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American-style
a bond that makes coupon payments every six months. the amount equals one-half the coupon rate times the face value.
ask price or offer price
the high price at which a dealer is willing to sell to a buyer—the price at which the client buys
bearer bonds
bonds where the person holding the paper bond receives the bond’s cash flows. steal these
bellwether or benchmark bond
the most recently issued 30-year US treasury bond
bid price
the low price at which a dealer is willing to buy from a seller—the price at which the client sells
bid-ask spread
the per-unit profit a dealer makes by buying something at the low bid price and selling it high at the ask price. for example, a dealer may stand ready at a moment in time to buy a share of Manitowoc stock for $28.70 and sell a share of Manitowoc stock for $28.84. therefore, the dealer’s profit is the bid-ask spread of $0.14 per share of Manitowoc stock.
bond ratings
predictions by rating agencies as to the likelihood a bond issuer will default. the big three agencies are Moodys, Standard & Poors, and Fitch. ratings of BBB above are investment-grade debt. ratings of BB and below and below are speculative-grade debt, also known as non-investment grade, junk, or high-yield fixed income
bond trustee
a fiduciary hired by the bond issuer responsible for monitoring the bond indenture and ensuring the bond issuer fulfills its terms
callable or redeemable bond
a bond with a provision that gives the issuer the right to prepay the debt. since issuers will only exercise the call provision when interest rates fall, it imposes reinvestment risk on the bondholders. US Treasurys do not have call provisions, but munis and corporates may
capital gains yield
the annual percentage change in a bond’s price. it is the portion of a bondholder’s total return due to a change in the bond’s value
convexity
the curvature of a bond’s price response due to changes in yields
corporates
bonds issued by corporations that often have twenty-year maturities but may extend to one hundred years. corporate bonds have default risk because corporations must generate cash for the contractually obligated payments through the unforced sales of goods and services to their customers
coupon payment
the interest-only payment the bondholders receive regularly. the coupon rate times the face value is the total interest paid annually. if the bond is European-style, coupon payments are annual, whereas American-style bonds make semiannual payments
coupon rate
the percentage of the face value paid out annually as interest only
credit risk or default risk
the uncertainty about a bond issuer’s ability to make all its required payments
current yield
the annual coupons divided by a bond’s price. it is the portion of a bondholder’s total return due to the receipt of regular cash flows, the coupons
dealer
a market intermediary that always stands ready to buy from sellers at the bid (low) price and sell to buyers at the ask (high) price, thus taking the bid-ask spread as the per-unit profit
dealer market
a market where buyers and sellers for a good or service transact through an intermediary called a dealer. this market structure implies that the dealer must hold inventory and that there is a risk that the price of the inventory may change while waiting to be sold. they are also known as over-the-counter (OTC) markets
debenture
a bond without collateral. all US Treasurys are debentures
deep market
a highly active and liquid market with many buyers and sellers
default
failure on the part of the bond issuer to fulfill the terms of indenture, often by failing to make a coupon payment or pay the face value
discount bond
a bond whose price is less than its face value because its coupon rate is less than the yields on similar bonds. a discount bond’s price will, on average, rise as the time to maturity shortens
duration
the average time it takes for the bondholder to receive the value of the bond. it is the value-weighted average of the times when the bondholder receives bond payments
duration risk or interest rate risk or price risk
the risk that a bond’s price will change in unexpected ways due to unanticipated changes in interest rates. the longer a bond’s duration, the more sensitive the bond’s price to interest rate surprises. all else equal, bonds with longer times to maturity have more duration rate risk than bonds with shorter times to maturity. all else equal, bonds with smaller coupon payments have more duration risk that bonds with large coupons
European-style
a bond that makes a single coupon payment each year. the amount equals the coupon rate times the face value
face value or par value
the principal amount of a bond repaid at the end of the term. its typically $1,000 but it could be anything
fixed-income securities
another name for bonds
floaters
bonds that do not have constant coupon payments; instead, the payments vary with an inflation or interest rate index
holding period yield (HPY)
a bondholder’s realized rate of return having owned the bond for some time interval. typically, we calculate it given some final sales date that occurs before the maturity date. in that case, the holding period yield and the yield to maturity almost always differ
