Understanding the Z-Spread Moorad Choudhry*
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Bond Basics: What Are Bonds?
Bond Basics: What Are Bonds? Have you ever borrowed money? Of course you have! Whether we hit our parents up for a few bucks to buy candy as children or asked the bank for a mortgage, most of us have borrowed money at some point in our lives. Just as people need money, so do companies and governments. A company needs funds to expand into new markets, while governments need money for everything from infrastructure to social programs. The problem large organizations run into is that they typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands of investors then each lend a portion of the capital needed. Really, a bond is nothing more than a loan for which you are the lender. The organization that sells a bond is known as the issuer. You can think of a bond as an IOU given by a borrower (the issuer) to a lender (the investor). Of course, nobody would loan his or her hard-earned money for nothing. The issuer of a bond must pay the investor something extra for the privilege of using his or her money. This "extra" comes in the form of interest payments, which are made at a predetermined rate and schedule. The interest rate is often referred to as the coupon. The date on which the issuer has to repay the amount borrowed (known as face value) is called the maturity date. Bonds are known as fixed- income securities because you know the exact amount of cash you'll get back if you hold the security until maturity. -
A Collateral Theory of Endogenous Debt Maturity
Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. A Collateral Theory of Endogenous Debt Maturity R. Matthew Darst and Ehraz Refayet 2017-057 Please cite this paper as: Darst, R. Matthew, and Ehraz Refayet (2017). \A Collateral Theory of Endogenous Debt Maturity," Finance and Economics Discussion Series 2017-057. Washington: Board of Gov- ernors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2017.057. NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. A Collateral Theory of Endogenous Debt Maturity∗ R. Matthew Darsty Ehraz Refayetz May 16, 2017 Abstract This paper studies optimal debt maturity when firms cannot issue state contingent claims and must back promises with collateral. We establish a trade- off between long-term borrowing costs and short-term rollover costs. Issuing both long- and short-term debt balances financing costs because different debt maturities allow firms to cater risky promises across time to investors most willing to hold risk. Contrary to existing theories predicated on information frictions or liquidity risk, we show that collateral is sufficient to explain the joint issuance of different types of debt: safe “money-like” debt, risky short- and long- term debt. -
Collateralized Debt Obligations – an Overview by Matthieu Royer, PRMIA NY Steering Committee Member Vice President – Portfolio Coordination, CALYON in the Americas
Collateralized Debt Obligations – an overview By Matthieu Royer, PRMIA NY Steering Committee Member Vice President – Portfolio Coordination, CALYON in the Americas What commonly is referred to as “Collateralized debt obligations” or CDOs are securitization of a pool of asset (generally non-mortgage), in other words a securitized interest. The underlying assets (a.k.a. collateral) usually comprise loans or other debt instruments. A CDO may be called a collateralized loan obligation (CLO) or collateralized bond obligation (CBO) if it holds only loans or bonds, respectively. Investors bear the “structured” credit risk of the collateral. Typically, multiple tranches (or notes) of securities are issued by the CDO, offering investors various composite of maturity and credit risk characteristics. Tranches are categorized as senior, mezzanine, and subordinated/equity, according to their degree of credit risk. If there are defaults or the CDO's collateral otherwise underperforms/migrates/early amortize, scheduled payments to senior tranches take precedence over those of mezzanine tranches, and scheduled payments to mezzanine tranches take precedence over those to subordinated/equity tranches. This is referred to as the “Cash Flow Waterfall”. Senior and mezzanine tranches are typically rated by one or more of the rating agencies, with the former receiving ratings equivalent of “A” to “AAA” and the latter receiving ratings of “B” to “BBB”. The ratings reflect both the expected credit quality of the underlying pool of collateral as well as how much protection a given tranch is afforded by tranches that are subordinate to it (i.e. acting as credit enhancement). The sponsoring organization of the CDO establishes a special purpose vehicle to hold collateral and issue securities. -
Principal Investment Strategy Main Risks
