Few corporate bonds (mostly railroad issues), called income bonds, that contain a provision permitting the firm to omit or delay the payment of interest if the firm’s earnings are too low. They have been issued as part of bankruptcy reorganizations or to replace a preferred-stock offering of the issuer. A variant of this bond type, deferrable bonds (also called trust preferred and debt/equity hybrids), witnessed explosive growth in the 1990s. Deferrable bonds are deeply subordinated debt instruments that give the issuer the option to defer coupon payment up to five years in the event of financial distress.
Zero-coupon bonds have been issued by corporations and municipalities since the early 1980s. For example, Coca-Cola Enterprises has a zero-coupon bond outstanding due June 20, 2020 that was issued on May 9, 1995. But nor our Indian Government nor big govts of the world issue a zero bond with maturity over an year. Merrill Lynch was the first to do this with its creation of Treasury Investment Growth Receipts (TIGRs) in August 1982. The most popular zero-coupon Treasury securities today are those created by government dealer firms under the Treasury’s Separate Trading of Registered Interest and Principal Securities (STRIPS) Program.Governments and corporations also issue inflation-indexed bonds whose coupon payments are tied to an inflation index. These securities are designed to protect bondholders from the erosion of purchasing power of fixed nominal coupon payments due to inflation. For example, in January 1997, the U.S. Treasury auctioned a 10-year Treasury note whose semiannual coupon interest depends on the rate of inflation as measured by the Consumer Price Index for All Urban Consumers (i.e., CPI-U). The coupon payments are adjusted annually. These issues are referred to as “Treasury Inflation-Protection Securities” (TIPS). As of this writing, thereasury issues TIPS with 5-year, 10-year, and 20-year maturities. Some corporations followed the Treasury and issued inflation-indexed bonds of their own.
There are securities that have a coupon rate that increases over time. These securities are called step-up notes because the coupon rate “steps up’’ over time. For example, a six-year step-up note might have a coupon rate that is 5% for the first two years, 5.8% for the next two years, and 6% for the last two years. Alternatively, there are securities that have a coupon rate that can decrease over time but never increase. For example, in June 1998, the Tennessee Valley Authority issued 30-year 6.75% putable automatic rate reset securities (PARRS), also known as ratchet bonds. Beginning five years after issuance and annually thereafter, the bond’s coupon rate is automatically reset to either the current 30-year constant maturity Treasury yield plus 94 basis points or to 6.75%, whichever is lower. The coupon rate may decline if Treasury yields decline, but it will never increase. This bond also contains a contingent put option such that if the coupon rate is lowered, the bond is putable at par. Ratchet bonds were designed as substitutes for callable bonds.
In contrast to a coupon rate that is fixed for the bond’s entire life, the term floating-rate security or floater encompasses several different types of securities with one common feature: The coupon rate will vary over the instrument’s life. The coupon rate is reset at designated dates based on the value of some reference rate adjusted for a spread. For example, consider a floating-rate note issued in September 2003 by Columbus Bank & Trust that matured on March 15, 2005. The floater delivers cash flows quarterly and has a coupon formula equal to the threemonth LIBOR plus 12 points.
Typically, floaters have coupon rates that reset more than once a year (e.g., semiannually, quarterly, or monthly). Conversely, the term adjustable-rate or variable-rate security refers to those issues whose coupon rates reset not more frequently than annually.There are several features about floaters that deserve mention. First, a floater may have a restriction on the maximum (minimum) coupon rate that will be paid aty reset date called a cap (floor). Second, while the reference rate for most floaters is a benchmark interest rate or an interest rate index, a wide variety of reference rates appear in the coupon formulas. A floater’s coupon could be indexed to movements in foreign exchange rates, the price of a commodity (e.g., crude oil), movements in an equity index (e.g., the S&P 500), or movements in a bond index (e.g., the Merrillynch Corporate Bond Index). Third, while a floater’s coupon rate normally moves in the same direction as the reference rate moves, there are floaters whose coupon rate moves in the opposite direction from the reference rate. These securities are called inverse floaters or reverse floaters. As an example, consider an inverse floater issued by the Federal Home Loan Bank in April 1999. This issue matured in April 2002 and delivered quarterly coupon payments according to the following formula:
18% − 2.5 × (three-month LIBOR)
This inverse floater had a floor of 3% and a cap of 15.5%. Finally, range notes are
floaters whose coupon rate is equal to the reference rate (adjusted for a spread) as long as the reference rate is within a certain range on the reset date. If the reference rate is outside the range, the coupon rate is zero for that period.
One reason that debt financing is popular with corporations is that the interest payments are tax-deductible expenses. As a result, the true after-tax cost of debt to a profitable firm is usually much less than the stated coupon interest rate. The level of the coupon on any bond is typically close to the level of yields for issues of its class at the time the bond is first sold to the public. Some bonds are issued initially at a price substantially below par value (called original-issue discount bonds, or OIDs), and their coupon rate is deliberately set below the current market rate. However, firms usually try to set the coupon at a level that will make the market price close to par value. This goal can be accomplished by placing the coupon rate near the prevailing market rate.
To many investors, the coupon is simply the amount of interest they will receive each year. However, the coupon has another major impact on an investor’s experience with a bond. The coupon’s size influences the volatility of the bond’s price: The larger the coupon, the less the price will change in response to a change in market interest rates. Thus the coupon and the maturity have opposite effects on the price volatility of a bond.Participants in the bond market use several measures to describe the potential return from investing in a bond: current yield, yield-to-maturity, yield-to-call for a callable bond, and yield-to-put for a putable bond. A yield-to-worst is often quoted for bonds. This is the lowest yield of the following: yield-to-maturity, yields to all possible call dates, and yields to all put date.
