AAA Rated: Unscrambling the Bond Market


BRASS Program, ALA Annual Conference, July 8, 1996

Glossary of Bond Terms

Compiled by:
Gary White
Tom Mirkovich
Craig Wilkins

Ability to Pay: The ability, present and future, for bond issuers to generate revenue in amounts adequate to pay principal and interest.

Accountant's Opinion: A statement issued and signed by an independent public accountant describing the examination of an organization's financial records. These statements serve to inform lenders of the borrower's condition at the time of examination.

Ad Valorem: Latin phrase meaning "according to value" which describes a method of assessing taxes on goods or property in which levies are based on an item's valuation rather than size.

After-Tax Real Rate of Return: The after-tax rate of return minus the inflation rate.

Annuity Bond: See Perpetual Bond.

Arbitrage: The simultaneous purchase and sale of the same or equal securities in such a way as to take advantage of price differences; buying something where it is less expensive and selling it where it is more expensive.

Baby Bond: A bond with a face value of less than $1,000.

Bank Discount Rate: The yield basis on which short-term, non-interest-bearing money market securities are quoted.

Basis Point: One one-hundredth of a percentage point. Example: A decline from 7.15% to 7.10% is a decline of five basis points.

Bearer Bond: A bond that does not have the owner's name registered on the books of the issuing corporation and is payable to the bearer.

Bid-Ask System: System used to place a market order. The bid price is what the dealer is willing to pay, while the ask price is the price at which the dealer will sell to individual investors. The difference between the bid and ask prices is the spread.

Blue List: A daily publication from Standard and Poor's listing bonds offered for sale with the price, yield, and other information.

Bond: A certificate representing creditorship in a corporation and issued by a corporation to raise capital. The company pays interest on a bond issue at specified dates and eventually redeems it at maturity, paying principal plus interest due.

Bond Anticipation Note: A short-term municipal debt instrument usually offered on a discount basis.

Bond Buyer: Daily newspaper published by American Banker which follows the municipal bond market. Included is an index often used as a yardstick against which bond yields are compared.

Bond Covenant: A legal agreement designed to mitigate potential conflicts of interest between bondholders and shareholders. Typically, covenants limit future dividends and restrict future debt. They may also address other areas of conflict such as claim dilution, underinvestment, and asset substitution.

Bond Equivalent Yield: A yield on a money market instrument or pass-through security computed so as to be comparable to a yield computed on a coupon security paying semiannual interest.

Bond Fund: A diversified portfolio of municipal securities sold to investors in units or shares by the investment company which owns the fund.

Bond Indenture: A document that defines the terms, or promises of a bond issuer, and guarantees certain rights to bondholders.

Bond Insurance: Insurance purchased by an issue for either an entire issue or specific maturities that provides for the payment of principal and/or interest.

Bond Issue: Bonds sold in one or more series authorized under the same indenture or resolution and having the same maturity date.

Bond Premium: The amount at which a bond or note is bought or sold above its par value without including accrued interest.

Bond Purchase Agreement: The contract between the issuer and underwriter that sets down the final terms, conditions, and prices by which the underwriter purchases an issue of municipal securities.

Bond Ratings : Evaluation of the creditworthiness of issuers and securities. Moody's Investors Services and Standard and Poor's are the largest rating agencies in the world.

Bondholder: Individual or institutional creditor who holds a contract by which the issuer agrees to make future payments in exchange for the advance of funds.

Bulldog Bond: A nickname for foreign bonds traded in the United Kingdom.

Call Feature : A provision in a bond indenture that allows the issuer the option of paying off an obligation, either partially or in full, before the instrument's date of maturity. The issuer is therefore able to retire expensive debt to take advantage of lower interest rates.

Call Price: The set price at which a bond may be redeemed by the issuer. The time period is established at issuance and the price is generally greater than par value to compensate the holder for the risk of early redemption.

Call Provision: See Call Feature.