Class Investor I Y PORTFOLIO TURNOVER Ticker DHRAX DHRIX DHRYX The fund pays transaction costs, such as commissions, when it Before you invest, you may want to review the fund’s Prospectus, which buys and sells securities (or “turns over” its portfolio). A higher contains information about the fund and its risks. The fund’s Prospectus and portfolio turnover rate may indicate higher transaction costs and Statement of Additional Information, both dated February 28, 2021, are may result in higher taxes when fund shares are held in a taxable incorporated by reference into this Summary Prospectus. For free paper or account. These costs, which are not reflected in annual fund electronic copies of the fund’s Prospectus and other information about the operating expenses or in the Example, affect the fund’s fund, go to http://www.diamond-hill.com/mutual-funds/documents.fs, email a performance. During the most recent fiscal year, the fund’s request to [email protected], call 888-226-5595, or ask any financial portfolio turnover rate was 28% of the average value of advisor, bank, or broker-dealer who offers shares of the fund. its portfolio. Investment Objective Principal Investment Strategy The investment objective of the Diamond Hill Core Bond Fund is to maximize total return consistent with the preservation of Under normal market conditions, the fund intends to provide capital. total return by investing at least 80% of its net assets (plus any amounts borrowed for investment purposes) in a diversified Fees and Expenses of the Fund portfolio of investment grade, fixed income securities, including This table describes the fees and expenses that you may pay if bonds, debt securities and other similar U.S. -
The Synthetic Collateralised Debt Obligation: Analysing the Super-Senior Swap Element
The Synthetic Collateralised Debt Obligation: analysing the Super-Senior Swap element Nicoletta Baldini * July 2003 Basic Facts In a typical cash flow securitization a SPV (Special Purpose Vehicle) transfers interest income and principal repayments from a portfolio of risky assets, the so called asset pool, to a prioritized set of tranches. The level of credit exposure of every single tranche depends upon its level of subordination: so, the junior tranche will be the first to bear the effect of a credit deterioration of the asset pool, and senior tranches the last. The asset pool can be made up by either any type of debt instrument, mainly bonds or bank loans, or Credit Default Swaps (CDS) in which the SPV sells protection1. When the asset pool is made up solely of CDS contracts we talk of ‘synthetic’ Collateralized Debt Obligations (CDOs); in the so called ‘semi-synthetic’ CDOs, instead, the asset pool is made up by both debt instruments and CDS contracts. The tranches backed by the asset pool can be funded or not, depending upon the fact that the final investor purchases a true debt instrument (note) or a mere synthetic credit exposure. Generally, when the asset pool is constituted by debt instruments, the SPV issues notes (usually divided in more tranches) which are sold to the final investor; in synthetic CDOs, instead, tranches are represented by basket CDSs with which the final investor sells protection to the SPV. In any case all the tranches can be interpreted as percentile basket credit derivatives and their degree of subordination determines the percentiles of the asset pool loss distribution concerning them It is not unusual to find both funded and unfunded tranches within the same securitisation: this is the case for synthetic CDOs (but the same could occur with semi-synthetic CDOs) in which notes are issued and the raised cash is invested in risk free bonds that serve as collateral. -
Chapter 06 - Bonds and Other Securities Section 6.2 - Bonds Bond - an Interest Bearing Security That Promises to Pay a Stated Amount of Money at Some Future Date(S)
Chapter 06 - Bonds and Other Securities Section 6.2 - Bonds Bond - an interest bearing security that promises to pay a stated amount of money at some future date(s). maturity date - date of promised final payment term - time between issue (beginning of bond) and maturity date callable bond - may be redeemed early at the discretion of the borrower putable bond - may be redeemed early at the discretion of the lender redemption date - date at which bond is completely paid off - it may be prior to or equal to the maturity date 6-1 Bond Types: Coupon bonds - borrower makes periodic payments (coupons) to lender until redemption at which time an additional redemption payment is also made - no periodic payments, redemption payment includes original loan principal plus all accumulated interest Convertible bonds - at a future date and under certain specified conditions the bond can be converted into common stock Other Securities: Preferred Stock - provides a fixed rate of return for an investment in the company. It provides ownership rather that indebtedness, but with restricted ownership privileges. It usually has no maturity date, but may be callable. The periodic payments are called dividends. Ranks below bonds but above common stock in security. Preferred stock is bought and sold at market price. 6-2 Common Stock - an ownership security without a fixed rate of return on the investment. Common stock dividends are paid only after interest has been paid on all indebtedness and on preferred stock. The dividend rate changes and is set by the Board of Directors. Common stock holders have true ownership and have voting rights for the Board of Directors, etc. -
3. VALUATION of BONDS and STOCK Investors Corporation
