Life Cycle of a Bond
Public Group
active 1 year, 6 months ago
Group Leadership
- Group Administrators
-
-
Bonds are originated in the primary market through a bond issuance process that offers the issue to the public for the first time. During this process, issuers receive capital, and in return, provide investors with bonds that outline the issuer’s obligations. Once the bonds are issued and in circulation, they are traded among investors and dealers in the secondary market. At the maturity date, bondholders receive a final coupon payment and are repaid the principal amount. Issuers have the option to refinance the debt obligations through the issuance of new bonds in the primary market.
The Market
The market is commonly used to refer to the primary and secondary markets collectively. In the debt capital markets, the primary market is the market where new bonds are created and the secondary market is the market where existing bonds are traded. The market provides an exchange for capital and is strictly regulated.
Bond Origination – Primary Market
The primary market is where corporations and government entities raise funds from investors. This is done through issuing new fixed income securities to investors in exchange for capital. In other words, fixed income securities are “originated” in the primary bond market. Bond originations are facilitated by dealers who act as an intermediary between issuers and investors.
Bond Trading – Secondary Market
The secondary bond market is where existing bonds are traded among holders of fixed income securities (i.e. investors). Fixed income securities are generally traded over-the-counter through a de-centralized dealer network. This contrasts with the equity markets, where securities can be readily traded on centralized exchanges. In particular, sales and trading desks at investment banks (dealers) facilitate transactions between buyers and sellers. Electronic trading platforms, usually in the form of inter-dealer networks provide an alternative marketplace to trade fixed income securities.
Bond Redemption & Maturity
Fixed income securities have a set maturity date, at which, principal amount is repaid to investors. Alternatively, issuers may redeem bonds prior to maturity through exercising early redemption features such as call provisions. Issuers may refinance bond maturities by issuing new bonds at or near the maturity date.
Key Bond Features
A credit rating is an objective, third-party measure of an issuer’s financial health, its ability to meet its debt obligations. The credit rating accounts for business and financial risks involved with investing in an issuer’s bonds. Investors should use credit ratings to supplement issuer-specific research and analysis.
1. Term to Maturity – long term bonds (10+years) offer investors higher yield compared to short term bonds but they are also exposed to higher interest rate risk.
2. Floating vs. Fixed Interest – floating-rate notes with interest coupons referencing a benchmark rate(G-sec) provide investors protection against increases in market interest rates. This is because investors receive higher interest payments as G-sec rises. Conversely, fixed rate bonds provide investors attractive returns when market interest rates decline, as the coupons are relatively higher than the market interest rate.
3. Collateral – bonds can be either secured or unsecured, with secured bonds backed by collateral. Unsecured bonds have higher risk of not getting repaid and therefore offer investors higher yields.
4. Seniority – this refers to a bond’s priority of claims to the issuer’s assets. The priority of claims is as follows:
Senior Secured
Senior Unsecured
Subordinated Tier I
Subordinated Tier II
The more subordinated the bond is the higher the risk an investor will not be repaid, however, these bonds should offer investors the highest yields.
5. Optionality – bonds frequently include option features. Two common option features are call options and put options. A bond with a call option, often referred to as a “callable” bond, allows the issuer to repurchase the bond at predetermined dates and prices; investors are compensated for the call risk with a higher yield. A bond with a put option, often referred to as a “puttable” bond, gives bondholders the option to sell the bond back to the issuer at predetermined dates and prices; this lowers the investment risk for investors and thus offers a lower yield.