Introduction to Fixed Income Securities

1
Introduction to Fixed Income Securities

• Fixed Income Securities
• MB 77

2
Outline

• Introduction to the Course
• Why a separate course only on Fixed Income
  Securities?
• What are fixed-income securities?
• Participants/Players
• Meaning of a Bond
• Features of a Bond
• Types of Bonds
• Sources of Risk and Return in Debt Securities
• Regulation of Fixed Income Securities

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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

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• 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

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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
  marketTreasury, Agency, Municipals,
  International, Mortgage, Mortgage-backed
  securities, CMOs.

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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

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• 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 obligationsBond Markets
• Preferred Stock

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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

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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

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Bond Markets

• Global Bond Markets
• U.S. Bond Markets

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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 months
• Cash flow pattern is know assuming no default