Fixed Income Glossary – Common Bond Definitions, Terms And Terminology
Welcome to our comprehensive guide on fixed income glossary, where we’ll demystify the world of bonds and debt securities. In this article, we’ve compiled a concise bond trading glossary of key terms and concepts to help you navigate the landscape of fixed-income investments.
Whether you’re a seasoned investor or just starting your journey in the world of finance, this guide will provide you with the essential knowledge to understand the language of fixed-income markets. Let’s dive in!
Bond Dictionary and terminology
A
Accordion Feature: An Accordion Feature is a flexible provision often included in fixed income agreements, allowing the issuer to increase or decrease the size of the debt instrument over time, usually in response to changing financial needs or market conditions. This feature grants the issuer the option to expand or contract the bond’s outstanding principal, providing them with greater financial flexibility and potentially lowering borrowing costs.
Accrued interest: Accrued interest refers to the interest that has been earned on a fixed income security but has not yet been paid to the investor. It accumulates daily and is typically calculated from the last interest payment date up to the settlement date of a trade. When buying or selling bonds, the buyer compensates the seller for the accrued interest, ensuring that each party receives the appropriate amount of interest income.
Adjusted options: Adjusted options are modified versions of standard options contracts, typically resulting from corporate actions like stock splits, mergers, or dividend payments. These adjustments are made to maintain the fairness and integrity of the options market, ensuring that the options continue to represent the underlying assets accurately.
Agency/GSE: Agency or Government-Sponsored Enterprise (GSE) bonds are debt securities issued by entities like Fannie Mae, Freddie Mac, or Ginnie Mae, which are sponsored or guaranteed by the U.S. government. They are considered relatively safe investments due to the implicit or explicit backing of the government, and they play a significant role in the mortgage and housing markets.
All or none: All or none is a trading order that specifies that the entire order must be executed in a single transaction, or none of it should be executed at all. This type of order is often used when an investor wants to ensure that a complete block of securities is bought or sold in one go, rather than in partial fills.
Ask yield to maturity: The ask yield to maturity represents the yield an investor can expect to receive if they purchase a fixed income security at its current asking price and hold it until maturity. It takes into account the security’s price, par value, coupon rate, and the time remaining until maturity, providing an estimate of the annualized return on the investment.
Auction: An auction in the context of fixed income refers to the process of selling or buying bonds through a competitive bidding system. Participants submit bids specifying the quantity and price at which they are willing to trade, and the bonds are awarded to the highest bidder(s) at the clearing price determined by the auction.
Auction date: The auction date is the specific day on which the auction for a particular fixed income security or bond issue takes place. It marks the deadline for investors to submit their bids and compete for the bonds being offered.
Auto Roll: (complete definition) Auto Roll is a feature in fixed income markets that allows investors to automatically reinvest the proceeds from maturing or called bonds into new bonds with similar characteristics. It simplifies the reinvestment process, helping investors maintain their portfolio’s desired allocation.
Average coupon rate: The average coupon rate is the weighted average of the interest rates or coupon payments of all the bonds within a particular fixed income portfolio. It provides an overall measure of the income generated by the bonds in the portfolio, taking into account their respective coupon rates and weights.
Average price: The average price represents the weighted average price of all the bonds within a fixed income portfolio. It takes into consideration the prices at which each bond was acquired or traded, with each bond’s weight determined by its market value or face value.
Average yield: Average yield is the weighted average yield of all the bonds within a fixed income portfolio. It factors in the yields of individual bonds, taking into account their respective weights based on market value or face value.
Average yield to worst: The average yield to worst is the weighted average of the yields to worst call or redemption options among the bonds held in a fixed income portfolio. It helps investors assess the potential minimum yield they could receive if issuers exercise their call options or the bonds are redeemed at the least favorable times for investors.
Annuity: In the realm of fixed income, an annuity refers to a regular series of payments made at equal intervals, typically annually or semi-annually. These payments are commonly associated with bonds or other fixed-income securities. Annuities serve as a mechanism for issuers to repay investors their principal along with interest over a predetermined period. Investors receive predictable, steady income from these periodic payments, making annuities a favored choice for risk-averse individuals seeking stable returns from their investments.
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B
Basis Point: A basis point is a unit of measurement commonly used in finance to express small changes in interest rates or bond yields. One basis point is equal to 0.01%, or one-hundredth of a percentage point. It allows for precise discussions of interest rate movements, especially in fixed income markets, where even minor rate changes can significantly impact bond prices and yields.
Benchmark Formula: The benchmark formula refers to a predefined mathematical calculation used to determine the interest rate or yield on a fixed-income security, such as bonds. This formula serves as a standard for pricing and valuation, helping investors compare different bonds or securities within the same asset class. Common benchmark formulas include government bond yields, LIBOR-based rates, or other market-established methodologies.
Benchmark Reference: A benchmark reference is a specific financial instrument, index, or rate that serves as a standard for measuring the performance or pricing of other fixed-income securities. It provides a point of comparison, enabling investors to assess the relative attractiveness of bonds or debt instruments in the market. Examples include the 10-year U.S. Treasury bond yield as a reference for other bond yields or the London Interbank Offered Rate (LIBOR) for short-term interest rates.
Bid: In the context of fixed income, a bid represents the price at which an investor or trader is willing to purchase a bond or other fixed-income security. It is the highest price that a buyer is willing to pay for the security at a given moment. Bids play a crucial role in bond markets, as they determine the buying side of the market and help establish market prices.