indenture
the written agreement between the bond issuer and the bondholders detailing all of the terms of the debt issue
inflation risk
the chance that unanticipated inflation will erode the purchasing power of the payments the bondholder receives
interest rate risk premium
the additional compensation bondholders require for the increased price risk of bonds with longer time to maturity
inverted yield curve
the situation where long-term Treasurys have lower yields than short-term bonds. they are uncommon and result from expectations that inflation or productivity will be much lower in the future
investment grade bonds
bonds rated BBB or above
liquidity
the ability to buy or sell an asset quickly at its full market value. there is an inverse relationship between liquidity and bid-ask spreads. US Treasury bonds are highly liquid, trading in very deep OTC/dealer markets with small bid-ask spreads. municipals are illiquid with large bid-ask spreads, while corporates fall in between Treasurys and munis
long-bonds
treasury bonds with twenty and thirty years to maturity
market maker
they act as an intermediary trading for their own benefit, but in doing so, match up buyers and sellers and improve market liquidity. dealers are a type of this
maturity date
the date specified in the indenture on which the issuer pays the principal amount of the bond, thus paying off the loan
municipals or munis
bonds issued by state and local governments. these bonds have default risk because the issuers have a limited liability to tax. maturity dates range from twenty to forty years. coupon payments are tax-exempt at the federal level
off-the-run
all the bonds of a type that were previously issued but are not the most recent. for example, if a 30-year bond was just issued, all other 30-year bonds previously issued are this type of bonds
on-the-run
the most recently issued debt for a given maturity date. for example, the most recently issued 30-year treasury bond is this kind of bond
par bond
a bond whose price equals its face value because its coupon rate is the same as the yields on similar bonds
premium bond
a bond whose price is greater than its face value because its coupon rate is greater than the yields on similar bonds. this bond’s price will, on average, fall as the time to maturity shortens
priority claim
the ranking of creditors’ claims should the borrower enter bankruptcy. shareholders have the lowest, hence the name, residual claimant
protective covenants
a part of the indenture either prohibiting specific actions by the issuer, or requiring others during the loan term to protect the lenders
registered bonds
bonds where the issuer keeps track of who receives the bond’s cash flows. dont steal these
reinvestment risk
the risk that a bondholder will reinvest a bond’s cash flows at a lower rate of return when invest rates fall. all else equal, bonds with shorter times to maturity have more of it than bonds with longer times to maturity
senior debt
creditors with high priority claims on the cash flows of a borrower. they often may have the right to seize collateral if a default occurs.
sinking fund
a feature of some bonds designed to reduce the probability of default at maturity by using funds to remove bonds from the market over time
sovereign bonds
debts issued by national governments
speculative or high-income or high-yield or junk bonds
bonds rated BB and below
subordinated debt or junior debt
creditors with low priority claims on the cash flows of a borrower
term structure of interest rates
the relationship between yield-to-maturity and time-to-maturity, all else equal. in general, as the time-to-maturity increases, so do yields-to-maturity, though historically, there have been important exceptions to this pattern
thin market
an illiquid market with relatively few buyers and sellers, resulting in low volume and high bid-ask spreads
time-to-maturity
the number of years until the issuer pays the face value of the bond
Treasury bills
short-term US Treasury debt with maturities of one year or less. these are zero-coupon bonds
Treasury notes
intermediate-term US Treasury debt with maturities of two to ten years. these bonds pay regular coupon payments
Treasury bonds
long-term US Treasury debt with thirty years to maturity, also called bellweather bonds. these bonds pay regular coupon payments
Treasurys
bonds issued by the federal governments. investors consider US Treasurys to be default riskless because the US government has a strong ability to tax economic activity
yield curve
a graph of US Treasury times to maturity and their corresponding yields. yield curves generally slope upward
yield-to-maturity (YTM) or yield or cost of debt
the interest rate the bondholders will earn if they hold the bond until maturity. yields are annual percentage rates (APRs) and change with market conditions. you use trial and error to solve for bond yields. this may have two components: the current yield and the capital gains yield
zero-coupon bond
a bond that does not make regular interest-only coupon payments. Treasury bills and pure discount loans are examples
