Level I – Fixed Income

Fixed-Income
Income Markets: Issuance, Trading and Funding

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 Contents and Introduction
Introduction Total debt and equity
Overview of Global Fixed-Income Markets outstanding: $212
Primary and Secondary Bond Markets trillion
Sovereign Bonds
Debt represents about
Non-Sovereign Government, Quasi-Government,
Government, and 75%
Supranational Bonds
Corporate Debt Understanding how the
Structured Financial Instruments market is structured is
Short-Term
Term Funding Alternatives Available to Banks important for issuers and
investors
Conclusion and Summary

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 2. Overview of Global Fixed-Income
Fixed Markets

• Classification of Fixed-Income
Income Markets

• Fixed-Income Indices

• Investors in Fixed-Income
Income Securities

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 2.1 Classification of Fixed-Income
Fixed Markets
• Type of issuer Interbank offered rates are sets of rates that reflect the
rates at which banks believe they could borrow
• Credit quality unsecured funds from other banks in the interbank
market for different currencies and different maturities.
maturities

• Maturity

• Currency denomination • Geography

• Type of coupon • Other classifications

 Fixed-rate versus floating-rate
 Reference rates

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Example 1

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 2.2 Fixed-Income
Income Indices
A fixed-income index is a multi-purpose
purpose tool used by investors and investment man-
man
agers to describe a given bond market or sector, as well as to evaluate the
performance of investments and investment managers.

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 2.3 Investors in Fixed-Income
Fixed Securities
• Major categories of bond investors include central banks, institutional investors,
and retail investors
 Central banks and institutional investors generally invest directly
 Retail investors generally invest through mutual funds and ETFs

• Central banks use open market operations to implement monetary policy

• Institutional investors are the largest group of investors in fixed-income

fixed securities

• Retail investors like the price and income stability generally associated with fixed-
fixed
income securities

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Example 2

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 3. Primary and Secondary Bond Markets

Primary bond markets are markets in which issuers first sell bonds to investors to
raise capital. Bonds can be sold (issued) via a public offering or a private
placement.

Secondary bond markets are markets in which existing bonds are subsequently
traded among investors

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 3.1 Primary Bond Markets
Public bond issuing mechanisms include underwritten offerings, best effort offerings,
shelf registrations, and auctions.

Underwritten offering:
Investment bank buys the entire issue and takes the risk of reselling it to investors or dealers.

Determination of Selection of the Structuring and

Pricing Issuance Closing
funding needs underwriter announcement

Best effort offering:

Investment bank serves as a broker and sells the bond Underwritten and best effort
issue only if it is able to do so. offerings are frequently used in the
issuance of corporate bonds.

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 3.1 Primary Bond Markets (Cont…)
A shelf registration is a method for issuing securities in which the issuer files a
single document with regulators that describes a range of future issuances

An auction is a public offering method that involves bidding, and that is helpful in
providing price discovery and in allocating securities. It is frequently used in the
issuance of sovereign bonds.

A private placement is typically a non-underwritten,

underwritten, unregistered offering of bonds
that are sold only to an investor or a small group of investors. Typical investors in
privately placed bonds are large institutional investors. A private placement can be
accomplished directly between the issuer and the investor(s) or through an
investment bank. Because privately placed bonds are unregistered and may be
restricted securities that can only be purchased by some types of investors, there is
usually no active secondary market to trade them.

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 3.2 Secondary Bond Markets
• Securities are traded among investors in the secondary market

• Secondary markets can be structured as organized exchanges or as OTC markets;

most bond trading happens in OTC markets

• Important to understand the liquidity of a market

 Bid-ask
ask spread reflect the liquidity of a market
 Eurobond market makers

• Settlement is the process the occurs after a trade is made

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Example 3

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Example 3 (Cont…)
(

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 4. Sovereign Bonds
Sovereign bonds are issued by national governments primarily for fiscal reasons.

