Debt security

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The Jolly Contrarian’s Dictionary

The snippy guide to financial services lingo.™
“Bond” as explained to my neighbor Phil

A bond certificate with coupons on the right

A bond (also called a “note”, “MTN” or a “debt security”) is a form of loan. It is like an IOU from a company or a government. Instead of taking one big loan from a bank, a company issues lots of little loans, in the form of bonds to investors. To buy a bond is to lend money to the issuing company, who must repay that money by “redeeming” the bond its stated maturity date. In the good old days, bonds were security-printed certificates with the loan terms and conditions printed on them.

Repayment to bearer: The company will pay principal and interest to the “bearer” of a bond — that is, whoever holds it, and who turns up on the correct payment date and presents the bond to the issuer for redemption.

Interest coupons: If interest is payable, the bond will have coupons — literally, little perforated tabs that you can tear off and present separately — for each interest payment. Hence the expression “coupon” has become synonymous in modern finance with interest.

Transferability: Because the issuer pays whoever holds the bond, this means the bond is negotiable — any bondholder can sell its bond to another investor without the issuer’s permission or knowledge. The issuer doesn't care: it has to redeem the same number of bonds, whoever holds them.

Electronic trading: Nowadays, almost all bonds trade and settle electronically, inside clearing systems, so there are no certificates or coupons, and everything happens in the blink of an eye. But the principle is the same.

Things my neighbor Phil was asking about: Bond | Swap | Quantitative easing | Repo | credit default swap | futures | options | antitrust

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Debt security /dɛt/ /sɪˈkjʊərɪti/ (n.)

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

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:

By interest feature

By position in the capital structure

Senior

Pari passu

Subordinated

By funkiness

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.

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