Bid Request: A bid request is a formal solicitation made by an issuer or seller to potential buyers in the fixed income market. It includes details about a specific bond or security, such as its characteristics, quantity available, and the desired terms of the transaction. Investors and dealers respond to bid requests with their bids, indicating their willingness to purchase the offered security.
Build America Bonds (BAB): Build America Bonds are a type of taxable municipal bond issued by state and local governments in the United States. These bonds were introduced as part of the American Recovery and Reinvestment Act of 2009 to stimulate infrastructure investments. BABs offer issuers the advantage of receiving federal subsidies on a portion of the interest payments, making them an attractive financing option for municipal projects.
Buy/Sell: In the fixed income market, “buy” and “sell” are straightforward terms indicating the two primary actions that investors or traders can take regarding bonds or other fixed-income securities. “Buy” refers to the act of purchasing a bond, while “sell” indicates selling a bond. These actions are essential for market liquidity and price discovery, as they determine the supply and demand dynamics influencing bond prices and yields.
Bonds: Bonds are debt securities issued by governments, corporations, or other entities to raise capital. When an investor buys a bond, they are essentially lending money to the issuer in exchange for periodic interest payments and the return of the bond’s face value at maturity. Bonds have fixed terms, interest rates, and payment schedules, making them a relatively stable investment option. They provide income to investors through these regular interest payments, hence offering a predictable stream of income. The bond market plays a crucial role in global finance and is a key component of diversified investment portfolios.
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Brady Bonds: Brady Bonds refer to US dollar-denominated debt securities issued by various emerging market governments during the late 1980s and early 1990s. Named after then-U.S. Treasury Secretary Nicholas Brady, these bonds were typically used to restructure and resolve the sovereign debt crises that plagued many developing countries. Brady Bonds often involved the exchange of defaulted loans for new bonds with more manageable terms, aiming to stabilize the economies of the issuing nations.
Brick Bond: A Brick Bond is a specialized type of municipal bond issued by a local government to fund the construction or maintenance of public infrastructure projects, such as schools, hospitals, or transportation systems. These bonds are typically backed by the revenue generated from specific projects, like tolls, user fees, or taxes, ensuring that the bondholders are repaid from the income generated by the funded facility or service.
C
Call Feature: A call feature in the context of fixed income refers to a provision in a bond’s terms that grants the issuer the option to redeem or “call” the bond before its maturity date. This feature allows issuers to repurchase the bond at a predetermined price, usually at a premium to the bond’s face value, providing them with flexibility when interest rates decline, ultimately reducing their interest expenses.
Call Protection: Call protection is a safeguard for bondholders, limiting the issuer’s ability to exercise the call feature for a specified period after issuance. During this call protection period, bondholders are shielded from the risk of an early redemption, ensuring they receive the promised interest payments until the protection period expires.
Call Provision: A call provision is a contractual clause in a bond’s documentation that outlines the conditions and terms under which the issuer can exercise its right to call or redeem the bond before its maturity date. It specifies the call date, call price, and any applicable call premiums or penalties.
Call Schedule: A call schedule is a predetermined timetable provided by the issuer, indicating the dates on which a callable bond can be redeemed before maturity. This schedule outlines the call dates, call prices, and any changes in the call premium or redemption terms over the bond’s life.
Callable: A callable bond is a type of fixed-income security that can be redeemed by the issuer before its scheduled maturity date, typically when interest rates have fallen, allowing the issuer to refinance at a lower cost. Callable bonds often provide higher yields to compensate investors for the increased risk of early redemption.
Called Bonds: Called bonds are those fixed-income securities that an issuer has chosen to redeem or “call” before their original maturity date, usually in accordance with the call feature stipulated in the bond’s terms. Once called, bondholders receive the predetermined call price and cease to receive interest payments.
Conditional Call: A conditional call is a callable bond provision that allows the issuer to exercise the call feature only under specific circumstances or conditions outlined in the bond’s documentation. These conditions may include changes in interest rates, financial performance metrics, or other predefined triggers.
Conduit Bonds: (complete definition) Conduit bonds are debt securities issued by a special purpose entity (SPE) or conduit to finance specific projects, such as infrastructure or real estate development. The issuer passes through the funds generated from the bond issuance to the project sponsor, and the bond’s repayment is typically dependent on the project’s cash flows rather than the issuer’s general creditworthiness.
Continuously Callable: A continuously callable bond is a type of security that can be redeemed by the issuer at any time after an initial call protection period. Unlike bonds with fixed call dates, continuously callable bonds provide issuers with ongoing flexibility to call the bonds whenever it is financially advantageous for them to do so, typically with advance notice to bondholders. This feature allows issuers to respond dynamically to changing interest rate environments.
Callable Bond: A callable bond is a type of bond issued by a corporation or government entity that includes a provision allowing the issuer to redeem or “call” the bond before its scheduled maturity date. When a bond is called, the issuer repurchases it from bondholders at a predetermined price, typically at a premium to the face value. Callable bonds offer issuers flexibility in managing their debt and interest expenses but can pose risks to investors, as they may receive their principal back earlier than expected, potentially reinvesting at less favorable terms.
Constant Perpetuity: In the realm of fixed income, a Constant Perpetuity refers to a financial instrument, often bonds,