Introduction to Fixed Income Securities

Fixed Income Securities

MB 77

Outline

Introduction to the CourseWhy a separate course only on Fixed Income

Securities?What are fixed-income securities?Participants/PlayersMeaning of a BondFeatures of a BondTypes of BondsSources of Risk and Return in Debt SecuritiesRegulation of Fixed Income Securities

Why a Separate Course on Fixed Income Securities?

Markets Prior to 1980s– Dominated by plain vanilla bonds with simple cash

flow structures– Valuation was simple and straightforward

Markets After 1980s– Complex cash flow structures– A variety of securities– Derivative products to facilitate portfolio strategies to

control interest rate risk and to enhance return– Wider range of investors

Two thirds of the market value of all the securities outstanding in world classified as fixed income

Most participants in the corporate and financial sectors participate in this market

Federal governments, state governments, and municipalities have not choice but to issue fixed income securities

Therefore, a need to have well informed participants so that they understand– the forces that drive the bond market– The valuation of complex cash flow structures– Portfolio management strategies

Objective of this Course

A detailed coverage of the fixed income securities markets in contrast to one or two chapters in a book on investments

Coverage of securities available in the market—Treasury, Agency, Municipals, International, Mortgage, Mortgage-backed securities, CMOs.

What are fixed Income Securities?

Financial claims issued by government, government agencies, state governments, corporations, municipalities, and banks and other financial institutions

The cash flows promised to the buyer of fixed income securities represent contractual obligations of the respective issuers.

Typically, when such contractual obligations are not met, the buyers of fixed income securities will have the right to take control of the firm that issued such debt securities

A fixed income security is a financial obligation of an entity that promises to pay a specified sum of money at specified future dates. The entity promising the payment is called the issuer of the security

Two categories: – Debt obligations—Bond Markets– Preferred Stock

Participants

Issuers/sellers• government, government agencies, state governments,

corporations, municipalities, and banks and other financial institutions

– To receive a fair value for their securities– Be able to issue securities that best fit their needs

Investors• Large institutions such as pension funds, insurance

companies, commercial banks, corporations, mutual funds, and central banks

• Smaller institutions• Individual investors

Participants

– Objective is to buy/sell at a fair market price and at narrow bid/offer spread.

Intermediaries– Help issuers in the initial offering of the security,

assist in pricing and distribution of the securities, make a secondary market, provide liquidity, and engage in proprietary trading activities

– Produce information about credit quality of different issuers

– Provide liquidity and credit enhancement for a fee

Bond Markets

Global Bond MarketsU.S. Bond Markets

Meaning of a Bond

A debt instrument requiring the issuer also called the debtor or borrower to repay to the lender/investor the amount borrowed plus interest over some specified period of time

A typical “plain vanilla” bond issued in the U.S. specifies– A fixed date when the amount borrowed is due– The contractual amount of interest, which is typically

paid every six monthsCash flow pattern is know assuming no default