2015 Study Session # 15, Reading # 52

FIXED-INCOME MARKETS: ISSUANCE, TRADING, AND FUNDING

2. OVERVIEW OF GLOBAL FIXED-INCOME MARKETS

2.1 Classification of Fixed-Income Markets

2.1.1 Classification by Type of Issuer

2.1.2 Classification by Credit Quality

This classification include:

Govt & govt related sectors

Corporate sector

Structured finance sector

Credit risk risk of loss resulting from the issuer

failing to make full & timely payments of interest
&/or principal.

Investment grade bonds bonds with credit
rating of BBB or above by S&P & Fitch.

Junk bonds bonds with ratings below BBB.

2.1.3 Classification by Maturity

2.1.4 Classification by Currency Denomination

Bonds can also be classified by the original maturity of

the bonds when they are issued.

Money market securities maturity range form
overnight to 1 year.

Capital market securities maturity > 1 year

Currency denomination of the bonds cash flows

influences which countrys interest rate affect
bond price.

2.1.5 Classification by Type of Coupon

These include:

Fixed coupon bonds.

Floating rate bonds.

2.1.6 Classification by Geography

These include domestic, foreign & euro bond.

Domestic bonds issued & sold in a specific country
denominated in its local currency & issued by a local issuer.

Euro bonds issued internationally.

2.1.7 Other Classifications of Fixed-Income Markets

These include:

Inflation-linked bonds.

Municipal bonds etc.

2.2 Fixed-Income Indices

Fixed-income index a multi-purpose tool used by investors &
investment managers to describe a given bond market or sector
& to evaluate investment managers performance.

Index construction (security selection & index weighting) varies
among indices.
2.2 Investors in Fixed-Income Securities

Major categories of bond investors include:

Central bank

Institutional investors.

Retail investors.

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2015 Study Session # 15, Reading # 52

3. PRIMARY AND SECONDARY BOND MARKETS

Primary bond markets markets in which issuers first sell bonds to
investor to raise capital.

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

3.1 Primary Bond Markets

3.1.1 Public Offerings

Any member of the public can buy
the bonds under this offering.

3.1.1.1 Underwritten Offerings

3.1.1.2 Shelf Registration

Under this arrangement, investment bank guarantees the

sale of bond issue at an offering price that is negotiated
with the issuer.

Phases of underwriting process.

Determination of underwriting needs.

Underwriter selection.

Defining transaction structure.

Assessing market conditions & bond pricing.

To determine demand of the issue.

Issuing phase.

It allows certain authorized issuers to offer additional

bonds to public without having to prepare a new &
separate offering circular for each bond issue.

Lower level of scrutiny compared with standard public
offering.

3.1.1.3 Auctions

Auction involves bidding.

Helpful in providing price discovery.

Primary dealers financial institutions that are
authorize to deal in new issue.

3.1.2 Private Placements

A non-underwritten, unregistered offering of bonds that
are sold only to an investor or a small group of investors.

Typically involves institutional investors.

3.2 Secondary Bond Markets

Secondary Markets Structure

Organized Exchange

Place where buyers & sellers can
meet to arrange their trades.

Over-The-Counter (OTC) Markets

Buy & sell order initiated from
various locations are matched
through a communication network.

Bid-ask spread difference b/w prices at which dealer

will buy from a customer (bid) & sell to a customer (ask).

Settlement process that occurs after the trade is made.

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2015 Study Session # 15, Reading # 52

4. SOVEREIGN BONDS
4.1 Characteristics of Sovereigns Bonds

Sovereign bonds have different names in different countries.

Bond names may also vary depending on the bond maturity.

On-the-run issue securities that were most recently issued.

4.2 Credit Quality of Sovereign Bonds

Usually not backed by collateral.

Budget surplus excess revenue is used to make interest &
principal payments.

Budget deficit new debt to roll over existing debt.

4.3 Types of Sovereign Bonds

4.3.1 Fixed-Rate Bonds

4.3.2 Floating-Rate Bonds

Most common type of sovereign bonds.

These include:

Zero coupon bonds.

Coupon paying bonds.

Bonds whose interest payments are linked with

some reference rate.

Lower interest rate risk than a simple fixed
coupon bond.

4.3.3 Inflation-Linked Bonds

Bonds whose interest payments are linked with
some reference rate.

Lower interest rate risk than a simple fixed
coupon bond.

5. NON-SOVEREIGN GOVERNMENT, QUASI-GOVERNMENT, AND SUPRANATIONAL BONDS

5.1 Non-Sovereign Bonds

Issued by provinces, regions, states & cities.

These bonds are usually issued to finance public projects.

Tax is the main source of interest & principal repayment.

5.2 Quasi-Government Bonds

Quasi-government entities organizations having public & private
sector characteristics but not actual govt entities.

Bonds are repaid from cash flows generated by the entity or from the
project bond issue is financing.
5.3 Supranational Bonds

Bonds issued by multilateral agencies (e.g. IME, WB).

Typically plain vanilla bonds with large size issues.

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2015 Study Session # 15, Reading # 52

6. CORPORATE DEBT

6.1 Bank Loans and Syndicated Loans

Bilateral loans loan from a single lender to a single borrower.

Syndicated loans loans from a group of lenders to a single borrower.

These loans are usually at floating rate & interest rate is based on a
reference rate plus a spread.

6.2 Commercial Paper

Commercial paper (CP) short-term, unsecured promissory note issued in
the public market that represents a debt-obligation of the issuer.

CP is a flexible, readily available & low cost source of short term financing.

Investors in CP are exposed to various level of credit risk depending on the
issuers creditworthiness.

Rolling over the paper (new issuance of CP to pay the existing one) is a
common practice.

Short-dated maturity,
credit risk &  no. of issuers feature of
attractive CP.

6.3 Corporate Notes and Bonds

No universally accepted taxonomy as to what constitute short, medium &
long term maturities usually:

Short term < 5 years.

Medium term > 5 year but < 12 year.

Long term > 12 years.

Serial maturity structure maturity dates are spread out during the bonds
life.

Tem maturity structure notional principal is paid off in lump sum at
maturity (more risk than serial maturity).

Seniority ranking is an important consideration for investors.

7. SHORT-TERM FUNDING ALTERNATIVES AVAILABLE TO BANKS

7.1 Retail Deposits

Primary source of funding for deposit taking banks.

Two main types include demand deposits & saving
accounts.
7.2 Short-Term Wholesale Funds

These funds include central bank funds, interbank funds & certificates of
deposit.

Central bank funds market allows banks that have a surplus of funds to loan
money to banks that need fund (maturity up to one year).

Central bank funds rates interest rates at which central bank funds are
bought or sold.

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2015 Study Session # 15, Reading # 52

7.3 Repurchase and Reverse Repurchase Agreements

Repurchase agreement sale of a security with a simultaneous agreement by
the seller to buy the same security back at an agreed-on price & future date.

Several factors can affect the repo rate including:

Risk associated with collateral.

Repo term.

Delivery requirement for the collateral.

Supply & demand conditions of the collateral.

Alternative financing rate.

Reverse repurchase agreement when repo agreement is viewed through the
lens of the cash lending counterparty, it is called reverse repo.

Credit risk is present in repo agreement for both parties.

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