This glossary focuses on the instruments, practices and the jargon of the cross-border bond

Transcription

1 Bonds Without Borders: A History of the Eurobond Market. Chris O Malley Chris O Malley. Published 2015 by John Wiley & Sons, Ltd. Glossary This glossary focuses on the instruments, practices and the jargon of the cross-border bond markets. It does not seek to explain the relevant regulatory bodies and regulatory measures relevant to the capital markets, which would probably fill a volume on their own. Account A client or customer. Account X A client order in a pot syndication where the client s identity is not revealed. Active bookrunner A bookrunner on a corporate bond issue charged with arranging, pricing and allocating the issue. Amortisation Debt repayment by way of instalments over a scheduled period. Asset stripping The process of buying an undervalued company with the intent to sell off its assets for a profit. Back office A securities firm s accounting, clearing and settlement operations. Bail-in When banks are in difficulty bondholders forfeit part or all of their investment to bail in the bank before taxpayers are called upon. Basis points or bps or bips One hundredth of one percent, i.e. 1 bp = 0.01%. Basis risk The risk that the relationship between the differences (spread) of the price or rates of two closely linked financial instruments will change over time. Bear squeeze (or short squeeze) A bond rising in value having been subject to a substantial level of short sales forcing traders to take losses. Bearer bonds A bond owned by whoever is holding it, rather than having a registered owner. Bells and whistles Additional features of a security designed to attract investors and/or reduce issuer costs. Benchmark Underlying (government) bond or swap of similar maturity against which spreads are calculated. Most bonds are priced relative to a benchmark. Benchmark issue An issue of normal, liquid size relevant to the type of borrower. Bid-ask or bid-offer spread A two-way price comprising a bid, or the price at which a trader is willing to buy, and an ask (or offer) at which a trader is willing to sell. Bond covenant A legally binding term of an agreement between a bond issuer and a bond holder. Bond covenants are always incurrence rather than maintenance based. Bookbuilding Investors indicate to the underwriter how many bonds they would like to buy in a new issue and these indications are accumulated in order to assess demand and set the price of the issue. Bookrunner A lead manager in a bond issue with the responsibility, in whole or part, for managing the P&L of the transaction. Bookrunners are always lead managers, but lead managers are not always bookrunners. 251

2 252 GLOSSARY Bought deal The lead manager(s) buys a whole bond issue on predetermined terms and price and then looks to place the bonds with investors, i.e. final issue terms are agreed between the lead manager and borrower prior to the issue s launch. Brady bonds Bank debt to developing countries converted into negotiable bonds backed by US Treasuries under a scheme introduced in 1989 by the then US Treasury Secretary Nicholas Brady. Bridge The automated interface or link between the ICSDs, Euroclear and Clearstream (formerly Cedel). Bullet A bond which pays a fixed rate of interest and is redeemed in full on maturity. Sometimes called a straight or vanilla bond. Bunds German government bonds. Buy-side Institutional investors who buy investments on behalf of others. Call feature The issuer has the option to redeem (i.e. call) the bond on specified dates and prices prior to maturity. Cap The highest interest rate that can be paid on a floating rate security. Capital adequacy Measure of the financial soundness of a bank, usually calculated as a ratio of its capital to its assets. Carry trade A transaction where money is borrowed at a low interest rate to finance the purchase of a security with a higher one. CD: Certificate of Deposit A money market instrument issued by a depository institution as evidence of a time deposit typically less than one year. CDO: Collateralised Debt Obligation A securitised interest in a pool of loans or debt instruments typically divided into tranches. It may be a collateralised loan obligation (CLO) if it holds only loans or collateralised bond obligation (CBO) if it holds only bonds. CDO 2 A CDO structure where the underlying portfolio is made up of other CDOs (also called a resecuritisation ). CDS: Credit Default Swap A credit derivative where the seller agrees, for an up-front or continuing premium or fee, to compensate the buyer when a specified event, such as default, restructuring of the issuer of the reference entity, or failure to pay, occurs. Central Counterparty or CCP CCPs place themselves between the buyer and seller of a transaction and effectively guarantee the obligations under the contract agreed between the two counterparties, both of which would be participants of the CCP. CMO: Collateralised Mortgage Obligation A bond backed by multiple pools (or tranches) of mortgage securities or loans. CoCo: Contingent Convertible Hybrid capital securities that absorb losses when the capital of the issuing bank falls below a certain level. They automatically convert into equity on some trigger event, such as a bank s core Tier 1 capital falling below a prescribed limit. Collar Upper and lower limits (cap and floor, respectively) on the interest rate of a floating rate security. Collective action clauses Contractual provisions that enable a sovereign issuer to approach bondholders with a proposal to modify key terms of the relevant bond(s). If certain specified quorums are reached, then the modifications are binding on all bondholders. Commercial paper Short-term financial obligations with maturities ranging from 2 to 270 days, issued by banks, corporations and other short-term borrowers. They are unsecured and usually sold at a discount. Convertible bond A bond containing an option that permits conversion to the issuer s common stock at some fixed exchange. Coupon The rate of interest on a bond. Eurobonds always pay interest annually.

