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Unit 2: Securities > 2.2 Debt types and features > Flashcards

2.2 Debt types and features Flashcards

1
Q

What options do companies vs governments have for raising capital?

A

Companies: debt and equity

Governments: Debt only

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2
Q

Can governments use bank loans to raise capital?

A

No - only companies have this option

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3
Q

What are the two types of debt securities and their respective maturities?

A

Bills: <1 year
Bonds: >1 year

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4
Q

What is the difference between capital markets and money markets?

A

Capital markets: Long-term issuance, generally >1year; (bonds)

Money markets: Short-term issuance, generally <1year; (bills)

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5
Q

What are the 4 main features of a bond?

A
  1. Coupon - represents interest (expressed as annual percentage per £100 of nominal value)
  2. Nominal value - capital payment holder receives at redemption (not the price of the bond!)
  3. Name - name given at issue (common for governments to refer to their bonds as treasury stock/bonds)
  4. Redemption - the year and date when the gilt is repaid (maturity date)
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6
Q

How often can coupons be paid?

A

On an annual or semi-annual basis

  • UK Government pays coupon on semi-annual basis
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7
Q

What are other names for the nominal value of a bond?

A

Par/redemption/capital
value

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8
Q

Why is the coupon of a bond often called the gross coupn?

A

Coupons are taxable (subject to income tax for individuals); but tax
is not normally deducted from the coupon payment -0 therefore it is referred to as being a gross coupon.

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9
Q

Who is responsible for debt and cash management for the UK government?

A

The Debt Management Office (DMO)

  • they repay capital to investor at redemption of a bond
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10
Q

What is the yield on UK Gilts considered?

A

UK Gilts are effectively credit risk free and are therefore used for benchmarking - their yield is considered the risk-free rate for sterling denominated bonds

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11
Q

What are the two main types of UK government bond?

A
  • Conventional
  • Index linked
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12
Q

What are the features of a conventional government bond?

A
  • fixed coupons
  • fixed maturity
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13
Q

What is a disadvantage of conventional gov. bonds?

A

If invested for a long period of time cashflows (coupon and nominal value) can be very easily eroded by inflation

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14
Q

What are the features of an index-linked government bond?

A
  • coupon and nominal value linked to inflation index
  • therefore inflation protected
  • NOTE: no deflation protection
  • stated cashflows (coupon and nominal value) will be returned in the case of zero-inflation since investing in the bond
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15
Q

Do index-linked bonds have higher or lower yield than conventional?

A
  • Lower yields as they provide additional safety so are lower risk (and therefore lower potential return)
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16
Q

What is the RPI?

A

Retail Prices Index - An average change in the prices of household
goods and services

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17
Q

What is the CPI?

A

Consumer Prices Index: Based on an EU-wide formula to allow
international comparison. Used by the MPC (monetary policy committee)

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18
Q

What is the PPI?

A

Producer Prices Index: Looks at goods and services further up the
production chain, at the wholesale level

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19
Q

What does STRIPS stand for?

A

Separate Trading of Registered Interest and Principal of Securities

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20
Q

What is a zero-coupon bond?

A

A bond issued at a discount to the nominal value - later redeemed at nominal value (pays no coupon)

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21
Q

What is a key benefit of zero coupon bonds?

A

It removes reinvestment risk as investors can precisely match their liabilities

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22
Q

Which firms dominate the zero-coupon market?

A

Large institution investors, insurance companies, pension funds - who have liabilities to meet

aka. Liability driven investors

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23
Q

Do UK and US governments issue zero-coupon bonds?

A

UK and US governments have historically never issued zero-coupon bonds in the capital market

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24
Q

How do the UK and US provide investors with zero-coupon bonds in another way?

A

Through the STRIPS market developed in US and UK treasury market

Designate certain UK Gilts to be strippable by the DMO - take all the cash flows of a gilt and turn it into a mini-zero coupon bond (STRIPS)

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25
Q

Which 3 parties in the UK are permitted to strip Gilts and create the zero-coupons?

A

GEMMs - Gilt-Edged Market Makers

HMT

BoE

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26
Q

How many STRIPS can a 5 year strippable Gilt be stripped into?

A

11 - it is the number of years x2 (to get the coupon cash flows) + 1 (to get the capital payment cash flow)

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27
Q

What is reinvestment risk and how can it be avoided?

A
  • Where the investor may not receive a required rate
    of return when reinvesting coupon payments
  • Often avoided through
    cash-flow matching, or dedication
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28
Q

What is dedication?

