The most comprehensive educational resources for finance

Federal Agency Securities

In any country, the central government can create an agency or a separate organization that issues bonds for its various departments and different purposes. The bonds so issued are not directly issued by the government, and therefore are called semi-government or agency bonds. Depending on the issue, these bonds may have an implied guarantee of

Overview of U.S. Treasury Securities

The United State’s Treasury issues various types of securities known as US Treasury securities. These securities are backed by full faith and credit of US government, hence, they are perceived to be credit risk-free. How are they issued and traded? Primary issue method: Sealed bid auctions on a regular cycle/single-price method. All the winning bidders

Four Methods of Distributing Government Securities

The central governments use one of the following four methods to distribute a new issue of securities: Regular calendar auction / Dutch style auction In this type of auction, there is a regular auction cycle. The winning bidders are allocated securities at yield (price) they bid. This is also called multiple-price method. Regular calendar auction

Credit Risk and Rating of Sovereign Debt

As we have learned earlier, the investors in bonds are exposed to credit risk as there is a chance that the issuer may default on its obligations. Even though the general perception is that the bonds issued by the government are considered free of default, in reality all bonds expose the investors to credit risk.

Types of Bond Markets

Even though there is no standard classification of bond market, we can broadly classify bonds from the perspective of a country as follows: Internal Bond Market: This is the national bond market of a country. The internal bond market itself has two subcategories: Domestic Bond Market: This refers to the market where the issuers domiciled

Event Risk and Sovereign Risk in Bonds

Event Risk The investors in bonds may also face event risk, i.e., the risk that the issuer will not be able to meet its interest and principal payment obligations due to a major event that impacts its financial condition. There are three broad categories of event risk: A natural disaster such as an earthquake, a

Volatility Risk in Bonds with Embedded Options

Bonds with embedded options such as call options and put options also have volatility risk. This happens because any factor that affects the value of the embedded option will also impact the value of the bond. We earlier learned that interest rates affect embedded options. When interest rates rise, the price of the embedded call

Inflation Risk in Bonds

Almost all bonds expose an investor to inflation risk, also known as purchasing power risk. It is a risk that the increase in inflation may wipe out the profits from the bond. I’ll take a simple example to explain this. Let’s say you buy a 1-year $100 bond that pays 8% coupon. At the end

Exchange Rate Risk in Bonds

Some bonds and other fixed income products also expose the investor to exchange rate risk (also known as currency risk). This happens when the investor purchases bonds that have cash flows in a foreign currency instead of his domestic currency. In such a case, when the investor receives the foreign currency-denominated cash flow, he will

Liquidity Risk in Bonds

Investors in bonds also face liquidity risk. This is the risk that the investor may have to sell the bond at a price lower than the expected price. Based on the market conditions and also on a review of recent market transactions, the investor can get an idea of the indicative price at which he