Writing about bonds is always interesting but requires skill and knowledge in abundance, soon there be a continuation.
Zero-coupon bonds have been issued by corporations and municipalities since the early 1980s. For example, Coca-Cola Enterprises has a zero-coupon bond outstanding due June 20, 2020 that was issued on May 9, 1995. But nor our Indian Government nor big govts of the world issue a zero bond with maturity over an year. Merrill Lynch was the first to do this with its creation of Treasury Investment Growth Receipts (TIGRs) in August 1982. The most popular zero-coupon Treasury securities today are those created by government dealer firms under the Treasury’s Separate Trading of Registered Interest and Principal Securities (STRIPS) Program.Governments and corporations also issue inflation-indexed bonds whose coupon payments are tied to an inflation index. These securities are designed to protect bondholders from the erosion of purchasing power of fixed nominal coupon payments due to inflation. For example, in January 1997, the U.S. Treasury auctioned a 10-year Treasury note whose semiannual coupon interest depends on the rate of inflation as measured by the Consumer Price Index for All Urban Consumers (i.e., CPI-U). The coupon payments are adjusted annually. These issues are referred to as “Treasury Inflation-Protection Securities” (TIPS). As of this writing, thereasury issues TIPS with 5-year, 10-year, and 20-year maturities. Some corporations followed the Treasury and issued inflation-indexed bonds of their own.
There are securities that have a coupon rate that increases over time. These securities are called step-up notes because the coupon rate “steps up’’ over time. For example, a six-year step-up note might have a coupon rate that is 5% for the first two years, 5.8% for the next two years, and 6% for the last two years. Alternatively, there are securities that have a coupon rate that can decrease over time but never increase. For example, in June 1998, the Tennessee Valley Authority issued 30-year 6.75% putable automatic rate reset securities (PARRS), also known as ratchet bonds. Beginning five years after issuance and annually thereafter, the bond’s coupon rate is automatically reset to either the current 30-year constant maturity Treasury yield plus 94 basis points or to 6.75%, whichever is lower. The coupon rate may decline if Treasury yields decline, but it will never increase. This bond also contains a contingent put option such that if the coupon rate is lowered, the bond is putable at par. Ratchet bonds were designed as substitutes for callable bonds.
In contrast to a coupon rate that is fixed for the bond’s entire life, the term floating-rate security or floater encompasses several different types of securities with one common feature: The coupon rate will vary over the instrument’s life. The coupon rate is reset at designated dates based on the value of some reference rate adjusted for a spread. For example, consider a floating-rate note issued in September 2003 by Columbus Bank & Trust that matured on March 15, 2005. The floater delivers cash flows quarterly and has a coupon formula equal to the threemonth LIBOR plus 12 points.
Typically, floaters have coupon rates that reset more than once a year (e.g., semiannually, quarterly, or monthly). Conversely, the term adjustable-rate or variable-rate security refers to those issues whose coupon rates reset not more frequently than annually.There are several features about floaters that deserve mention. First, a floater may have a restriction on the maximum (minimum) coupon rate that will be paid aty reset date called a cap (floor). Second, while the reference rate for most floaters is a benchmark interest rate or an interest rate index, a wide variety of reference rates appear in the coupon formulas. A floater’s coupon could be indexed to movements in foreign exchange rates, the price of a commodity (e.g., crude oil), movements in an equity index (e.g., the S&P 500), or movements in a bond index (e.g., the Merrillynch Corporate Bond Index). Third, while a floater’s coupon rate normally moves in the same direction as the reference rate moves, there are floaters whose coupon rate moves in the opposite direction from the reference rate. These securities are called inverse floaters or reverse floaters. As an example, consider an inverse floater issued by the Federal Home Loan Bank in April 1999. This issue matured in April 2002 and delivered quarterly coupon payments according to the following formula:
18% − 2.5 × (three-month LIBOR)
This inverse floater had a floor of 3% and a cap of 15.5%. Finally, range notes are
floaters whose coupon rate is equal to the reference rate (adjusted for a spread) as long as the reference rate is within a certain range on the reset date. If the reference rate is outside the range, the coupon rate is zero for that period.
One reason that debt financing is popular with corporations is that the interest payments are tax-deductible expenses. As a result, the true after-tax cost of debt to a profitable firm is usually much less than the stated coupon interest rate. The level of the coupon on any bond is typically close to the level of yields for issues of its class at the time the bond is first sold to the public. Some bonds are issued initially at a price substantially below par value (called original-issue discount bonds, or OIDs), and their coupon rate is deliberately set below the current market rate. However, firms usually try to set the coupon at a level that will make the market price close to par value. This goal can be accomplished by placing the coupon rate near the prevailing market rate.
To many investors, the coupon is simply the amount of interest they will receive each year. However, the coupon has another major impact on an investor’s experience with a bond. The coupon’s size influences the volatility of the bond’s price: The larger the coupon, the less the price will change in response to a change in market interest rates. Thus the coupon and the maturity have opposite effects on the price volatility of a bond.Participants in the bond market use several measures to describe the potential return from investing in a bond: current yield, yield-to-maturity, yield-to-call for a callable bond, and yield-to-put for a putable bond. A yield-to-worst is often quoted for bonds. This is the lowest yield of the following: yield-to-maturity, yields to all possible call dates, and yields to all put date.
Writing about bonds is always interesting but requires skill and knowledge in abundance, soon there be a continuation.
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