Fixed Income Glossary

This is a glossary of common terms used in fixed income.

Accrued Interest
The interest that accumulates on a fixed income security between one interest payment and the next. This amount can be calculated by multiplying the coupon rate with the number of days since the previous interest payment. In the US, the bond's price typically excludes the accrued interest. Thus, when you buy a bond, you will pay the price plus the accrued interest and then receive the full amount of the next interest payment which is reimbursement for the accrued interest.

Agency Bond
A federal agency like Ginnie Mae (GNMA) can raise money by issuing bonds or short-term discount notes. Interest earned is slightly higher than that on Treasury issues, though they are considered nearly as safe from default. Some of the interest earned is exempt from income taxes.

Annual Percentage Rate (APR)
The APR of a loan is the cost of the credit per year, expressed as a percentage of the loan amount. The APR is typically higher than the nominal rate, as it includes upfront fees as well.

Annual Percentage Yield (APY)
The APY of a loan is the amount that is earned on an interest-bearing investment per year, expressed as a percentage of the total due. The APY is typically higher than the interest rate, as the interest is being compounded.

Annuity
An annuity is also an insurance product that allows you to accumulate tax-deferred assets that can be converted to a source of lifetime annual income.

Ask
The ask price is the price at which you can buy a security from a market maker or broker.

Asset-backed Bond
An asset-backed bond is secured by loans or money owed to a company for products or services that were purchased on credit. For example, a bank could bundle debt like credit card or car loans and sell it to investors who would then receive the payments (if any) made on these loans.

Average Annual Yield
The average annual yield is the average yearly income on an investment, expressed as a percentage of the cost.

Barbell Strategy
Refers to the strategy of investing equivalent amounts in short- and long-term bonds, without buying middle-term bonds. This creates the shape of a "barbell." The idea is to earn more interest than intermediate-term bonds without taking on more risk. It requires continually rolling the short-term bonds that come due.

Basis Price
100 basis points equal 1%. These small variations are needed to help price yields on fixed income investments which have regular small fluctuations.

Basis
The basis is the total cost of buying an investment. It includes the price, commissions, and other charges. When selling the investment, the basis is subtracted from the selling price to determine the capital gain/loss.

Bearer Bond
A bearer bond is a certificate that is paid to the owner. Bearer bonds came with detachable coupons that had to be presented to the issuer/bank in order to receive the interest payments. This is why a bond's interest rate is known as the coupon rate. Nowadays, bonds are registered electronically, and there is no need for this physical form of tracking.

Bid (and) Ask
The bid-ask is the prices at which you can buy and sell a security. The difference between these two prices is known as the bid-ask spread.

Bid
The bid price is the price at which you can sell a security to a market maker or broker.

Bond Rating
Bond ratings refer to the assessment of several independent agencies, like Standard & Poor's (S&P) and Moody's Investors Service, on the likelihood that bond issuers will default on their loans or interest payments. Only the top few tiers are considered investment-grade bonds, and the rest are known as junk bonds.

Bond
A bond is a long-term debt security that is issued by governments or corporations, with maturities of 10 years or more. These are loans that are made in exchange for the promise of being paid interest regularly.

Call Premium
The dollar amount paid as a penalty by the issuer to exercise his right to repurchase the security before its maturity date.

Call
The action taken to repurchase a callable bond prior to the stated maturity date.

Callable Bond
A callable bond can be redeemed by the issuer before it matures. These bonds are usually redeemed when interest rates fall, as the issuer can save money by paying off existing debt and offer new bonds at the lower interest rates. The issuer will pay a premium for redeeming these bonds.

Ceiling The upper limit for the interest rate on a floating-rate bond.

Certificate of Deposit (CD)
These are issued by banks with maturities that vary from a few weeks to several years. The bank pays a fixed interest rate that is determined at the start. Early withdrawal usually results in a penalty payment that could be as high as the entire interest accrued.

Collar
The lower and upper limits for the interest rate on a floating-rate bond.

Compound Interest
Interest is compounded if it is paid out in each time period, which allows you to earn interest on the previous interest payment. Banks typically pay compound interest monthly, based on the average amount of money held daily in a bank account.

Continuously compounded interest
Continuously compounded interest refers to compounding interest at every single possible moment. As such, the value of the investment will be \( P e ^ { rt } \).

Convertible Bond
This is a bond which contains a provision that allows conversion of the bond to common stock at some fixed exchange rate.

