Securities: Defining Elements
LOS a Describe
Basic Features
Issuer: Who will pay interest, repay principal?
Fixed Income (1)
 Corporations
 Sovereign, non-sovereign governments
Fixed-Income Securities:
Defining Elements
 Quasi-government entities
 Supranational entities
 Special purpose entities
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LOS a Describe
Securities: Defining Elements
LOS a Describe
Basic Features
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Securities: Defining Elements
Basic Features
Maturity date: Date of final payment
Coupon rate: Annual interest as percent of par
Tenor: Time to maturity at any point in time
Coupon frequency: Payments per year, periodicity
Money market: Original maturities ≤ 1 year
Currency denomination (e.g., euros, pounds, yen)
Capital market: Original maturities > 1 year
Dual-currency bond: Interest payments in one
currency, principal payments in another
Par (face) value: Principal to be repaid
Currency option bond: Choice of currency
Premium, Discount: Price relative to par value
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LOS b,c Describe/Compare/Identify
Securities: Defining Elements
Bond Indenture
Securities: Defining Elements
LOS d Describe
Domestic and Foreign Bonds
Trust deed or indenture: Legal contract between issuer and
bondholder, held by trustee
Domestic bonds: Domestic issuer and currency (e.g.,
$US Microsoft bonds, issued in the United States)
Covenants: Provisions of an indenture
Foreign bonds: Foreign issuer, trade in domestic
currency, raise capital in a broader market (e.g., $US
Heineken bonds issued in the United States, registered
with the SEC)
Affirmative covenants: Actions issuer must perform (e.g.,
make payments on time, insure assets, comply with laws)
Negative covenants: Restrictions on issuer actions that
would disadvantage bondholders (e.g., cannot pay dividends
until bond payments made)
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LOS d Describe
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Securities: Defining Elements
National bond market: Includes trading both types of
issues
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Securities: Defining Elements
LOS d Describe
Eurobonds
Eurobonds
 Sold by an international syndicate, issued
Advantages of eurobonds:
simultaneously to investors in many countries
 Avoid regulation, no tax withholding, issue USD bonds
 Issued outside the jurisdiction of any single country
 Issued in a currency other than the issuer’s
domestic currency (e.g., euroyen, eurodollar bonds)
without registering with the SEC (cannot be traded in the
United States)
 Reach a large pool of investors globally, primarily in the
eurozone, Asia-Pacific, and the United States
Global bonds: Eurobonds that also trade in a domestic bond
market (e.g., World Bank bonds)
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LOS d Describe
Securities: Defining Elements
Collateral
Securitized Bonds
Unsecured bonds: Claim to issuer’s overall assets
Secured bonds: Claim to specific asset owned by issuer
(asset is pledged as collateral)
Collateral trust bonds: Securities held by trustee
Equipment trust certificates: Physical assets owned by
trust, leased to firm
Secured bonds have seniority over unsecured bonds.
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LOS d Describe
Securities: Defining Elements
 Issued by a Special Purpose Entity (SPE)
 Firm sells assets to the SPE (bankruptcy remote)
 Asset cash flows make payments to bondholders
 Assets separate from firm, safe from firm problems
 Created to reduce borrowing costs, e.g. Mortgage-backed
securities (MBS), Credit card receivables, Business loans,
Automobile loans
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Securities: Defining Elements
LOS d Describe
Covered Bonds
Credit Enhancement
Legislation protects assets segregated, but still
owned by the firm and on the firm’s balance sheet.
 Primarily issued by financial firms
 Firm must augment assets whenever they are
insufficient to support the covered bonds
 Bondholders effectively have recourse to the firm
as well as the segregated financial assets
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Securities: Defining Elements
LOS d Describe
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External
Bank guarantee – issued by bank
Provided by third party
Counterparty risk
Surety bond – insurance company
Letter of credit – financial institution
Cash collateral account: Cash borrowed by issuer,
invested in low-risk short-term debt securities at
inception
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Securities: Defining Elements
LOS d Describe
Credit Enhancement
Tax Considerations
 Interest typically taxed as ordinary income
Internal: Built into structure of bond issue
Overcollateralization: Collateral value is greater
than amount borrowed
Excess spread: Yield on asset pool is greater than
yield of bonds issued
Tranches: Different priority of claims for different
bond classes, waterfall structure
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Securities: Defining Elements
LOS d Describe
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 Interest on municipal bonds (U.S.) exempt from taxes
 Some domestic bonds pay interest net of tax
 For bonds sold prior to maturity, may be capital gains
or losses if yield has changed
 Long-term capital gains (and capital gains in general)
often taxed at lower rate
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Securities: Defining Elements
LOS d Describe
Tax Considerations
Original issue discount (OID) bonds
 Bonds issued with coupon < market rate
 Price increase from passage of time is typically taxed
as interest income annually
Zero-coupon (pure discount) bonds
 Pay only par value at maturity
 May require annual payments for taxes
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