3 Oct 2013

Debt Securities & Bond Characteristics

Debt Securities

A bond is a debt obligation contracted by an issuer/borrower, where the issuer is obliged to make regular payments of both interest and principal. Compared with loans, there is a much more active secondary market and bonds can be sold without requiring the approval of the borrower.

Bond Characteristics

Bonds have the following attributes:
  • They generally do not have flexible payment structures. The bond indenture, specifying the rights of bond holders, generally requires approval by a majority (substantial) vote before amendments can be made to the documents
  • Their issuance requires some form of public disclosure (the amount of information depends on the market used for issuance)
  • Bonds are much easier to sell to investors when they have a credit rating
  • The maturity of bonds can be much longer than for bank loans. For example, bank loans are rarely longer than seven years (perhaps beyond ten years for property loans), whereas bonds can be issued with maturities of thirty years and beyond. There are three groups of bond maturities: short term (bills) for maturities up to one year; medium term (notes) for maturities between one and ten years, and long term (bonds) for maturities greater than ten years
  • Bonds can be issued paying either fixed or floating interest. Floating rate bonds are called FRNs (Floating Rate Notes). Each year, the amounts of fixed or floating bonds issued vary according to the inclinations of issuers and investors. In the US, most bonds pay a coupon on a semi-annual basis while in Europe, most bonds are annual and pay only one coupon a year. It is also worth noting that each currency market assumes a different day count convention when calculating the accrued interest payable for each coupon (actual/360, actual/365, 30/360 or actual/actual)
  • Bonds are less likely to have restrictive covenants. However, in recent years, investors have been able to achieve more protection, particularly the change of control covenant
  • Some bonds may contain embedded optionality that grants either the holder or the issuer certain predefined rights. Callable bonds give the issuer the right to repay the principal before the scheduled maturity date on specified call dates at a price typically around the bond’s par value. Such structures are frequently used in the US agency and high yield markets. Puttable bonds offer holders the right to force the issuer to repay the bond before the maturity date on the specified put dates; offering investors extra protection against declining creditworthiness.

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