3rd of august

Normal day at work and all, started the journey of the 70days fast today; may God see me through. This is also the first day i would be reading in the university premises. So I left the office by 5:20, and got there by 6:15. I went to the closest place to the university’s gate which was the faculty of education, and I called my cousin whose faculty is the said faculty. She was to take me to their faculty library, I waited for like 15 minutes before she came, so I used that time period to pray.

 

She finally came,and we went to buy some stuffs to eat,shortly after, we were off to the library. I was not with my university id card and I thought that was going to be an issue, but my cousin knew them there and they let me in (unto connection things na….*wink*). So at the library, I continued from where I stopped with the bonds. Here is the summary, please enjoy.

 

Bonds, types of bonds and payment of bonds

BONDS  CONT’D

Legal or regulatory issues addressed in a trust deed include

1. Legal information about the entity issuing the bond
2. Any assets pledged to support repayment of the bonds
3. Any additional feature that increases the probability of repayment
4. Convenants describing any action the firm must take and any action the firm is prohibited from taking.

 

Sovereign bonds are usually repaid by tax receipts of the issuing country, with non-sovereign bonds like state bonds being paid by either general taxes or project specific revenues. Corporate bonds are paid from cash generated by the firm’s operations. Bonds can also be classified based on the collateral put down by the issuer of the bond.

Unsecured bonds,  secured bonds

Secured bonds are bonds backed up by a specific asset of a corporation and this reduces the risk of default. Assets pledged to support a bond issue or any loan are referred to as collateral.

Unsecured bonds are just a general claim to the overall assets and cash flows of the issuer. In the pecking order of settling debts in the case of a liquidation, secured bonds would be settled first by selling the specific asset, while unsecured bonds would be settled if there is an excess on ground.

For unsecured bonds, there are also categories which are senior unsecured debt and junior debt. The senior unsecured debt’s claim is below that of a secured debt but ahead of a junior or subordinated debt.

Credit enhancement in bonds is a method of making the bonds more attractive to potential buyers. Methods of credit enhancement include:

• Overcollateralization: Whereby the value of collateral is higher than the par value of the bond.
• Excess spread: ie The yield on the financial asset supporting the debt is greater than the par value of the debt issued.
• Divide a bond issue into tranches with different seniority of claims.
• Surety Bonds: This is an external credit enhancement whereby the bond is insured by insurance companies.
• Bank guarantees
• Letter of credit: promise to lend money to the issuing entity if it defaults on payments

Payment of bonds

Bullet structure: Periodic interest payments (coupon payments) are made over the life of the bond, and the principal value is paid with the final interest payment at maturity.
Interest payments are referred to as coupons.

Balloon payment: is the same as bullet structure, but the final payment includes a lump sum in addition to the final interest payment.

Loan amortizing structure: Here the part of the principal and the interests for the period are paid periodically until the principal is exhausted. If a bond is fully amortizing, that means the principal is fully paid off when the last periodic payment is made.

Floating rate notes

These are bonds that pay periodic interests depending on the current market rate of interest. These bonds are called floating rate notes or floaters.

 

CREDIT LINKED BONDS

This type of bond carries a provision stating that the coupon payment of the bond increases if the credit rating of the issuer falls, and the coupon payment of the bond falls if the credit rating of the issuer rises.

 

Payment- in- kind bonds

Here, coupon payments are made by increasing the principal amount of the outstanding bonds, by paying owed bond interests with more bonds.

 

Index linked bonds

Coupon payment or principal value is based on a commodity index, an equity index or some other published index number. Index- linked bonds that will not pay less than their original par value at maturity even when the index has decreased, are termed principal  protected bonds. The more common of the indexed linked bonds is the inflation linked bonds. They include the index annuity bond, indexed zero coupon bond, interest indexed bond and capital indexed bond.

The capital indexed bond is the most interesting of the index linked bonds. In this, the coupon remains constant and the principal value of the bond is adjusted for inflation or deflation by specific rates.

For example, consider a bond with a par value of 1000 naira, at issuance, a 5% annual coupon rate paid semiannually and a provision that the principal value will be adjusted for inflation or deflation. It is noticed that the inflation rate is 2% over the first period of 6 months.

Then the principal value of the bond is increased to 1020 naira and then the coupon payment for the 6months would be 2.5% of the new principal (1020) and that would give 25.5 naira.

So in the sense, the 5% coupon rate is the real rate of interest ie it is adjusted for inflation.

 

Equity Linked notes

They are debt securities with no coupon payments, like a zero coupon payment, but the principal at maturity is not fixed but dependent on an equity index. This means that the investor may gain or lose his money invested.

 

 

In a bond, there might be contingency provisions which describe suitable actions to be taken if an event occurs. They are referred to as embedded options in bond indentures.

Some embedded options are exercisable at the option of the issuer of the bond, and so are valuable to the issuer. Others are exercisable at the option of the purchaser of the bond and thus, have value to the bondholder.

 

Examples of embedded options are call options. A call option gives the issuer the right to redeem all or part of a bond at a specific price (if they choose)

 

Putable bond (Put option)

Put option gives the bondholder the right to sell the bond back to the issuing company at a pre-specified price. Here the embedded option has more value to the bond holder.

 

Convertible bonds

They are bonds with the option of being converted to common stock. This gives bondholders the opportunity to profit from increases in the value of common share. Convertible bonds are referred to as hybrid securities because they have properties of both debt and equity.

 

Warrants

Warrants give bond holders the right to buy the firm’s common shares at a given price over a given period of time.

 

Recommended Reading 

Frank Fabozzi., Financial management and analysis