glossary investing bonds en

8/9/2019 Glossary Investing Bonds En

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Glossary of Bond Terms

Accrued interest

Interest deemed to be earned on a security but not yet paid to the investor. The amount is

calculated by multiplying the coupon rate by the number of days since the previous interest

payment.Ask price

Price being sought for the security by the seller.

Ask yield

The return an investor would receive on a Treasury security if he or she paid the ask price.

Asset allocation

Asset allocation is an investment strategy in which an investor divides his/her assets among

different broad categories of investments (such as bonds) to reduce risk in an investment

portfolio while maximizing return. The percentages allocated to each investment category at any

given time depend on individual investor needs and preferences including investment goals, risktolerance, market outlook, and how much money there is to invest.

Asset swap spread

The asset swap spread (also called the gross spread) is the aggregate price that bondholders

would receive by exchanging fixed rate bonds for floating rate bonds using the swaps market,mainly used to reduce interest rate risk. The asset swap spread is one widely used metric to

determine relative value of one bond against other bonds of the same currency. Asset swaps can

be a tool to understand which bond or bonds maximize the spread or price over a referenceinterest rate benchmark, almost always LIBOR, the London InterBank Offered Rate.

Asset-backed bonds or securities (ABS)

Asset-backed securities, called ABS, are bonds or notes backed by financial assets other than

residential or commercial mortgages. Typically these assets consist of receivables other than

mortgage loans, such as credit card receivables, auto loans and consumer loans. ABS constitute arelatively new but growing segment of the debt market in Europe.

Average annual yield

Average annual yield is the average yearly income on an investment, such as a bond, expressedin percentage terms. To calculate average annual yield, add all the income from an investment

and divide that total amount by the number of years in which the money was invested. For

example, if you receive 10 interest on a 1,000 bond each year for ten years, the average annual

yield is 1% (10 1,000 = 0.01 or 1%).Balance of trade

The difference between the value of a regions imports and exports during a specific period of

time. If the European Union or a specific country imports more than it exports, it has a trade

deficit; if the EU exports more than it imports it has a trade surplus.

Barbell strategy


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Barbell strategy is used as a way to earn more interest without taking more risk when investingin bonds. In a barbell strategy, an investor invests in short-term bonds, say perhaps some

maturing in one to two years and long-term bonds such as those maturing in 30 years. When

shorter-term bonds come due, the investor replaces them with other short-term bonds, thuskeeping a balance between short and long term bonds. The goal is to earn more interest without

taking more risk than having a portfolio of intermediate term bonds only.Basis point

One onehundredth of 1 percent (0.01%). 100 basis points equal 1%. Basis points are often

used to measure differences in bond yields. For example, if the yield on a bond changes from5.55% to 5.5%, it has dropped 5 basis points.

Bearer bond

A bond that is not registered and has no identification as to owner. It is presumed to be owned by

the person who holds it. Bearer securities are freely negotiable, since ownership can be quickly

transferred from seller to buyer by delivery of the instrument. Bearer bonds allow investors toremain anonymous. Eurobonds are an example of bearer bonds.

Behavioural finance

Behavioural finance is the study of why investors act the way they do and how such behaviour

affects the markets. Behavioural finance theorists use the disciplines of economics andpsychology to suggest that the investor behaviour that affects market prices may be not be based

on such rational factors as analysis of the strength or performance of a company.

Benchmark

A benchmark used in investing is a standard against which the performance of an individual

bond or group of bonds can be measured. Different types of benchmarks are chosen for differentinvestments by individual investors and financial professionalsthe benchmark might be an

index, an interest rate such as LIBOR or EURIBOR, or the yield on a particular governmentbond such as on a US Treasury bond. For example, if an investor uses an index to track a specificsegment of the bond market, the changing value of the index indicating a stronger or weaker

performance is also the standard against which the investor measures the performance of aparticular bond, bond fund or bond portfolio. For investors who want to set up investment

performance benchmarks, there are two major types of benchmarksfixed rate or absolute

benchmarks and relative benchmarks. Fixed or absolute benchmarks might be targets that anindividual sets--return on a portfolio or some return relative to inflation for example; relative

benchmarks are standard market indices or measurements that help an investor compare the

performance of his/her investment portfolio to that market index investment benchmark so as to

gauge the success of his own strategy to his investment objectives.

Individual investors and financial professionals often also use benchmarks to discern broader

expectations about the direction of the markets or the economy.

Bid (and ask)

Bid is the price at which a buyer, broker or market maker offers to pay for a bond; and the ask is

the price at which the broker or market maker offers to sell. The difference between the twoprices is called the spread. Bid and ask is sometimes known as a quote.


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Bond

A bond is a debt security, a loan similar to an I.O.U. When you purchase a bond, you are lendingmoney to a government, corporation, or other entity known as the issuer. In return for the loan,

the issuer promises to pay you a specified rate of interest during the life of the bond and to repay

the face value of the bond (the principal) when it matures, or comes due. Because most bonds

pay interest, and on a regular basis, they are sometimes described as fixed-income investments.

Bond fund

A bond fund sells investors shares of a fund that consists of a portfolio of bonds structured to

meet a particular investment objective, such as providing regular income. Bond funds, unlike

individual bonds, do not have a maturity date and therefore do not guarantee an interest rate asthe portfolio is not fixed. Bond funds, also unlike individual bonds, do not guarantee a return of

principal. Investors may invest in bond funds because they want to diversify bond investments

with smaller amounts of money than required to buy an entire portfolio of bonds. There aredifferent types of bond funds from which an investor can choose which may invest in different

types of bonds (government, corporate, covered, etc), have different investment strategies (short-

term, long term, etc.), and offer different levels of risk (for example, highest rated investmentgrade bonds, high-yield bonds, etc.).

Bond insurance, Financial guaranty insurance

Credit quality can be enhanced by bond insurance, sometimes known as financial guaranty

insurance. Specialised insurance firms serving the fixed income markets guarantee the timely

payment of principal and interest on bonds they have insured. Most bond insurers have at leastone triple A rating from a recognised rating agency attesting to their financial soundness,

although some bond insurers bear lower credit ratings. In either event, insured bonds in turn

receive the same rating based on the insurers capital and claims-paying resources. In Europe, thefinancial guaranty insurance sector and the market for insured or wrapped bonds have grown

rapidly, although have been affected by the market turmoil. Pension reform efforts in Europe areexpected to increase the demand for bond insurance because insuring the complex pension

financing structures can increase investor confidence and impact the credit quality of the bonds

issued as well. In the US, the focus of insurance activity has been in the municipal governmentbond market although bond insurers have also provided guarantees in the mortgage and asset

backed securities markets.

Some ABS use external credit enhancement from a third party such as a monoline insurance or

surety company. A surety bond is an insurance policy provided by a rated and regulatedinsurance company to reimburse the ABS for any losses incurred. Often the insurer provides its

guarantees only to securities already of at least investment-grade quality (that is, BBB/Baa or

higher).

Monolines or monoline insurance companies guarantee the timely repayment of bond principaland interest when an issuer defaults. They are called monoline because they insure only one

category of risk and provide financial guarantees, or insurance protection, to buyers of a wide

variety of financial and capital market instruments, including in the public sector and for

infrastructure projects. Certain but not all of the monoline insurance companies have beendowngraded during the market turmoil of 2007-2008.

Bond insurance is not available for purchase by individual investors.


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Bond rating and Bond rating agencies

Independent bond rating agencies, such as Standard & Poors (S&P), Moodys, Fitch RatingService, provide ratings that assess individual bond issues as to how likely they are to default on

their loans or interest payments. Ratings systems differ among the different agencies, but AAA

(Aaa for Moodys) is considered the highest rating and D the lowest. Bonds rated BBB (or Baa)

and higher are considered investment-grade bonds. Bonds rated C and below are consideredspeculative grade bonds.

Bond swap

The sale of a bond and the purchase of another bond of similar market value. Swaps may be

made to establish a tax loss, upgrade credit quality, extend or shorten maturity, etc. Bond swapsare sometimes called bond switches.

