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Bonds and Its types
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- 3. Bond What Is Bond??? “Abond is a long-term debt instrument with a final maturity generally being 10 years or more. If the security has a final maturity shorter than 10 years, it is usually called a note”.
- 4. Example Of Bond HowIt Works(Examples) When an investor purchases a bond, they are "loaning" that money (called the princi pal) to the bond issuer, which is usually raising money for some project. When the b ond matures, the issuer repays the principal to the investor. In most cases, the inve stor will receive regular interest payments from the issuer until the bond matures. Different types of bonds offer investors different options. For example, there are bonds that can be redeemed prior to their specified maturity date, and bonds that can be exchanged for shares of a company. Other bonds have different levels of ris k, which can be determined by its credit rating .
- 5. Characteristics of Bonds MostBonds share some common basic characteristics Face Value: is the money amount the bond will be worth at its maturity, and is also the reference amount the bond issuer uses when calculating interest payments. It is also called per value or principal value. Coupon Rate: Is the rate of interest the bond issuer will pay on the face value of t he bond, expressed as a percentage. For example, a 13 percent coupon rate indica tes that the issuer will pay bondholders $130 per annum for every $1,000-par-val ue bond that they hold. Coupon Date: Are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi-annual coupon payments.
- 6. (Cont…) Coupon Date: Are thedates on which the bond issuer will make interest payments. Ty pical intervals are annual or semi-annual coupon payments. Maturity date Is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond. Issue price Is the price at which the bond issuer originally sells the bonds.
- 7. Trustee Definition: Trustee is aperson or institution designated by a bond issuer as the offi cial representative of the bondholders. Typically, a bank serves as trustee. Example of Trustee: Let's assume Company XYZ issues $100 million of bonds. Compa ny XYZ will appoint a trustee, usually a bank, to act on behalf of the bondholders. The trustee maintains lists of the bondholders in addition to receiving and distrib uting interest payments. The trustee also monitors Company XYZ's compliance wit h the agreements and communicates with the bondholders when the issuer is not in compliance. Companies often involve trustees in debt offerings, mergers, and other situations i nvolving two parties, a large amount of money, and conditions under which the mon ey moves between the parties.
- 8. Indenture Definition Of Indenture: Anindenture agreement is the formal contract between a bond issuer and the bondholders. It sets forth the details of all the terms and conditions of the bonds , such as the exact day of their maturity, the timing of the interest payments and how they are calculated, and the details of any special features.
- 9. Examples of Indenture Howit works with(Examples) For example, the indenture gives bondholders exact instruction about whom to contact if the bonds are called and describes the procedures for tendering their certificates and receiving their compensation. Other details in a bond indenture include a description of how the bond certificates will look and what language will appear on them, as well as a list of financial covenants the issuer must abide by and the formulas for calculating whether the issuer is abiding by the covenants. Since indenture agreements can be very technical, the issuer usually appoints a trustee (usually a large bank) to act on behalf of the bondholders in certain situations, including making sure the issuer is abiding by the covenants, paying interest on time, collecting and distributing certificates, and so forth.
- 10. Long Term DebtInstrument What is long term debt???Debt Instrument??? Long Term debt: Long-term debt consists of loans and financial obligations lasting over one year. Long- term debt for a company would include any financing or leasing obligations that are to come due i n a greater than 12-month period. Long-term debt also applies to governments: nations can also have long-term debt. In the U.K., long-term debts are known as "long-term loans.“ Debt Instrument: Debt instruments are assets that require a fixed payment to the holder, usually with interest. Examples of debt instruments include bonds (government or corporate) and mortgages. The equity market (often referred to as the stock market) is the market for trading equity inst ruments. Bonds backed by a pool of mortgages
- 11. Types of Longtermdebt Instrument Bonds can be issued on two bases: 1. Secured Basis(Asset Baked) 2. Unsecured Basis
- 12. Types of Longtermdebt Instrument This diagram show that secured and unsecured Bonds.
- 13. Debenture Definition of Debenture: Adebenture is a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by th e general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond to secure capital. Like other ty pes of bonds, debentures are documented in an indenture.
- 14. Types of Debenture Thereare two types of debenture: 1. Convertible Debenture. which can be converted into equity shares of the issuing company after a predetermined period of time. 2. Nonconvertible Debenture. which cannot be converted into equity shares of the liable company . They usually carry higher interest rates than the convertible ones.