A

Where the investor matches the maturity of cash-flows to the
liabilities

  • Simplest way to do this is use a zero-coupon bond
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29
Q

What are the features of French government bonds?

A

Legal form - bearer

Life when issued -

OATs: 2-50 years

Coupons - annual

Settlement time - T+2

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30
Q

What are the features of German government bonds?

A

Legal form - bearer

Life when issued -

Schatz: Up to 2 years
Bobl: 5 years
Bund: >10 years

Coupons - annual

Settlement time - T+2

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31
Q

What are the features of UK government bonds?

A

Legal form - registered

Life when issued -

Short: < 7 years
Medium: 7-15 years
Long: >15 years

Coupons - semi-annual

Settlement time - T+1

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32
Q

What are the features of US government bonds?

A

Legal form - registered

Life when issued -

T-notes: 2-10 years
T-bonds: >10 years

Coupons - semi-annual

Settlement time - T+1

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33
Q

What are the features of Japanese government bonds?

A

Legal form - registered or bearer

Life when issued -

Maturities tend to be anywhere between 2-40 years

Long: 10 years (most common)

Superlong: 20 years

Coupons - semi-annual

Settlement time - T+1

34
Q

Where has a significant increase in issuance of government bonds been observed and what is a downfall?

A

In emerging/frontier markets:

  • increased volatility and uncertainty
35
Q

List the emerging markets

A

Brazil, Russia, India, China, South Africa, Indonesia, Mexico, Turkey and Malaysia

36
Q

List the frontier markets

A

Bangladesh, Bahrain, Mauritius and Sri Lanka

37
Q

What are the two main types of corporate bonds?

A
  • secured debt securities
  • unsecured debt securities
38
Q

What are the 2 types of secured corporate bonds?

A
  • Fixed charge over assets
  • Floating charge over assets
39
Q

What are fixed charge over assets secured bonds?

A

a fixed charge is security over a certain
specific (named) company asset, e.g. a building or land, and is the most common form of security for debentures

A mortgage charge is a type of fixed charge

40
Q

What are floating charge over assets secured bonds?

A

security over a class (pool)
of assets, e.g. plant and machinery, fixtures and fittings, trade debtors, inventory, receivables

41
Q

What is another term for unsecured debt?

A

Loan stock

42
Q

What is an unsecured debt transaction called in the UK?

A

A debenture

43
Q

What does debenture refer to in the US?

A

Generally refers to a loan agreement with no security at all

44
Q

What terms does the US use for secured issues and secured debt?

A

Secured issue: asset-backed security

Secured debt: asset backed security (ABS)

45
Q

List corporate bonds in order of least to most risky

A
  1. fixed charge over assets secured bond
  2. floating charge over assets secured bond
  3. unsecured bond
46
Q

What is the difference between ABS and covered bonds?

A

The difference comes from who owns the pool of assets:

  • if owned by the originator (eg. the bank that lent out money for mortgage in first place): covered bond
  • if owned by a SPV (sold on by bank to SPV whose purpose is to securitise the bond)
47
Q

What does it mean to securitise something?

A

Turn it into a security (take smt difficult to trade and turn it into smt easy to trade)

48
Q

What is a trust deed?

A

Empowers trustee alone to act on behalf of debenture holders (for ABS) - ensures organised action and parity of treatment through a single entity

49
Q

What is the role of the trustee?

A

Protect interests of debenture holders

50
Q

What is a note trustee?

A
  • Appointed to represent the interests of holders of issues of securities
  • also provides guidance to the issuer
51
Q

What is a security trustee?

A
  • takes legal control of assets; assets re-registered in trustee’s name
  • Where bonds are secured (debentures) the security is protected by the
    trustee for the benefit secured parties
  • The governing documents dictate
    the order of priority of payments among the entitled parties
52
Q

What is a share trustee?

A
  • Holds the shares in an issuing Special Purpose Vehicle (SPV) in order to ensure off-balance-sheet treatment for the originator of
    the transaction
  • Share trustee becomes legal owner of SPV
  • Sometimes these SPVs are domiciled in offshore
    jurisdictions
53
Q

What is a successor trustee?

A

This role played by a trustee is provided for banks which need to resign because of conflicts of interest (especially in connection with defaulted or
bankrupt issues) or when work requirements exceed the bank’s capacity

54
Q

What is the typical life of unsecured corporate bonds?

A

7-30 years

55
Q

What are the 5 types of unsecured debt with different features to conventional bonds?

A
  • convertible bonds
  • exchangeable bonds
  • guaranteed bonds
  • Floating rate notes (FRNs)
  • Payment in kind notes (PIK)
56
Q

What is a convertible bond?