Bond Unit Trusts (Open Ended Investment Companies --OEICs or ICVCs-- and SICAVs)

Investors in unit trusts, which are operated by investment management companies, receive units

in a fund, the price of which are calculated on a daily basis (value of the portfolio of the fund

divided by the number of units). There are different categories of legal forms of these fundsfound in Europe.

An OEIC (pronounced oik), Open Ended Investment Company, is available to investors across

Europe. OEICs have one single, same price per share or unit and like unit trusts provide anopportunity to invest in a broad selection of bonds. OEICs are also known as ICVCs or

Investment Company with Variable Capital. The terms ICVC and OEIC are used

interchangeably.

In some countries in Europe, especially Luxembourg, Switzerland, Italy and France, SICAVs,socit dinvestissement capital variable, or investment company with variable capital is the

main type of open ended fund. The value of the funds investments is divided by the number of

outstanding shares; an investor can ask that his shares be cashed out at any time. A fondscommun de placement (FCP) is similar to a UK unit trust and can be a stand alone fund or anumbrella fund.

Bonos and Obligaciones del EstadoSpanish government bonds

Spanish government bonds are obligations of the Spanish government issued by the SpanishPublic Treasury. Letras del Tesoro are short term treasury bills with maturities of 6 months, 12

months and 18months; Bonos y Obligaciones del Estado are Treasury bills with exactly the same

features except for different maturities; the Treasury currently issues Government bonds with 3and 5 year maturities; and obligaciones with maturities of ten, fifteen and thirty years.

Bookentry

A method of recording and transferring ownership of securities electronically, eliminating theneed for physical certificates.

Bourse

Bourse, meaning purse in French, is the French term for stock exchange. The term Bourse isused throughout Europe and is the synonym for the US term, stock exchange."

Broker


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A broker is an intermediary agent for a buyer and seller. The broker, buyer and seller may bebusinesses, individuals, or institutions. In most jurisdictions, brokers work for banks or

brokerage firms and must be licensed or otherwise certified or registered in order to handle

buying and selling of investments such as bonds. Consult your countrys financial regulatorlisted in the Resource Centre for additional information.

BTP or Italian government bonds

Italian government bonds are issued by the Dipartimento del Tesoro. The Ministry of the

Economy and Finance issues different types of Government bonds that are held by both

individual investors and institutional investors: short term BOT bonds (Buoni Ordinari delTesoro) with maturities up to 365 days; CTZs (Certificati del Tesoro Zero Coupon), which like

BOTs are zero coupon bonds, with maturities of 24 months; BTPs Italian Treasury bonds (Buoni

del Tesoro Poliennali), with maturities of three, five, ten, fifteen and thirty years; and CCTTreasury certificates (Certificati di Credito del Tesoro), floating rate securities that have a 7 year

maturity.

Bullet

A bond that repays principal in full in a single payment on redemption.

Bund or German government bonds

German bonds are known as Bunds (from Bundesanleihen). Bund maturities range from four tothirty years. Other bonds, such as five year federal notes Bobls (from Bundesobligationen);

two year maturity federal Treasury notes Schatze and Federal savings notes

(Bundesschatzbriefe) are also purchasable by individuals. The German Government Bond

issuance is considered a gold standard or benchmark in Europe (even after the creation of theEuro).

Buy and hold

A strategy for investing in which investors buy a bond and hold the bond until the date ofmaturity when the investor receives principal back and interest, if any.

Call

A call is the right of the issuer to redeem a bond it has sold before the maturity date by paying

investors a stated price, usually a premium above par value. A full call is when the issuer

redeems the entire issue of the bond; a partial call is when only a portion of the issue isredeemed. Many high-yield bonds allow issuers to call bonds after the first five years.

Call premium

An amount, usually stated as a percent of the principal amount called, paid by the issuer as a

penalty for the exercise of a call provision.Call risk or refunding risk

A call feature creates uncertainty as to whether the bond will remain outstanding until itsmaturity date. Investors risk losing a bond paying a higher rate of interest when rates have

declined and issuers decide to call in their bonds. When a bond is called, the investor must

usually reinvest in securities with lower yields. Calls also tend to limit the appreciation in abonds price that could be expected when interest rates start to slip.


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Because a call feature puts the investor at a disadvantage, callable bonds carry higher yields thannoncallable bonds, but higher yield alone is often not enough to induce investors to buy them and

some investors will only buy noncallable bonds.

Callable bonds

Bonds with a redemption or call provision usually have a higher annual return to compensate forthe risk that the bonds might be called early. There are two subcategories of these types of bonds:European callable bonds and American callable bonds. The issuers can only call European

callable bonds on pre-specified dates whereas they can call the American callable bonds any time

after the call protection period. The call protection period is one of the terms set before the use ofa bond, i.e. the date until which it is protected and after which it can be called.

Cap

The top interest rate that can be paid on a floating-rate bond.

Capital markets

Capital markets are the electronic and physical markets in which bonds and other financial

instruments such as shares and commodities are sold to investors. Institutions such asgovernments and corporations use the capital markets to raise money through public offerings of

bonds and shares or through private placements of securities to institutional investors such as

pension funds and insurance companies.

Central bank

The central bank of a country is the public authority--usually a federal government-relatedentity--that sets or carries out the countrys monetary policy, controls the countrys money

supply, may set short-term interest rates, is usually entrusted with control of the commercial

banking system and financial institutions and markets; and acts as lender of last resort.

The European Central Bank (ECB) is the European Monetary Unions (EMU) central banklocated in Frankfurt, Germany which governs monetary policy for the European Union through a

board as well as central bank governors from each participating country. The ECB sets short-term interest rates for the Euro-zone, guided by the need to maintain price stability. Together

with the ECB, the EMU National Central Banks (such as the Deutsche Bundesbank and the

Banque de France) form the European System of Central Banks.

Clean price

Price of a bond excluding accrued interest. Bond prices are usually quoted clean.

Closed-end investment company

An investment company created with a fixed number of shares which are then traded as listed

securities on a stock exchange. After the initial offering, existing shares can only be bought fromexisting shareholders.

Closing price

The closing price of a bond is the last trading price before the exchange or market in which it is

traded closes for the day. Given the existence of after-hours trading, the opening price at the start

of the next trading day may be different from the closing price of the day before.

Collar


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Upper and lower limits (cap and floor, respectively) on the interest rate of a floating-ratesecurity.

Collateral

Assets with monetary value which are used to guarantee a loan. If a borrower defaults and fails

to repay a loan, the collateral or some portion of it, may become the property of the lender.Secured loans are loans that are guaranteed by collateral.

Collateralised Debt

Collateralised debt (securitisation, structured products and covered bonds) has been one of the

fastest developing investment vehicles in the last decade based on the idea that credit can be

advanced on the basis of whatever collateral, security, or compensation in the case of default aborrower can use to repay the loan. The collateralised debt instrument is therefore a kind of

promissory note backed by collateral, security or whatever other compensation in the event of a

default that a borrower has. The collateral or security can come from one or more sources such as

mortgages or loans or bonds/debt or asset-backed securities. The speed at which this conceptspread through Europe at the turn of the 21st century has created a significant European market in

these complex bond products. This is largely an institutional bond market, because the products

are very complex in structure and size and difficult for a non professional individual investor tounderstand.

Collateralised Debt Obligation (CDO)

A collateralised debt obligation (CDO) is a type of securitisation, whereby a diversified pool of

loans or securities is packaged into various tranches backed by the cash flows of the asset pool.

CDOs may pay a fixed or floating coupon, semi annually, quarterly or monthly, with most seniordebt being rated AAA to A and subordinate debt BBB to B and/or an unrated first loss tranche.

There are many types of CDOs. Some are backed by a diversified pool of a single asset class

(such as mortgages, loans to small and medium sized companies, large companies) or a mixture

of asset classes. Due to their complexities, some CDOs can be relatively volatile in terms ofratings and their market value. For example, CDOs backed by the tranches of othersecuritisations particularly subprime loans, have been very volatile and many have been

downgraded. Other CDOs, such as those backed by corporate loans, have been relatively stable

and continue to offer high yields with reasonable stability.