- 15. Subordinate Debenture Definition ofsubordinate Debenture: Subordinated debenture is debt which ranks after other debt s should a company fall into receivership or be closed. Such debt is referred to as subordinate, because the debt providers (the lenders) have subordinate status in relationship to the normal d ebt. Has a lower priority than other bonds of the issuer in case of liquidation during bankr uptcy, below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. Because subordinated debenture is repayable after other debts have been paid, th ey are more risky for the lender of the money. It is unsecured and has lesser priority than that of an additional debt claim on the same assets
- 16. Similar Terms forSubordinate Debenture 1) Subordinated loan 2) Subordinated bond 3) Subordinated debt 4) Junior debt
- 17. Examples of SubordinateDebenture Example: let's assume Company XYZ has $100 million in assets, but it has filed bankruptcy and is liquidating. Let's also assume that Company XYZ has $125 million in total debt in the following categories: $95 million of Series A senior debt, $10 million of Series B subordinated debt, and $20 million owed to suppliers (called general creditors). The Series B creditors are subordinate to the Series A creditors. So, of Company XYZ's $100 million in assets, the Series A creditors now own $95 million of them. This leaves only $5 million for the other Series B bondholders. Although this doesn't repay all of the $10 million owed to t hem, it is better than nothing, which is what the suppliers (who are owed $20 million) will get in this situation. After the senior secured debtholders, other lenders have fewer and fewer claims on assets.
- 18. Income Bond Definition: A bondwhose payment of interest is contingent on sufficient earnings.” Income bond is a debt security in which only the face value of a bond is promised to be paid to t he investor and pays interest only if the issuing entity has earned income. The amount of interes t paid may vary with the earnings of the entity, so investors are essentially participating in the earnings of the business. These bonds are commonly used during the reorganization of a failed or failing business. This als o means that investors share in the risk of the issuer, since no earnings equates to no interest p ayments. Given the risk profile of an income bond, it is usually only issued by companies having si gnificant financial difficulties (usually in bankruptcy reorganization), and it is bought by investor s with a high tolerance for risk.
- 19. Example of IncomeBond Example: For Examples an income bond may be issued to finance an income producing P roject.
- 20. Junk Bond Definition: Junk bondis a fixed-income security that is rated below investment grade by one or more of the major bond ratings agencies. A junk bond works the same as most other bonds -- an investor purchases a bond from a bond is suer with the assumption that the money will be paid back when the bond reaches its maturity d ate. The difference between an "investment grade" bond and a "junk" bond is that the junk bond issuer may not be able to repay the original principal. Bonds often receive this type of low rating when the corporation, municipality or other entity th at issued the bond is facing financial trouble. In these cases, the credit risk on the bonds is fair ly high -- in other words, there is a relatively decent chance that the junk bond issuer will have trouble fulfilling its repayment obligations (including interest and principal). However, many junk bonds also pay higher yields than investment-grade bonds in order to attract investors.
- 21. Mortgage Bonds Mortgage bondis a secured bond. Definition: A mortgage bond uses a mortgaged property as collateral. HOW IT WORKS (EXAMPLE): A mortgage bond is collateralized by one or several mortgaged properties. In case of default, the mortgaged properties may be sold to pay back bondholders. For example, suppose bond ABC is backed by a mortgage on property XYZ. If bond ABC goes int o default, the holders of the bond may liquidate property XYZ as compensation. WHY IT MATTERS: Mortgage bonds, unlike traditional bonds with similar characteristics, ten d to have lower yields. The reason is that mortgage bonds are lower risk because the mortgaged property is pledged as collateral.
- 22. Equipment Trust Certificate Definition: Theterm Equipment Trust Certificate is used to describe a debt instrument that is held by a trust and secured by a specific asset. Equipment trust certificates are typically backe d by an asset that can be readily transported and sold. Once the debt has been repaid, ownersh ip of the asset is transferred to the issuer of the certificate. One type debt instrument which is similar in some ways to a mortgag e or a lease, with an equipment trust certificate, the investor is given use of a particular asset, which he/she pays for over time according to the specifications of the agreement. When the de bt is fully paid off, the investor receives the title for the asset. In a typical ETC transaction, a "trust certificate" is sold to investors in order to finance the purchase of an aircraft by a trus t managed on the investors' behalf. The trust then leases the aircraft to an airline and the trus tee routes payments through the trust to the investors. Upon maturity of the note, the airline r eceives title to the aircraft.
- 23. Equipment Trust Certificate Example: ETCsare commonly used as a method for financing the purchase o f items such as aircraft these certificates were originally designed for finan cing railroad cars. Some companies prefer using ET Cs because of the tax since the asset is not officially owned by the company while they are still paying for it, it is not considered property of the compan y and taxes are not owed on it.
- 24. Asset Securitization About Assetsecuritization Asset Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. Asset securitizatio n is a process conversion of receivables and cash flow generated from a collection or pool of fin ancial assets like mortgage loans, auto loans, credit cards receivables etc. into marketable secur itization.
- 25. Asset Securitization Example: Mortgage-backed securitiesare a perfect example of securitization. By c ombining mortgages into one large pool, the issuer can divide the large pool into smaller pieces b ased on each individual mortgage's inherent risk of default and then sell those smaller pieces to investors. The process creates liquidity by enabling smaller investors to purchase shares in a lar ger asset pool. Using the mortgage-backed security example, individual retail investors are able to purchase portions of a mortgage as a type of bond. Without the securitization of mortgages, retail investors may not b e able to afford to buy into a large pool of mortgages.