maturity will all increase convexity

Front 135

Convexity for callable bonds

Back 135

the convexity of a callable bond can be negative at low yields. This is because at low yields the call option becomes more valuable and the call price puts an effective limit on increases in bond value

Opposite for putable bonds (greater convexity, put option gives bond a "floor"

Front 136

change in full bond price with convexity

Back 136

–annual modified duration(ΔYTM)+ ½ annual convexity(ΔYTM)^2

Front 137

term structure of yield volatility

Back 137

relation between the volatility of bond yields and their times to maturity.

Front 138

Macaulay duration application in matching a bond to an investor’s investment horizon.

Back 138

When the investment horizon and the bond’s Macaulay duration are matched, a parallel shift in the yield curve prior to the first coupon payment will not (or will minimally) affect the investor’s horizon return.

Front 139

duration gap

Back 139

The difference between a bond’s Macaulay duration and the bondholder’s investment horizon

Front 140

Using duration with spread

Back 140

Same formula just % change in spread instead of % change in yield.

%Δ bond value = –duration(Δspread) + ½ convexity(Δspread)^2

Front 141

Default risk

Back 141

probability that a borrower (bond issuer) fails to pay interest or repay principal when due.

Front 142

Loss severity, or loss given default

Back 142

refers to the value a bond investor will lose if the issuer defaults. Loss severity can be stated as a monetary amount or as a percentage of a bond’s value (principal and unpaid interest).

Front 143

expected loss

Back 143

equal to the default risk multiplied by the loss severity. Expected loss can likewise be stated as a monetary value or as a percentage of a bond’s value.

Front 144

recovery rate

Back 144

percentage of a bond’s value an investor will receive if the issuer defaults. Loss severity as a percentage is equal to one minus the recovery rate.

Front 145

Credit migration risk or downgrade risk

Back 145

possibility that spreads will increase because the issuer has become less creditworthy

Front 146

Market liquidity risk

Back 146

risk of receiving less than market value when selling a bond and is reflected in the size of the bid-ask spreads

Front 147

Tiers of priority of claims (aka tiers of seniority ranking)

Back 147

First lien or first mortgage.
Senior secured debt.
Junior secured debt.
Senior unsecured debt.
Senior subordinated debt.
Subordinated debt.
Junior subordinated debt.

Front 148

pari passu

Back 148

have same priority of claims

Front 149

Issuer credit ratings issue-specific ratingsvs issue-specific ratings

Back 149

Issuer ratings are corporate family ratings (CFR), while issue-specific ratings are called corporate credit ratings (CCR)

Front 150

cross default provision.

Back 150

When a company defaults on one of its several outstanding bonds, provisions in bond indentures may trigger default on the remaining issues as well

Front 151

Notching

Back 151

the practice by rating agencies of assigning different ratings to bonds of the same issuer.

Front 152

four Cs of credit analysis

Back 152

capacity, collateral, covenants, and character.

Front 153

Capacity

Back 153

refers to a corporate borrower’s ability repay its debt obligations on time.

(1) industry structure, (2) industry fundamentals, and (3) company fundamentals.

Front 154

Collateral

Back 154

Collateral analysis is more important for less creditworthy companies. The market value of a company’s assets can be difficult to observe directly.

Intangible assets.Depreciation. Equity market capitalization. Human and intellectual capital

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Covenants

Back 155

Overly restrictive of an issuer’s operating activities may reduce the issuer’s ability to repay. On the other hand, covenants create a legally binding contractual framework for repayment of the debt obligation, which reduces uncertainty for the debt holders

Front 156

Character

Back 156

refers to management’s integrity and its commitment to repay the loan. Factors such as management’s business qualifications and operating record are important

Soundness of strategy, track record, accounting policies, prior treatment of bond holders

Front 157

Funds from operations (FFO

Back 157

Ffrom operations are net income from continuing operations plus depreciation, amortization, deferred taxes, and noncash items. FFO is similar to cash flow from operations (CFO) except that FFO excludes changes in working capital.

Front 158

Ratios for credit analysis

Back 158

Leverage (debt/capital, debt/ebitda, ffo/debt)

Profits and Cash Flows ((EBITDA, FFO, FCF)

Coverage Ratios (EBITDA/interest expense)

Front 159

EBITDA

Back 159

operating income + depreciation and amortization

Front 160

FCF

Back 160

cash flow from operations – capital expenditures – dividends

Front 161

Calculate leverage for different seniorities of debt

Back 161

Include the total value of debt in that level AND higher up the priority structure.