3. VALUATION OF BONDS AND STOCK Objectives: After reading this chapter, you should be able to: 1. Understand the role of stocks and bonds in the financial markets. 2. Calculate value of a bond and a share of stock using proper formulas. 3.1 Acquisition of Capital Corporations, big and small, need capital to do their business. The investors provide the capital to a corporation. A company may need a new factory to manufacture its products, or an airline a few more planes to expand into new territory. The firm acquires the money needed to build the factory or to buy the new planes from investors. The investors, of course, want a return on their investment. Therefore, we may visualize the relationship between the corporation and the investors as follows: Capital Investors Corporation Return on investment Fig. 3.1: The relationship between the investors and a corporation. Capital comes in two forms: debt capital and equity capital. To raise debt capital the companies sell bonds to the public, and to raise equity capital the corporation sells the stock of the company. Both stock and bonds are financial instruments and they have a certain intrinsic value. Instead of selling directly to the public, a corporation usually sells its stock and bonds through an intermediary. An investment bank acts as an agent between the corporation and the public. Also known as underwriters, they raise the capital for a firm and charge a fee for their services. The underwriters may sell $100 million worth of bonds to the public, but deliver only $95 million to the issuing corporation. -
Auction Rate Securities Issue Brief
C ALIFORNIA DEBT AND ISSUE BRIEF INVESTMENT ADVISORY California Debt and Investment Advisory Commission August 2004 C OMMISSION AUCTION RATE SECURITIES Douglas Skarr CDIAC Policy Research Unit The Auction Rate Securities market has Securities must carefully evaluate the current expanded significantly in the public finance environment, their objectives, and consider how sector since 2001. Nationwide, issuance of this debt will be managed over the long term. auction rate securities, including the public finance area, grew from $100 billion in the This Issue Brief provides an overview of the first quarter of 2002 to $200 billion by the end market, mechanics, costs, benefits and risks of the fourth quarter of 2003. Public finance associated with Auction Rate Securities. has become the fastest-growing sector to use auction rate securities, with total issuance I. DEFINITION AND PURPOSE projected to grow at double-digit rates in the Auction Rate Securities (ARS) are long term, future (see Figure 1). variable rate bonds tied to short term interest rates. ARS have a long term nominal maturity Figure 1 – ARS Issues Outstanding with interest rates reset through a modified ARS Outstanding 2002-2003 Dutch auction, at predetermined short term 250 intervals, usually 7, 28, or 35 days. They trade 200 at par and are callable at par on any interest payment date at the option of the issuer. 150 Interest is paid at the current period based on 100 the interest rate determined in the prior auction ($)In Billions period. 50 0 Although ARS are issued and rated as long term Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- 2002 2002 2002 2002 2003 2003 2003 2003 bonds (20 to 30 years), they are priced and Total Municipal traded as short term instruments because of the liquidity provided through the interest rate reset The use of auction rate financing is becoming mechanism. -
Bond Liquidity and Dealer Inventories: Insights from US and European Regulatory Data
52 Financial Conduct Authority Occasional Paper Securities and Exchange Commission DERA Working Paper February 2020 Bond liquidity and dealer inventories: Insights from US and European regulatory data Plamen Ivanov, Alexei Orlov and Michael Schihl Occasional Paper 52 / DERA Working Paper Bond liquidity and dealer inventories Occasional Paper 52 / DERA Working Paper Abstract Most corporate bond research on liquidity and dealer inventories is based on the USD- denominated bonds transactions in the US reported to TRACE. Some of these bonds, however, are also traded in Europe, and those trades are not subject to the TRACE reporting require- ments. Leveraging our access to both TRACE and ZEN, the UK's trade reporting system which is not publicly available, we find an overlap of about 30,000 bonds that are traded both in the US and in Europe. This paper examines how using the CUSIP-level information from TRACE and ZEN affects the computation of bond liquidity metrics, dealer inventories, and the relationship between the two. We find that in the combined dataset, the weekly volume traded and number of trades are significantly higher than in TRACE: e.g., the average unconditional number of trades in investment-grade (high-yield) bonds is 17% (20%) higher and the average uncondi- tional volume traded is 15% (17%) higher when we incorporate the information from ZEN. We find a strong positive relationship between inventories and liquidity, as proxied by the trading activity metrics (i.e., number of trades, zero trading days, or par value traded) in TRACE data, and this result carries over to the combined dataset. -
Mortgage-Backed Securities & Collateralized Mortgage Obligations