Collateralised Mortgage Obligations (CMOs)

Collateralised mortgage obligations are fixed income investments backed by mortgages or pools

of mortgages. A conventional mortgage-backed security has one interest rate and one maturity

date. A CMO backed by a pool of mortgages is divided into four tranches, and each tranch has a

different interest rate and term. As with all mortgage-backed securities, CMOs are subject to

interest rate risk in which a change in interest rates can affect the market value and therepayment rate.

Commercial Mortgage Backed Securities (CMBS)

Commercial mortgage-backed securities (CMBS) have as underlying collateral loans on hotels,multifamily housing, retail properties, and office or industrial properties. Unlike residential

mortgage loans, commercial loans tend to be locked out from prepayment for ten years and

thus prepayment risk is reduced. However, default risk is greater on commercial loans.


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Commercial paper

Short term, unsecured bond notes issued by a corporation or a bank to meet immediate short termneeds for cash. Maturities typically range from 2 to 270 days. Commercial paper is usually

issued by corporations with high credit ratings and sold at a discount from face value.

CommissionA charge from a broker or agent to make a transaction on behalf of an investor. Commissionsdiffer in how they are calculated, including whether the investor is using a bank, brokerage or

online firm. Investors should be sure to ask and to understand what commission or other sales

fees are charged by a broker or agent to make an investment transaction, including if such

information is not provided in writing.

Compound Interest

Compound interest is when interest earned on an investment is added to the existing investment

to create a larger investment base on which to earn future interest. Without compounding, simple

interest is earned and investments do not grow as quickly.

Compounding

Compounding is the process by which investment interest earnings added to the investmentprincipal form a larger base on which to accumulate additional earning over time.

Contraction risk

For mortgage-related securities, the risk that declining interest rates will accelerate the assumed

prepayment speeds of mortgage loans, returning principal to investors sooner than expected andcompelling them to reinvest at the prevailing lower rates. In contraction risk, the average time

that it takes for the investor to get principle back is what is being contracted.

Convertible bond

A bond that provides the investor an option to exchange the bond for a preset number of sharesin the issuer at a preset price and time.

Convexity

A measure of how sensitive a bond is to changes in interest rates. Convexity is the rate of change

in the duration (price volatility) of a bond and shows how much a bond's yield changes inresponse to changes in price. Most bonds that have a fixed coupon and maturity date have

positive convexity. Bonds with negative convexity have prices that tend to go up less and down

more than those with positive convexity. Convexity can also be used to compare bonds with the

same yield and duration.

Corporate bond

Bond issued by a corporation to raise money for business needs.

Coupon

This part of a bond denotes the amount of interest due, on what date and where payment will be

made. Bonds with coupons may also be known as bearer bonds because the bearer (of thecoupon) is entitled to the interest on the bond. Note that while most new bonds are electronically


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registered rather than issued and so physical coupons are increasingly scarce, dealers andinvestors often still refer to the stated interest rate on a bond as the coupon. Zero coupon bonds

do not have a coupon; their return is based on the fact that they are sold at a significant discount

to their redemption value.

Coupon rate

The interest rate the issuer of the bond pays during the term of the bond. For example, a bondpaying 5% annual interest has a coupon rate of 5%.

Covered bonds

Covered bonds are debt issued by banks that are fully collateralised by residential or commercial

mortgage loans or by loans to public sector institutions. Covered bonds typically have the highestcredit ratings, with most, but not all having AAA ratings. The notes offer an additional protection

to bondholders than asset-backed debt because in addition to looking at the collateral pool as an

ultimate source of repayment, the issuing bank is also liable for repayment, although in some

cases the rating of the covered bonds is based more on the collateral than on the rating of thebank. If the issuing bank is downgraded, then the covered bond may also be downgraded but this

depends on the specific situation.

Covered bonds are the second largest segment of the European bond market after government

bonds. Germany leads issuance in the European covered bond market. As the covered bondworld grows in importance, certain covered bond frameworks have been combined with

techniques borrowed from securitisation. There are two types of covered bondsthose covered

bonds that are subject to relevant national legislation, and covered bonds that are not subject tonational legislation, which are called structured covered bonds.

Credit rating

Designations used by credit rating agencies to give relative indications of credit quality of bond

issuers by formally evaluating an issuer on a specific set of objective criteria such as acompanys financial health and ability to repay debt obligations. Each major rating service inEurope and the US such as Standard & Poors, Moodys and Fitch Ratings uses somewhatdifferent criteria to assess issuers but the evaluation is summarised in a rating along a spectrum

from highest quality investment grade to speculative or AAA (Aaa) to D. Bonds rated in the

BBB category or higher are considered investment grade; securities with ratings in the BB

category and below are considered high yield, or below investment grade. Ratings usuallyaffect the interest rate a bond issuer must pay to attract investorslower rated issuers pay higher

rates.

Credit risk

The risk for bond investors that the issuer will default on its obligation (default risk) or that thebond value will decline and/or that the bond price performance will compare unfavourably to

other bonds against which the investment is compared due either to perceived increase in the risk

that an issuer will default (credit spread risk) or that a companys credit rating will be lowered

(downgrade risk).

Currency risk or exchange rate risk


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Investors who invest in a government bond that is not in his/her home currency face currency orexchange rate risk since the value of his/her investment could go down as well as up depending

on what happens to the currency exchange rate.

Current yield

The ratio of annual interest payments from a bond to the actual market price of the bond, statedas a percentage. For example, a bond with a current market price of 1,000 that pays 80 peryear in interest would have a current yield of 8%.

CUSIP,ISIN

CUSIP and ISIN are systems that provide unique identifying information for securities, including

bonds, commercial paper and shares. Not all issuers use the ISIN numbering scheme.

ISIN is the numbering code system set up by the International Organization for Standardisationand used by internationally traded securities to identify and number each issue of securities. An

ISIN code has twelve characters structured as follows: the first two characters of the ISIN are the

country of origin for the security; the security identification number (which is called the National

Securities Identifying Number NSIN) is the next 9 characters long; and a final character, called acheck digit, is added to prevent errors and provide an additional verification for authenticity. The

organization that allocates ISINs in any given country is called the National Numbering Agency

(NNA). The NNA of the appropriate country administers the 9 digit security identificationnumber.

In the US, that NNA is called the Committee on Uniform Security Identification Procedures

(CUSIP) Service Bureau, established under the auspices of the American Bankers Association to

develop a uniform method of identifying securities. CUSIP numbers are unique nine-digitnumbers assigned to each series of securities. The CUSIP number is used to identify and track

bonds when they are bought and sold in the US. Some securities may have CUSIP-derived ISIN

numbers. Other US bonds only have CUSIP numbers.

Dated date (or issue date)

The date of a bond issue from which the first owner of a bond is entitled to receive interest.

Debenture

A debenture is an unsecured bond, whose holder has claim of a general creditor on all assets of

an issuer not specifically pledged to secure other debt.

Default

Failure to pay principal or interest when due. Defaults can also occur for failure to meet non-

payment obligations, such as reporting requirements, maintenance of collateral or financial

covenants, or when a material problem occurs for the issuer, such as an insolvency orbankruptcy. A bond issuer that defaults may not repay principal at maturity or pay interest when

it becomes due or both. For bond issuers, conditions for default are defined in a legal document

called a bond indenture.

Default risk

The risk to bondholders that the issuer is unable to meet principal and/or interest payments whendue.


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Derivative

Derivatives are complex and varied financial instruments with values that change in response tochanges of the underlying assets, interest rates, currency exchange rates or indices. The main

types of derivatives are futures, forwards, options and swaps. Derivatives are sometimes known

as synthetics.

The main purpose of a derivative is to reduce risk to one party. Futures or forwards derivativesare contracts to buy or sell an asset on a specified future date. Options give the holder the right to

buy or sell an asset on a specified future date. The most common form of swap is an interest rate

swap. These derivatives allow investors to profit from a falling, rising or static market.

Derivatives may be tools in their own right or may be used to build other investment vehiclessuch as structured products. There is debate in the financial community as to whether derivatives

are suitable for individual investors due to their complexity.

Discount

The amount by which the purchase price of a security is less than the principal amount, or par

value.Discount note

Short-term obligations issued at discount from face value, with maturities ranging from

overnight to 360 days. They have no periodic interest payments; the investor receives the notes

face value at maturity.

Discount rate

The key interest rates central banks charge on overnight loans to commercial and member banks.

