e
Buy this Course Now

1.1 Basic Features of a Fixed-Income Securities

Based on total market value, fixed-income securities constitute the most prevalent means of raising capital globally.

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 dates.

A fixed-income security is an instrument that allows governments, companies, and other types of issuers to borrow money from investors. Any borrowing of money is debt.

The terms "fixed-income securities," "debt securities," and "bonds" are often used interchangeably.

Securitised bonds are created from a process called "securitisation," which involves moving assets into a special legal entity.

This legal entity then uses the assets (such as mortgages, auto loans, student loans, credit card receivables, etc.) as guarantees to back (secure) bond issue, leading to the creation of securities bonds.

There are three important elements when investing in a fixed-income security:

  • The bond features, including the issuer, maturity, par value, coupon rate and frequency, and currency denomination.
  • The legal, regulatory, and tax considerations.
  • The contingency provisions that may affect the bond's scheduled cash flows.

All bonds, whether they are traditional or securitised bonds, are characterised by the same basic features.

Creditworthiness

  • Based on creditworthiness, bonds can be investment-grade or non-investment-grade (high yield, speculative).
  • The three largest credit rating agencies are Moody's Investors Service, Standard & Poor's, and Fitch Ratings. Investment-grade bonds are Baa3 or BBB- or higher.
  • Higher-grade bonds are expected to have lower credit risk.

Issuers

  • Supranational organisation
  • Sovereign (national) government
  • Non-sovereign (local) government
  • Quasi-government entity
  • Company (Corporates)

Maturity

  • The maturity date is the date when the issuer is obligated to redeem the bond.
  • The tenor, also known as term to maturity, is the time remaining until the bond's maturity date.
  • Money market securities are fixed-income securities with maturity up to one year.
  • Capital market securities are fixed-income securities with maturity longer than one year.

Par value (principal) of a bond

  • The par value of a bond is the amount the issuer agrees to repay the bondholders on the maturity date.
  • Other names for par value are face value, nominal value, redemption value, and maturity value.
  • Bonds can have any par value.
  • Bond prices are often quoted as a percentage of their par value.

Coupon rate and frequency

  • The coupon or nominal rate (yield) of a bond is the interest rate that the issuer agrees to pay each year until the maturity date. Spreads are usually expressed in basis points (bps).

One basis point is equal to 0.01%.

  • The coupon is the annual amount of interest payments and is determined by multiplying the coupon rate by the par value of the bond.
  • Plain vanilla bonds pay a fixed rate of interest.
  • Floating-rate notes (FRNs) or floaters pay a floating rate: a reference rate plus a spread. (A popular reference rate for FRNs is Libor (London interbank offered rate) and T-bill rate in Kenya).
  • Bonds that do not pay interest are called "zero-coupon bonds." Currency denomination
  • Bonds can be issued in any currency, mostly currency of issuing country.
  • Dual-currency bonds make coupon payments in one currency and pay the par value at maturity in another currency.
  • Currency option bonds are a combination of a single currency bond plus a foreign currency option.
  • Several yield measures are used by market participants. For example, nominal yield (i.e., coupon rate), current (i.e., running) yield, yield to maturity, and others.

Lesson Wrap-Up

This lesson should leave you able to explain the basic features of a fixed-income securities in a fixed-income context and connect it to the decisions made by issuers, investors, or analysts.

Review Prompts

  1. Explain basic features of a fixed-income securities in your own words.
  2. State one exam-style risk, valuation, or market implication of the basic features of a fixed-income securities.