3 Glossary 253 Covered bond Senior, secured obligations of a regulated financial institution. The bonds are secured by a pool of mortgage loans or public sector debt and they offer investors a preferential claim over these assets. Credit card receivables Asset-backed securities collateralised by credit card repayments. Credit derivative An OTC derivative designed to transfer credit risk from one party to another. Credit enhancement A variety of provisions that may be used to reduce the credit risk of an obligation. Cross default Repayment of a bond issue can be accelerated if a borrower defaults on any of its other debts. Currency swap A swap that involves the exchange of principal and interest in one currency for the same in another currency. Custodian A bank or other institution that holds securities on behalf of investors. The custodian s tasks include: the safekeeping of securities, delivering or accepting traded securities and collecting principal and interest payments on held securities. DCM: Debt Capital Markets The bond new issues department of a bank or securities house. Delivery against Payment, or Delivery versus Payment (DvP) A settlement system that stipulates that cash payment must be made simultaneously with the delivery of the security. Delta The delta of any derivative instrument tells us the relation between its price and that of the underlying security. In other words, for a change in the underlying price, the delta represents how much of the change will be reflected in the price of the derivative. Delta hedging An options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. Due diligence The process of researching a borrower s fitness to issue bonds in the international capital markets. Event of default A borrower declares itself bankrupt or is forced into voluntary liquidation. Event risk The risk that an event will have a negative impact on a bond issuer s ability to pay its creditors. FIG: Financial Institutions Group The origination group or desk in DCM servicing such borrowers. Final terms A term sheet specifying details of an issue under a debt programme and linking to the full description of the product/issuer in the base prospectus. Fixed price re-offer The lead manager distributes bonds to the management/ underwriting group who place them with clients. The managers agree to sell to investors at a fixed price, agreed in advance, until syndicate is broken. Syndicate is broken by the lead when most of the issue has been placed at the fixed price. Force majeure A contractual clause in an underwriting agreement which gives new issue managers the right to suspend an offering in the event of major disruptions in the markets caused by external circumstances. Foreign bond A bond offered by a foreign borrower to investors in a domestic capital market and denominated in that nation s currency. A foreign bond issue in the US is a Yankee and in Japan is called a Samurai bond. Forward Rate Agreement or FRA An agreement between two parties who agree on a fixed rate of interest to be paid/received on a fixed date in the future. Fungible An asset perfectly interchangeable with any other of the same type, class and issuer. A fungible bond is a new issue that has all the same specifications as an existing issue, other than price.

4 254 GLOSSARY Futures Transferable, exchange-traded contracts to buy or sell a standard quantity of a specific currency, interest rate, debt instrument or financial index at a future date at a price agreed between the two parties. Global bond A bond eligible to trade in both the domestic and the Eurobond market via special settlement arrangements. Grey market The pre-issue market. The trading of bonds immediately after an issue is announced. Sales are made, as per the ICMA Recommendation, on an if, as and when issued basis. Haircut The percentage by which an asset s market value is reduced for the purpose of calculating capital requirement, margin and collateral levels. Hedge fund A private investment vehicle that uses strategies such as short selling, leverage and derivatives to reduce risk and enhance returns. High-yield bonds Typically corporate bonds that are rated below investment grade by the major rating agencies sometimes called junk bonds. Hybrid A security having features of both debt and equity instruments. Index linked A bond with a coupon rate that varies according to some underlying index (typically CPI or RPI). Initial Price Thoughts (IPT) Tentative price indications for a proposed issue on which managers are seeking feedback. Unlike formal price guidance they may involve several successive iterations that may widen as well as tighten. The process is also termed Price discovery. Inter-dealer Broker (IDB) Specialist financial intermediary that facilitates transactions between traders. Interest rate swap A contractual agreement between two counterparties to exchange interest rate cash flows, based on a specified notional amount; from a fixed rate to a floating rate (or vice versa) or from one floating rate to another. Inverse FRN An interest rate swap where the floating rate has a coupon which rises when the underlying floating rate falls. Thus when the market floating rate falls the payout increases. Investment grade Bonds that are rated at or above Baa by Moody s, or BBB by S&P. IOIs: Indications of Interest Non-binding orders to purchase securities. IPO or Initial Public Offering The first sale of equity by a private company to the public. itraxx Indices A family of credit derivative indices, where the underlying reference entities are a defined basket of European credits. Lead manager A senior or main underwriter of a new issue. Where there is more than one lead manager, they are referred to as Joint Lead Managers or JLMs. Leveraged Buy Out (LBO) The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Liability management Transactions enabling issuers to restructure or retire their debt as their business strategies and/or goals evolve. Libor: The London Interbank Offered Rate The rate banks charge each other for shortterm Eurodollar loans. It is the benchmark used to price many capital market and derivative transactions. Long bond The 30-year US Treasury bond; considered one of the benchmark indicators of interest rates. Mark-to-market The process of daily adjustment of a financial instrument s value to reflect its current market value as the prices go up and down in the market.

