Learning Module 1
Fixed-Income Instrument Features
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Describe the features of a fixed‑income security, including issuer, maturity, principal, coupon rate and frequency, seniority, and contingency provisions.
Describe the contents of a bond indenture and contrast affirmative covenants (what issuers must do) and negative covenants (what issuers cannot do).
1 · Key Features of Fixed‑Income Securities
Issuer & Maturity
Issuer: Any legal entity — sovereign, local government, supranational, corporate, or special purpose entity (SPE). Sovereign bonds are backed by taxation and fiscal power, representing the lowest credit risk in a region.
Maturity: The date of the final payment. Money market securities have tenor ≤ 1 year (e.g., T‑bills, commercial paper). Capital marketsecurities have tenor > 1 year. Perpetual bonds have no stated maturity but have contractually defined cash flows and seniority over equity.
Principal & Coupon
Principal (par/face value): Amount repaid at maturity. May be repaid in equal/variable increments over time (e.g., amortizing loans).
Coupon rate and frequency: Fixed‑coupon bonds pay uniform payments (monthly, quarterly, semiannual, annual). Corporate bonds typically pay semiannually.
Floating‑rate notes (FRNs): Coupon = MRR (market reference rate) + credit spread. MRR resets periodically; the spread is fixed at issuance.
Zero‑coupon bonds: No periodic interest; issued at a discount to par; the difference represents cumulative interest at maturity.
Annual coupon = Par value × Coupon rate
FRN coupon = MRR + Credit spread
Seniority & Contingency Provisions
Seniority: Priority of repayment in bankruptcy/liquidation. Senior debt is paid before junior (subordinated) debt.
Contingency provisions: Embedded options — call (issuer can redeem early), put (investor can sell back), and conversion (convert to equity). These cannot be traded separately from the bond.
Yield Measures
Current yield (CY): Annual coupon ÷ Bond price (analogous to dividend yield).
Yield‑to‑maturity (YTM): Internal rate of return (IRR) using price and expected cash flows to maturity. Quoted as an annual rate. Investor earns YTM only if (1) all payments received as scheduled, (2) held to maturity, and (3) coupons reinvested at YTM.
Yield curve: Graph of YTM vs. time‑to‑maturity for an issuer's debt. The spread over sovereign bonds reflects credit risk.
Price = Σ [PMT / (1 + r)ⁿ] + [Par / (1 + r)ᴺ]
where r = yield per period, N = number of periods
2 · Bond Indentures & Covenants
Bond Indenture
The legal contract describing the bond's form, issuer obligations, and bondholder rights. Specifies features, sources of repayment, and any commitments or provisions that support repayment.
Sources of Repayment
Sovereign bonds: Tax revenues (and, in some cases, the ability to print currency).
Local/regional government bonds: Local taxes or fees from infrastructure projects (tolls, transit).
Corporate bonds: Operating cash flows. Unsecured bonds rely solely on cash flows. Secured bonds have a legal claim (lien/pledge) on specific assets as a secondary source.
Asset‑backed securities (ABS): Cash flows from a pool of loans or receivables owned by the SPE.
Bond Covenants
Use of proceeds
Provide timely financial reports
Permit bondholders to redeem at a premium if issuer is acquired
Pari passu clause ("equal footing") — ensures equal treatment with other senior debt
Cross‑default clause — default on one obligation triggers default on others
Limitation on liens (pledging assets as security for other debt)
Limitation on sale and leaseback
Merger and consolidation restrictions
Limitation on additional debt (incurrence tests)
Restrictions on dividends and distributions
Negative pledge clause — prohibits issuing senior debt to existing obligations
Incurrence test: A financial ratio test (e.g., Net Interest Bearing Debt/EBITDA ≤ 4.5×, Interest Coverage Ratio > 3.0×) that must be met before taking certain actions (e.g., issuing additional debt, paying dividends).
Covenant violations give bondholders recourse: interest rate increases, accelerated debt payments, or termination of the debt agreement.
3 · Quick Reference — Bond Features
Feature | Description |
|---|---|
Issuer | Sovereign, local government, supranational, corporate, SPE |
Maturity | Date of final payment; tenor ≤ 1 yr (money market) or > 1 yr (capital market) |
Principal | Par/face value repaid at maturity; may amortize over time |
Coupon | Fixed, floating (MRR + spread), or zero‑coupon |
Seniority | Senior → secured > senior unsecured > subordinated |
Contingency | Call (issuer), put (investor), conversion (to equity) |
Yield | Current yield = coupon/price; YTM = IRR to maturity |
Indenture | Legal contract; contains covenants (affirmative & negative) |