Definition of Terms
Research
Agency
A debt instrument that has an explicit or implicit guaranty from a Government’ (i.e.: BNG, CADES, SNCF).
Bond
A legal contract sold by an issuer promising to pay the holder its face value plus amounts of interest at future dates.
Call
The optional right of an issuer to redeem bonds before their stated maturity, at a given price on a given date. When a loan is called, the principal is due in its entirety.
Convertible bond
A bond that is converted at some stage into another form of security (usually stock of the bond issuer) at some fixed pre-determined exchange ratio. Convertible bonds are similar to exchangeable bonds, the only difference being that the issuer/guarantor of the bond, and stock the bonds are exchanged for, are different companies.
Convexity
Duration works reasonably well as a measure of bond price sensitivity to changes in prevailing interest rates. However, it becomes increasingly inaccurate, the greater the change in interest rates. This is because duration attempts to determine price sensitivity as a straight-line relationship to interest, when it is actually a curve. Each bond has a best-fit parabola for price/interest rate sensitivity.
Convexity is a measure of how the slope itself changes as interest rates change. The change in slope, or convexity, measures the curvature of the price-yield relationship.
The sign of the convexity can usually be seen from the price-yield curve: a convex curve will give a positive sign (this implies that bond prices rise more quickly than the durations would indicate for a drop in interest rates, and drop less quickly for a rise in interest rates), whereas a concave curve will give a negative sign.
Coupon
The periodic interest payment on a security paid by the issuer to the holder. Coupon is quoted as a percentage of face amount. The coupon is payable annually, semi-annually or, in some cases, quarterly.
Duration
Also known as Macaulay’s duration, the weighted average maturity of the security’s cash flows, where the present values of the cash flows serve as the weights. The cash receipts from a bond are a combination of coupon payments and principal, but with infinite variations on the relationships between these two components and their timing. Duration provides the sensitivity to changes in prevailing interest rates; the higher the duration, the greater is the risk. In the case of a floater its duration matches the length of the coupon.
D/Swap (Differential to swap)
This is the difference between the yield of a given bond and the interpolated swap rate to the same date as the bond that is being priced.
Floating Rate Note (FRN)
A bond whose interest rate is adjusted according to the interest rates of other financial instruments. Also known as “floaters”, these instruments provide protection against changes in interest rates.
EU Tax
Refers to the bonds, which will be taxed according to the European Directive 2003/48/EC on taxation of savings in the form of interest payments. The bonds without ‘EU Tax’ are subjected to the grandfather clause and would not be taxed.
Exposure
The exposure is the duration weighted by the Net Asset Value.
Fallen Angel
A security that was investment grade at time of issue but that has since dropped below investment grade quality due to negative developments.
Global bond
A temporary certificate representing the whole of an issue of debt instruments, created to control the primary market distribution of the issue. This is done either to comply with particular legal restrictions or because definitive bond certificates are not available immediately. Also known as "global certificate."
Government bond
Debt issued by a government in its own currency (eg. Danish government bonds in DKK).
High-Yield bonds
A speculative bond with a rating of BB or Ba or lower. Also called « Junk bonds ».
Inflation Linked Bonds
A bond whose principal increases at the same rate as an Inflation Index. The interest payment is then calculated off that inflated principal, which is repaid at maturity.
Investment Grade
Bonds rated BBB or Baa and above.
Junk bonds
A speculative bond with a rating of BB or Ba or lower. Also called « High-Yield bonds ».
Make Whole Call
A provision that allows a borrower to prepay the remaining fixed rate term debt. The borrower, however, has to make an additional payment that is derived from a formula based on the net present value of the future debt payments. This can often be significant, which is why such provisions are rarely invoked.
Nominal
The face value of a security (as opposed to its actual cash value).
Outlook
Values the potential direction of a long-term credit rating over the intermediate to longer term (1-3 years). There are 4 options, positive, stable, negative or developing. Not necessarily a precursor to a rating change or credit watch listing.
Perpetual
A bond with no maturity date that will pay interest indefinitely. (The issuer generally retains the right to call such a bond).
Preferred bond
A class of debt that, pays dividends at a specified rate and that generally has preference over stock in payment of dividends and liquidation of assets on bankruptcy.
Price Value
The change in price of a security if yield changes by a given number of basis points. The greater the basis point change, the greater the price volatility of the security. Price changes are almost symmetrical for small changes in yield; therefore, it does not matter whether you increase or decrease yields to calculate this value. For larger changes in yield, there is a difference between the price value if the yield is increased or decreased. The change in price value depends on the convexity of the security.
Put
The optional right of a holder to present the bond at a predetermined time to an issuer and demand payment of its nominal value from the issuer, before the final maturity.
Rating
The credit quality of debt established by rating agencies such as Moody’s and S&P. Bonds are rated from ‘AAA’ (highly unlikely to default) through to a low of ‘D’ (companies in default). The rating is based on such factors as the issuer’s management, debts and its record in paying interest.
Sovereign bonds
Debt issued by a public issuer, government, municipality, etc, in another currency than its own (eg. Danish government bonds in USD). Debt issued by an entity fully owned by a public issuer and with an explicit guarantee (eg. KFW, OKB).
Stepped Coupon Security
A variable-rate security with a coupon that rises according to a predetermined schedule. (step-up / step-down).
Subordinated
A type of debt that places the investor in a position behind or subordinated to a company’s primary creditors. Securities issued as subordinated debt will pay interest and principal but only after all interest that is due has been paid on all senior debt (in the case of a liquidation or a bankruptcy).
W/Tax (Withholding Tax)
A tax deducted at source that a paying agent is legally obliged to deduct from its payments of interest or dividends. However, persons or institutions residing outside the country levying the tax are not subject to payment of it.
WL (Watch List)
Focuses on identifiable events and/or short-term trends that deviate from expectations (possible change, usually within 90 days). There are 3 options, positive, negative or developing.
Yield to Maturity (YTM)
The return earned on a bond at a given price if the security is held to its maturity date. The calculation is based on the coupon rate, length of time to maturity, and market price. It assumes that coupon interest paid over the life of the security is reinvested at the same rate.
Yield Value
The change in yield of a security if price changes by a certain value. The lower the price change, the greater the dollar price volatility. Yield changes are almost symmetrical for small changes in price; therefore, it does not matter whether you increase or decrease price to calculate this value. For larger changes in price, there is a difference between the yield value if the price is increased or decreased. The change in yield value depends on the convexity of the security.
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