Call Risk: The threat that a bond may be retired or paid off by the issuer. As interest rates drop, a bondholder may see the value of his/her investment drop toward the call price and, if the bond is called, he/she could be forced to reinvest the funds at a lower interest rate.

Callable Bond: A bond that the issuer has the right to redeem prior to maturity by paying some specific call price.

Cash Flow Yield: A yield on a pass-through security based on a projected stream of monthly principal and interest payments.

Collared Bond: A bond with a non-fixed, or floating, coupon rate that has an established minimum rate of return (floor) and an established maximum rate of return (cap).

Collateral Trust Bond: A bond issue that is protected by providing bondholders with a lien against an issuer's property, usually a portfolio of securities held in trust by a commercial bank.

Collateralized Mortgage Obligation: A type of mortgage-backed security in which the cash flow from a mortgage pool is distributed at varying rates of return, based on the bondholder's class or level of investment.

Commercial Paper: A short-term, negotiable certificate sold by one institution to another in order to meet immediate cash needs.

Convertible Bond : A bond containing a provision that permits conversion between the issuer's bonds and common stock at some fixed exchange ratio. See also: Exchangeable Bond.

Corporate Bond: A bond issued by corporations to meet financial obligations or to acquire assets.

Coupon: The annual interest payment made to a bondholder during the life of a bond. Coupon payments in the U.S. are typically made semi-annually, while Eurobonds pay once per year.

Coupon Rate: The specified interest rate payable to the bondholder. The coupon rate multiplied by the face value of the bond equals the coupon amount.

Credit Risk : The threat that the issuer, or borrower, will default on its obligation. Typically, the greater the credit risk, the higher the yield must be to attract investors.

Creditworthiness: The ability of an issuer to meet its obligations. Creditworthiness is rated by Moody's Investors Service, Standard and Poor's, and other credit agencies. See also: Bond Ratings.

Currency Denomination of Cash Flow: The currency in which the coupon payment or cash flow is paid. These payments need not be in the same currency used in the country where the bond was issued.

Current Yield: The ratio of the coupon rate on a bond to the dollar purchase price; expressed as a percentage.

Cushion Bond: High coupon bonds that sell at a moderate premium because they are callable at a price below that at which a comparable non-callable bond would sell.

Debenture Bond : A bond not secured by a specific pledge of property. Assets that are not pledged specifically to secure other debt may be used to satisfy any debenture bondholder's claims. See also: Unsecured Obligation Bond.

Debt Warrant : This allows the warrant holder to buy additional bonds from the issuer at the same price and yield as the bond with which the warrant was issued. See also: Warrant.

Deep-Discount Bond: Bonds selling at a large discount because their coupon is below going market rates.

Default: The failure of a corporation to pay principal and/or interest on outstanding bonds. See also: Credit Risk.

Discount Bond: A bond selling at a price below its redemption value.

Discount Rate: The rate of interest charged by the Fed to member banks in the Federal Reserve district.

Dollar Bond: A bond that is quoted and traded in dollars rather than in yield to maturity.

Doubling Option: Option that allows the issuer the right to retire twice the amount of debt required by a sinking fund. See also: Sinking Fund Requirement.

Dual-Currency Issue: A bond in which coupon interest is paid in one currency and the principal is paid in another. These issues are common in the Eurobond market.

Equipment Trust Certificate: A bond collateralized by the machinery and/or equipment of the issuing corporation.

Equity Warrant : This allows the warrant holder the option of buying the common stock of a company at a predetermined price. See also: Warrant.

Equivalent Bond Yield: A percentage used to express the comparison of the discount yield with the coupon yield of government obligations.

Essential Function Bond: A type of municipal bond in which the monies raised are used for traditional government activities.

Eurobond: A bond issued in Europe outside the confines of any national capital market. See also: External Bond Market.

Event Risk: External factors such as regulatory changes, natural disasters, corporate takeovers, or accidents that may affect a bond issuer's ability to meet its obligations.