Convexity
Convexity is a measure of curvature in the relationship between bond prices and bond yields. This accounts for the change in duration for a given change in yield. Non-redeemable securities typically exhibit positive convexity, while callable securities can have negative convexity to account for the embedded call option.

Counter-Party Risk
This is the risk to each part of a contract that the counterparty will not live up to the contractual obligations.

Coupon Frequency
This is the established date that interest payments on a bond are due. Typically, most bonds pay semi-annual interest payments, though some pay monthly, quarterly, yearly, or no interest payments.

Coupon Rate
The coupon rate is the interest rate that the issuer of a bond promises to pay during the term of a loan.

Credit Default Swap (CDS)
A CDS is a swap in which one party provides a guarantee for the benefit of a second counterparty to the swap with respect to the credit performance of a reference issuer on its debt obligations. For a premium, the CDS seller will make a payment in the event of a default to compensate the buyer on a specified notional amount of the debt.

Current Yield
This is a measure of the return on a bond, calculated by dividing the annual interest on the bond by the amount paid for the bond. It is the actual income rate, or the yield to maturity, as opposed to the coupon rate.

Default
A bond issuer is in default when they fail to pay the interest or principal when due. This often results in a great drop in the price of the bond, since future payments are extremely unlikely.

Discount Bond
A discount bond is a bond whose price is lower than its par value. This is often because the bond has a coupon rate that is lower than the yield rate or because the bond is deemed extremely risky and has a high likelihood of default.

Discount Note
This is a short-term obligation that is issued at discount from the face value. There are no coupons offered, and interest is paid at maturity.

Discount Rate
This is the rate that the Federal Reserve charges for loans to member banks. It is often used as a benchmark for other loan rates. It also refers to the interest rate used in discounted cash flow analysis.

Discount
A discount refers to the amount by which the sales price of a note/bond is less than the par value.

Dollar Price
The unit which the market quotes a fixed income security, often stated as a percentage of the face value. The fractional component is quoted in decimals or thirty-seconds, depending on the type of the security. The dollar price does not include accrued interest.

Double-exemption Bonds
Bonds that are exempt from both state and federal income taxes.

Downgrade
A bond's rating is downgraded by a rating agency lowering their rating. This indicates a perceived increase in the likelihood of default.

Duration
This is the dollar amount change in the price of a security for a one percent change in yield.

Dutch Auction
A dutch auction is a specific type of auction in which the participants submit sealed bids for a security. The price is set to the lowest price \(P\) at which there is sufficient bids to fulfill the required amount of the action, and all of those who bid above this price will receive the security at this price \(P\). Bids below this level do not receive the security. This process is used by several Treasury bond issues.

Face Amount
The value at maturity of a bond, also known as par value.

Fed Funds Effective Rate
The overnight rate at which banks lend funds to each other, unusually in the form of unsecured loads. The Fed funds rate is the average dollar-weighted rate of these overnight funds. This is the US version of the LIBOR.

First Call Date
The earliest date in a schedule of call dates, indicating prices at which a bond can be called.

Fixed Income Security
A security, like a note or a bond, that pays a stated rate of interest during the term of the security and returns the principal at maturity.

Flat
A bond that is trading without accrued interest. This is the common practice in the US.

Floating-rate Bond
A bond with a variable interest rate that changes at intervals.

Floor
The lower limit for the interest rate on a floating-rate bond.

Forward Price/Yield / Rate
This is the price implied by the current yield curve for a security whose settlement date is in the future.

General Obligation Bonds (GO)
These are municipal bonds that are backed by the taxing and borrowing power of the municipality that issues the bonds.

High-grade Bonds
Top rate bonds, often AAA, that carry relatively little risk of default.

High-yield Bond
These are bonds that are rated lower than BBB/Baa and are considered to have a much higher risk of default, and as such they pay a higher yield than investment grade bonds. These are also known as junk bonds.

Leverage
Using borrowed money to increase investing power. This magnifies the outcome of profits and losses and hence is considered extremely risky.

LIBOR
LIBOR stands for the London Interbank Offered Rate. It is the average interest rate that banks charge each other for borrowing. The loan periods vary from overnight to one year. It has become the primary benchmark for short-term interest rates around the world.

Liquidity
The capacity of a market to absorb a reasonable level of selling or buying without significant price movements.

Mark-To-Market
The recording of the actual market value of securities.

Market Maker
A firm or person that accepts risk and is actively involved in making bids and offers to facilitate trading.

Maturity Date
The date when the principal amount of a security becomes due and payable.

