The followiJag is a rn-icwofthe fixed Income BalK Concepu principlel dc-signed to .ddrns the lcuniog
outcome lutemenu Jet fOM by CFA Institute. TfUl topic il 1.110covered in.:
FIXED-INCOME SECURITIES: DEFINING
ELEMENTS
S.udy S••• ion 15
ExA.\I Focus
Here your focus should be on leaming the basic characteristics of debt securities and as
much of the bond terminology as you can remember, Key items art: the coupon structure
of bonds and options embedded in bonds: call options. put options, and conversion (to
common stock) options.
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.
LOS 52.a: Describe the basic features of a fixed-income security.
CFA~ Prt1f.'llm Curriculum, Volume 5, pagt 300
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.
02013 Kaplan, Inc.
,Study Sessioo 15
Cros$-~ft~oce to CFA lrutiwte Assigntd ~adin8 '52 - Ftstd-loCODltSecuritits: Dtfioiog Eltmtnu
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
mil"'""
valuc is also referred to as the fi/(~ velu«; vllllI~. mJnnptilJn 1IIt11l~.
or principal
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
J>.gc:10 02013 Kaplan. Ine,
, Study Session IS
Crou-Rd'erenc< 10 CFA Institule Assigned ReadUlg 'S2 - Fixed-Income Securities: Defining Elements
with a 5% coupon would pay 2.5% of $1,000, or $25, cnty six months. A bond with a
fixed coupon rate is called a plain vanilla bond or a conventional bond.
Some bonds pay no interest prior to maturity and arc called zero-coupon bonds or pure
discount bond s, Pur« JiStDU1l' refers to the fact that these bonds are sold at a discount
to their par value and the interest is aU paid at maturity when bondholders receive the
par value. A 10-ycar, $1,000, zero-coupon bond yielding 7% would sell at about $500
initially and pay $1,000 at maturity. We discuss various other coupon structures later in
Ihis topic review.
Currencies
Bonds arc issued in many currencies. Sometimes borrowcrs from countries with
volatile currencies issue bonds denominated in euros or U.S. dollars to make them
more snrscdve to a wide range investors. A dual-currency bond makes coupon interest
payments in one currency and the principal repayment at maturity in another currency.
A currency option bond gives bondholdcrs a choice of which of two currcncics thcy
would like to receive their payments in.
LOS 52.b: Describe functions of a bond indenture.
LOS 52.c: Compare affirmative and negative covenants and identify examples
of each.
CFA® Program Currjrulum, Vo/Umt 5, pag~ 306
The legal conuact between the bond issuer (borrower) and bondholders (lenders) is
called a trust deed, and in the United States and Canada, it is also often referred to as
the bond indenture. 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,
The provisions in the bond indenture arc known as (ollt1la1lts and include both 1ltgari",
rollt1la1lts (prohibitions on the borrower) and ajJirmariv~ (ollt1la1ltJ (actions the borrowcr
promises to perform).
Negativt: covenants includc restrictions on assct sales (thc company can't sell assets
that have been pledged as collateral), negative pledge of collateral (the company can't
claim that the same assets back several debt issues simultaneously), and restrictions
on additional bcrrowings (the company can't borrow additional money unless certain
financial conditions arc mer),
Negativc covcnants serve to protect the interests of bondholders and prevent the issuing
firm from taking actions that would increase the risk of default. At the same time, the
covenants must not be so restrictive that thcy prevent the firm from taking advantagc of
opportunities that arise or responding appropriately to changing business circumstances.
02013 Kaplan, Inc.
, Study Se";"n 15
Cross-lUft",nce to CFA I",titult Assi&ned lUading '52 - Fu.td·incomt Securities: Dtfining Eltmtnu
Affirmatiw: covenants do not typieally 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 and
regulations.
LOS 52.d: Describe how legal, regulatory, and tax considerations affect the
issuance and trading of fixed·income securities.
CF.A® Prognzm Curr;<IIlum. VDlumt 5. pagt 314
Bonds are subject to diEkrent legal and regulatory requirements depending on where
they are issued and traded. Bonds issued by a firm domiciled in a country and also
traded in that country's currency are referred to as domestie bonds. 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 arc referred to as foreign bonds. Examples
include bonds issued by foreign firms that trade in China and arc denominated in yuan.
which are called pll""" bomb, and bonds issued by firms incorporated outside the United
States that trade in the United States and are denominated in U.S. dolws, which are
called YAnktt bonds.
Eurobonds arc issued outside the jurisdiction of anyone country and denominated in
a currency diEkrent feom the currency of the countries in which they arc sold. They are
subject to less regulation than domestic bonds in most jurisdictions and were initially
introduced to avoid U.S. regulations. Eurobonds should not be confused with bonds
denominated in euros or thought to originate in Europe, although thcy can be both.
Eurobonds got the "euro" name because they were first introduced in Europe. and most
arc still traded by firms in European capitals. A bond issued by a Chinese firm that is
denominated in yen and traded in markets outside Japan ·...ould fit the definition of a
Eurobond. 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. arc referred to as global bonds.
Eurobonds arc referred to by the currency they arc denominated in. Eurodollar bonds arc
denominated in U.S. dollars, and eutoyen bonds arc denominated in yen. The majority
of Eurobonds are issued in bearer form. Ownership of bearer bonds is evidenced simply
by possessing the bonds, whereas ownership of registered bonds is recorded. Bearer
bonds may be more attractive than registered bonds to those seeking to avoid taxes.
Other legal and regulatory issues addressed in a trust deed include:
o Legal information about the entity issuing the bond.
o Any assets (collateral) pledged to support repayment of the bond.
o Any additional features that increase the probability of repayment (credit
enhancemenu).
o Covenants describing any actions the firm must take and any actions the firm is
prohibited from taking.
