Course Content
FIXED-INCOME SECURITIES: DEFINING ELEMENTS
This chapter is covered under study session 14, reading 42 of the study materials provided by the Institute. After reading this chapter, a student should be able to: a. describe basic features of a fixed-income security; b. describe the content of a bond indenture; c. compare affirmative and negative covenants and identify examples of each; d. describe how legal, regulatory, and tax considerations affect the issuance and trading of fixed-income securities; e. describe how cash flows of fixed-income securities are structured; f. describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and identify whether such provisions benefit the borrower or the lender.
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LOS A: Basic Features of a Fixed-Income Security
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LOS D: Legal, Regulatory & Tax Considerations
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LOS E: Structure of a Bond’s Cash Flow
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LOS F: Contingency Provisions
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FIXED-INCOME MARKETS: ISSUANCE, TRADING, AND FUNDING
This chapter is covered under study session 14, reading 43 of the study material provided by the Institute. After reading this chapter, a student should be able to: describe classifications of global fixed-income markets; b describe the use of interbank offered rates as reference rates in floating-rate debt; c describe mechanisms available for issuing bonds in primary markets; d describe secondary markets for bonds; e describe securities issued by sovereign governments; f describe securities issued by non-sovereign governments, quasi-government entities, and supranational agencies; g describe types of debt issued by corporations; h describe structured financial instruments; i describe short-term funding alternatives available to banks; j describe repurchase agreements (repos) and the risks associated with them.
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LOS A and B: Bond Market Classification
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LOS C: Primary Markets
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LOD D: Secondary Market
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LOS E: Sovereign Bonds
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LOS F: Non-Sovereign Bonds, Supernational, & Quasi-Government Bonds
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LOS G: Corporate Bonds
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LOS H: Structured Financial Instruments
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LOS I: Short-term Funding
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LOS J: Repurchase Agreements
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INTRODUCTION TO FIXED-INCOME VALUATION
This chapter is covered under study session 14, reading 44 of the study material provided by the Institute. After reading this chapter, a student should be able to: a calculate a bond’s price given a market discount rate; b identify the relationships among a bond’s price, coupon rate, maturity, and market discount rate (yield-to-maturity); c define spot rates and calculate the price of a bond using spot rates; d describe and calculate the flat price, accrued interest, and the full price of a bond; e describe matrix pricing; f calculate annual yield on a bond for varying compounding periods in a year; g calculate and interpret yield measures for fixed-rate bonds and floating-rate notes; h calculate and interpret yield measures for money market instruments; i define and compare the spot curve, yield curve on coupon bonds, par curve, and forward curve; j define forward rates and calculate spot rates from forward rates, forward rates from spot rates, and the price of a bond using forward rates; k compare, calculate, and interpret yield spread measures.
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LOS A: Bond Price and Time Value of Money
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LOS B: Relationships Among a Bond’s Price, Coupon Rate, Maturity, and Market Discount Rate
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LOS C: Spot Rates
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LOS D: Flat Price, Accrued Interest & Full Price
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LOS E: Matrix Pricing
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LOS F, G, and H: Yield Measures
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LOS I: Term Structure of Yield
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LOS K: Yield Spread
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INTRODUCTION TO ASSET-BACKED SECURITIES
This chapter is covered under study session 14, reading 45 of the study material provided by the Institute. After reading this chapter, a student should be able to: a. explain benefits of securitization for economies and financial markets; b. describe securitization, including the parties involved in the process and the roles they play; c. describe typical structures of securitizations, including credit tranching and time tranching; d. describe types and characteristics of residential mortgage loans that are typically securitized; e. describe types and characteristics of residential mortgage-backed securities, including mortgage pass-through securities and collateralized mortgage obligations, and explain the cash flows and risks for each type; f. define prepayment risk and describe the prepayment risk of mortgage-backed securities; g. describe characteristics and risks of commercial mortgage-backed securities; h. describe types and characteristics of non-mortgage asset-backed securities, including the cash flows and risks of each type; i. describe collateralized debt obligations, including their cash flows and risks.
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Introduction
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LOS A: Benefits of Securitization
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LOS B and C: Securitization
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LOS D: Residential Mortgage Loans
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LOS E: Mortgage Pass-Through Securities
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LOS E: Collateralized Mortgage Obligations (CMOs)
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Non-Agency Residential Mortgage Backed Security
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LOS G: Commercial Mortgage-Backed Securities (CMBS)
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Auto Loan-Backed Securities (ALBs)
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Credit Card Receivable- Backed Securities
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Collateralized Debt Obligations (CDOs)
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UNDERSTANDING FIXED-INCOME RISK AND RETURN
This chapter is covered under study session 15, reading 46 of the study materials provided by the Institute. After reading this chapter, a student should be able to: a. calculate and interpret the sources of return from investing in a fixed-rate bond; b. define, calculate, and interpret Macaulay, modified, and effective durations; c. explain why effective duration is the most appropriate measure of interest rate risk for bonds with embedded options; d. define key rate duration and describe the use of key rate durations in measuring the sensitivity of bonds to changes in the shape of the benchmark yield curve; e. explain how a bond’s maturity, coupon, and yield level affect its interest rate risk; f. calculate the duration of a portfolio and explain the limitations of portfolio duration; g. calculate and interpret the money duration of a bond and price value of a basis point (PVBP); h. calculate and interpret approximate convexity and distinguish between approximate and effective convexity; i. estimate the percentage price change of a bond for a specified change in yield, given the bond’s approximate duration and convexity; j. describe how the term structure of yield volatility affects the interest rate risk of a bond; k. describe the relationships among a bond’s holding period return, its duration, and the investment horizon; l. explain how changes in credit spread and liquidity affect the yield-to-maturity of a bond and how duration and convexity can be used to estimate the price effect of the changes.
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LOS A: Sources of Return
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LOS B, C, and D: Interest Rate Risk
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LOS F: Duration of a Bond Portfolio
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LOS G: Money Duration
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LOS G: Price Value of a Basis Point
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LOS H: Convexity of a Bond
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Investment Horizon
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LOS L: Credit and Liquidity Risk
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FUNDAMENTALS OF CREDIT ANALYSIS
This chapter is covered under study session 15, reading 47 of the study material provided by the Institute. After reading this chapter, a student should be able to: a. a describe credit risk and credit-related risks affecting corporate bonds; b. describe default probability and loss severity as components of credit risk; c. describe seniority rankings of corporate debt and explain the potential violation of the priority of claims in a bankruptcy proceeding; d. distinguish between corporate issuer credit ratings and issue credit ratings and describe the rating agency practice of “notching”; e. explain risks in relying on ratings from credit rating agencies; f. explain the four Cs (Capacity, Collateral, Covenants, and Character) of traditional credit analysis; g. calculate and interpret financial ratios used in credit analysis; h. evaluate the credit quality of a corporate bond issuer and a bond of that issuer, given key financial ratios of the issuer and the industry; i. describe factors that influence the level and volatility of yield spreads; j. explain special considerations when evaluating the credit of high yield, sovereign, and non-sovereign government debt issuers and issues.
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LOS A and B: Credit Risk
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LOS C, D, and: E Capital Structure and Seniority
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LOS F, G, H, I: Credit Analysis
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LOS J: Special Consideration
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Fixed Income
About Lesson

