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Glossary of Fixed Income Terms

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A

Ascending yield curve- Also called as normal yield curve. A sharp upwards slope is often an early sign of an accelerating economy, which increases future inflation expectations. The ascending curve suggests that the market expects interest rates to increase in the future and investors would want to buy long term bonds, driving down bond prices and raising bond yields..

Ask Price- If you are buying a bond, the ask price is the price another investor or entity will sell it for..

Asset allocation- A term describing the proportion of a portfolio invested among the three main types of investments - cash or short-term equivalents such as Treasury bills (T-bills); longer-term interest-bearing securities such as bonds; and stocks or equities. An investor's asset allocation strategy can depend on a number of factors including; investment objectives, age, time horizon, risk tolerance, investment experience, etc.

Average Maturity- A weighted average of all the maturities of the debt securities in a portfolio, computed by weighing each maturity date (the date the security comes due) by the market value of the security.

B

Barbell- A yield curve strategy which uses a portfolio containing both long-term and short-term bonds but lacking intermediate-term bonds. The long-term end of a barbell allows an investor to lock into attractive long-term interest rates while the short-term end frees up capital sooner to invest elsewhere, especially if the bond market takes a downturn.

Basis point- One 1/100 of a percentage point. In other words, 100 basis points equals one percent.

Benchmark- A standard by which investment products are measured. An example of a fixed income benchmark is the 10 year Government of India bond, which is the benchmark for bond yields.

Bid price- The price an investor is willing to pay for a security on the secondary market. If you are selling a bond, the bid price is the price another investor or entity will pay for it.

Bond- An interest bearing or discounted government or corporate security that obligates the issuer to pay the bond holder a specified sum of money, usually at specific intervals, and to repay the principal amount of the load at maturity.

Bond ladder- A bond strategy designed to help an investor reap the typically higher coupon rates of longer-term investments, while enjoying some level of protection against the inherently greater interest rate risk. A ladder is made up of multiple bonds with staggered maturities that typically have an equal amount of time between each maturity.

Bullet- A yield curve strategy which uses a portfolio which is constructed so that all of the bonds mature at approximately the same time.

C

Call Date- A specified date that a bond containing a call provision may be called.

Call Premium- The difference between the call price and the face value of a callable bond.

Call Price- A set price, usually above face value, which an issuer must pay if a bond is called.

Call Provision- A provision in a debt agreement which allows the issuer the right to retire the debt, fully or partially, before the scheduled maturity date.

Capital gain/loss- A capital gain is the profit that results when you sell a capital asset for more than its cost. A capital loss arises when you sell for less than its cost. The costs associated with the purchase or sale will reduce your capital gain or increase your loss.

Carry Trade- The strategy that involves the simultaneous trading of two securities in order to create two offsetting positions, one of which creates an incoming cashflow that is greater than the obligations of the other.

Certificate of Deposits- Certificate of Deposits (CDs) are short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year. They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments.

Commercial Paper- Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. Corporates, primary dealers and Financial Institutions are eligible to issue CP. It can be issued for maturities between a minimum of 15 days and a maximum of up to one year from the date of issue..

Cost of Carry- Cost of "carrying" or holding a position. In a long position, the cost of carry is the funding cost paid minus the cash inflows (dividends or coupons).

Coupon- The periodic interest that bond investors receive throughout the life of the security. Generally the larger a bond's coupon the less its price will change when market interest rates fluctuate.

Coupon-rate- The percentage which is multiplied by the principal to arrive at the yearly coupon payment. While many bonds pay interest more often than annually, coupon-rates are given in annual percentages.

Credit Default Swap: A credit default swap (CDS) is an agreement in which one party buys protection against losses occurring due to a credit event of a reference entity up to the maturity date of the swap. The protection buyer pays a periodic fee for this protection up to the maturity date, unless a credit event triggers the contingent payment. If such trigger happens, the buyer of protection only needs to pay the accrued fee up to the day of the credit event, and deliver an obligation of the reference credit in exchange for the protection payout.

Credit risk- The risk that an issuer of a security may default. Also known as default risk.

Credit Quality- A measure of a debt security issuer's ability to repay interest and principal in a timely manner.

Credit Spread- The yield differential between two issues with the same maturity but different credit quality; often used to compare the risk premium of corporate issues in relation to Government securities.

Current yield- A type of yield calculation that relates the annual coupon interest of a security to the market price. Current yield calculations fail to account for capital gains and losses as well as interest-on-interest from reinvesting coupon payments.

