1. Fixed Income

2. Overview of Bond Sector
and Instruments
Understanding Yield Spreads

3. Bond Sector Government Agencies Municipal Corporation Bank Obligations
US Treasury
Agencies
Federally Related Institution
Government Sponsored Enterprises
Municipal
General Obligation
Revenue
Special Bonds Structure
Corporation
Secured Bonds
Unsecured Bonds
Medium Term Notes
Commercial Paper
Bank Obligations
Negotiabl e CDs
Bankers Acceptances

4. Government Sovereign Bonds
Bonds issued by a country’s central government
Issued in domestic market, another country”s foreign market, or in the Eurobonds market
Typically issued in the currency of the issuing country, but can be issued in other currencies as well

5. Government Four Primary Methods of issuance
Regular cycle auction – single price
Under this method highest price (lowest yield) at which the entire issue to be auctioned can be sold is awarded to winning bidders
Regular cycle auction – multiple price
Under this method, winning bidders receive the bonds at the price that they bid
An ad hoc auction system
Refers to a method where the central government auctions new securities when it determines market conditions are advantageous
A tap system
Refers to the issuance and auctions of bonds identical to previously issued bonds

6. US Treasury US Treasury Fixed-Principal Treasuries Treasury Bills
Treasury Notes
Treasury Bonds
Inflation-Indexes Treasuries (TIPSs)
Treasury Strips (created by private sector)
Coupon Strips
Principal Strips

7. US Treasury On The Run and Off The Run
Treasury issues are divided into 2 categories based on their vintage :
On the run issues, the most recently auctined Treasury issues.
Off the run issues, older issues that have been replaced (as most traded issue) by a more recently auctioned issued. Issues replaced by several more recent issues are known as well off the run issues

8. US Treasury
TIPSs
Coupon rate reflects real rate, net of inflation, change in inflation reflected in the principal
TIPS Coupon payment = inflation-adjusted par value x (stated coupon rate/2)
Cons: if consumer prices decline, so does the principal. Also, inflation adjustments are taxed
Example of TIPS : A TIPS has coupon rate of 3%, par value of $100,000. Annual inflation rate: 4%, compute the semi-annual coupon payment!
Answer:
Semi annual inflation = 4% x 0.5 = 2%
Inflation-adjusted principal = $100,000 x (1+0.02) = $102,000
Semi annual coupon payment = $102,000 x 1.5% = $1530

9. US Treasury Treasury Strips Principal strips Coupon strips
Refers to strips created from coupon payments stripped from the original security, denoted as ci
Principal strips
Refers to bond and note principal payments with the coupons stripped off. Those derived from stripped bonds are denoted bp and those from stripped notes np

10. Agencies Federal Agency Debts Instrumen Types
Debt securities issued by various agencies and organizations of the U.S Government
There are two types of federal agencies :
federal government agencies such as Ginnie Mae, TVA
government sponsored entities (privately owned) such as Fannie Mae, Freddie Mac, Sallie Mae
Instrumen Types
Debentures, securities not backed by collateral
Mortgage and Asset backed securities

11. Collateralized Mortgage Obligations (CMOs)
Agencies
Mortgage Backed Securities
Mortgage pass through
Pooling of several mortgages
Sold in the form of participation certificates
Cash flows passed through to investors
Collateralized Mortgage Obligations (CMOs)
Derivative of pass-through
Different tranches created
Prepayment risk distributed across tranches

12. Municipal Issued by local government
Issuer
Issued by local government
In US issued by state, local government and entities that they create
Types
Tax-Backed Debt
Revenue Bonds
Special Bonds Structure

13. Municipal Tax-Backed Debt General Obligation Debt (G.O. Debt)
Unlimited Tax
Issuer has unlimited taxing authority
Lmited Tax
Issuer has a statutory limit on tax increase
Doule Barelled
Backed also by additional revenues
Appropriation-Backed Obligation (Moral Obligation Bonds)
State Issue a non-binding pledge to cover shortfalls
Public Credit Enhanced Programs
State or Federal agency guarantees payment

14. Corporation Corporate Debt Securities Corporate Bonds Secured Bonds
Mortgage Debt
Collateral Trust Bonds
Unsecured Bonds
Credit Enhanced Bonds
Third-Party
Bank Letter of Credit
Medium Term Notes (MTNs)
Structured Notes
Commercial Paper
Directly-placed
Dealer-placed