Mortgage-backed Securities & Collateralized Mortgage Obligations: Prudent CRA INVESTMENT Opportunities by Andrew Kelman,Director, National Business Development M Securities Sales and Trading Group, Freddie Mac Mortgage-backed securities (MBS) have Here is how MBSs work. Lenders because of their stronger guarantees, become a popular vehicle for finan- originate mortgages and provide better liquidity and more favorable cial institutions looking for investment groups of similar mortgage loans to capital treatment. Accordingly, this opportunities in their communities. organizations like Freddie Mac and article will focus on agency MBSs. CRA officers and bank investment of- Fannie Mae, which then securitize The agency MBS issuer or servicer ficers appreciate the return and safety them. Originators use the cash they collects monthly payments from that MBSs provide and they are widely receive to provide additional mort- homeowners and “passes through” the available compared to other qualified gages in their communities. The re- principal and interest to investors. investments. sulting MBSs carry a guarantee of Thus, these pools are known as mort- Mortgage securities play a crucial timely payment of principal and inter- gage pass-throughs or participation role in housing finance in the U.S., est to the investor and are further certificates (PCs). Most MBSs are making financing available to home backed by the mortgaged properties backed by 30-year fixed-rate mort- buyers at lower costs and ensuring that themselves. Ginnie Mae securities are gages, but they can also be backed by funds are available throughout the backed by the full faith and credit of shorter-term fixed-rate mortgages or country. The MBS market is enormous the U.S. -
Convertible Bond Investing Brochure (PDF)
Convertible bond investing Invesco’s Convertible Securities Strategy 1 Introduction to convertible bonds A primer Convertible securities provide investors the opportunity to participate in the upside of stock markets while also offering potential downside protection. Because convertibles possess both stock- and bond-like attributes, they may be particularly useful in minimizing risk in a portfolio. The following is an introduction to convertibles, how they exhibit characteristics of both stocks and bonds, and where convertibles may fit in a diversified portfolio. Reasons for investing in convertibles Through their combination of stock and bond characteristics, convertibles may offer the following potential advantages over traditional stock and bond instruments: • Yield advantage over stocks • More exposure to market gains than market losses • Historically attractive risk-adjusted returns • Better risk-return profile • Lower interest rate risk Introduction to convertibles A convertible bond is a corporate bond that has the added feature of being convertible into a fixed number of shares of common stock. As a hybrid security, convertibles have the potential to offer equity-like returns due to their stock component with potentially less volatility due to their bond-like features. Convertibles are also higher in the capital structure than common stock, which means that companies must fulfill their obligations to convertible bondholders before stockholders. It is important to note that convertibles are subject to interest rate and credit risks that are applicable to traditional bonds. Simplified convertible structure Bond Call option Convertible Source: BofA Merrill Lynch Convertible Research. The bond feature of these securities comes from their stated interest rate and claim to principal. -
Corporate Bonds and Debentures
Corporate Bonds and Debentures FCS Vinita Nair Vinod Kothari Company Kolkata: New Delhi: Mumbai: 1006-1009, Krishna A-467, First Floor, 403-406, Shreyas Chambers 224 AJC Bose Road Defence Colony, 175, D N Road, Fort Kolkata – 700 017 New Delhi-110024 Mumbai Phone: 033 2281 3742/7715 Phone: 011 41315340 Phone: 022 2261 4021/ 6237 0959 Email: [email protected] Email: [email protected] Email: [email protected] Website: www.vinodkothari.com 1 Copyright & Disclaimer . This presentation is only for academic purposes; this is not intended to be a professional advice or opinion. Anyone relying on this does so at one’s own discretion. Please do consult your professional consultant for any matter covered by this presentation. The contents of the presentation are intended solely for the use of the client to whom the same is marked by us. No circulation, publication, or unauthorised use of the presentation in any form is allowed, except with our prior written permission. No part of this presentation is intended to be solicitation of professional assignment. 2 About Us Vinod Kothari and Company, company secretaries, is a firm with over 30 years of vintage Based out of Kolkata, New Delhi & Mumbai We are a team of qualified company secretaries, chartered accountants, lawyers and managers. Our Organization’s Credo: Focus on capabilities; opportunities follow 3 Law & Practice relating to Corporate Bonds & Debentures 4 The book can be ordered by clicking here Outline . Introduction to Debentures . State of Indian Bond Market . Comparison of debentures with other forms of borrowings/securities . Types of Debentures . Modes of Issuance & Regulatory Framework .