The European Central bank focuses on three key interest rates for the Euro area as its way to

manage inflation and the economy: the main short term lending interest rate on the main

refinancing operations (MRO); the rate on the deposit facility which banks may use to makeovernight deposits; the rate on the marginal lending facility, which offers overnight credit to

banks. The rates are closely watched by markets as setting these rates are a prime way for acentral bank to manage inflation. Commercial banks use the discount rate as a benchmark for the

interest rates they charge on other financial instruments and products, including commercial and

consumer loans.

Discounting

The opposite of compounding, discounting allows an investor to multiply an amount by a

discount rate to compute the present or discounted value of an investment. As an example 1,000

compounded at an annual interest rate of 10% will be 1,610.51 in five years. The present value

of 1,610.51 realized after five years of investment is 1,000, when discounted at an annual rate

of 10%.

Diversification

A strategy by which an investor distributes investments among different asset classes and within

each asset class among different types of instruments in order to protect the value of the overallportfolio in case of changes in market conditions or market downturn. For example, a diversified

bond portfolio might include different types of bonds and/or bond funds with different maturities

and coupons.


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Downgrade risk or credit risk

Downgrades result when rating agencies lower their rating on a bond-for example, a change in aStandard & Poors rating from a B to a CCC rating. Downgrades are usually accompanied by

bond price declines and may change a bond from an investment grade rating to a speculative

grade rating. In some cases, the market anticipates downgrades by bidding down prices prior to

the actual rating agency announcement. Before bonds are downgraded, agencies often place themon a creditwatch status, which also tends to cause price declines.

Dual-currency bonds

Dual-currency bondsare bonds in which principal payments are in one currency and coupon

payments are in another currency. This type of bond is used for foreign bonds, when an issuerissues bonds in a foreign country and makes coupon payments in that countrys currency, but

principal payments are made in the currency of the issuers country of residence.

Duration

The effect that each 1% change in interest rates has on a bonds market value. Duration takes

into account a bonds interest payments in measuring bond price volatility and is stated in years.As an example, a 5 year duration means that a bond will decrease in value by 5% if interest rates

rise 1% and increase in value by 5% if interest rates fall 1%.

Duration risk

The duration of a bond is a measure of its price sensitivity to interest rates movements, based onthe average time to maturity of its interest and principal cash flows. Duration enables investor to

more easily compare bonds with different maturities and coupon rates by creating a simple rule:

with every percentage change in interest rates, the bonds value will decline by its modifiedduration, stated as a percentage. Modified duration is the approximate percentage change in a

bonds price for each 1% change in yield assuming yield changes do not change the expected

cash flows. For example, an investment with a modified duration of 5 years will rise 5% in valuefor every 1% decline in interest rates and fall 5% in value for every 1% increase in interest rates.

Bond portfolio managers increase average duration when they expect rates to decline, to get the

most benefit, and decrease average duration when they expect rates to rise, to minimize thenegative impact. If rates move in a direction contrary to their expectations, they lose.

Early amoritisation risk

Most revolving ABS are subject to early-amortisation eventsalso known as payout events or

early calls. A variety of developments, such as the following, may cause an early-amortisation

event: insufficient payments by the underlying borrowers; insufficient excess spread; a rise in thedefault rate on the underlying loans above a specified level; a drop in available credit

enhancements below a specified level; and bankruptcy on the part of the sponsor or the servicer.Early call risk

The risk to bond investors that high-yielding bonds will be called early, with the result that

proceeds may be reinvested at lower interest rates.

Economic indicator


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Statistical measures of current conditions in an economy. Leading economic indicators such asthose that track consumer confidence, factory orders, or money supply may signal short term

economic strength or weakness. Lagging economic indicators such as business spending or

unemployment figures move up or down as the economy strengthens or weakens. Economicindicators together provide a picture of the overall health of an economy or economic zone and

how bond prices and yields might be affected.Economic risk

Economic risk describes the vulnerability of a bond to downturns in the economy. Virtually all

types of high-yield bonds are vulnerable to economic risk. In recessions, high-yield bondstypically lose more principal value than investment-grade bonds. If investors grow anxious about

holding low-quality bonds, they may trade them for the higher-quality debt, such as government

bonds and investment-grade corporate bonds. This flight to quality particularly impacts high-yield issuers.

Embedded option

A provision within a bond giving either the issuer or the bondholder an option to take some

action against the other party. The most common embedded option is a call option, giving the

issuer the right to call, or retire, the debt before the scheduled maturity date.

Emerging Market bonds

Emerging market bonds usually include government (or sovereign) bonds; sub-sovereign

bonds and corporate bonds. Domestic emerging market bondsthose issued within an emerging

market countrymake up about of the amount of debt in the emerging market bond markets

but because it can be difficult for a variety of reasons to trade in domestic emerging bonds,emerging market bonds held by foreign investors are usually foreign or external emerging

market bonds. The majority of external emerging market bonds are government bonds.

EURIBOR (Euro InterBank Offered Rate)EURIBOR are Euro-denominated interest rates charged by Eurozone banks for Euro-denominated loans among themselves. Because banks involved in setting EURIBOR are among

the largest and most credit worthy participants in the EU money market, these rates have becomethe key benchmark for short-term interest rates within the Eurozone affecting mortgages and

other consumer loans.

Euro

The name of the common currency in the European Monetary Union which replaced the national

currencies of participating countries in 2002. Demarcated with EURO or .

Eurobond

Eurobonds are bonds that are denominated in a currency other than that of the country in which

they are issued. They are usually issued in more than one country of issue and traded across

international financial centres. Supranational organisations and corporations are major issuers in

the Eurobond market.

European Central Bank (ECB)


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Central bank of the European Monetary Union, whose member countries use the Euro ascurrency. ECB is based in Frankfurt, Germany and oversees monetary policy, issues currency

and sets short-term interest rates with a goal of price stability and control of inflation.

European Commission (EC)

The European Commission is the institution of the European Community which recommendsbroad guidelines for the economic policies in the Community, monitors public finances andinitiates procedures on excessive deficits.

European Union (EU)

The European Union, formerly known as the European Community (EC) or the European

Economic Community (EEC), is an economic and political alliance of European nations joinedtogether under common legislation for the purpose of economic stability and to enhance political,

economic and social co-operation. EU decision-making processes involves a number of

institutions, including the Council, European Parliament and European Commission. Some

countries in the European Union, such as Denmark and the United Kingdom, have not adoptedthe Euro as their currency.

Euro-zone

The European Union Countries that use the Euro as the single currency and in which a single

monetary policy is conducted under the responsibility of the European Central Bank. In sharing acommon currency, the member states of the European Economic and Monetary Union (EMU)

are governed by the same monetary policy but this uniformity does not extend at the country

level to alignment of all economic, regulatory and fiscal matters, including matters of taxation.

Event risk

Company and industry event risk encompasses a variety of pitfalls that can affect a companysability to repay its debt obligations on time. These include poor management, changes in

management, failure to anticipate shifts in the companys markets, rising costs of raw materials,regulations and new competition. Events that adversely affect a whole industry can have ablanket effect on the bonds of its members. Other types of bonds also have event risk for bond

investors created by the possibility of unexpected events such as natural or man made disasters.

Excess spread

The net amount of interest payments from the underlying assets after bondholders and expensesare paid and after all losses are covered. Excess spread may be paid into a reserve account and

used as a partial credit enhancement or it may be released to the seller or the originator of the

assets.

Exchange rate risk or currency risk

Investors who invest in a government bond that is not in his/her home currency face currency or

exchange rate risk since the value of his/her investment could go down as well as up depending

on what happens to the currency exchange rate.

Exchange traded funds (ETFs)

Fixed income exchange-traded funds (ETFs), whose shares are traded on major stock exchanges,are a special type of fund designed to track the performance of a specific bond market index.


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Different ETFs offer investors the opportunity to achieve broad or targeted bond marketexposure. ETFs are also created and managed by financial firms, but not necessarily by the same

institutions that create and manage the index on which they are based. Common brand names for

ETFs include iShares, SPDRs (short for Standard& Poors Depository Receipts, also known asspiders), Diamonds and Vipers. ETFs based on equity indices are more common, but some of

these brands include fixed income ETFs as well. Unlike most bonds, ETFs generally trade onorganised exchanges, hence the name exchange-traded funds.