Exchange or Currency Risk: When bond payments on a given issue occur in a foreign currency, domestic currency cash flows are dependent on the foreign currency exchange rate. The bondholder therefore incurs risk associated with fluctuations in capital markets.

Exchangeable Bond : A bond that can be exchanged for the common stock of a company other than the company issuing the bond. See also: Convertible Bond.

External Bond Market : The external bond market refers to bond trading activity wherein the bonds are underwritten by an international syndicate, are offered in several countries simultaneously, are issued outside any country's jurisdiction, and are not registered. The Eurobond market is a major external bond market. The external bond market combined with the internal bond market comprises the global bond market. Examples of an external bond are the "global bond," issued by the World Bank, and Eurodollar bonds. See also: Internal Bond Market.

Face Value : The redemption value of a bond or preferred stock appearing on the face of the certificate. Face value does not include interest, coupons, or other fees. See also: Par Value.

Federal Home Loan Mortgage Corporation (Freddie Mac): A private corporation authorized by Congress which sells participation certificates and collateralized mortgage obligations backed by pools of conventional mortgage loans.

Federal Housing Administration: A division of the Department of Housing and Urban Development, whose business includes insuring residential mortgage loans under a nationwide system.

Federal National Mortgage Association (Fannie Mae) : A private corporation created by Congress to support the secondary mortgage market by buying and selling residential mortgages insured by FHA or guaranteed by VA. It also issues mortgage-backed securities backed by conventional mortgages. See also: Mortgage Backed Securities.

Flat Trade: A bond (or any security) that trades without accrued interest or at a price that includes accrued interest. The price quoted covers both principal and unpaid, accrued interest.

Floating Rate Issues: Bonds in which the coupon rate is reset periodically, based on the movements of a specified benchmark, such as the U.S. treasury-bill rate.

Flower Bond: A type of treasury bond selling at a discount that permits redemption at par value after the owner's death to pay federal estate taxes.

Foreign Bond: A bond issued by a nondomestic borrower in the domestic capital market.

Full-Coupon Bond: A bond whose coupon rate equals going market rates and consequently sells at or near par.

Full Faith and Credit Pledge: A phrase indicating that a government entity promises full taxing authority and other revenue streams to repayment of bond holders.

General Obligation Bond: A tax-exempt bond whose pledge is the issuer's good faith, credit, and full taxing power.

Gold Warrant : A warrant that allows the holder to buy gold from the issuer of the host bond. see also: Warrant.

Government National Mortgage Corporation (Ginnie Mae) : A wholly owned government corporation operated by the Department of Housing and Urban Development. GNMA issues and guarantees mortgage-backed securities carrying no tax exemptions which are backed by the full faith and credit of the U.S. Government. See also: Mortgage-Backed Securities.

Guaranteed Bond: A bond issued by a subsidiary corporation and guaranteed as to principal and/or interest by the parent corporation. For example, government-owned companies may issue bonds that are guaranteed by their central government.

High-Yield Bond : Also called junk or non-investment grade bonds, these bonds have low ratings (below BBB) or are in default. They usually carry a higher degree of risk and a higher potential yield than other bonds, and are often associated with excessive leveraging, corporate takeovers, and leveraged buyouts.

Housing Authority Bond: A municipal bond whose payment of interest and/or principal is contingent upon the collection of rents and other fees from users of a housing facility built with the proceeds of the issuance of the bond.

Inactive Bond: A bond that trades only infrequently.

Industrial Development Bond: Industrial revenue bonds issued to improve the environment.

Industrial Revenue Bond: Municipal bonds issued for the purpose of constructing facilities for profit-making corporations.

Inflation Risk: The risk of the effect that real or anticipated inflation can have on the cash flow of a bond.

Interest Rate Risk: See Market Risk.

Internal Bond Market : The internal bond market refers to all bond trading activity in a given country and is comprised of both a domestic bond market and a foreign bond market. Also referred to as the "national bond market." The internal and external bond markets comprise the global bond market. See also: External Bond Market.