15. Factor specific to particular debt issue
Corporation
Considered Factors for Rating
Character, Capacity, Collateral and Covenant
The Firm Specific Factors considered
Past repayment history
Quality of management, ability to adapt to changing conditions
The industry outlook and firm strategy
Overall debt level of the firm
Operating cash flow, ability to service debt
Other sources of liquidity (cash, salable assets)
Competitive position, regulatory enviroment and union contracts/history
Financial management and controls
Susceptibility to event risk and political risk
Factor specific to particular debt issue
Priority of the claim being rated
Value/quality of any collateral pledged to secure the debt
The covenants of the debt issue
Any guarantees or obligations for parent company support

16. Corporation Corporate Bonds Issues Medium term Notes
Corporate bond issues typically are :
Sold all at once
Sold on a firm commitment basis whereby an understanding syndicate guarantees the sale of the whole issue
Consist of bonds with a single coupon rate and maturity
Medium term Notes
Medium term notes (MTNs) differ from a regular corporate bond offering in all of these characteristics

17. Corporation Structured Notes
A debt security created when the issuer combines a typical bond or note with derivative.
Types of structured notes include :
Step up notes, coupon rate increases over time on a preset schedule.
Inverse Floaters, coupon rate increases when the reference rate decreases and decreases when the reference rate increases.
Deleveraged Floaters, coupon rate equals a fraction of the reference rate plus a constant margin.
Dual Indexed Floaters, coupon rate is based on the difference between two reference rates.
Range Notes, coupon rate equals the reference rate if the reference rate falls within a specified range, or zero if the reference rate falls outside that range.
Index amortizing Notes, coupon rate is fixed but some principal is repaid before maturity with the amount of principal prepaid based on the level of the reference rate.

18. Corporation Commercial paper
A short term unsecured debt instrument used by corporations to borrow money at rates lower than bank rates.
Directly placed paper , commercial paper that is sold to large investors without going through an agent or broker dealer. Large issuers will deal with a select group of regular commercial paper buyers who customarily buy very large amounts.
Dealer placed paper, sold to purchasers through a commercial paper dealer. Most large investment firms have commercial paper desk to serve their customers’ needs for short term cash management products.

19. Bank Obligation Negotiable Certificate of deposit Bankers Acceptances
Certificate of deposit, promise by the bank to repay a certain amount plus interest with specific and for specific periods of time, that can be trade on the secondary market
Bankers Acceptances
Guarantees by a bank that a loan will be rapaid. Created as part of commercial transaction, especially international trade

20. Asset Back Securities Special Purpose Vehicle/Corporation
a separate legal entity to which a corporation transfers the financial assets for an ABS issue.
The Motivation for a corporation to issue asset backed securities to reduce borrowing costs. By transferring the assets into a separate entity, the entity can issue the bonds and receive a higher rating than the unsecured debt of the corporation.
External Credit Enhancements :
Corporate guarantees, which may be provided by the corporation creating the ABS or its parent.
Letters of credit, which may be obtained from a bank for a fee
Bond Insurance, which may be obtained from an insurance company or a provider specializing in underwriting such structures. This is also referred to as an insurance wrap

21. Collateralized Debt Obligations
Collateralized Debt Obligation (CDO)
A debt instrument where the collateral for the promise to pay is an underlying pool of other debt obligations and even other CDOs
Tranches of CDO are created based on the seniority of the claim to the cash flows of underlying assets, and given different credit rating based on seniority

22. Primary and Secondary Market
Primary Market
The Primary Market for debt typically used an investment banker to involved in advising the debt issuer and in distributing (selling) the debt securities to investors.
Two type of underwriting : firm commitment and best effort.
Secondary Market
The Secondary Market for debt securities includes exchanges, an over the counter dealer market and electronic trading networks

23. Exercise Exercise 1 Exercise 2
A treasury note (T-note) principal strip has six months remaining to maturity. How is its price likely to compare to a 6 month treasury bill (T-bill) that has just been issued ? The T-note price should be :
A. lower
B. higher
C. the same
Exercise 2
Which of the following statements about treasury securities is most accurate?
A. Treasury principal strips are usually created from treasury bills
B. Treasury bonds may be used to create treasury coupon strips
C. Treasury coupon strip make lower coupon payments than treasury principal strips

24. Exercise Exercise 3 Exercise 4
Which of the following municipal bonds typically has the greater risk and is issued with higher yields ?
A. Revenue bonds
B. Limited tax general obligation bonds
C. Unlimited tax general obligation bonds
Exercise 4
A debt security that is collateralized by a pool of the sovereign debt of several developing countries is most likely a (n) :
A. CMO
B. CDO
C. ABS

25. Exercise
Exercise 5
Activities in the primary market for debt securities would least likely include :
A. market making
B. a best efforts offering
C. a firm commitment

26. Thank You and Success
Agus Salim CFA