Exchangeable bond

A bond with an option to exchange it for shares in a company other than the issuer.

Expected maturity date

The date on which principal is projected to be paid to investors. It is based on assumptions about

collateral performance.

Extension risk

The risk that rising interest rates will slow the anticipated rate at which mortgages or other loans

in a pool will be repaid, causing investors to find that their principal is committed for a longerperiod than expected. As a result, they may miss the opportunity to earn a higher rate of interest

on their money.

Face amount or face value

Par value (principal or maturity value) of a security appearing on the face of the instrument and

representing the amount the issuer has borrowed. In the secondary market where most individualinvestors participate, bonds may trade at a discount, which is less than face value, or at a

premium, which is more than face value.

Fallen angel

A corporate bond which when issued was investment-grade rated by credit rating agencies suchas Standard & Poors or Moodys but is now downgraded due to a deteriorated financial

situation.

Federal funds rate

The interest rate charged by US banks on loans to other banks. The US central bank FederalReserves ability to add or withdraw reserves from the US banking system gives it close control

over this rate. Changes in the US federal funds rate are sometimes studied by economists and

investors for clues to US Federal Reserve intentions.

Final maturity date

The date on which the principal must be paid to investors, which is later than the expected

maturity date. Also called legal maturity date.

Fixed-rate bonds

Sometimes known as a conventional or plain vanilla bond, this is a bond that pays a regular fixed

interest rate over a fixed period of time to maturity with the return of principal on the maturitydate.

Floating-rate bond or Floating-rate note (FRN)


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A bond for which the interest rate is adjusted periodically according to a predetermined formula,usually linked to an index or to a reference rate such as LIBOR or EURIBOR. Sometimes called

Floating-rate note (FRN).

Floor

The lower limit for the interest rate on a floatingrate bond.Foreign bonds

Foreign bonds are denominated in the currency of the country in which a non resident or foreignissuer actually issues the bond. These bonds trade similarly to other bonds in the domestic

market in which they are issued. For example, Bulldog bonds are sterling denominated bonds

issued in the UK by a non-UK issuer. Yankee bonds are dollar denominated bonds issued in theUS by a non-US issuer. Rembrandt bonds are issued in the Netherlands; Matador bonds in Spain,

etc. The most important country for foreign bond issues has been the US dollar market.

Foreign currency-linked bonds

Foreign currency-linked bondsare bonds linked to changes in foreign currency. Unlike foreign

currency denominated bonds in which case all the payments are made in that currency, forforeign currency-linked bonds, the amount is linked to a foreign currency exchange rate. This

type of bond is used in countries with unstable or weak currencies.

French government bonds

French Government Bonds are also known as OATs, (Obligations Assimilables du Trsor) which

are longer term bonds. There are also BTF (Bons du Trsor taux fixe et intrt prcompt)short-term bonds and BTANs (Bons du Trsor taux fixe et intrt annuel) medium term

bonds with a maturity of two to five years. Agence France Trsor (ATF) is the Department of the

French Finance Ministry responsible for managing public debt and the Treasury.

Futures

Financial futures are a contract agreeing to buy or sell a specified amount of an underlying

financial instrument at a specific price on a specific day in the future. The price is agreed to atthe time of the contract. Financial futures are usually of three main types: interest rate futures;

stock index futures or currency futures. Because futures are complicated and risky, with the

potential for losses not limited to your original investment, futures products are not suitable for

many individual investors.

General obligation bond

A US municipal bond secured by the pledge of the issuers full faith, credit and taxing power.

German government bonds or bunds

German bonds are known as Bunds (from Bundesanleihen). Bund maturities range from four to

thirty years. Other bonds, such as five year federal notes Bobls (from Bundesobligationen);

two year maturity federal Treasury notes Schatze and Federal savings notes(Bundesschatzbriefe) are also purchasable by individuals. Inflation-linked German Government

Bonds have been added recently to bond market offerings. The German Government Bond

issuance is considered a gold standard or benchmark in Europe (even after the creation of theEuro).


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Gilts or UK government bonds

Government bonds issued by the United Kingdom are also called gilt-edge securities, or giltsand sometimes Treasury Stock. Gilts are issued by the UK Debt Management Office on behalf of

Her Majestys Treasury and are listed on the London Stock Exchange. Most gilts are sold with a

fixed rate of interest for the life of the bond, paid semi-annually, with full repayment of the face

value on maturity (sometimes called bullets). UK government securities are considered one ofthe highest quality bonds in the world because the UK has never defaulted on an issue (although

past results are not a guarantee that there will be no default in the future).

Global bond

Global bonds are bonds issued in several countries currencies simultaneously.

Government bond

A bond issued by a central or sovereign government. Among the types of European Government

bonds are: Gilts (UK); OATs (France); Bunds (Germany); BTPs (Italy). US Treasuries are US

Government issued bonds.

Hedge

An investment made with the intention of minimizing the impact of adverse movements ininterest rates or securities prices.

High-yield bond

There are two categories of corporate bonds for investors--investment-grade corporate bonds and

speculative-grade bonds, also known as high-yield or the investor might hear the word junk.Speculative-grade bonds are issued by corporations that are perceived to have a lower level of

credit quality compared to more highly rated, investment-grade, corporate issues. Speculative-

grade refers to the fact that originally banks were not allowed to invest in bonds beyond the four

investment grade ratings because the bonds were too speculative, too risky. The speculative-grade category has six levels of ratings.

High-yield bonds are issued by organizations that do not qualify for investment-grade ratingsby one of the leading credit rating agenciesMoodys, Standard & Poors and Fitch Ratings.

Illiquid

A market is illiquid when there is insufficient cash flowing to meet financial debts or obligations.

In the context of bonds or other investments, illiquid refers to a bond or other investment that

cannot be converted into cash quickly or near prevailing market prices. Liquid investments orassets are defined as those that can be converted into cash quickly and without great impact on

the price of the asset.

Index

A way to report change in a financial market, collective markets, or an economy, usually

expressed as a percentage and as points of change (up (+) or down (-). There are many marketand economic indices, each tracking and measuring a different set of data; each also tracks

change from a specific starting date. Investors and financial professionals may use a particular

index as a performance benchmark against which to measure the return of investments that are


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similar to those measured by the index. Indices may be weighted which means that certainfactors in the data are given more significance or weight in the index.

Index fund

A bond index fund is designed to mirror the performance of a particular bond index, by keeping

pace with the index, not outperforming it.Index-linked bonds

Bonds whose face value and interest payments are linked to an index. The best known areinflation-linked bonds, in which the face value and interest payment are linked to a consumer

retail price index, and thus the investor receives a return that is inflation protected. Many

governments now issue inflation-indexed or index-linked bonds. The way index-linked bondswork varies from country to country.

Inflation

The rate of increases in the price of goods and services usually measured on an annualised basis.

Inflation riskThe risk to bond investors that the fixed value of bond holdings might erode with a sustained

increase in inflation rates.

Institutional investors

Large organisational entities with significant amounts of money to invest such as insurancecompanies, pension funds, investment companies and unit trusts. Institutional investors account

for a majority of overall volume in the bond markets.

Interest

Compensation paid or to be paid for the use of money, generally expressed as a percentage rate.

The rate may be constant over the life of the bond (fixed-rate) or may change from time to timeby reference to an index (floating-rate).

Interest rate or market risk

While investors are effectively guaranteed to receive interest and principal as promised, theunderlying value of the bond itself may change depending on the direction of interest rates. As

with all fixed-income securities, if interest rates in general rise after a bond is issued, the value of

the issued security will fall, since bonds paying higher rates will come into the market. Similarly,if interest rates fall, the value of the older, higher-paying bond will rise in comparison with new

issues. Interest rate risk is also known as market risk.

Interest-rate Swaps

Interest-rate swaps are a derivative financial instrument which exchange or swap fixed rate

interest rate payments for floating rate interest rate payments. Usually these swaps are anagreement between to parties to exchange one stream of interest payments for another over a set

period of time. Plain, vanilla swaps are the most commonly used type of interest rate swap in

the market. Investors use interest-rate swaps for debt portfolio management; corporate finance;to lock in interest rates; and to manage and hedge risk. . It is important for an individual investor

to understand that swaps are between institutions and not between individual investors; however,


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the result of these swaps may affect his/her portfolio or the price he/she may pay for a particularbond.

