BONDS GLOSSARY

Volume 1 Bond Investment Terminologies

A B C D E F

A

Above par:

Having a price above face value.

Absolute priority rule:

The idea that creditors’ claims take precedence over shareholders’ claims in the event of a liquidation or reorganization.

Accrued interest:

Interest that is due on bond or other fixed-income security since the last interest payment was made. This often occurs for bonds purchased on the secondary market, since bonds usually pay interest every six months, but the interest is accrued by the bondholders every month. When a bond is sold, the buyer pays the seller the market price plus the accrued interest, for which the buyer will be reimbursed at the end of the six-month period.

Advance refunding:

A money-management approach based on informed, independent judgment, as opposed to passive management (indexing), which seeks to match the performance of the overall market (or some part of it) by mirroring its composition or by being broadly diversified. The buying and selling of bonds, as opposed to holding them to maturity.

Arrears:

The unpaid portion of serial bond at maturity.

Ask:

The lowest price that any investor or dealer has declared that he/she will sell a given security or commodity for. For over-the-counter stocks, ask is the best quoted price at which a market maker is willing to sell a stock.

Asset coverage:

The extent to which a company’s net assets cover its debt obligations and/or preferred stock. It is expressed in Rupee terms or as a percentage.

Asset swap:

An exchange of two assets. A common example is the replacement of debt obligation with another. A swap might cover fixed rate to a floating rate asset in order to achieve a more favorable payment stream.

Asset-backed security:

A bond or a note backed by loan paper or accounts receivable originated by banks, credit card companies, or other providers of credit.

At par:

Refers to a bond or preferred stock that is selling at a price equal its face value.

Average effective maturity:

A measure of bond’s maturity that takes into consideration the possibility that issuer may call the bond before its maturity date. A weighted average of the maturities of the bonds in a portfolio taking into account all mortgage prepayments, puts, and adjustable coupons.

Average nominal maturity:

A measure of a bond’s maturity which, unlike average effective maturity, does not take into account mortgage prepayments, puts, or adjustable coupons.

Average weighted maturity:

The length of time until the average security in a fund will mature or be redeemed by its issuer. It indicates a fixed-income fund’s sensitivity to interest rate changes. Longer average weighted maturity implies greater volatility in response to interest rate changes.

B

Balloon maturity:

A repayment schedule for an issue of bonds in which a large number of the bonds come due at the same time, typically the final maturity date.

Bearer:

The holder of a negotiable instrument.

Benchmark interest rate:

The minimum interest rate investors will accept for investing in a non-government security.

Best ask:

The lowest price any seller is willing to pay at a given time for a given security.

Best bid:

The highest price any buyer is willing to pay at a given time for a given security

Bid:

The highest price any buyer is willing to pay at a given time for a given security. It is also called bid price.

Bond:

A debt instrument issued for a period of more than one year with purpose of raising capital by borrowing.

Bond rating:

A measure of the quality and safety of a bond, based on issuer’s financial condition. It is an evaluation from a rating service indicating the likelihood that a debt issuer will be able to meet scheduled interest and principal repayments. Typically, AAA is highest and D is the lowest rating.

Bond ratio:

The percentage of a company’s capitalization that is represented by bonds, equal to the total amount of bonds due after one year divided by that amount plus equity. Traditionally, a ratio of 30 to 40 percent or more is considered highly leveraged.

Bond swap:

The simultaneous sale of one bond issue and the purchase of another, to stretch out maturities or for tax reasons.

Buyback:

The purchase of a long position to offset a short position. A corporation’s repurchase of stock or bonds it has issued. Reasons for doing so include putting unused cash to use, raising earnings per share, increasing internal control of the company, and obtaining stock for employee stock option plans or pension plans.

C

Cabinet security:

An increase in the market price of an asset

Call:

An option contract that gives the holder the right to buy a certain quantity of an underlying security from the writer of the option, at a specified price up to a specified date. It is the right to redeem a callable bond before its scheduled maturity.

Call date:

Date, prior to maturity, on which a callable bond may be redeemed.

Capital Structure:

The permanent long-term financing of a company, including long-term debt, common stock, preferred stock, and retained earnings. It differs from financial structure, which includes short-term debt and accounts payable.

Capitalization:

The sum of a corporation’s long-term debt, stock, and retained earnings. Also called invested capital.

Cash equivalents:

Highly liquid, very safe investments which can be easily converted into cash, such as treasury bills and money market funds.

Collateralized bond obligation:

CBO is an investment-grade bond backed by a large, diversified pool of junk bonds. Usually it is broken down into tiers with varying degrees of risk and varying interest rates.

Commercial paper:

An unsecured obligation issued by a corporation to finance its short-term credit needs, such as accounts receivable and inventory.

Consolidated bond:

A bond issued to replace two or more earlier bonds, to make things simpler or to take advantage of lower interest rates.

Convertible bond:

A corporate bond, usually a junior debenture that can be exchanged, at the option of the holder, for a specific number of shares of company’s preferred stock or common stock.

Convexity:

A volatility measure for bonds used in conjunction with modified duration in order to measure how the bond’s price will change as interest rates change. It is equal to the negative of the second derivative of the bond’s price relative to its yield, divided by its price.

Corpus:

The principal amount of debt instrument, or the underlying assets in a trust.

Credit analysis:

The process of evaluating an applicant’s loan request or a corporation’s debt issue in order to determine the likelihood that the borrower will live up to his/her obligations.

Credit risk:

The possibility that a bond issuer will default, that is fail to repay principal and interest in a timely manner. Also called default risk.

D

Debt capital:

Capital raised through the issuance of debt.

Debt market:

The market for trading debt instruments like commercial papers, certificates of deposit, bonds, non-convertible debentures, etc.

Debt/equity ratio:

A measure of a company’s leverage calculated by dividing long-term debt by common shareholder’s equity, usually the data from previous fiscal year.

Debt-equity swap:

A transaction in which a corporation exchanges newly issued stock (equity) for existing bonds (debt).

Deep-discount bond:

A bond that sells at a discount of 20% or more from face value. Deep-discount bond most often refers to a zero-coupon bond.

Derivative:

A financial instrument whose characteristics and value depend on the characteristics and value of an underlying instrument or asset, typically a commodity, bond, equity or currency. Examples are futures and options.

Downgrade:

A negative change in ratings for a security. Two common examples are an analyst’s downgrading a stock (from buy to sell) and credit bureau’s downgrading a bond.

Dual listing:

The situation that arises when a security is registered for trading on more than one exchange. Dual listings can lead to increased liquidity for the issue. Some securities are listed on one exchange may not be listed on another exchange, preventing dual listing.

Dutch auction:

A type of auction in which the price on an item is lowered until it gets its first bid and is sold at that price.

E

Escrowed to maturity:

The holding of proceeds from a new bond issue in an escrow account, to be used to pay off an existing bond issue at its maturity.

Event risk:

The likelihood that the rating of a bond will drop due to an event, such as the taking of the additional debt or a recapitalization by a company.

Exchangeable security:

A security that grants the holder the right to exchange the security for the common stock of a company other than the issuer.

Extension swap:

A swap in which an investor extends the maturity of his investment by selling one security and buying another one with a longer maturity.

F

Fallen angel:

A bond that was investment-grade when issued but is now of significantly lower quality.

Fixed income:

A security that pays a specific interest rate, such as a bond, money market instruments, or preferred stock.

Flat yield curve:

A yield curve showing the same yield for short-maturity and long-maturity bonds. Also known as even yield curve.

Floating-rate bond:

Bond whose interest is pegged to a benchmark, such as government bond rate, and adjusted periodically.

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