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1.A: Features of Fixed Income Securities
a: Describe the basic features of a bond (maturity, coupon rate, par value, provisions for paying off
bonds, currency denomination, and options granted to issuer or investor).
Maturity: the term to maturity (or simply "maturity") is the length of time until the loan contract
or agreement expires. Borrowers are committed to meet their obligations over this period.
Coupon rate: the coupon rate is the rate that when multiplied with the par value of a bond
gives the amount of interest to be paid by the borrower every period.
The par value of a bond is the amount that the borrower promises to pay before the end of the
term to maturity. Bonds can be paid off in a variety of forms:
o Bullet maturity bonds pay the entire principal in one lump sum amount at the
maturity date.
o Serial bonds pay the principal at different intervals. Bonds are issued in series with a
separate payment date specified for each series.
Amortizing securities make periodic principal and interest payments. The following
embedded options are granted to issuers:
1. The right to call the issue.
2. The accelerated sinking fund provision.
3. In the case of amortizing securities, the prepayment right granted to the borrowers of
the underlying loans.
4. The cap on the floating coupon rate that limits the amount of interest payable by the
borrower/issuer.
b: Identify and describe the range of coupon rate structures (zero-coupon bonds, set-up notes,
deferred coupon bonds, and floating-rate securities).
Zero-coupon bonds: zero-coupon bonds are bonds that do not pay interest. If you are
wondering why any investor would buy such a security, the answer lies in the fact that such
securities always sell below their par value prior to maturity. The difference, F-P, between their
selling price (P) and face value (F) represents the implicit interest that would be earned by the
investor if the bond were to be held to maturity.
Step-up notes: step-up notes have coupon rates that increase over time at a pre-specified
rate. The increase may take place once or more during the life of the bond. For example, a
bond may carry a 6 percent coupon for the first 3 years, which steps up to 6.25 percent for the
following two years, and may increase again to 6.5 percent in the eighth year.
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