Modified Duration
This is the percentage change in price of a security for a one percent change in yield. A security with a higher duration would have higher interest rate risk.

Moral Obligation Bond
This is a revenue bond which, in addition to the primary source, also allows the state to make up for shortfalls, subject to legislative approval. There is no legal obligation for the state to make such a payment, but the market understands that failing to honor the "moral" pledge would result in negative consequences for the state's creditworthiness.

Mortgage
A legal instrument that creates a lien upon real estate securing the payment of a specific debt.

Near Money
A bond that is close to its maturity date.

Net Price
The total amount an investor pays for a bond, which would include the accrued interest.

Notes
Short-term instruments to pay specified amounts of money. They have maturity dates ranging from 1 year to 10 years.

Oversubscribed
In a syndicated deal, an issue is oversubscribed when the total investor orders are greater than the offered size of the bond issue. This often leads to higher prices (or a lower yield).

Par Value
The value at maturity of a bond.

Parity
The theoretical price which would make the yield equal to the coupon.

Payment Date
The date that principal or interest payments are due to be paid to the owner of the security.

Perpetuity
A perpetuity is a bond that pays a coupon forever. This bond doesn't mature and hence does not have a principal amount. The price can be calculated by discounting all of the coupon payments.

Premium Bond
A premium bond is a bond whose price is higher than its par value. This is often because the bond has a coupon rate that is higher than the yield rate.

Present Value
The (net) value today of a sum of money that is available in the future, based on a certain interest rate.

Primary Market
The primary market refers to the market for new issues, stocks or bonds initially offered for sale, and the money goes directly to the issuer.

Realized Yield
The return on a bond, which includes reinvestment of the coupon payments at a stated rate of interest.

Reinvestment Risk
The risk that interest income or principal repayments will have to be reinvested at a lower rate, especially when rates are declining.

Repurchase
An issuer buys back bonds or stocks from the public.

Revenue Bonds
Revenue bonds are issued to finance projects or enterprises in which the bond issuers pledge the revenues generated by the financed projects to repay bondholders. These include utilities, health care, and transportation.

Roll
Rolling down the future curve refers to selling a shorter-term maturity and buying a longer-term maturity. This allows one to roll their position from one month to the next.
Roll also refers to the difference in yield or price between two maturities.

Secondary Market
The secondary market refers to trading stocks or bonds after they have been issued. It includes the exchanges, trading rooms, electronic networks, etc. where these transactions occur. The issuer receives no proceeds from this sale.

Settlement Date
The date on which a security has to be delivered in exchange for funds. This differs for each security type.

Short-term Debt
Debt with a maturity of less than one year. Short-term Treasury debt is also known as Treasury bills.

Simple Interest
Simple interest is a quick method of calculating the interest charge on a loan. It is determined by multiplying the interest rate by the number of periods by the principal amount. It ignores the effect of compounding and hence is an under-approximation.

Strip
This refers to the process of removing coupons from a bond and then selling the parts separately as a zero-coupon bond and an interest-only product.

Sub-prime
Loan pools that are considered inferior due to certain characteristics like having a low FICO score or a high LTV.

Swap
The exchange of one security for another to change the maturity, quality of issue, or to meet other investment objectives.

Treasury Bills
This is a security issued by the US government with a maturity of one year or less. T-bills are purchased at a discount to the full face value, which is received on maturity.

Treasury Bonds
These are the long-term obligations of the US government-backed debt, that mature in 10 or more years. Interest is paid semi-annually.

Treasury Inflation-protected Security
This is a special type of Treasury note which offers protection from inflation. The coupon payments and underlying principal are automatically increased to compensate for inflation.

Underlying Asset
A structured product proves a return based on the performance of some underlying reference asset of an index. This could be single stocks, equity indices, commodities, or currencies.

Volatility
The propensity for a security's price to rise or fall.

Yield Curve
The line tracing relative yields on a type of security over a spectrum of maturities ranging from three months to 30 years.

Yield to Call
The expected yield to maturity of a bond if it is called on the scheduled exercise date.

Yield to Maturity
The expected rate of return of a bond if it is held to its maturity date. It is equivalent to the internal rate of return (IRR).

Yield
The income return on an investment expressed on an annual percentage. The basis on which a bond is priced and sold, reflecting the value of the bond in consideration of the time to maturity, creditworthiness of the issuer, and general market conditions.

Zero-coupon Bond
This is a fixed income security that does not pay a coupon. Instead, it is issued at a discount.