Page 12 02013 KapIan.llIC.
outcome lutemenu Jet fOM by CFA Institute. TfUl topic il 1.110covered in.:
FIXED-INCOME SECURITIES: DEFINING
ELEMENTS
S.udy S••• ion 15
ExA.\I Focus
Here your focus should be on leaming the basic characteristics of debt securities and as
much of the bond terminology as you can remember, Key items art: the coupon structure
of bonds and options embedded in bonds: call options. put options, and conversion (to
common stock) options.
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.
LOS 52.a: Describe the basic features of a fixed-income security.
CFA~ Prt1f.'llm Curriculum, Volume 5, pagt 300
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.
02013 Kaplan, Inc.
,Study Sessioo 15
Cros$-~ft~oce to CFA lrutiwte Assigntd ~adin8 '52 - Ftstd-loCODltSecuritits: Dtfioiog Eltmtnu
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
mil"'""
valuc is also referred to as the fi/(~ velu«; vllllI~. mJnnptilJn 1IIt11l~.
or principal
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
J>.gc:10 02013 Kaplan. Ine,
, Study Session IS
Crou-Rd'erenc< 10 CFA Institule Assigned ReadUlg 'S2 - Fixed-Income Securities: Defining Elements
with a 5% coupon would pay 2.5% of $1,000, or $25, cnty six months. A bond with a
fixed coupon rate is called a plain vanilla bond or a conventional bond.
Some bonds pay no interest prior to maturity and arc called zero-coupon bonds or pure
discount bond s, Pur« JiStDU1l' refers to the fact that these bonds are sold at a discount
to their par value and the interest is aU paid at maturity when bondholders receive the
par value. A 10-ycar, $1,000, zero-coupon bond yielding 7% would sell at about $500
initially and pay $1,000 at maturity. We discuss various other coupon structures later in
Ihis topic review.
Currencies
Bonds arc issued in many currencies. Sometimes borrowcrs from countries with
volatile currencies issue bonds denominated in euros or U.S. dollars to make them
more snrscdve to a wide range investors. A dual-currency bond makes coupon interest
payments in one currency and the principal repayment at maturity in another currency.
A currency option bond gives bondholdcrs a choice of which of two currcncics thcy
would like to receive their payments in.
LOS 52.b: Describe functions of a bond indenture.
LOS 52.c: Compare affirmative and negative covenants and identify examples
of each.
CFA® Program Currjrulum, Vo/Umt 5, pag~ 306
The legal conuact between the bond issuer (borrower) and bondholders (lenders) is
called a trust deed, and in the United States and Canada, it is also often referred to as
the bond indenture. 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,
The provisions in the bond indenture arc known as (ollt1la1lts and include both 1ltgari",
rollt1la1lts (prohibitions on the borrower) and ajJirmariv~ (ollt1la1ltJ (actions the borrowcr
promises to perform).
Negativt: covenants includc restrictions on assct sales (thc company can't sell assets
that have been pledged as collateral), negative pledge of collateral (the company can't
claim that the same assets back several debt issues simultaneously), and restrictions
on additional bcrrowings (the company can't borrow additional money unless certain
financial conditions arc mer),
Negativc covcnants serve to protect the interests of bondholders and prevent the issuing
firm from taking actions that would increase the risk of default. At the same time, the
covenants must not be so restrictive that thcy prevent the firm from taking advantagc of
opportunities that arise or responding appropriately to changing business circumstances.
02013 Kaplan, Inc.
, Study Se";"n 15
Cross-lUft",nce to CFA I",titult Assi&ned lUading '52 - Fu.td·incomt Securities: Dtfining Eltmtnu
Affirmatiw: covenants do not typieally 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 and
regulations.
LOS 52.d: Describe how legal, regulatory, and tax considerations affect the
issuance and trading of fixed·income securities.
CF.A® Prognzm Curr;<IIlum. VDlumt 5. pagt 314
Bonds are subject to diEkrent legal and regulatory requirements depending on where
they are issued and traded. Bonds issued by a firm domiciled in a country and also
traded in that country's currency are referred to as domestie bonds. 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 arc referred to as foreign bonds. Examples
include bonds issued by foreign firms that trade in China and arc denominated in yuan.
which are called pll""" bomb, and bonds issued by firms incorporated outside the United
States that trade in the United States and are denominated in U.S. dolws, which are
called YAnktt bonds.
Eurobonds arc issued outside the jurisdiction of anyone country and denominated in
a currency diEkrent feom the currency of the countries in which they arc sold. They are
subject to less regulation than domestic bonds in most jurisdictions and were initially
introduced to avoid U.S. regulations. Eurobonds should not be confused with bonds
denominated in euros or thought to originate in Europe, although thcy can be both.
Eurobonds got the "euro" name because they were first introduced in Europe. and most
arc still traded by firms in European capitals. A bond issued by a Chinese firm that is
denominated in yen and traded in markets outside Japan ·...ould fit the definition of a
Eurobond. 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. arc referred to as global bonds.
Eurobonds arc referred to by the currency they arc denominated in. Eurodollar bonds arc
denominated in U.S. dollars, and eutoyen bonds arc denominated in yen. The majority
of Eurobonds are issued in bearer form. Ownership of bearer bonds is evidenced simply
by possessing the bonds, whereas ownership of registered bonds is recorded. Bearer
bonds may be more attractive than registered bonds to those seeking to avoid taxes.
Other legal and regulatory issues addressed in a trust deed include:
o Legal information about the entity issuing the bond.
o Any assets (collateral) pledged to support repayment of the bond.
o Any additional features that increase the probability of repayment (credit
enhancemenu).
o Covenants describing any actions the firm must take and any actions the firm is
prohibited from taking.
Page 12 02013 KapIan.llIC.
