Fixed Income

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The content you've provided covers various aspects of fixed income securities, including bonds, their issuers, coupon types, coupon calculations, discount paper, the difference between debt and equity, the risk-return tradeoff, and bond trading and valuation. Here's a summary of the key points from your content:

  1. Learning Objectives:

    • Identify the features of fixed income securities.
    • Understand who the bond issuers are.
    • Identify different coupon types.
    • Learn how to calculate coupons.
    • Understand what discount paper is.
    • Differentiate between debt and equity.
    • Grasp the concept of risk vs. return.
    • Explain bond trading and valuation.

  2. Content:

    • Debt Instruments (Bonds): These are securities issued by institutions to raise money. Bondholders lend money to entities (e.g., companies or governments) for a specific period at a fixed interest rate (coupon rate).

    • Bond Holders: Bondholders are creditors of the bond issuer and have no control over the issuer's decision-making processes. Bonds are considered fixed income securities because their returns are predictable if held until maturity.

2.1. Bond Issuers:

  • Corporations: Companies issue bonds to raise funds for various purposes, and corporate bonds usually offer higher interest rates than government bonds due to higher perceived risk.
  • Governments: Governments issue bonds when tax receipts are insufficient to cover expenses, using the funds for infrastructure, social programs, etc.

2.2. Coupon Types:

  • Fixed Rate: The interest rate remains constant throughout the bond's life, with periodic interest payments based on the bond's face value.
  • Floating Rate: The interest rate varies with market conditions (e.g., LIBOR plus a spread) and is reset at each coupon payment date.

2.3. Calculating Interest:

  • Interest is calculated based on the bond's coupon rate, frequency of payments, and the number of days since the last payment date, using different day-count methods (e.g., 30/360, Actual/Actual, Actual/365).

2.4. Discount Paper:

  • Short-term debt instruments issued at a discount and maturing at par. They don't pay interest coupons; instead, the return comes from the appreciation of the paper's value. Example: U.S. Treasury Bills.

2.5. Debt vs. Equity:

  • Bonds represent debt, while stocks represent equity. Bondholders are creditors with a claim on assets and receive fixed interest payments. Shareholders are owners with voting rights and a share in profits.

2.6. Risk vs. Return:

  • Yield reflects the return on a bond and can change as the bond's price changes. Yield to maturity (YTM) accounts for reinvestment of interest payments and potential gains/losses if held to maturity.
  • Bond prices move inversely to prevailing interest rates: rising rates lead to falling bond prices and vice versa.

2.7. Accounting & Valuation:

  • Bond prices change daily in the market. Bonds are treated "clean" for accounting, meaning accrued interest is separated from the principal.
  • Sellers are entitled to accrued interest up to the settlement date, added to the agreed-upon price for net cash flow.
  • Unrealized gains/losses and interest accrual are calculated for accounting and tax purposes.
  • Realized gains/losses occur when bonds are sold, and the proceeds differ from the base cost.

The content provides comprehensive information on fixed income securities, bond types, and their accounting treatment. It also emphasizes the importance of understanding bond pricing and accounting for accrued interest in trading and valuation.

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