from other banks in the interbank market for different currencies and different maturities.
● Based on where the bonds are issued and traded, a distinction is made between domestic and international bond markets. The latter includes the Eurobond market, which falls outside the jurisdiction of any single country and is characterized by less reporting, regulatory, and tax constraints. Investors also make a distinction between developed and emerging bond markets.
● Fixed-income indices are used by investors and investment managers to describe bond markets or sectors and to evaluate performance of investments and investment managers.
● The largest investors in bonds include central banks; institutional investors, such as pension funds, some hedge funds, charitable foundations and endowments, insurance companies, and banks; and retail investors.
● Primary markets are markets in which issuers first sell bonds to investors to raise capital. Secondary markets are markets in which existing bonds are subsequently traded among investors.
● There are two mechanisms for issuing a bond in primary markets: a public offering, in which any member of the public may buy the bonds, or a private placement, in which only an investor or small group of investors may buy the bonds either directly from the issuer or through an investment bank.
● Public bond issuing mechanisms include underwritten offerings, best effort offerings, shelf registrations, and auctions.
● When an investment bank underwrites a bond issue, it buys the entire issue and takes the risk of reselling it to investors or dealers. In contrast, in a best efforts offering, the investment bank serves only as a broker and sells the bond issue only if it is able to do so. Underwritten and best effort offerings are frequently used in the issuance of corporate bonds.
● The underwriting process typically includes six phases: the determination of the funding needs, the selection of the underwriter, the structuring and announcement of the bond offering, pricing, issuance, and closing.
● 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.
● Most bonds are traded in over-the-counter (OTC) markets, and institutional investors are the major buyers and sellers of bonds in secondary markets.
● Sovereign bonds are issued by national governments primarily for fiscal reasons. They take different names and forms depending on where they are issued, their maturities, and their coupon types. Most sovereign bonds are fixed-rate bonds, although some national governments also issue floating-rate bonds and inflation-linked bonds.
● Local governments, quasi-government entities, and supranational agencies issue bonds, which are named non-sovereign, quasi-government, and supranational bonds, respectively.
● Companies raise debt in the form of bilateral loans, syndicated loans, commercial paper, notes, and bonds.
● Commercial paper is a short-term unsecured security that is used by companies as a source of short-term and bridge financing. Investors in commercial paper are exposed to credit risk, although defaults are rare. Many issuers roll over their commercial paper on a regular basis.
● Corporate bonds and notes take different forms depending on the maturities, coupon payment, and principal repayment structures. Important considerations also include collateral backing and contingency provisions.
● Medium-term notes are securities that are offered continuously to investors by an agent of the issuer. They can have short-term or long-term maturities.
● Financial institutions have access to additional sources of funds, such as retail deposits, central bank funds, interbank funds, large-denomination negotiable certificates of deposit, and repurchase agreements.
● A repurchase agreement is similar to a collateralized loan. It involves the sale of a security (the collateral) with a simultaneous agreement by the seller (the borrower) to buy the same security back from the purchaser (the lender) at an agreed-on price in the future. Repurchase agreements are a common source of funding for dealer firms and are also used to borrow securities to implement short positions.
PROBLEMS
This question set was developed by Michael Whitehurst, CFA (San Diego, CA, USA). Copyright © 2013 by CFA Institute.
1. In most countries, the bond market sector with the smallest amount of bonds outstanding is most likely the:
A. government sector.
B. financial corporate sector.
C. non-financial corporate sector.
2. The distinction between investment grade debt and non-investment grade debt is best described by differences in:
A. tax status.
B. credit quality.
C. maturity dates.
3. A bond issued internationally, outside the jurisdiction of the country in whose currency the bond is denominated, is best described as a:
A. Eurobond.
B. foreign bond.
C. municipal bond.
4. Compared with developed markets bonds, emerging markets bonds most likely:
A. offer lower yields.
B. exhibit higher risk.
C. benefit from lower growth prospects.
5. With respect to floating-rate bonds, a reference rate such as the London interbank offered rate (Libor) is most likely used to determine the bond's:
A. spread.
B. coupon rate.
C. frequency of coupon payments.
6. Which of the following statements is most accurate? An interbank offered rate:
A. is a single reference rate.
B. applies to borrowing periods of up to 10 years.
C. is used as a reference rate for interest rate swaps.
7. An investment bank that underwrites a bond issue most likely:
A. buys and resells the newly issued bonds to investors or dealers.
B. acts as a broker and receives a commission for selling the bonds to investors.
C. incurs less risk associated with selling the bonds than in a best efforts offering.
8. In major developed bond markets, newly issued sovereign bonds are most often sold to the public via a(n):
A. auction.
B. private placement.
C.