D

Derivative- A financial instrument that derives its value from an underlying variable. The underlying variables commonly used are stocks, bonds, commodities, currencies, interest rates and market indexes.

Discount- The term for when a bond is purchased or sold at a price below its face value.

Diversification- Investing in a variety of securities to minimize the risk of loss. By spreading your investment among different types of securities (for example, both stocks and bonds), you may cushion your portfolio against sudden swings in any one area..

Duration- Duration estimates how much a bond's price fluctuates with changes in comparable interest rates. If rates rise 1%, for example, a fund with a 5-year duration is likely to lose about 5% of its value. Other factors also can influence a bond fund's performance and share price. A bond fund's actual performance may differ.

E

Event risk- The risk that an event such as a natural or industrial disaster, a takeover or a corporate restructuring could have an adverse effect on the price of a security.

Exchange rate- The rate at which one currency can be traded for another.

F

Face value- The stated value of an investment at maturity. Also called as par value.

Fallen Angel- A former blue chip firm that has undergone problems and must issue high yield debt..

Fair market value- The amount a willing buyer would pay and a willing seller would accept in an open and unrestricted market, assuming that both parties are knowledgeable, are dealing at arm's length, and neither is under any compulsion to act. Stock and bond prices quoted in daily newspapers, for example, are at fair market value.

Flat yield curve- A yield curve is flat when long- and short-term rates are almost the same, and it usually is a sign that the economy is in a state of change. The market may be giving mixed signals of rising short rates and declining long rates..

Floating-rate bond- A type of bond where the coupon changes periodically based on some predetermined benchmark such as the spread above the yield on a six-month Treasury security.

G

Gilt- Also known as government bonds or Treasury bills. A debt security issued by the Reserve Bank of India on behalf of the Indian Government.

H

High yield bond- Also known as a "junk bond," this type of corporate bond is rated below investment grade by one of the major rating agencies.

I

Income Risk- The possibility that a portfolio's dividends will decline as a result of falling interest rates. Income risk is generally greatest for money market instruments and short term bonds, and least for long term bonds.

Inflation- A general rise in the prices of goods and services.

Inflation risk- The risk that inflation will be greater than the coupon rate over the term of the investment. Also known as purchasing power risk.

Internal rate of return (IRR)- A form of yield calculation which treats the coupon payments an investor receives as if he reinvested them and earned interest at the same rate of return he is earning on the investment as a whole.

Interest Rate- The amount charged for borrowing money.

Inverted yield curve- Also called as descending yield curve. When short-term rates are above long-term rates, an inverted yield curve is formed. Inverted curves are often seen as a predictor of economic recession. While this may lower the threat of inflation, it also may lead investors to believe that long-term bond yields will be lower in the future (due to lower expected inflation), and they are better off buying bonds now and locking in a better rate. This increased demand for long-term bonds drives prices higher and yields lower, further exacerbating the flattening effect of higher short-term rates, leading to an inverted curve.

Investment Grade Security- Generally, these are debt securities issued by organisations that the ratings agencies deem as being likely to meet payment obligations.

Issuer- A government, corporation, municipality or agency who issues a security in order to raise capital. The issuer of a security is the primary determinant of a bond's characteristics.

L

Liquidity risk- The risk that an investor may be unable to sell a bond at or near its face value.

M

Marked-to-Market :An arrangement whereby the profits or losses on a futures contract are settled up each day.

Maturity- The date the principal of a bond will be redeemed along with any remaining interest payments.

Maturity value- Similar to face value, except that maturity value may include accumulated income.

Mortgage-backed securities (MBS)- A security that represents an investment in mortgage loans. An MBS investor owns an undivided interest in a pool of mortgages, which serves as the underlying assets for the security.

N

Net asset value (NAV)- A liquidation price for shares of a unit investment trust that is net of deferred sales charges.

Net worth-Total assets minus total liabilities.

Noncallable bond- A bond which cannot be called for any reason.

O

Offer price- If you are buying a bond, the offer price is the price another investor or entity will sell it for.

Outperform vs.Underperform
A security is said to outperform when its price rises more or falls less than the benchmark's price and its yield either falls more or rises less than the benchmark's yield; a security is said to underperform when its price falls more or rises less than the benchmark's price and its yield either rises more or falls less than the benchmark's yield.

Over-the-counter (OTC)- A dealer network which makes markets in both fixed income and equity securities and sets fair and orderly prices.

