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Lesson 1 of 5 · 12 min
Bonds, issuers, maturity and principal
A fixed-income instrument is a contract in which a borrower takes investors' money today and commits to pay interest and repay principal on set dates, and its first features are who borrows, for how long and how much.
In short
- Fixed-income instruments are debt: loans (private agreements, usually with a bank) and bonds (standardised, tradeable securities sold to investors).
- Every fixed-income instrument is a liability, but not every liability (payables, leases, pensions) is a fixed-income instrument.
- Key features: issuer, maturity, principal, coupon rate and frequency, seniority and contingency provisions. Together they define the cash flows.
- Issuers: sovereign and local governments, supranationals, quasi-government agencies, corporations and special purpose entities (which issue ABS). Sovereigns are usually the lowest credit risk in their region.
- Tenor = time left to maturity. One year or less at issue: money market; more than one year: capital market. Perpetual bonds have no maturity date.
Loans, bonds and the rest of the balance sheet
Fixed-income instruments are debt. The borrower (the issuer) receives cash now and promises investors (the lenders) interest plus repayment of the amount borrowed. Those promised, contractual cash flows are what separates debt from equity, whose payouts are discretionary.
A loan is a private agreement, usually between a person or company and a bank. A bond (or fixed-income security) is a more standardised contract between a larger issuer and many investors, designed to be easy to trade. Governments finance themselves almost entirely with bonds, with a few exceptions such as loans from the IMF.
A company typically has only one or two classes of shares, but it may have many debt issues outstanding, each with its own maturity, ranking and currency. That is why the features of each issue need to be read separately.
All fixed-income instruments are liabilities, but many liabilities are not fixed-income instruments. Amounts owed to suppliers, employees, customers or tax authorities are liabilities, and leases and pension obligations resemble debt, but in these modules 'fixed income' means only loans and bonds: claims settled in cash whose counterparty is an investor or a bank.
| Liability | Owed to | Fixed-income instrument? |
|---|---|---|
| Accounts payable | Suppliers | No |
| Accrued payroll | Employees | No |
| Deferred revenue | Customers | No |
| Taxes payable | Governments | No |
| Lease and pension liabilities | Lessors, retirees | No (debt-like, but outside scope) |
| Loans | Banks | Yes |
| Bonds | Investors | Yes |
Who issues bonds
Any legal entity can issue a bond, and the issuer is liable for every interest and principal payment. Issuers fall into a government sector and a private sector.
The sovereign (national government) can tax economic activity in its territory, so its bonds usually carry the lowest credit risk in their region. Bonds of the strongest developed-market sovereigns serve as the benchmark against which other bonds are measured.
| Sector | Issuer | Examples |
|---|---|---|
| Government | Sovereign (national) | A finance ministry's government bonds and bills |
| Government | Local / regional government | A city or province |
| Government | Supranational | Organisations owned by several countries, e.g. the World Bank |
| Government | Quasi-government | Agencies owned or sponsored by a government, e.g. a postal service or state railway |
| Private | Corporate | Companies funding operations or capital spending |
| Private | Special purpose entity | A vehicle that owns loans or receivables and funds them with asset-backed securities (ABS) |
Maturity and tenor
The maturity date is the date of the issuer's final payment. The tenor is the time remaining until then, so a ten-year bond issued three years ago has a tenor of seven years.
Instruments with a tenor of one year or less at issuance are money market securities, for example government bills and corporate commercial paper. Anything longer than one year at issuance is a capital market security.
Perpetual bonds have no stated maturity. Public bodies issued them first; today local authorities and banks (to meet regulatory capital rules) use them. They are still debt, not equity: their cash flows are set by contract, they carry no votes, and they rank ahead of shares in the capital structure.
Classify money market versus capital market by the tenor at issuance, not today's remaining tenor. A five-year bond with six months left is still a capital market bond.
Principal (par or face value)
The principal, par value or face value is the amount the issuer agrees to repay. For a standard bond it is the amount investors pay at issue and get back in one lump sum at maturity.
Some instruments amortise: they return principal in pieces over the life of the debt. A home mortgage is the classic case, where each monthly payment mixes interest with a slice of principal, so nothing large is left to repay at the end.
Bond prices are usually quoted per 100 of par. A price of 98.5 means the bond costs 98.5% of its face value, whatever the size of the holding.
Worked examples
Example 1 Classifying five instruments
Classify each: (1) a 270-day note issued by Valtera Foods; (2) a bond of the Asian Infrastructure Lending Bank, owned by 30 member countries; (3) a 10-year bond of Norrland Rail, a state-owned railway; (4) a bond of the Republic of Ostrava with no maturity date; (5) notes issued by Lumen Auto Receivables Ltd, which owns a pool of car loans.
Example 2 Is a perpetual bond really debt?
An investor says: 'Brennholt Bank's perpetual bonds never repay principal, so they are just shares with a coupon.' What is wrong with this view?
On the exam
Matching questions: money market versus capital market versus perpetual, issuer types (supranational, quasi-government, sovereign), and why sovereign bonds are usually the lowest-risk bonds in their market.
- Money market means one year or less at issuance, not remaining tenor.
- Perpetual bonds are not equity: contractual cash flows, no votes, higher seniority.
- Not every liability is fixed income: payables, leases and pensions are outside the scope.
- Sovereign bonds are backed by the power to tax, not by pledged collateral.
Check yourself
Q1A bank issues a note with 180 days to maturity at issuance. The note is most accurately described as a:
Q2Which of the following liabilities of a company is a fixed-income instrument as defined in these modules?
Q3A national postal service, wholly owned by its government, issues bonds. The issuer is best described as:
Q4Compared with ordinary shares of the same bank, the bank's perpetual bonds most likely:
Q5Sovereign bonds usually have the lowest credit risk in their region because they are:
Answer the 5 questions: +10 XP for each one you get right first time.
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