• Characteristics of sovereign bonds

• Credit quality of sovereign bonds

• Types of sovereign bonds

 Fixed-rate bonds
 Floating-rate bonds
 Inflation-linked bonds

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Example 4

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5. Non-Sovereign Government, Quasi-Government,
Quasi
and Supranational Bonds
• Non-sovereign bonds

• Quasi-government
government or agency bonds

• Supranational bonds

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Example 5

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 6. Corporate Debt

• Bank loans and syndicated paper

• Commercial paper

• Commercial notes and bonds

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 6.1 Bank Loans and Syndicated Loans
A bilateral loan is a loan from a single lender to a single borrower. A syndicated loan
is a loan from a group of lenders, called the “syndicate,” to a single borrower.

• Most bilateral and syndicated loans are floating-rate

floating loans

• For highly rated companies, both bilateral and syndicated loans can be more
expensive than bonds issued in financial markets

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 6.2 Commercial Paper
Commercial paper is a short-term,
term, unsecured promissory note issued in the public
market or via a private placement that represents a debt obligation of the issuer.

• Commercial paper is a valuable source of flexible, readily available, and relatively

low-cost short-term financing
 Working capital and seasonal demands for cash
 Bridge financing

• Yield on commercial paper > yield on short-term

short sovereign bonds
 Credit risk
 Liquidity risk

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 Commercial Paper (Cont…)
(
Exhibit 7 – Commercial Paper Ratings

Backup lines of credit

Rolling over the paper

Exhibit 8 – USCP vs. ECP

Discount basis versus interest-bearing

basis

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 6.3 Corporate Notes and Bonds
• Maturities
 Short-term, medium-term, long-term
 Medium-term note (MTN)

• Coupon payment structures

• Principal repayment structures

• Asset or collateral backing

• Contingency provisions

• Issuance, trading and settlement

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Example 6

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 7. Structured Financial Instruments

• Capital Protection Instruments

• Yield Enhancement Instruments

• Participation Instruments

• Leveraged Instruments

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 Example 7
If an investor holds a credit-linked
linked note and the credit event does not occur, the investor receives:
A. all promised cash flows as scheduled.
B. all coupon payments as scheduled but not the par value at maturity.
C. all coupon payments as scheduled and the par value minus the nominal value of the reference
asset to which the credit-linked
linked note is linked at maturity.

A structured financial instrument whose coupon rate is determined by the formula 5% – (0.5 × Libor) is
most likely:
A. a leveraged inverse floater.
B. a participation instrument.
C. a deleveraged inverse floater.

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 8. Short-Term Funding Alternatives Available to Banks

• Retail deposits

• Short-term wholesale funds

 Central bank funds (reserve funds)
 Interbank funds
 Certificates of deposit

• Repurchase are reverse repurchase agreements

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 Repurchase and Reverse Repurchase Agreements
A repurchase agreement or repo is the sale of a security with a simultaneous
agreement by the seller to buy the same security back from the purchaser at an
agreed-on price and future date
Example: A dealer sells the 2.25% U.K. gilt that matures in three years to a
counterparty for cash today. At the same time, the dealer makes a promise to buy the
same gilt the next business day for an agreed-on
agreed price.

• Reverse repo Repo rates are impacted by:

• Repurchase price • Risk associated with collateral
• Repurchase data • Term of repurchase agreement
 Overnight repo • Delivery requirement
 Term repo • Supply and demand
• Repo rate • Interest rates of alternative financing
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 Credit Risk Associated with Repurchase Agreements
Each market participant is exposed to credit risk

Lender has greater exposure to credit risk

Difference between market value of collateral and value of loan is called the repo
margin (haircut); the level of the margin depends on:
 Length of the repurchase agreement
 Quality of the collateral
 Credit quality of the counter party
 Supply and demand conditions of the collateral

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Example 8

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Example 7 (Cont…)
(

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 Summary
• Classifications
• Interbank offer rates
• Mechanisms for issuing bonds in primary markets
• Secondary markets
• Debt issued by sovereign governments, non-sovereign
non governments,
agencies, supranational entities
• Debt issues by corporations
• Repos and their importance

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 Conclusion
• Read the summary

• Review learning objectives

• Examples

• Practice problems

• Practice questions from other sources

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