5 Glossary 255 Market-maker A firm or person that is actively involved in making simultaneous bid and offer prices in certain securities to facilitate trading and provide liquidity. Master agreement A standard agreement used in over-the-counter derivatives transactions. Medium-term note A debt security issued under a programme that allows an issuer to offer notes continuously to investors through a panel of dealers. Mezzanine The tier between the junior, or equity, tier and the senior tier in a tranched CDO. Mid-swaps The average of bid and offer swap rates for euros used as a benchmark or reference rate over which euro-denominated bonds are priced. Monoline insurers Specialists in providing insurance against the risk of a bond default on a timely basis. Mortgage-Backed Security (MBS) A security that is secured by home (i.e. Residential or RMBS) and other real estate loans (i.e. Commercial or CMBS). Negative carry A situation in which the cost of holding a security exceeds the yield earned. Negative pledge A clause in a bond agreement, which prevents a borrower from pledging assets to other lenders if by so doing bondholders security would be reduced. Netting Instead of swap agreements leading to a stream of individual payments by either party, payment flows are offset against each other so that only one net payment is made. Note A short-term debt instrument, typically with a maturity of between one and 10 years. OATs French government bonds (Obligation Assimilable de Trésor). On-the-run The most recently issued US Treasury bond or note of a particular maturity. Off-the-run refers to Treasury securities that have been issued before the most recent issue and are still outstanding. Optional redemption A right to retire all or part of an issue prior to the stated maturity during a specified period of years, often at a premium. Origination Solicitation of potential borrowers for new debt offerings. OTC: Over the Counter (Also called off-exchange trading) is any trading performed without a formal exchange. Traders negotiate directly with one another over computer networks and by phone. Pari passu Ranking equally. Passive bookrunner A bookrunner without any role in organising and distributing a new corporate bond issue. Passive bookrunners typically get a full underwriting commitment plus fees and access (eventually) to the pot. Pass-through A security representing a direct interest in a pool of mortgage loans. The passthrough issuer or servicer collects payments on the loans in the pool and passes through the principal and interest to the security holder on a pro rata basis. Paying agent Place where principal and interest are payable, usually a designated bank. Perpetual (or perp ) A floating rate note that has no final maturity and therefore has no arrangement for repayment of principal. With no repayment the note assumes equity characteristics. Petrodollars A term prevalent in the 1970s to describe the abundance of dollars held and invested by members of OPEC and other oil producing countries. Pot syndication All or part of a new issue is set aside to be allocated to investors out of a central order book (i.e. the pot ) run by one or more bookrunners. Other syndicate members contribute orders to the pot, but do not control the final allocation or distribution of bonds. Pot issues require syndicate members who are putting orders into the pot to disclose the names of their investors ( name give-up ).

6 256 GLOSSARY Praecipium The part of the management fee of a new issue formally paid to the lead manager. Prepayment risk The possibility that the issuer will call a bond and repay the principal investment to the bondholder prior to the bond s maturity date. A particular feature of RMBS. Price discovery (See Initial Price Thoughts.) Price guidance The price range formally indicated for a proposed issue at or immediately after announcement. Price tension Competition between underwriters on price. Primary market A financial market where the first sale of a financial instrument by the original issuer is sold. Principal write-down A write-down of part or all of the principal of a bond upon the occurrence of a particular trigger event (common in CoCos). Protection A guarantee of a minimum allocation of bonds to an underwriter. Protection buyer The credit default swap counterparty that pays another counterparty to compensate them in the event that the reference entity suffers a credit event. Protection seller The credit default swap counterparty that takes on credit risk of a reference entity in return for appropriate compensation. Put A security that provides a purchaser with the right, but not the obligation, to sell an underlying asset at a specified price at or for a specified period of time. Quanto A type of derivative in which the underlying is denominated in one currency, but the instrument itself is settled in another currency at some fixed rate. Such products are attractive for speculators and investors who wish to have exposure to a foreign asset, but without the corresponding exchange rate risk. Re-allowance The portion of an underwriting fee passed on to other distributers. Receivables Debts or other monetary obligations owed to a company by its debtors or customers. Red herring US term for the preliminary prospectus or offering circular of a new issue, which may be used to obtain an indication of the market s interest. Regulation S The rules governing sales of bearer securities to US investors outside the US. Re-offer Offer of securities from the underwriters or management group to investors (whereas the offer is between the issuer and the management group). Repo A Repurchase Agreement. An agreement between two parties where one party sells a bond to the other party for a specified price with the commitment to buy the security back at a later date. Repo rate The interest rate in a repurchase agreement in which an asset is sold by one party to another in return for collateral. Retention Underwriting banks take up an allocation of bonds but do not disclose where the bonds are distributed. Road show A series of presentations by an issuer of securities to potential investors in different financial centres. Rule 144A The rules governing sales of bearer securities to US-based investors. Secured debt Debt backed by specific assets or revenues of the borrower. In the event of default, secured lenders can force the sale of such assets to meet their claims. Securitisation The process of grouping assets or debt together in order to convert them into marketable securities. Selling concession The compensation in an underwriting agreement paid to members of a selling group.