a.  The MBSs dealt with so far are the agency mortgage-backed securities. There are other MBSs that can be for any kind of real estate property.

b.  For the non-agency-backed securities, the first lien is on the mortgaged property.

c.  The non-agency securities can take the form of pass-throughs or CMOs. In this market, the CMOs are created either from a pool of pass-throughs or the CMOs.

d.  The main difference between an agency MBS and a non-agency MBS is that the latter does not carry a precise government guarantee of the payment of interest and principal as is with the agency security.

e.  The credit ratings for these types of securities generally require credit enhancement, either internal or external credit enhancement.

f.  Credit enhancement of security implies the existence of support for one or more of the bondholders in the structure.

1.1.         External Credit Enhancement

a.  It is in the form of third-party guarantees which protect against losses up to a particular fixed level.

b.  This is available in form of a corporate guarantee, a letter of credit from a bank, or bond insurance.

c.  Though a third-party guarantee is referred to as a ‘first-loss protection’, it is generally not used as primary protection.

d.  For example, if in a $ 100 million ABS deal, 10% is guaranteed, then for any losses that are in excess of 10%, the sponsor will not be liable. However, the ABSs backed by external credit support is prone to the credit risk of the third-party guarantor. If the third-party guarantor undergoes a downward change in credit ratings, the ratings of the issue will also be lowered, even if the performance of the entire structure is intact.

1.2.         Internal Credit Enhancement

a.  The internal credit enhancement can be in the form of reserve funds, over-collateralization, or a senior-subordinate structure.

b.  The senior-subordinate tranche structure is the most common form of internal credit enhancement. Here there are two different types of asset tranches, some being superior to the other ones. The subordinate tranches provide credit support to the senior tranches; in case of any default, the senior tranches have priority in terms of the claim over the receipts from the assets.

c.  The reserve funds can be kept in form of cash reserve funds or the excess spread accounts. The cash reserve funds are a part of underwriting profits deposited in funds, which are normally in money market instruments and generally form a separate fund. The excess spread account, on the other hand, is the profits made on the spread from the cash flow expected from the receivables and cash flow payables.

d.  Overcollateralization is a process of holding extra assets as collateral than the liabilities, i.e. the bonds issued against them.

 

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