Tag Archives | debt instrument

What is a Bond?

what is a bondWhat is a bondIt is a corporate or government debt instrument. It represents a loan to the company from the investing public. In this case, the company is the borrower and the investor is the lender. Companies issue bonds to raise money for business investments.

What is a Bond?

A bond has a par value, a maturity date, and a coupon rate. The maturity date is the date the company must repay the investor an amount equal to the par value. The par value is the amount the lender will receive at the maturity date. The coupon rate is the interest rate on the bond. A coupon is typically semi-annually. So if the bond has a coupon rate of 8%, the investor will receive two payments per year, each equal to 4% of the bond’s par value.

Rating agencies rate the creditworthiness of bonds. High quality bonds are considered investment grade. Low quality bonds are considered noninvestment grade, or junk bonds.

what is a bond

See Also:
Non-Investment Grade Bonds
Yield to Maturity of a Bond
Zero Coupon Bonds
Sukuk
Baby Bonds

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Treasury Inflation Protected Securities

Treasury Inflation Protected Securities

Treasury Inflation Protected Securities or TIPS for short are debt instruments that are issued by the U.S. government. TIPS are indexed with the Consumer Price Index (CPI), and adjust accordingly to the inflation rate presented in the CPI.

Treasury Inflation-Protected Securities (TIPS) Explained

Treasury TIPS means that the security will adjust for inflation or deflation on whether the CPI increases or decreases. Because of this extra protection from inflation rates, TIPS owners are forced to pay more in taxes, a major disadvantage, when the security matures or it is sold. Treasury tips are normally sold with 5, 10, or 30 year maturities in denominations of $1,000 or more.

Treasury Inflation Protected Securities (TIPS) Example

Timmy has just invested in a TIPS note which has a 4% rate of return and a 10 year maturity. The following results are how an inflation protected security react to inflation and the market.

If interest rates rise by 1% in the first year then the principal would change to $1,010 (1,000 * 1.01). Thus the coupon rate would be calculated by taking 4% * $1,010 which equals a coupon payment of $40.40.

If the interest rates were to rise again by 2% then the new principal would change to $1,020 ($1,000 * 1.02), and the coupon payment would be 4% * $1,020 which equals $40.8.

Note: The new coupon payment and interest will change in the same manner no matter if deflation or inflation occurs.

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treasury inflation protected securities
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treasury inflation protected securities

See Also:
Treasury Securities
Treasury Notes (t notes)

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Secured Claim

See Also:
Pledged Collateral
Collateralized Debt Obligations
Debt Ratio Analysis
Debt Service Coverage Ratio (DSCR)
Convertible Debt Instrument
Asset Based Financing

Secured Claim Definition

The secured claim definition is debt backed by collateral. It can refer to loans, mortgages, bonds, and other financial debt instruments.

As stipulated in the debt contract, the debtor backs the debt with assets that the creditor may claim in the event of default. In a secured claim contract, if the debtor defaults, or is unable to payback the debt, the creditor can take ownership of the collateral and sell it to pay off what the debtor owes. For example, if a consumer defaults on a mortgage, the bank can claim the house and sell it to pay off the consumer’s debt. In the event of default, the secured claim is worth only as much as the collateral that backs it.

In contrast, unsecured claims are debt contracts or instruments not backed by collateral. Secured claims are considered less risky. In addition, these contracts or instruments offer lower yields. In comparison, unsecured claims are more risky. These contracts or instruments offer higher yields to compensate the lender (or investor) for the higher risk.

secured claim

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Monetize

See Also:
Current Assets
External Sources of Cash
Fixed Assets
Cash is in Your Business
Track Money In and Out of a Company

Monetize Definition

Monetizing is the act of converting an item into cash usually a bank note or some other certificate that is readily convertible at a bank into cash. However, there are also projects that can be monetized. That may include a website or maybe a book that an author is working on.

Monetize Meaning

Monetization means that a person is converting something into cash. Monetization methods could simply be a television that is sold at a pawn store to a debt instrument sold in the market. Regardless of what the convertible is, the final part of the process is a conversion whereby the final product is either legal tender or cash. Monetization often occurs with governments where the government will issue treasury securities in exchange for cash. Corporations will also use this type of monetization financing to support their operations.

Monetize Example

For example, Jim is currently working on monetizing a website that he created and worked on for over a year. He has finally reached the desired amount of traffic on the website, and has begun to implement his monetization strategies. As soon as the website starts making money for Jim monetization has officially started. Although it may be unclear for something like a website to readily value the amount of cash that will be received via the website. A debt instrument is much more liquid. It can be readily valued according to its interest rate and principal price. Likewise, you can readily value a treasury security. Therefore the act of monetization can occur overtime rather than the immediate returns by liquidating a television or a debt instrument.

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Monetize
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Monetize

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Maturity Date Defined

See Also:
Coupon Rate Bond
Covenant Definition of a Bond Contract
Long Term Debt
Non-Investment Grade Bonds
Par Value of a Bond

Maturity Date Defined

In finance, maturity date defined is the date on which a debt instrument is due. For example, when a bond reaches maturity, the issuer must pay the bondholder the principle and the final interest payment. A debt instrument’s maturity is one of the factors that determine the price and yield of the instrument. Because of the time value of money and the increased risk of volatility, debt instruments with longer maturities often have higher yields.


