CIFA

FIXED-INCOME SECURITIES: DEFINING ELEMENT BOND PRICES, YIELDS, AND RATINCS There are two important points about fixed-income securities that we wiU develop further along in the Fixed Income study sessions but may be ...

FIXED-INCOME SECURITIES: DEFINING ELEMENT BOND PRICES, YIELDS, AND RATINCS There are two important points about fixed-income securities that we wiU develop further along in the Fixed Income study sessions but may be helpful as you read this topic review. • The most common type of fixed-income security is a bond that promises to make a series of interest payments in fixed amounts and to repay the principal amount at maturity. When market interest rates (i.e., yields on bonds) inc",lu, the value of such bonds aurtlUts because the present value of a bond's promised cash flows decreases when a higher discount rate is used. • Bonds arc rated based on their relative probability of default (failure to make promised payments). Because investors prefer bonds with lower probability of default, bonds with lower credit quality must offer investors higher yields to compensate for the grt:ater probability of default. Other things equal, a decrease in a bond', rating (an increased probability of default) will decrease the price of the bond, thus increasing its yield. The features of a fixed-income security include specification of: • The issuer of the bond. • The maturity date of the bond. • The par value (principal value to be:repaid). • Coupon rate and fre:que:ney. • Currency in which payments will be:made Issuers of Bonds There are several types of entities that issue bends when they borrow money. including: • Corporations_ Often corporate bonds arc divided into those issued by financial companies and those issued by nonfinancial companies. • Sovereign national go..,mmenu_ A prime example is U.S. Treasury bonds, but many countries issue sovereign bonds. • Nonsovneign gcm:rnmenu. Issued by gcm:rnment entities that arc not national govern menu. such as the state of California or the ciry of Toronto. • Quasi-govcrnmcot entities. Not a direct obligation of a country's government or central bank. An example is the Federal National Mongage Association (Fannie Mac). • Supranational entities. Issued by organizations that operate globally such as the World Bank. the European Investment Bank. and the International Monetary Fund (IMF). Bond Maturity The maturiry date of a bond is the date on which the principal is to be repaid. Once a bond has been issued. the time remaining until maturiry is referred to as the term to maturiry or tenor of a bond. When bonds arc issued, their terms to maturity range from one day to 30 years or more. Both Disney and Coca-Cola have issued bonds with original maturities of 100 years. Bonds that have no maturity date arc called perpetual bonds. They make periodic interest payments but do not promise to repay the principal amount. Bonds with original maturities of one year or less arc referred to as money market securities. Bonds with original maturities of more than one year arc referred to as apical market securities. Par Value The par value of a bond is the principal amount that will be repaid at maturity. The par valuc is also referred to as the fi/(~ velu«; mil"'"" vllllI~. mJnnptilJn 1IIt11l~. orprincipal vllllI~ of a bond. Bonds can have a par value of any amount. and their prices arc quoted as a percentagc of par. A bond with a par value of $1.000 quoted at 98 is selling for $980. A bond that is selling for more than its par value is said to be trading at a premium to par; a bond that is selling at less than its par value is said to be trading at a discount to par; and a bond that is selling for cxaedy its par value is said to be trading at par. Coupon Payments The coupon rate on a bond is the annual percentage of its par value that will be paid to bondholders. Some bends make coupon interest payments annually. while others make semiannual. quarterly, or monthly payments. A $1.000 par value semiannual-pay bond