Debt security
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The Law and Lore of Repackaging A Jolly Contrarian owner’s manual™
Debt security in all its glory
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Debt security
Debt security (/dɛt/ /sɪˈkjʊərɪti/.)
A freely transferable financial instrument evidencing indebtedness. Contrast debt securities to equity securities — instruments such as shares, warrants units, which pay neither principal nor interest, but rather account for the overall performance of the company who issue them. Debt securities generally rank ahead of equity securities in the capital structure of the issuer. This is because an issuer must pays off creditors before shareholders.Comes in a few different types:
By type of issuer
- Government bonds - issued by sovereigns so existing free of capital structure, logically immune to insolvency, but practically distressingly capable of default (yes we're looking at you Argentina) and of course the “who’s queen?” gambit
- Corporate bonds
- Structured notes — weird & wacky securitised derivatives, issued outta espievies
By name
Categorisations that will appeal (and occur) only to etiquette freaks — the sort of folk who are jazzed by which side of your plate you take the bun from — and lawyers:
- bond - traditionally a fixed rate debt security
- Note - traditionally a floating rate security
- Medium term note - A debt security issued off a programme rather than as a stand alone)
By interest feature
By position in the capital structure
Senior
Pari passu
- Bond: A bond is a debt security, traditionally bearing a fixed rate of interest, and issued as a stand-alone (rather than off an MTN programme). Compare with a note — which traditionally bears interest at a floating rate, and a medium term note, which can be fixed, floating or structured with all kinds of exotic derivative payoffs, but is issued from a medium term note programme, rather than as a stand-alone issue.
- Note: A note is a debt security, traditionally bearing a floating rate of interest, and issued as a stand-alone (rather than a medium term note, which is issued off an MTN programme).
- Medium term note (or “MTN”): A medium term note is a debt security, which may bear a fixed or floating rate of interest (or some other kooky derivative payoff), and is issued off an MTN programme). At one time, MTNs were typically issued only for a medium term — up to about 5 years — but that's all gone now. They still get called medium term notes though. In practice standalone bonds and notes are far less common these days, because they’re such a faff to issue and list, whereas MTNs are much easier and do pretty much the same job. I know how much you love a metaphor, so think of bonds and notes as broadsheet newspapers, and MTNs as an android app.
- Convertible bond:
Subordinated
By funkiness
- Repackagings - See “weird and wacky securitised derivatives” - jam a par asset swap in an espievie and away you go...
- Securitisations — monetising future cashflows, once so rock ’n’ roll that even Bowie was into it until someone had the idea of...
- Collateralised debt ob — DON'T SAY IT YOU ARE NOT ALLOWED TO SAY IT IT IS LIKE VOLDEMORT
Why aren’t debt securities traded on exchange?
Unlike shares which can trade on exchange, in organised trading facilities or over-the-counter, debt securities (bonds, notes, MTNs, certificates of deposit and so on) tend to trade only over-the-counter. They are not traded on exchange, and (while in bearer form) tend not to be traded in the secondary market nearly as often.
A given issuer tends to issue only one type of share (okay, maybe two - ordinary shares and preference shares). All of its ordinary shares are the same and are interchangeable (technically, they’re “fungible” with each other), meaning the same security is common across all venues in the market. That’s what gets listed, and it is (relatively) liquid.
By contrast, debt securitiess come in all kinds of shares and sizes. The same issuer might issue hundreds of different series with different economic characteristics, maturities and yields and features. Bonds of one series are not fungible with bonds of other series. Hence a given bond is generally far less liquid than an ordinary share of the same issuer. This, there are more issuers, and issues of bonds with different characteristics, which makes it difficult for bonds to be traded on exchanges. Another reason why bonds are traded over the counter is the difficulty in listing current prices.