International Bond Market: See External Bond Market.

Inverse Floaters: See Reverse Floaters.

Investment Grade: A bond with a rating of AAA to BBB, as contrasted with a junk or non-investment grade bond. See also: Bond Ratings.

Junk Bond: See High-Yield Bond.

Letter Bond: Privately sold bonds that allow the investor to transfer or resell them.

Leveraged Buyout: Leverage expresses a firm's debt to net worth. Leveraged buyouts occur when a public corporation assumes considerable debt through the issuance of junk bonds in order to reorganize itself as a narrowly held company.

Long Bond: A bond with a long current maturity. A slang expression for 30-year U.S. Treasuries.

Macaulay Duration: An indicator that measures the price sensitivity, or volatility, of a bond to a change in yield.

Market Risk : Bonds sold before maturity may suffer a loss due to a rise in interest rates or other market conditions. Volatility is an expression of a bond's susceptibility to market risk. See also: Risk.

Matador Bond: A nickname for foreign bonds traded in Spain.

Maturity: Refers to the period of time in which the amount owed on a bond or obligation must be paid off. Typically, bond maturity is "short-term" (1-5 years), "intermediate-term" (5-12 years), or "long-term" (12-30 years or longer).

Maturity Date: Date at which a bond becomes due. Principal and any accrued interest due must be paid at this time.

Maturity Value: The amount an investor receives when a bond is redeemed at maturity.

Mortgage-Backed Securities : Bonds backed by pools of mortgage loans whereby investors receive the cash flow generated by the pool as determined by their investment. See also: Federal National Mortgage Association; Government National Mortgage Corporation.

Mortgage Bond: A bond secured by a lien on property, equipment, or other real assets.

Municipal Bond: A bond issued by a state or local government or authorized agencies in which the interest paid is exempt from federal income taxes and is generally exempt from state and local taxes in the state of issuance.

National Bond Market: See Internal Bond Market.

Nominal Yield: Also known as coupon yield, the nominal yield is the annual interest rate payable on a bond and is specified in the indenture and printed on the face of the bond.

Non-Investment Grade Bond: See High-Yield Bond.

Note: An obligation that is due in less than ten years from the date of issue.

Official Statement: A legal opinion attesting to the legality of a municipal bond issue. This is similar to a prospectus in stock issues.

Offshore Bond Market: See External Bond Market.

Overlapping Debt: A bond having two issuers.

Par Value : Face value of a security. For bonds, it usually signifies the figure on which interest is based and the amount that is redeemed on maturity. See also: Face Value.

Pass-Through Security: A type of mortgage-backed security in which the cash flow from a mortgage pool is distributed to investors on a pro rata basis.

Perpetual Bond : A bond with no maturity date. Also called an annuity bond. Though they have infinite maturity, perpetual bonds are frequently callable by the borrowers. Perpetual bonds are common to the Eurobond market.

Premium: The amount by which the price paid for a security exceeds its face value.

Price to Call: The yield of a bond priced to the first call date rather than maturity.

Primary Market : Refers to the underwriting or auctioning of newly issued bonds. non-central government bonds are underwritten by investment firms, banks, and other financial institutions, while central government bonds are usually distributed through an auction process. See also: Secondary Market.

Principal: See Face Value.

Prior Lien Bond: A bond that takes precedence over all other bonds because they hold a higher priority claim.

Private Placements: The act by underwriters of giving issued bonds directly to institutional investors rather than making them available to the general public.

Put Bond : A bond that can be redeemed on a date prior to the stated maturity date.

Put Provision: Allows the bondholder the option of selling the bond back to the issuer at par value on specified dates. See also: Put Bond.

Redemption: The retirement of a bond by the repayment of its face value.

Registered Bond: A bond whose owner's name is registered on the books of the issuing corporation.

