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CFA® Level I · Fixed Income · free lesson
Fixed-Income Instrument Features
A bond is a legal contract, and every later calculation in fixed income depends on reading that contract correctly. This module explains the basic features of a fixed-income security, what the bond indenture contains, how affirmative and negative covenants protect lenders, and how legal jurisdiction, regulation and taxation shape where bonds are issued and who buys them.
What you will learn
1. Describe the basic features of a fixed-income security, including its issuer, maturity, par value, coupon rate and frequency, currency and seniority.
- Basic features: issuer, maturity (tenor), par value, coupon rate and frequency, currency and seniority.
- Money market: original maturity of one year or less; capital market: longer than one year; perpetual bonds have no maturity.
- Prices are quoted as a percentage of par; coupons are always computed on par, not on the price.
- Periodic coupon = coupon rate x par / number of payments per year.
- Current yield = annual coupon / price; it ignores any gain or loss as the bond moves to par.
2. Describe the contents of a bond indenture, including the issuer's legal identity, the source of repayment, collateral backing and credit enhancements.
- The indenture (trust deed) is the bond's legal contract; a trustee acts for the bondholders.
- Source of repayment: taxes (sovereign), taxes or project revenues (non-sovereign), operating cash flow (corporate), an asset pool (securitized).
- Secured bonds have collateral; unsecured bonds rely on general credit; covered bonds give dual recourse to the issuer and a cover pool.
- Internal credit enhancement: subordination, overcollateralization, reserve accounts. External: surety bonds, bank guarantees, letters of credit.
- An external guarantee replaces part of the issuer's credit risk with the guarantor's credit risk.
3. Distinguish affirmative covenants from negative covenants and explain how covenants protect bondholders.
- Affirmative covenants: what the issuer must do (pay on time, insure assets, comply with laws, report, pari passu ranking, cross-default).
- Negative covenants: what the issuer must not do (extra debt, negative pledge, prior claims, distributions, asset sales, investments, mergers).
- Negative covenants protect bondholders but limit the issuer's flexibility, so they lower the yield the issuer must pay.
- High-yield bonds carry more and tighter covenants than investment-grade bonds.
- Bondholders are protected only by the covenants written into the contract.
4. Explain how legal jurisdiction, regulation and taxation affect the issuance and trading of fixed-income securities, and classify bonds as domestic, foreign, Eurobond or global.
- Domestic: local issuer, currency and market. Foreign: foreign issuer in another country's domestic market and currency (Yankee, Samurai, Bulldog, Panda).
- Eurobond: outside any single jurisdiction, usually in a currency different from that of the market where it is sold. Global bond: Eurobond and domestic markets at once.
- Governing law matters: local-law bonds are easier for a sovereign issuer to alter than foreign-law bonds.
- Compare tax-exempt and taxable yields with the taxable-equivalent yield.
- Original issue discount may be taxed as it accretes, before any cash is received.
Module at a glance
- Read the contract first: issuer, maturity, par, coupon rate and frequency, currency and seniority.
- Coupons are computed on par; current yield = annual coupon / price.
- The indenture sets out the issuer's legal identity, source of repayment, collateral, credit enhancements and covenants.
- Internal credit enhancements are structural; external ones depend on a third party's credit.
- Affirmative covenants say what the issuer must do; negative covenants say what it must not do.
- Domestic, foreign, Eurobond and global bonds differ by issuer, currency, market and regulation.
- Governing law and taxation change who can alter a bond's terms and what investors keep after tax.
This free module has 4 lessons, 13 practice questions with full explanations.