CFA Level I Fixed Income

Fixed-Income Markets: Issuance, Trading and Funding

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Reproduced and republished with permission from CFA Institute. All rights reserved.

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 Contents and Introduction
1. Introduction Total debt and equity
2. Overview of Global Fixed-Income Markets outstanding: $212
3. Primary and Secondary Bond Markets trillion
4. Sovereign Bonds
Debt represents about
5. Non-Sovereign Government, Quasi-Government, 75%
and Supranational Bonds
6. Corporate Debt Understanding how the
7. Short-Term Funding Alternatives Available to market is structured is
Banks important for issuers and
8. Conclusion and Summary investors

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 2. Overview of Global Fixed-Income Markets

Classification of Fixed-Income Markets

Fixed-Income Indices

Investors in Fixed-Income Securities

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 2.1 Classification of Fixed-Income Markets
Type of issuer Interbank offered rates are sets of rates that reflect the
rates at which banks believe they could borrow
Credit quality unsecured funds from other banks in the interbank
market for different currencies and different maturities.

Maturity

Currency denomination Geography

Type of coupon Other classifications

Fixed-rate versus floating-rate
Reference rates

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Example 1

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 2.2 Fixed-Income Indices
A fixed-income index is a multi-purpose tool used by investors and investment man-
agers to describe a given bond market or sector, as well as to evaluate the
performance of investments and investment managers.

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 2.3 Investors in Fixed-Income Securities
Major categories of bond investors include central banks, institutional investors,
and retail investors
Central banks and institutional investors generally invest directly
Retail investors generally invest through mutual funds and ETFs

Central banks use open market operations to implement monetary policy

Institutional investors are the largest group of investors in fixed-income securities

Retail investors like the price and income stability generally associated with fixed-
income securities

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Example 2

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 3. Primary and Secondary Bond Markets

Primary bond markets are markets in which issuers first sell bonds to investors to
raise capital. Bonds can be sold (issued) via a public offering or a private
placement.

Secondary bond markets are markets in which existing bonds are subsequently
traded among investors

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 3.1 Primary Bond Markets
Public bond issuing mechanisms include underwritten offerings, best effort offerings,
shelf registrations, and auctions.

Underwritten offering:
Investment bank buys the entire issue and takes the risk of reselling it to investors or dealers.

Determination of Selection of the Structuring and

Pricing Issuance Closing
funding needs underwriter announcement

Best effort offering:

Investment bank serves as a broker and sells the bond Underwritten and best effort
issue only if it is able to do so. offerings are frequently used in the
issuance of corporate bonds.

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 3.1 Primary Bond Markets (Cont)
A shelf registration is a method for issuing securities in which the issuer files a
single document with regulators that describes a range of future issuances

An auction is a public offering method that involves bidding, and that is helpful in
providing price discovery and in allocating securities. It is frequently used in the
issuance of sovereign bonds.

A private placement is typically a non-underwritten, unregistered offering of bonds

that are sold only to an investor or a small group of investors. Typical investors in
privately placed bonds are large institutional investors. A private placement can be
accomplished directly between the issuer and the investor(s) or through an
investment bank. Because privately placed bonds are unregistered and may be
restricted securities that can only be purchased by some types of investors, there is
usually no active secondary market to trade them.

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 3.2 Secondary Bond Markets
Securities are traded among investors in the secondary market

Secondary markets can be structured as organized exchanges or as OTC markets;

most bond trading happens in OTC markets

Important to understand the liquidity of a market

Bid-ask spread reflect the liquidity of a market
Eurobond market makers

Settlement is the process the occurs after a trade is made

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Example 3

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Example 3 (Cont)

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 4. Sovereign Bonds
Sovereign bonds are issued by national governments primarily for fiscal reasons.

Characteristics of sovereign bonds

Credit quality of sovereign bonds

Types of sovereign bonds

Fixed-rate bonds
Floating-rate bonds
Inflation-linked bonds

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Example 4

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5. Non-Sovereign Government, Quasi-Government,
and Supranational Bonds
Non-sovereign bonds

Quasi-government or agency bonds

Supranational bonds

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Example 5

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 6. Corporate Debt

Bank loans and syndicated paper

Commercial paper

Commercial notes and bonds

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 6.1 Bank Loans and Syndicated Loans
A bilateral loan is a loan from a single lender to a single borrower. A syndicated loan
is a loan from a group of lenders, called the syndicate, to a single borrower.

Most bilateral and syndicated loans are floating-rate loans

For highly rated companies, both bilateral and syndicated loans can be more
expensive than bonds issued in financial markets

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 6.2 Commercial Paper
Commercial paper is a short-term, unsecured promissory note issued in the public
market or via a private placement that represents a debt obligation of the issuer.

Commercial paper is a valuable source of flexible, readily available, and relatively

low-cost short-term financing
Working capital and seasonal demands for cash
Bridge financing

Yield on commercial paper > yield on short-term sovereign bonds

Credit risk
Liquidity risk

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 Commercial Paper (Cont)
Exhibit 7 Commercial Paper Ratings

Backup lines of credit

Rolling over the paper

Exhibit 8 USCP vs. ECP

Discount basis versus interest-bearing

basis

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 6.3 Corporate Notes and Bonds
Maturities
Short-term, medium-term, long-term
Medium-term note (MTN)

Coupon payment structures

Principal repayment structures

Asset or collateral backing

Contingency provisions

Issuance, trading and settlement

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Example 6

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 7. Short-Term Funding Alternatives Available to Banks

Retail deposits

Short-term wholesale funds

Central bank funds
Interbank funds
Certificates of deposit

Repurchase are reverse repurchase agreements

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 Repurchase and Reverse Repurchase Agreements
A repurchase agreement or repo is the sale of a security with a simultaneous
agreement by the seller to buy the same security back from the purchaser at an
agreed-on price and future date
Example: A dealer sells the 2.25% U.K. gilt that matures in three years to a
counterparty for cash today. At the same time, the dealer makes a promise to buy the
same gilt the next business day for an agreed-on price.

Reverse repo Repo rates are impacted by:

Repurchase price Risk associated with collateral
Repurchase data Term of repurchase agreement
Overnight repo Delivery requirement
Term repo Supply and demand
Repo rate Interest rates of alternative financing
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 Credit Risk Associated with Repurchase Agreements
Each market participant is exposed to credit risk

Lender has greater exposure to credit risk

Difference between market value of collateral and value of loan is called the repo
margin (haircut); the level of the margin depends on:
Length of the repurchase agreement
Quality of the collateral
Credit quality of the counter party
Supply and demand conditions of the collateral

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Example 7

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Example 7 (Cont)

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 Summary
Classifications
Interbank offer rates
Mechanisms for issuing bonds in primary markets
Secondary markets
Debt issued by sovereign governments, non-sovereign governments,
agencies, supranational entities
Debt issues by corporations
Repos and their importance

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 Conclusion
Read the summary

Review learning objectives

Examples

Practice problems

Practice questions from other sources

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