Interest-rate swaps have become critical to the bond markets. Initially interest-rate swaps helped

corporations pay fixed rates and receive floating rate payments (or vice versa depending on their

business needs). But then, swaps were seen to reflect market expectations and sensitivity to

interest rates and credit concerns via what an interest-rate swap reflects which is a desire toexchange loansone that was borrowed at a fixed rate and the other at a floating rate tied to

LIBOR. The graph plotting swap rates across available maturities became known as the swapcurve. Swap rates suggest what the market expects the direction of LIBOR rates to be; and

reflect the markets perception of credit quality. The swap rate curve is an important interest-rate

benchmark for the bond markets and is commonly used in Europe as the pricing reference for allEuropean government bonds.

Investment grade

Bonds considered suitable for purchase by prudent investors toward preservation of invested

capital. Bonds rated Baa3 and above by Moodys and BBB- and above by Standard & Poors and

Fitch Ratings are considered investment grade.

ISIN,CUSIP

ISIN and CUSIP are systems that provide unique identifying information for securities, includingbonds, commercial paper and shares. Not all issuers use the ISIN numbering scheme.

ISIN is the numbering code system set up by the International Organization for Standardisation

and used by internationally traded securities to identify and number each issue of securities. An

ISIN code has twelve characters and are structured as follows: the first two characters of theISIN are the country of origin for the security; the security identification number (which is called

the National Securities Identifying Number NSIN) is the next 9 characters long; and a final

character, called a check digit, is added to prevent errors and provide an additional verification

for authenticity. The organization that allocates ISINs in any given country is called the NationalNumbering Agency (NNA). The NNA of the appropriate country administers the 9 digit securityidentification number.

In the US, the Committee on Uniform Security Identification Procedures, established under the

auspices of the American Bankers Association developed a uniform method of identifying

securities. CUSIP numbers are unique ninedigit numbers assigned to each series of securities.The CUSIP number is used to identify and track bonds when they are bought and sold in the US.

Issue Date

The date of a bond issue from which the first owner of a bond is entitled to receive interest.

IssuerAn entity which issues and is obligated to pay principal and interest on a debt security.

Italian Government Bonds or BTPs

Italian Government Bonds are issued by the Dipartimento del Tesoro. The Ministry of theEconomy and Finance issues different types of Government bonds that are held by both

individual investors and institutional investors: short term BOT bonds (Buoni Ordinari del

Tesoro) with maturities up to 365 days; CTZs (Certificati del Tesoro Zero Coupon), which like


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BOTs are zero coupon bonds, with maturities of 24 months; BTPs Italian Treasury bonds (Buonidel Tesoro Poliennali), with maturities of three, five, ten, fifteen and thirty years; and CCT

Treasury certificates (Certificati di Credito del Tesoro), floating rate securities that have a 7 year

maturity.

Junk bond

In some cases, the term junk bonds is used to refer to all high-yield bondsi.e., those that arerated below investment grade or are not rated. In other cases, the term refers to the lower tiers of

high-yield bonds in credit quality. Many of todays high-yield bonds, particularly those rated Ba

by Moodys or BB by other rating agencies, are not considered junk.

Laddering

Investment strategy to reduce the impact of interest-rate risk by structuring a portfolio with

different bond issues that mature at different dates.

Legislative risk

The risk that a change in the tax code could affect the value of taxable or tax-exempt interest

income.

Leverage

The use of borrowed money to increase investing power.

LIBOR (London Interbank Offered Rate)

LIBOR, short for London Interbank Offered Rate, is the index of interest rates that banks offer

each other in the London wholesale money markets for maturities ranging from overnight to one

year. LIBOR rates are a standard global benchmark for short-term interest rates and aredenominated in the British pound (GBP), the US dollar (USD) and many other world currencies.

Liquidity or Marketability

A measure of the relative ease and speed with which a security can be purchased or sold in the

secondary market at a price that is reasonably related to its actual market value. For example,

liquid investments or assets are defined as those that can be converted into cash quickly andwithout great impact on the price of the asset so buyers can be found for a bond if an investor

wants to sell.

Liquidity risk

The risk to bondholders that bonds cannot be sold quickly or at a good price.

Market or interest rate risk

While investors are effectively guaranteed to receive interest and principal as promised, the

underlying value of the bond itself may change depending on the direction of interest rates. As

with all fixed-income securities, if interest rates in general rise after a bond is issued, the value ofthe issued security will fall, since bonds paying higher rates will come into the market. Similarly,

if interest rates fall, the value of the older, higher-paying bond will rise in comparison with new

issues. Interest rate risk is also known as interest rate risk.

Maturity


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A bonds maturity refers to the specific future date on which the investors principal will berepaid. Bond maturities generally range from one day up to 30 years. There is a market in Euros

for bonds with maturity up to 50 years. In some cases, bonds have been issued for terms of up to

100 years. Maturity ranges are often categorised as follows:

Maturity date

The date of maturity is the day when the bonds term ends and the principal amount of a securityis payable along with any final interest payment. Most bonds have a fixed maturity date

(although many may be called prior to maturity). Also called redemption date.

MiFID

European Union-wide directive on the provision of, and trading in, financial services andproducts includes rules to protect clients of financial services organizations, MiFID, came into

effect November 1, 2007. In general, the key is that when an investor is making an investment

decision, the regulations require that investors need to be adequately informed by investment

firms and investment professionals about the nature of the product or service being proposed forinvestment and the risks in that particular investment. If you are classified as a retail client - and

individual investors are likely to be - you will be given the most information.

Modified duration

A measure of the approximate change in bond price for a 1% or 100 basis point change in yieldassuming the bond's expected cash flows do not change when the yield changes. Modified

duration is inversely related to the approximate percent change in price for a given change in

yield. Modified duration is not a new definition for duration but rather a particular formula for

duration.

Monolines or monoline insurance companies

Monolines or monoline insurance companies guarantee the timely repayment of bond principal

and interest when an issuer defaults. They are called monoline because they insure only onecategory of risk and provide financial guarantees, or insurance protection, to buyers of a wide

variety of financial and capital market instruments, including in the public sector and for

infrastructure projects.

Mortgage pass-through

A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or

servicer collects payments on the loans in the pool and passes through the principal and

interest to the security holders on a pro rata basis.

Mutual fundAlso known as an open-end investment company, to differentiate it from a closed-end investmentcompany. Mutual funds invest pooled cash of many investors to meet the funds stated

investment objective. Mutual funds stand ready to sell and redeem their shares at any time at the

funds current net asset value: total fund assets divided by shares outstanding. Sometimes bondfunds are called bond mutual funds, but the term mutual fund related to a bond fund is not used

widely in Europe.


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Nominal value

The face value of a bond (as opposed to the amount an individual investor might have paid forthe bond).

Non-callable bond

A bond that cannot be called for redemption by the issuer before its specified maturity date.

OATs or French government bonds

French Government Bonds are also known as OATs (Obligations Assimilables du Trsor), which

are longer term bonds. There are also BTF (Bons du Trsor taux fixe et intrt prcompt)short-term bonds and BTANs (Bons du Trsor taux fixe et intrt annuel) medium term

bonds with a maturity of two to five years. Agence France Trsor (ATF) is the Department of the

French Finance Ministry responsible for managing public debt and the Treasury.

Offer

The price at which a seller will sell a security.

Offering price

The price at which members of an underwriting syndicate for a new issue will offer securities to

investors.

Open-end index fund

An open-end index fund continuously issues and redeems shares based on investor demand. As

an index fund, its investment objective is to duplicate the performance of the index it uses as abenchmark.

Open-ended Investment Company OEIC-- or Bond Unit Trusts or SICAVs

Investors in unit trusts, which are operated by investment management companies, receive units

in a fund, the price of which are calculated on a daily basis (value of the portfolio of the funddivided by the number of units). There are different categories of legal forms of these funds

found in Europe.