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Maturity Date Defined

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Maturity Date Defined

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Loan Agreement

Loan Agreement Definition

A loan is a debt instrument. One party lends assets, property, or money to another party in exchange for interest payments and the eventual return of the borrowed asset, property, or money. A loan agreement is usually drawn up in writing before any assets change hands between parties.

Loan Term Explanation

A loan agreement includes a creditor and a debtor. The creditor is the party that lends assets to the borrower. The debtor is the party that borrows assets from the lender. Often, individuals will borrow money from financial institutions such as banks. And frequently corporations will borrow money from investors by issuing bonds or other debt instruments.


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Loan Term Features

A typical loan will have several standard features, including a principal amount, a maturity date, and an interest rate.

The principal amount is the amount that the borrower receives initially from the lender, and that the borrower must repay to the lender at the end of the loan contract. The maturity date is simply the date the loan contract expires. It is the date by which the borrower must repay all borrowed funds to the lender. The interest rate is essentially the cost of the loan. An interest rate states the amount of interest, as a percentage of the principal, that the borrower must pay the lender periodically over the life of the loan contract.

Loan Term Secured and Unsecured

Secured debt refers to a loan backed by collateral. It is a loan contract with collateral. At initiation of the loan agreement, the borrower agrees to pledge certain assets to back the loan contract. If the borrower defaults on the loan, the creditor then has a claim on the collateral. The creditor, in event of default, can claim the collateral stated in the contract and liquidate it towards repaying the owed principal and interest.

An unsecured debt is a loan agreement that is not backed by collateral. The borrower does not pledge assets to back the loan contract. This type of loan is a more risky investment for the lender, as in the event of default there are no physical assets to claim and liquidate to collect unpaid debts.

Loan Term Default

Loan default occurs when the debtor becomes unable to make required payments to the creditor. Over the life of the loan, the debtor typically makes interest payments and then finally repays the principal amount. If at any time the debtor fails to make the required payments, the loan is considered in default.

Loan Term Example

Cathryn is a loan agent at a local commercial bank. Her job, mainly, is to evaluate and complete loan packages for customers that are suited to be taking a business loan. Cathryn loves her work because she can use her skills of analysis while also helping people create financial independence.

Today, Cathryn speaks with a customer who is needing a loan to start his industrial flooring business. Paul, the customer, believes he can create a successful business with a small amount of start up capital. Cathryn does her proper due diligence and confirms that Paul, a man with a solid standing in all of the 5 C’s of banking, is qualified for the loan.

Cathryn and Paul work out the specifics of the loan. Eventually, they establish the loan term. The two discuss the matter and decide that Paul, due to the small amount of money he needs beyond his savings, is looking for a short term loan. The two set one year as the period in which the loan must be repaid.

Paul appreciates Cathryn’s assistance. Cathryn appreciates the professional attitude Paul has brought to the table. The two appreciate the professional connection and agree to meet for lunch soon. Today has been a successful day for both parties.

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Loan Agreement

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Loan Agreement

See Also:
Line of Credit
Can Factoring Be Better Than A Bank Loan?
How important is personal credit in negotiating a commercial loan?
Collateralized Debt Obligations
Commercial Paper
Loan Origination Fee
Sinking Fund

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Interest Rate Risk

See Also:
Sharpe Ratio
Effective Rate of Interest Calculation
Fixed Interest Rate vs Floating Interest Rate
Interest Expense
When is an interest rate not as important in selecting a loan?

Interest Rate Risk Definition

Interest rate risk is the risk or volatility associated with bonds or long term debt as their interest rates, coupon, yield to maturity, and maturity dates move within the market.

Factors of Interest Rate Risk

There are typically five types of interest rate risk on bonds and debt instruments as follows:

1) Bond prices and their yields are inversely related. Thus, if a interest rate increases the bond price falls or drops to a discount, and if the interest rate drops the bond prices rises or is considered at a premium. The fluctuations in the market is an interest rate risk that must be accounted for accordingly when investing.

2) The longer the maturity the more sensitive a bond or debt instrument is to interest rate changes. As a bond comes closer to its maturity the price fluctuates less and less from changes in the market. This means that a shorter term security has less interest rate risk.

3) An increase in interest rates will yield a much larger change in a bond than a decrease of the same amount. This means that a bond has the ability to lose its overall value in price than it does in gaining or selling at a premium.

4) Prices of low coupon bonds are much more sensitive to market yield changes than the prices of higher coupon bonds.

5) A bond or debt instrument’s price is much more sensitive if that particular bond has a lower yield to maturity. Thus, the higher the yield to maturity the less sensitive the bond price.

Note: None of these factors matter if a person plans on holding a bond or debt instrument until its maturity. If a person holds a bond until its maturity the fact that interest rates fluctuate is irrelevant because all bonds pay coupons and finally the face value at maturity. This means that this person will automatically make the desired return and therefore need not worry about interest rate risk measures.

Interest Rate Risk Example

Chuck wants to invest in a debt instrument, and comes across some lucrative bonds. He has narrowed the search down to two, and is trying to decide between bond A and bond B. Both bonds pay a coupon of 8% and have a current yield to maturity of 6%. The only large difference between them is that the maturity for bond A is 5 years and B has a maturity of 30 years. After consulting with a close friend Chuck decides to buy bond A because his friend tells him there is less interest rate risk inherent in bond A.

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Interest rate risk

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