A

Choice to convert into stock of the issuer (at discretion of investor)

57
Q

What is an exchangeable bond?

A

Converts into stock of another (usually subsidiary of issuer)

58
Q

What is a guaranteed bond?

A

Credit enhancement based on credit rating of a third party (a guarantor)

So investors know that there is a bigger/better company than the issuer that is guaranteeing the debt

  • this is a safer bond (less risk) and therefore reduces financing cost for issuer (can issue more cheaply)
59
Q

What are floating rate notes?

A
  • variable coupon
  • coupon floats in line with market interest rates
  • trades near par (price = nominal value usually) so you dont have the inverse relationship between interests rates and bond prices
  • capital protection as it trades near par (less risk of loss of capital)
60
Q

What are PIKs?

A
  • generally subordinated debt
  • zero coupon bonds that are issued at substantial discount to face value
61
Q

What is a Eurobond?

A
  • international bonds issued in more than 1 country
  • bearer documents
  • issued in eurocurrency
62
Q

What is eurocurrency?

A
  • any currency other than the currency of the market in which the eurobond is issued
63
Q

Where are eurobonds typically dealt?

A

Usually OTC but some are exchange traded

64
Q

Who regulates Eurobonds and what is settlement period?

A

International Capital Markets Association (ICMA)

  • trades reported and matched through TRAX
  • settlement is T+2(if settled through euroclear/clearstream)
65
Q

What is the day count convention for accrued interest on eurobonds?

A

30/360

66
Q

Is the coupon taxed for a eurobond and how often are they issued ?

A

No - its a gross annual coupon

67
Q

What does it mean to immobilise a bearer document?

A

Put in a depositary (eg. Euroclear/clearstream

68
Q

What is the order of payout in the case of liquidation?

A
  1. Liquidator
  2. Fixed charge holders (Fixed charge debentures)
  3. Preferential creditors (eg. employees)
  4. Floating charge holders
  5. Unsecured creditors (eg. trade creditors and the government, unsecured bonds)
  6. Subordinated loan stock (eg. PIK)
    ^the above are creditors
  7. preference shareholders (nominal value only except participating shares)
  8. ordinary shareholders
    ^the above are owners
69
Q

What is the order in which bondholders get paid in event of liquidation?

A
  1. Fixed charge holders
  2. Floating charge holders
  3. Unsecured creditors
  4. Subordinated loan stock
    5.. Mezzanine debt
70
Q

What sits on the line between subordinate loan stock and pref. shareholders?

A

Mezzanine debt - lowest form of debt

71
Q

What is a straight or plain vanilla eurobond?

A

fixed coupon eurobonds or bullet bonds that normally pay the coupons once a year

72
Q

What is a ZCB (eurobond variant)?

A

Zero coupon bond - no coupon

Issued at a discount and
redeemed at par value

73
Q

What is a floating rate eurobond?

A

Eurobonds where the coupon rate
varies

The rate is adjusted in line with published market interest rates

The published interest rates that are normally used are a reference rate e.g. SONIA

74
Q

What is a Stepped bond?

A

A variant of eurobond where the coupon increases over the life of the bond

75
Q

What is speculative grade/bonds in default for Standard and Poor’s and Fitch?

A
  • Starts at BB +
    (each grade (exceot AAA) divided into two, plus and minus)
  • D
76
Q

What is speculative grade/bonds in default for Moody’s?

A
  • Starts at Ba 1 (each grade (Except Aaa) subdivided into three - 1, 2, 3)
  • C
77
Q

What happens when credit worthiness changes?

A

Credit rating goes down: Price goes down, yield goes up

Credit rating goes up: Price goes up, yield goes down

NOTE: Coupon is never affected (only the yield/return)

78
Q

What kind of relationship do prices and yields have?

A

Inverse

79
Q

What are the pros and cons of debt for companies?

A

Pros:
- another way to raise capital
- no sacrifice of control
- known obligations (fixed coupon, nom value, redemption date etc)
- paid from pre-tax profit (interest charge comes out before tax on IS)
- cheaper to finance

Cons:
- obligation to pay regardless of performance
- redemptions (have to pay back)
- default can lead to significant repercussions

80
Q

What are the pros and cons of debt for investors?

A

Pros:
- known payments
- priority in payment
- some debt is default risk-free

Cons:
- historically lower return
- not all debt is default risk free

81
Q

What are the credit rating agencies for Japan and Africa?

A
  • Japan Credit Rating Agency
  • Global Credit Rating (for Africa)

Unit 2: Securities (13 decks)

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