An OEIC (pronounced oik), Open Ended Investment Company, is available to investors acrossEurope. OEICs have one single, same price per share or unit and like unit trusts provide an

opportunity to invest in a broad selection of bonds. OEICs are also known as ICVCs or

Investment Company with Variable Capital. The terms ICVC and OEIC are usedinterchangeably.

In some countries in Europe, especially Luxembourg, Switzerland, Italy and France, SICAVs,

socit dinvestissement capital variable, or investment company with variable capital is the

main type of open ended fund. The value of the funds investments is divided by the number ofoutstanding shares; an investor can ask that his shares be cashed out at any time. A fonds

commun de placement (FCP) is similar to a UK unit trust and can be a stand alone fund or an

umbrella fund.

Par value

The principal amount of a bond or note due at maturity.

Paying agent


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Place where principal and interest are payableusually a designated bank or the office of thetreasurer of the issuer.

Pfandbriefe

Bond issued by German mortgage banks that is collateralised by long-term assets. These types of

bonds represent the largest segment of the German private bond market and are considered someof the safest debt instruments in the private sector.

Point

If a bond price changes from 100 to 101, it has changed a point. A one point change in the price

of a bond affects the bonds currency denomination value by 1% of the face value. For example,

a point is worth 1 when a bond has a 100 face value.

Portfolio

The group of investments that an individual or institutional investor holds.

Premium

The amount by which the price of a bond exceeds its principal amount.

Prepayment

The unscheduled partial or complete payment of the principal amount outstanding on a mortgage

or other debt before it is due. Rules related to prepayment are more restrictive in Europe than in

the US.

Prepayment risk

The risk that falling interest rates will lead to heavy prepayments of mortgage or other loans

forcing the investor to reinvest at lower prevailing rates. Rules related to prepayment are more

restrictive in Europe than in the US.

Primary market

The market for new issues when bonds are first sold to investors by an issuer.

Principal

The face value amount of a bond, payable by the borrower to the lender/investor at maturity.

Prior charge

The claim that a bondholder may have on the assets of a company in the event of liquidation

ahead of other asset holders.

Prospectus

Documents provided to investors who are considering investing in financial instruments such asshares, bonds, bond funds, investment trusts, etc. The prospectus details the investments

objectives, the nature of the investment, past performance, information on the investmentcompany or managers, etc.

Put

Contract enabling the option holder to sell a bond to the other party at a set price until the

contract expires.


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Puttable bond

Bond that gives holder the option to sell the bond back to the issuer on pre-set terms.

Rating service

A rating service such as Standard & Poors, Moodys, Fitch Ratings, etc. evaluates bond issuers

on a specific set of objective criteria that determines the level of risk their bond issues pose toinvestors along a spectrum from highest quality investment-grade to speculative investments(ratings AAA (Aaa) being the highest to D being the lowest).

Ratings or credit ratings

Designations used by credit rating agencies to give relative indications of credit quality of bond

issuers by formally evaluating an issuer on a specific set of objective criteria such as a

companys financial health and ability to repay debt obligations. Each major rating service inEurope and the US, such as Standard & Poors, Moodys and Fitch Ratings, uses somewhat

different criteria to assess issuers but the evaluation is summarised in a rating along a spectrum

from highest quality investment grade to speculative grade or ratings AAA (Aaa) to D. Bonds

rated in the BBB category or higher are considered investment-grade; securities with ratings inthe BB category and below are considered high yield, or below investment-grade. Ratings

usually affect the interest rate a bond issuer must pay to attract investorslower rated issuers

pay higher rates.

Redemption date (maturity date)

The redemption date is the day when the bonds term ends and the principal amount of a security

is payable along with any final interest payment. Also called maturity date.

Redemption yield

Annual percentage return received by investor if the bond is held to maturity, a calculation often

used to compare bonds. Also called true return. The redemption yield on the bond is a functionof the price paid for the bond (which will almost always differ from its face, or par, value), the

coupon rate and the length of time to go to maturity. What is needed to work out a redemptionyield is the coupon, the frequency of coupon payments, the price of the bond, the trade

settlement date, the maturity date of the bond, and the repayment value (usually 100).

Fortunately it is rare that investors need to calculate a redemption yield from scratch. Bondyields are listed in the financial pages, on financial web sites like Bloomberg.com and FT.com,

or can be worked out with relative ease using the function in a spreadsheet or a pocket financial

calculator.

The really important aspect of the redemption yield is that it is the single number thatencapsulates all aspects of a bond where the price stands relative to par, whether the bond is

high coupon or low coupon (or indeed zero coupon), and its number of years to maturity. It cantherefore be used to compare any bond from any issuer with any other bond from any otherissuer.

Reinvestment risk

The risk to bond investors that interest income or principal repayments will have to be reinvested

at lower rates in a declining rate environment. Zero-coupon bonds do not have interest payment

reinvestment risk.


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Repo (Repurchase) market

Arrangements through which market professionals agree to repurchase various types of securitiesat a price and date set prior to the sale. In effect, a repurchase agreement is a collateralised loan

in which the securities serve as collateral. The repo market is used by financial institutions to

finance the purchase of securities, lend excess funds and raise short term capital.

Residential Mortgage backed Securities (RMBS)

Mortgage securities represent an ownership interest in mortgage loans made by financial

institutions (savings and loans, commercial banks or mortgage companies) to finance the

borrowers purchase of a home or other real estate. Mortgage securities are created when these

loans are packaged, or pooled, by issuers or servicers for sale to investors. As the underlyingmortgage loans are paid off by the homeowners, the investors receive payments of interest and

principal.

Investors may purchase mortgage securities when they are issued or afterward in the secondary

market. Investments in mortgage securities are typically made by large institutions when thesecurities are issued. These securities may ultimately be redistributed by dealers in the secondary

market.

Retail investors

Individual investors who invest smaller amounts of money in the markets than institutionalinvestors.

Revenue bond

A US municipal bond (a sub-sovereign type of bond) payable from revenues derived from tolls,

charges or rents paid by users of the facility constructed with the proceeds of the bond issue.

Revolving trust

A securitisation structure frequently used for assets with high turnover rates, such as credit card,trade and dealer floor-plan receivables. It is characterized by having a revolving period and an

accumulation (or controlled-amortisation) period.

Ring fencing

A new term that essentially represents the series of steps involved in securitisations where assetsare made "bankruptcy remote" or "bankruptcy proof." The goal of ring fencing is to enable such

assets to stand independent of any bankruptcy or reorganization of the ultimate or immediate

parent of the entity that holds the relevant assets.

Risk and risk tolerance

The chance that an investment will go down in value or up in value sharply in a unpredictable or

volatile manner. All investments have some level of risk, since returns on investments are not

guaranteed. If an investor is unwilling to take a chance that an investment might drop in value,

the investor is said to have little or no risk tolerance. There are different kinds of risk in bondinvestments. Defining what is an acceptable level of risk may vary from investor to investor and

change over time.

Running yield or simple yield or income yield


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The coupon of a bond expressed as a percent of the price of the bond. An example is a 20-yearbond with a coupon of 6% selling at 120 has a simple yield of 5% (6 x 100/120).

Seasoning

The age of accounts. In the ABS market, this term refers to the fact that various asset types have

different seasoning patterns, which are characterized by periods of rising and then declininglosses.

Secondary market

Market for issues previously offered or sold.

Securitisation

Securitisation may be broadly defined as the process of issuing new securities backed by a pool

of existing assets such as loans, residential or commercial mortgages, credit card debt, or other

assets. These securities, which are generally referred to as mortgage or asset-backed securitiesor RMBS or ABS, are issued and sold to investors (principally institutions) and the cash flows

or economic values following the assets are redirected to them.

Securitisation includes a diverse array of assets, such as residential and commercial mortgage

loans, trade receivables, credit card balances, consumer loans, lease receivables, automobileloans, insurance receivables, commercial bank loans, health care receivables, obligations of

purchasers to natural gas producers, future rights to entertainment royalty payments and other

consumer and business receivables.

