Glossary of Bond Terms Accrued Interest Interest Deemed to Be Earned on a Security but Not Yet Paid to the Investor

Glossary of Bond Terms Accrued interest Interest deemed to be earned on a security but not yet paid to the investor. The amount is calculated by multiplying the coupon rate by the number of days since the previous interest payment. Ask price Price being sought for the security by the seller. Ask yield The return an investor would receive on a Treasury security if he or she paid the ask price. Asset allocation Asset allocation is an investment strategy in which an investor divides his/her assets among different broad categories of investments (such as bonds) to reduce risk in an investment portfolio while maximizing return. The percentages allocated to each investment category at any given time depend on individual investor needs and preferences including investment goals, risk tolerance, market outlook, and how much money there is to invest. Asset swap spread The asset swap spread (also called the gross spread) is the aggregate price that bondholders would receive by exchanging fixed rate bonds for floating rate bonds using the swaps market, mainly used to reduce interest rate risk. The asset swap spread is one widely used metric to determine relative value of one bond against other bonds of the same currency. Asset swaps can be a tool to understand which bond or bonds maximize the spread or price over a reference interest rate benchmark, almost always LIBOR, the London InterBank Offered Rate. Asset-backed bonds or securities (ABS) Asset-backed securities, called ABS, are bonds or notes backed by financial assets other than residential or commercial mortgages. Typically these assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans and consumer loans. ABS constitute a relatively new but growing segment of the debt market in Europe. Average annual yield Average annual yield is the average yearly income on an investment, such as a bond, expressed in percentage terms. To calculate average annual yield, add all the income from an investment and divide that total amount by the number of years in which the money was invested. For example, if you receive €10 interest on a €1,000 bond each year for ten years, the average annual yield is 1% (€10 ÷ €1,000 = 0.01 or 1%). Balance of trade The difference between the value of a region’s imports and exports during a specific period of time. If the European Union or a specific country imports more than it exports, it has a trade deficit; if the EU exports more than it imports it has a trade surplus. Barbell strategy Barbell strategy is used as a way to earn more interest without taking more risk when investing in bonds. In a barbell strategy, an investor invests in short-term bonds, say perhaps some maturing in one to two years and long-term bonds such as those maturing in 30 years. When shorter-term bonds come due, the investor replaces them with other short-term bonds, thus keeping a balance between short and long term bonds. The goal is to earn more interest without taking more risk than having a portfolio of intermediate term bonds only. Basis point One one—hundredth of 1 percent (0.01%). 100 basis points equal 1%. Basis points are often used to measure differences in bond yields. For example, if the yield on a bond changes from 5.55% to 5.5%, it has dropped 5 basis points. Bearer bond A bond that is not registered and has no identification as to owner. It is presumed to be owned by the person who holds it. Bearer securities are freely negotiable, since ownership can be quickly transferred from seller to buyer by delivery of the instrument. Bearer bonds allow investors to remain anonymous. Eurobonds are an example of bearer bonds. Behavioural finance Behavioural finance is the study of why investors act the way they do and how such behaviour affects the markets. Behavioural finance theorists use the disciplines of economics and psychology to suggest that the investor behaviour that affects market prices may be not be based on such “rational” factors as analysis of the strength or performance of a company. Benchmark A benchmark used in investing is a standard against which the performance of an individual bond or group of bonds can be measured. Different types of benchmarks are chosen for different investments by individual investors and financial professionals—the benchmark might be an index, an interest rate such as LIBOR or EURIBOR, or the yield on a particular government bond such as on a US Treasury bond. For example, if an investor uses an index to track a specific segment of the bond market, the changing value of the index indicating a stronger or weaker performance is also the standard against which the investor measures the performance of a particular bond, bond fund or bond portfolio. For investors who want to set up investment performance benchmarks, there are two major types of benchmarks—fixed rate or absolute benchmarks and relative benchmarks. Fixed or absolute benchmarks might be targets that an individual sets--return on a portfolio or some return relative to inflation for example; relative benchmarks are standard market indices or measurements that help an investor compare the performance of his/her investment portfolio to that market index investment benchmark so as to gauge the success of his own strategy to his investment objectives. Individual investors and financial professionals often also use benchmarks to discern broader expectations about the direction of the markets or the economy. Bid (and ask) Bid is the price at which a buyer, broker or market maker offers to pay for a bond; and the ask is the price at which the broker or market maker offers to sell. The difference between the two prices is called the spread. Bid and ask is sometimes known as a “quote.” Bond A bond is a debt security, a loan similar to an I.O.U. When you purchase a bond, you are lending money to a government, corporation, or other entity known as the “issuer.” In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it “matures,” or comes due. Because most bonds pay interest, and on a regular basis, they are sometimes described as fixed-income investments. Bond fund A bond fund sells investors shares of a fund that consists of a portfolio of bonds structured to meet a particular investment objective, such as providing regular income. Bond funds, unlike individual bonds, do not have a maturity date and therefore do not guarantee an interest rate as the portfolio is not fixed. Bond funds, also unlike individual bonds, do not guarantee a return of principal. Investors may invest in bond funds because they want to diversify bond investments with smaller amounts of money than required to buy an entire portfolio of bonds. There are different types of bond funds from which an investor can choose which may invest in different types of bonds (government, corporate, covered, etc), have different investment strategies (short- term, long term, etc.), and offer different levels of risk (for example, highest rated investment grade bonds, high-yield bonds, etc.). Bond insurance, Financial guaranty insurance Credit quality can be enhanced by bond insurance, sometimes known as financial guaranty insurance. Specialised insurance firms serving the fixed income markets guarantee the timely payment of principal and interest on bonds they have insured. Most bond insurers have at least one triple A rating from a recognised rating agency attesting to their financial soundness, although some bond insurers bear lower credit ratings. In either event, insured bonds in turn receive the same rating based on the insurer’s capital and claims-paying resources. In Europe, the financial guaranty insurance sector and the market for insured or “wrapped” bonds have grown rapidly, although have been affected by the market turmoil. Pension reform efforts in Europe are expected to increase the demand for bond insurance because insuring the complex pension financing structures can increase investor confidence and impact the credit quality of the bonds issued as well. In the US, the focus of insurance activity has been in the municipal government bond market although bond insurers have also provided guarantees in the mortgage and asset backed securities markets. Some ABS use external credit enhancement from a third party such as a monoline insurance or surety company. A surety bond is an insurance policy provided by a rated and regulated insurance company to reimburse the ABS for any losses incurred. Often the insurer provides its guarantees only to securities already of at least investment-grade quality (that is, BBB/Baa or higher). Monolines or monoline insurance companies guarantee the timely repayment of bond principal and interest when an issuer defaults. They are called monoline because they insure only one category of risk and provide financial guarantees, or insurance protection, to buyers of a wide variety of financial and capital market instruments, including in the public sector and for infrastructure projects. Certain but not all of the monoline insurance companies have been downgraded during the market turmoil of 2007-2008. Bond insurance is not available for purchase by individual investors. Bond rating and Bond rating agencies Independent bond rating agencies, such as Standard & Poor’s (S&P), Moody’s, Fitch Rating Service, provide ratings that assess individual bond issues as to how likely they are to default on their loans or interest payments. Ratings systems differ among the different agencies, but AAA (Aaa for Moody’s) is considered the highest rating and D the lowest.

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