Fixed Income Investment Analysis cheat sheet

Key terms

Issuer

The entity borrowing the funds: a government, agency, supranational or corporation (see the next chapter, on market participants), each carrying different credit risk.

Maturity

The date the issuer must repay the principal (par/face value), defining the bond's term.

Par value (face value)

The amount the issuer promises to repay at maturity, and the amount coupon payments are typically calculated against.

Coupon rate and frequency

The stated annual interest rate paid to bondholders, and how often it is paid (annually, semi-annually), determining the size and timing of periodic cash flows.

Currency denomination

The currency the bond's cash flows are paid in, introducing currency risk (see Introduction to Finance and Investments, on asset classes) for an investor whose base currency differs.

Fixed-rate bonds

Pay a constant coupon throughout the bond's life.

Floating-rate notes (FRNs)

Pay a coupon that resets periodically against a reference rate (see the next chapter) plus a fixed spread, so the coupon amount varies with market rates.

Zero-coupon bonds

Pay no periodic coupon at all, issued at a discount to par and redeemed at par, the entire return coming from that price appreciation.

Amortising bonds

Repay principal gradually over the bond's life alongside interest, rather than a single lump sum at maturity (the loan amortisation logic of Introduction to Finance and Investments, applied to a tradable bond).

Inflation-linked bonds

Index their principal or coupon to an inflation measure, protecting the investor's real (inflation-adjusted) return.

Bond indenture

The legal contract between issuer and bondholders setting out the bond's terms, covenants, and the trustee's role in enforcing them on bondholders' collective behalf.

Affirmative covenants

Actions the issuer promises to take, maintaining specified financial ratios, using proceeds as stated, providing regular financial reporting.

Negative covenants

Actions the issuer promises not to take, incurring additional debt beyond a specified limit, disposing of key assets, paying dividends beyond a specified threshold, protecting bondholders against value being transferred away to shareholders (echoing the shareholder-bondholder version of the agency conflict in Professional Ethics and Governance).

Legal, regulatory and tax effects

Three sets of rules bear on a bond:

Bonds with embedded options

Bonds carrying a right, held by the issuer or the bondholder, to alter the bond's cash flows before scheduled maturity, developed fully in the chapter on bonds with embedded options.

Call provision

Gives the issuer the right to redeem the bond early, typically exercised when interest rates fall and refinancing at a lower rate becomes attractive (see the chapter on bonds with embedded options).

Put provision

Gives the bondholder the right to sell the bond back to the issuer early, typically exercised when interest rates rise and the bond's fixed coupon becomes unattractive (see the chapter on bonds with embedded options).

Conversion provision

Gives the bondholder the right to convert the bond into a specified number of the issuer's common shares (see Convertible bonds, in the chapter on embedded options), linking the bond's value to the issuer's equity performance.

Sinking fund provision

Requires the issuer to retire a portion of the bond issue periodically before final maturity, reducing the credit risk of a single large repayment at maturity.