Bond Features

Section: Fixed Income — Bond Features Estimated study time: 45 minutes Content: A bond is a debt security representing a loan from the investor (bondholder) to the issuer. In exchange for the principal (face value or par value), the issuer promises to make periodic interest payments (coupons) and to repay the principal at maturity. Understanding bond indentures — the legal contract governing a bond — and the key structural features of bonds is foundational to fixed income analysis. The indenture specifies the covenants, which may be affirmative (the issuer must do certain things, like maintain insurance or file financial statements) or negative (the issuer must refrain from certain actions, like incurring additional debt above a threshold or paying dividends above a specified amount). Covenants protect bondholders from actions that would reduce the security of their investment. Bond features vary along several dimensions. Coupon structure: fixed-rate bonds pay a constant coupon; floating-rate notes (FRNs) pay a variable coupon tied to a reference rate (e.g., SOFR + spread); zero-coupon bonds pay no coupon but are issued at a discount to par and mature at par. Maturity: short-term bonds (typically <2 years) have low interest rate sensitivity; long-term bonds (>10 years) have high sensitivity. Seniority: secured bonds have claims on specific collateral; senior unsecured bonds have general claims on assets; subordinated bonds have residual claims after senior creditors are satisfied. In bankruptcy, the absolute priority rule dictates the order of repayment: secured creditors first, then senior unsecured, then subordinated, then preferred equity, then common equity. Embedded options in bonds significantly affect their pricing and behavior. Callable bonds give the issuer the right to redeem the bond before maturity at a specified call…