Issuers and investors need to consider repayments structure and redemption features
Fixed income securities are structured to fit an issuer's specific objectives and financial limitations while satisfying market demand. As such, interest and principal repayment schedules of a fixed income security are customized by adjusting one or more of these characteristics:
Adjusting any of these characteristics will alter the fixed income securities repayment schedule, price, and investor interest.
The issuer initially receives the $1,000 loan from the investor. At each subsequent period (i.e. 6 months), the issuer will pay the investor a $25 coupon payment until maturity. When the bond matures, the issuer will pay the investor a $25 coupon in addition to the $1000 principal. A non-callable fixed-rate bond is also known as a bullet bond.
Semi-annual pay bonds are the standard form of borrowing in the debt capital market. These bonds pay a fixed coupon rate of interest in two equal semi-annual payments until maturity. Their maturity dates are typically set in advance. The cash flow of this bond is broken down into a series of fixed interest payments and a single principal payment at maturity.
Floating rate notes (FRNs) are variable rate bonds with coupon rates that are tied to a benchmark rate (e.g. 3-month LIBOR). FRN coupon payments are paid monthly, quarterly, semiannually, or annually and reset every period. FRNs are typically between two to five years to maturity, but may be as long as ten years.
Amortized bonds, or “amortizers”, are bonds where the principal amount is paid down over the life of the bond along with the coupon payments. An amortized bond’s principal and coupon payments follow an amortization schedule, which typically has equal payments.
Real return bonds (RRBs) are inflation-linked bonds. RRBs’ coupon rates are adjusted for inflation. For example, coupon payments for each period could be linked to the prevailing Consumer Price Index (CPI) at the start of each payment period.
A bond can include a sinking fund feature where the issuer makes periodic payments to retire part of the issue by purchasing bonds in the open market. A sinking fund adds safety from the perspective of investors as the likelihood of default due to failure to repay principal is reduced.
Following the financial crisis of 2008, global interest rates have declined to all-time lows, with sovereign yields in many countries becoming negative – something many economists never believed to be possible. A key driver of the decline comes from central banks globally, that have since 2008, engaged in the most accommodative monetary policy in history. This new era of low interest rates has been popularized by PIMCO as the “new neutral”
The extensive level of monetary policy is best understood through two key pillars:
Overall, the extreme decline in interest rates has driven distortions in both fixed income and equities markets and has driven many economists to question previously popular frameworks.