There are various ways to classify securitised assets, but perhaps the key distinction for investorsis whether the assets are amortising or nonamortising, because this affects the cash flows

investors receive. An amortising loan is one that must be paid off over a specified period with

regular payments of both principal and interest. A nonamortising, or revolving, loan does notrequire principal payments on a schedule, so long as interest is paid regularly. Revolving credit

card accounts are perhaps the leading example of nonamortising loans.

Security

Collateral pledged by a bond issuer (debtor) to an investor (lender) to secure repayment of the

loan.

Selection risk

The risk that an investor chooses a security that underperforms the market for reasons that cannot

be anticipated.

Senior debt

Bonds ranked for repayment ahead of all other debt in the event of corporate liquidation except

for debentures secured on specific assets.

Settlement date

The date for the delivery of securities and payment of funds.

Share


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A share is a unit of ownership in a corporation, or a mutual fund or an interest in a partnership. Inthe US, the term stock is often used instead of share, although an investor actually owns shares

of stock.

SICAV investment company with variable capital--Bond Unit Trusts or OEICs

Investors in unit trusts, which are operated by investment management companies, receive unitsin a fund, the price of which are calculated on a daily basis (value of the portfolio of the funddivided by the number of units). There are different categories of legal forms of these funds

found in Europe.

An OEIC (pronounced oik), Open Ended Investment Company, is available to investors across

Europe. OEICs have one single, same price per share or unit and like unit trusts provide anopportunity to invest in a broad selection of bonds. OEICs are also known as ICVCs or

Investment Company with Variable Capital. The terms ICVC and OEIC are used

interchangeably.

In some countries in Europe, especially Luxembourg, Switzerland, Italy and France, SICAVs,socit dinvestissement capital variable, or investment company with variable capital is the

main type of open ended fund. The value of the funds investments is divided by the number of

outstanding shares; an investor can ask that his shares be cashed out at any time. A fondscommun de placement (FCP) is similar to a UK unit trust and can be a stand alone fund or an

umbrella fund.

Sinker

A bond with a sinking fund.

Sinking fund

Money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeemingdebt.

Sovereign risk

The risk that the government in the country where the bonds are issued will take actions that willhurt the bonds value.

Spanish government bonds--Bonos and Obligaciones del Estado

Spanish government bonds are obligations of the Spanish government issued by the Spanish

Public Treasury. Letras del Tesoro are short term treasury bills with maturities of 6 months, 12

months and 18months; Bonos y Obligaciones del Estado are Treasury bills with exactly the samefeatures except for different maturities. The Treasury currently issues Government bonds with 3

and 5 year maturities; and obligaciones with maturities of ten, fifteen and thirty years.

Special-purpose vehicle (SPV)

Financial institutions that originate loans sell pools of loans to a special-purpose vehicle (SPV),

whose sole function is to buy such assets in order to securitise them. In Europe, the SPV isusually a company, although in the US, trusts are utilised as issuing vehicles. The SPV

repackages the loans as interest-bearing securities and actually issues them. The true sale of

the loans by the sponsor to the SPV provides bankruptcy remoteness, insulating the trust fromthe sponsor. The securities, which are sold to investors by the investment banks that underwrite


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them, are credit-enhanced with one or more forms of extra protectionwhether internal,external or both.

Spread

The difference between the yields (yield spread) or the differences between the prices (price

spread) of two bonds or between a bond yield and a recognized benchmark yield. Investors usespreads to compare past behaviour of similar bonds with different maturities, different bondsectors, different credit ratings etc. Spreads are usually displayed in basis points.

STRIPS

Separate Trading of Registered Interest and Principal of Securities. This is the mechanism by

which zero-coupon bonds are created.

Structured products

Many different types of products are structured to some extent. Structuring usually refers toany type of obligation that is not a straightforward secured or unsecured government or corporate

obligation. Although these types of transactions are usually issued through special purpose

vehicles, this is not always the case. For example, securitisations are one type of structuredproduct. Another type of structured product refers to a packaging or repackaging of bonds

together with various types of interest rate swaps and/or credit derivatives to change the interest

and principal payment stream, in order to provide an investor with a particular risk profile thatthey want. In some cases, these products are also called structured credit if they involve

products with some type of corporate or asset-related credit risks. Due to the complexity of

structured products, they are rarely part of traditional retail investor portfolios or fund offerings.

Subordinated (junior) debt

Bonds ranked for repayment behind debentures secured on specific assets and senior debt in theevent of corporate liquidation.

Sub-Sovereign bond

The Sub-Sovereign bond market is defined first as any level of government below the national orcentral government, which includes regions, provinces, states, municipalities, etc. that issues

bonds. In Europe, the sub-sovereign market is primarily one dominated by government agencies

and supranational institutions such as the World Bank, KfW (Kreditanstalt Fr Wiederaufbau-

German Development Bank) and the European Investment Bank (EIB). As European countrieshave increasingly become one market, the growth of the sub-sovereign bond market has been

significant as well.

Surety bond

A bond that backs the performance of another. In the ABS market, a surety bond is an insurancepolicy typically provided by a rated and regulated monoline insurance company to guarantee

securities holders against default.

Swap

Simply, the sale of a block of bonds and the purchase of another block of similar market value.

Swaps may be made to achieve many goals, including establishing a tax loss, upgrading creditquality, extending or shortening maturity, exchanging fixed rate liabilities for floating ones and


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vice versa, etc. Bond swaps are sometimes called switches. Note that interest rate swaps aredifferent financial instruments, derivatives, and not what is being referred to here.

Timing risk

The risk that an investment performs poorly after its purchase or better after its sale.

Total return

A measure of bond investment return that includes both interest and price change. Expressed as a

percentage of the cost of the investment on an annualized rate, it is the combination of annualincome yielded by an investment, plus or minus the capital gain or loss and it assumes

reinvestment of all interest back into the investment.

Trade date

The date when the purchase or sale of a bond is transacted.

Tranche

Classes in certain types of securities that have different interest rates, maturities, levels of risk,

etc but share similar characteristics within each class. For example, Collateralised MortgageObligations (CMOs) are made up of a number of different classes--or tranches--of debt, each

class of which may differ from the others in the interest rate paid, the date of maturity, the levelof risk, or other distinguishing differences. When such securities are sold, each of the tranches is

sold separately. Tranche is the French word for slice.

Transfer agent

A party appointed by an issuer to maintain records of securities owners, to cancel and issue

certificates, and to address issues arising from lost, destroyed or stolen certificates.

TreasuriesUS government bonds

US Treasury securitiessuch as bills, notes and bondsare debt obligations of the USgovernment. Because these debt obligations are backed by the full faith and credit of the US

government, and thus by its ability to raise tax revenues and print currency, US Treasury

securities are considered the safest of all investments. They are viewed in the market as havingno credit risk, meaning that it is virtually certain your interest and principal will be paid on

time. (Foreign buyers of US Treasuries, however, do have risk of currency exchange ratechanges.)

True sale

An actual sale, as distinct from a secured borrowing, which means that assets transferred to an

SPV are not expected to be consolidated with those of the sponsor in the event of the sponsorsbankruptcy. Rating agencies usually require what is called a true-sale opinion from a law firm

before the securities can receive a rating higher than that of the sponsor.

Trustee

A bank designated by the issuer as the custodian of funds and official representative of

bondholders.

UK government bonds or gilts


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Government bonds issued by the United Kingdom are also called gilt-edge securities, or giltsand sometimes Treasury Stock. Gilts are issued by the UK Debt Management Office on behalf of

Her Majestys Treasury and are listed on the London Stock Exchange. Most gilts are sold with a

fixed rate of interest for the life of the bond, paid semi-annually, with full repayment of the facevalue on maturity (sometimes called bullets). UK government securities are considered one of

the highest quality bonds in the world because the UK has never defaulted on an issue (althoughpast results are not a guarantee that there will be no default in the future).

Unit investment trust

Investment fund created with a fixed portfolio of investments that never changes over the life ofthe trust. As investments within the trust are paid off, they provide a steady, periodic flow of

income to investors.

Unsecured debt

Debt with a claim for repayment that ranks last after all other forms of debt securities in the

event of a corporate liquidation.

US government bonds--TreasuriesUS Treasury securitiessuch as bills, notes and bondsare debt obligations of the US

government. Because these debt obligations are backed by the full faith and credit of the US

government, and thus by its ability to raise tax re