P

Pari Passu In the case of insolvency, all bondholders of the entity's debt are treated equally.

Passive portfolio strategy- A bond investment strategy whose performance will replicate the performance of a predetermined index. Therefore, the forecasting analysis involved in an active portfolio strategy is replaced by an index in a passive portfolio strategy.

Passthrough- a type of mortgage-backed security where an issuer collects monthly payments from homeowners, then passes on a proportionate share of the collected principal and interest to the investor.

Payment-in-kind bond (PIK)- A type of deferred-coupon structure that allows the issuer the option of paying cash at any given coupon payment date or paying with a similar bond.

Portfolio- A group of selected securities that an individual or mutual fund owns.

Premium- The term for when a bond is purchased or sold at a price above its face value.

Prepayment rate- The rate at which mortgages are refinanced. The prepayment rate is connected to interest rate movements.

Prepayment risk- A risk involved in an investment in a mortgage-backed security. Prepayment risk is the risk that mortgagers will pay off more than their expected monthly payments. In the event of increased prepayment, the average life will decrease.

Primary market- A market where investors purchase bonds directly from the issuer at face value.

Principal- The amount of a loan, excluding interest.

Prospectus- A document that must be provided to investors before they buy mutual funds or certain other investments. The prospectus describes the product for sale, the investing objectives, past performance, management, potential risks, tax considerations, fees and other data to help you make an informed investment decision.

Purchasing power risk- See inflation risk.

R

Real Yield- A debt security's yield, adjusted for inflation.

Redemption Yield- This yield shows the total return that a debt security would receive if it was held until maturity date taking into account all expected cash flows and redemption value.

Reinvestment risk- The risk that prevailing interest rate fluctuations will adversely affect the price of a bond. Also known as market risk.

Rising Star- A company that is forced to issue high yield debt because it lacks the track record to be considered investment grade.

Risk tolerance- A term describing how much investment risk or variability an investor is willing to accept..

Rupee cost averaging- A strategy which provides a way for a bond investor to enter the investment environment without completely exposing himself to the perils of interest rate fluctuations. The strategy calls for investing the same amount of money regularly (e.g. monthly or quarterly), regardless of the interest rate environment so that the investor can average out the purchase price of his investment.

S

Secondary market- Exchanges and OTC markets where securities are bought and sold subsequent to original issuance which took place in the primary market. Proceeds of the secondary market accrue to selling dealers and investors, not to the companies that originally issued the securities as in the primary markets.

Sovereign Debt- Bonds issued by a national government in a foreign currency, in order to finance the issuing country's growth. Sovereign debt is generally a riskier investment when it comes from a developing country, and a safer investment when it comes from a developed country.

Steepening vs. Flattening
A curve is steepening if there is an increasing yield spread between a point on the short-end of the curve and a point on the long-end of the curve; a curve is flattening if there is a decreasing yield spread between a point on the short-end of the curve and a point on the long-end of the curve.

Sub-Investment Grade Security- A debt security that is rated as below investment grade. Sub-investment grade securities generally have a higher yield than investment grade securities to compensate for the higher risk associated with them.

T

Term- The number of years until redemption date.

Treasury bill (T-bill)- A short-term discounted security issued by a government, with a maturity generally from 30 to 364 days. T-bills have a face value and sell at a discount based on current interest rates.

V

Variable-rate bond- A type of bond that is similar to a floating-rate bond. Variable-rate bonds, also known as adjustable-rate bonds have long-term benchmarks and reset annually, while floating-rate bonds have short-term benchmarks and can reset more than once a year.

Y

Yield- A bond's yield is its effective annual rate of return expressed as a percentage. Yields, which are calculated using a number of factors including the principal, the maturity and the coupon, is one of the primary measuring sticks for a security.

Yield curve- A graphical tool that demonstrates the relationship between yield and maturity for a set of similar securities.

Yield curve strategy- A bond investment strategy designed to minimize interest rate risks by investing at the appropriate point on the yield curve.

Yield-to-maturity- A type of yield calculation that accounts for capital gains and losses as well as interest-on-interest from reinvesting coupon payments.

Yield-to-worst- The lowest possible yield-to-call calculation. The yield-to-worst is the safest assumption about the potential worth of a given bond.

Z

Zero coupon bond- A type of bond which an investor buys at a discount, holds the bond until maturity and makes a profit based on the difference between the buy price and the face value of the bond.