Reinvestment Risk : The threat that future interest rates at which coupons can be reinvested will be lower than the yield to maturity at the time the bond is acquired. See also: Risk.

Rembrandt Bond: A nickname for foreign bonds traded in the Netherlands.

Repo or Repurchase Agreement: A transaction in which a party purchases a government security and resells it for the same price plus an interest charge.

Revenue Bond: A bond whose interest payments are generated from the revenue derived from operating the facility or project.

Reverse Floaters : Floating rate bonds that move in the opposite direction of interest rate benchmarks. Reverse floaters are typically used by investors as a hedging device.

Risk : A measure of the probability of an item not gaining in value. See also: Market Risk; Reinvestment Risk.

Samurai Bond: A nickname for foreign bonds traded in Japan.

Savings Bond: Bonds issued through the U.S. government at a discount.

Secondary Market : A bond market characterized by the lack of a centralized trading facility. Trading is usually conducted over-the-counter. In the secondary market, the liquidity of a bond is indicated by the spread between asking and bid price. The narrower the spread, the greater the bond's liquidity or marketability. See also: Primary Market.

Secured Obligation Bond: A bond whose payment of interest and principal is secured by physical assets.

Securitization: The act of acquiring loans and issuing a collateralized security that closely resembles a bond. This activity was pioneered in the mortgage-backed security market by the Federal National Mortgage Association and other quasi-official government agencies.

Serial Bond: A bond issue in which maturities are staggered over a number of years.

Series EE (Savings) Bond: U.S. government bonds issued in denominations of $50 to $10,000 at a discount.

Series HH (Current Income) Bond: Nontransferable U.S. government bonds that pay interest semiannually.

Short Bond: Bonds with a short current maturity.

Sinking Fund Requirement : A provision for repayment whereby the bond issuer retires a certain portion of an issue at regular intervals over the life of the bond.

Special Obligation Bond: A bond secured by a specific revenue source.

Split Rating: A bond having differing assessments as to creditworthiness from crediting agencies. See also: Bond Ratings.

Stripped Bond: The coupons on stripped bonds are separated from the body of the bond and both parts are sold separately. The body is traded as a discount bond and the coupons are separated by date and also traded as discount bonds.

Swap: A transaction in which a bondholder can exchange floating interest-rate bonds for fixed interest rate bonds, change the currency in which interest is paid, or change the benchmark base for floating interest-rate issues.

Taxable Equivalent Yield: The yield an investor would have to get on a U.S. government or taxable corporate bond to match the same after-tax yield on a municipal bond.

Term Bond: A bond issue in which all bonds mature at the same time.

Treasury Bond: A federal registered or bearer obligation issued in denominations of $500 to $1 million with maturities ranging from five to thirty-five years and having a fixed interest rate.

Triple Tax Exempt: A feature of municipal bonds in which the interest received is exempt from Federal, state, and local taxes.

Unsecured Obligation Bond : A bond whose repayment is backed solely by the creditworthiness of the security. Also called a debenture. See also: Debenture Bond.

Variable-Rate Bond: A bond without a fixed coupon interest rate.

Warrant : A warrant allows the bondholder the option of entering into other financial dealings with the bond issuer. See also: Equity Warrant, Debt Warrant, and Gold Warrant.

Watch List: A list of securities singled out for special observation by brokerage firms for potential credit risk, mergers, or other events.

Yankee Bond: Nickname for a dollar-denominated, foreign issued bond that is registered for sale in the U.S.

Yield: The flow of interest income generated by a bond.

Yield Curve: Graph depicting the relation of interest rates to time.

Yield to Call: The return available until the call date.

Yield to Maturity: The return available until the maturity date.

Zero Coupon Bond: A bond with no interest payments. Interest is paid at maturity. Zero coupon bonds are sold below maturity or principal value, appreciate as they approached maturity, and guarantee the holder a fixed rate of return.

bulletAAA Rated: Unscrambling the Bond Market
BRASS Program, ALA Annual Conference, July 8, 1996

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