7 Glossary 257 Selling group Distributers in a syndicate with no underwriting obligation. Selling restrictions Rules governing the selling of securities in different jurisdictions. Sell-side Firms that sell investment services to investors. Short sale A trade involving the sale of a security by an investor who does not actually own it, with the intention of buying the security at a lower price at a later date to earn a profit. Sinking fund Mandatory prepayments made by a borrower to redeem a certain amount of a bond issue, thus reducing the principal amount due at maturity. SIV: Special Investment Vehicle A pool of investment assets that attempts to profit from credit spreads between short-term debt, i.e. issuing commercial paper, and investing in long-term structured finance products such as asset-backed securities. Spread The spread of a bond refers to the difference between the yield of the bond and the yield of, say, a government bond of comparable maturity. Since government bonds are traditionally considered risk-free, the spread reflects the risk premium of the bond. The spread is expressed in basis points ( 1 of 1%). 100 SPV or SPE: Special Purpose Vehicle/Entity A legal entity created by an originator, or seller; typically a major bank or finance company. An SPV s operations are typically limited to the acquisition and financing of specific assets. The SPV issues bonds that are backed by the cash flows of income-generating assets. Stabilisation The process of supporting the price of a new issue by means of over-allotment and then the management group buying the bonds for a limited period of time in the aftermarket. Step-up Bonds with coupon payments that increase ( step-up ) during the life of the security. In many cases, step-ups become callable by the issuer on each anniversary date that the coupon resets after an initial non-call period. Straight bond (See Bullet.) Structured product A security created by combining underlying instruments such as bonds with derivatives. The resulting product is designed to choose the most acceptable risk level and return requirements for the investor. Subordinated bonds Bonds with a promise to pay that cannot legally be fulfilled until payments on certain other obligations have been made, e.g. secured and senior unsecured. Subprime The term used for lending to borrowers at a higher rate than the prime rate as they have a higher risk of default. Subprime borrowers typically have low credit scores due to prior bankruptcy, missed loan payments, home repossession etc. SSA: Sovereign, Supranational and Agency The origination group or desk in DCM servicing such borrowers. Super-senior The highest tier of a tranched CDO with highest credit rating and the lowest exposure to risk. A super-senior tranche is often defined as one that is senior to a AAA rated tranche. Supranational International development organisations owned by groups of sovereign states, e.g. the World Bank. Swap spread The difference between the swap rate for a specific maturity and the yield on a Treasury with the same maturity. Synthetic CDO A CDO created from the securitisation of a portfolio of credit default swaps. Tax gross-up Eurobonds are structured so that they are free of any taxes imposed by the country of the issuer. If withholding taxes are imposed then it is the responsibility of the issuer to make gross-up payments to ensure the investor receives his full return. Thrift A savings and loan institution (similar to a UK building society) in the US.

8 258 GLOSSARY Ticket A securities trade. The term comes from the ticket that records all the terms, conditions and basic information of a trade. Tombstone An advertisement announcing an underwritten bond offering that includes the name of the issuer, amount and basic terms of the bonds. Traditionally it included a list of underwriters ranked in order of seniority. VaR: Value-at-risk A statistical measure which calculates the maximum loss that any financial instrument or portfolio may be expected to suffer over a defined period with a specified confidence level. Warrant An option on an underlying asset which is in the form of a transferable security. Waterfall or cascade Payment allocation of principal and interest cash flows to debt holders in order of priority in a multi-tranche security such as a CDO. Withholding tax A tax levied on income (interest and dividends) from securities owned by a non-resident. Wrap An unconditional and irrevocable guarantee of timely interest and principal payment on a security by the guarantor (typically a monoline insurer). Yield curve A graph showing returns of bonds with the same bond ratings but differing maturities over the same period of time. Yield to maturity The calculated return on investment that an investor will get if they hold the bond to maturity. It takes into account the present value of all future cash flows, as well as any premium or discount to par that the investor pays. Zero coupon bonds A bond that does not pay any interest during its life, but is initially sold at a discount and pays the face value at maturity.