Fixed Income Security

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 Session Chapters from course textbook and reading material Pedagogy (Case Studies/in-class
Module Session Topic
No(s) other than case studies exercise/questionnaire/presentations)
Time Value of Money Financial Management: An Introduction
1 Chapter 1
(TVM)
Introduction of the time value of money

How to calculate present values: Multiple cash

2 flow; Perpetuities; Annuity Chapter 4 The Investment Detective

How interest is paid and quoted

Time Value of Money: A Home Investment Decision
3 Application of the time value of money Chapter 4
Dilemma
How to calculate present values: Growing
perpetuities; Growing annuities
4 Chapter 4 Case-let/In-class exercise
Application the time value of money: Retirement
Planning

Security Valuation 5 Bond Valuation Chapter 8 Case-let/In-class exercise

6 Equity Valuation Chapter 9 Case-let/In-class exercise

Net present value (NPV); Internal Rate of Return Case-let/In-class exercise

Investment Decision 7 Chapter 5
(IRR); Payback Period The Investment Detective

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Overview of Fixed Income
Security

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Difference between debt and Equity

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Balance Sheet
Resources = Amount from Creditors + Amount from Owners
Resources = Claims
Assets = Liabilities + Shareholder’s Equity

Temporary
Debt Periodic interest and Repayment of capital
No ownership

Assets

Permanent
Equity No obligation to pay dividends, and repay
Ownership

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 Some characteristics of financial claims
• Payoff structure (e.g., fixed promised payment)
• Priority
• Maturity
• Restrictive Covenants
• Voting rights
• Options (convertible securities, call provisions, etc)

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Difference between Debt and Equity

Equity Debt
Duration Permanent Temporary
Payment (Div/Int) No obligation to pay dividend Periodic payment of interest
Repayment of Capital No obligation Repayment of capital
Liquidation Claim Residual Seniority
Ownership Ownership No ownership
 Which one will be treated on par with equity?

1. Perpetual Non-Cumulative Preference Shares (PNCPS)

2. Perpetual Cumulative Preference Shares (PCPS)
3. Redeemable Non-Cumulative Preference Shares (RNCPS)
4. Redeemable Cumulative Preference Shares (RCPS)
 Fixed income security
• Fixed income securities are investment where the cash flows are according
to a predetermined amount of interest, paid on a fixed schedule. Popularly
known as Debt instrument
• Issuer
– Central Government
– State Governments
– Government Agencies/Statutory Bodies
– Public Sector Units
– Corporate
– Banks
– Financial Institutions
– NBFCs

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 Instruments

• Zero Coupon Bonds

• Coupon Bearing Bonds
• Treasury Bills
• Tax-free Bonds
• Sovereign Bonds
• Debentures
• Commercial Paper
• Floating Rate Bonds

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 Bonds
• A bond is a long-term contract under which a borrower agrees
to make payments of interest and principal on specific dates to
the holders of the bonds
• Key Characteristic of bonds
– Par value
– Coupon rate
– Maturity date

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 Other features
• Convertible bonds
• Warrants
• Call provisions
– Give issuer the right to call the bonds for redemption
• Put provisions
– Investors have option to redeem

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 Covenants in Debt Contracts
Performance-covenants
• Cash interest coverage ratio
• Debt service coverage ratio
• Level of EBITDA
• Fixed charge coverage ratio
• Interest coverage ratio
• Ratio of debt to EBITDA
• Ratio of senior debt to EBITDA
Source: Christensen and Nikolaev, 2011
Capital-covenants
• Quick ratio
• Current ratio
• Debt-to-equity ratio
• Loan-to-value ratio
• Ratio of debt to tangible net worth
• Leverage ratio
• Senior leverage ratio
• Net worth requirement
Types of Bonds

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 Zero-coupon bond
• A zero-coupon bond is a bond where the face value is repaid at
the time of maturity.

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 Perpetual bond
• With no maturity date

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Coupon bonds

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 Valuation

C1 C2 1,000 + C N
PV = + + ... +
(1 + r )
1
(1 + r ) 2
(1 + r ) N

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• A bond has an annual coupon rate of 11.5%, paid annually. If
investors demand an annual return of 7.5%. The face value of
the bond is INR 100. The bond is going to mature in 5 years
from now. What is the price of the bond? [Hint:116.184]

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 Government of India Securities
Name of the Security Coupon rate (%) Date of Last Coupon payment Date of Coupon payments

7.17% GS 2028 7.17 July 8 July 08 and Jan 08

6.62% GS 2051 6.62 May 28 May 28 and Nov 28

7.63%GS 2059 7.63 May 19 Dec 17 and June 17

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