Accrued Interest
The interest accumulated on a bond since issue date of the last coupon payment. The buyer of the bond pays the market price and accrued interest, which is payable to the seller.
Active Management
A portfolio strategy of aggressively managing assets by continually repositioning portfolios to take advantage of the most favorable opportunities.
Agency
The debt of an agency of the U.S. Government. Payment of principal and interest are sometimes guaranteed by the government itself.
Amortisation
A reduction of debt by means of periodic payments sufficient to meet current interest and liquidate the debt at maturity.
Annualised
A figure (as in a percentage) calculated by a formula to find the "average" performance per year for a period greater than one year.
Annual Return
The total return of a security over a specified period, expressed as an annual rate of interest.
Arbitrage
Technically, the purchase of a security in one market and the simultaneous sale of it or its equivalent in the same market or other markets for the differential or spread prevailing, at least temporarily, because of conditions peculiar to each market. Commonly refers to a swap done between two similar issues based upon an anticipated change in price spreads.
Assets
All stocks, bonds, cash, interest earned, etc., owned by a given account.
Barbell
Portfolio structuring technique using a mix of short and long-term securities to achieve a targeted average maturity or duration.
Basis
1. Yield to maturity
2. Discount basis
3. The difference in price or yield between a futures position and the financial instrument being hedged: a difference that can change during the hedge period to produce a basis gain or a basis loss.
Basis Points
One one-hundredth of one percent. One hundred basis points equal one percent.
Basis Risk
1. The risk of a change in yield to maturity.
2. The risk of an unfavorable basis change resulting in a futures gain less than a cash market or a futures loss greater than a cash market gain.
Bear Market
A market characterised by a trend of falling prices.
Bear Spread
A simultaneous sale of a nearby delivery month and purchase at a deferred delivery month fixed interest future in expectation of short-term interest rates rising, thereby increasing the relative attractiveness of the back month contract.
Bear Duration
A proprietary measurement developed by PIMCO that estimates the price change in a security or portfolio in the event of a rapid, 50 basis-point rise in interest rates over the entire yield curve. This tool measures the effect that mortgages and callable bonds will have on the lengthening (or extending) of the portfolio’s duration.
Bearish
Pessimistic about the market; anticipating a decline in prices
Below Investment Grade
A below-investment grade bond is a corporate or municipal bond that has a credit rating below triple-B from the major credit rating agencies. These are also called junk bonds.
Benchmark
A bond, frequently the most recent, sizable issue, whose terms set a standard for the market. The benchmark bond usually has the greatest liquidity, the highest turnover, and is the most frequently quoted. In certain markets (e.g., the Japanese), there is a seasoning period during which the bond is not the benchmark.
Bid and Asked/Bid and Offer
The price at which as owner offers to sell (asked of offer) and the price at which a prospective buyer offers to purchase (bid).
Bond
An instrument of debt issued by a corporation or government to raise capital. Bonds are interest bearing and promise to pay the holder a specified sum of money at its maturity plus interest at given intervals.
Bond Returns
Consist of two components, 1) current yield (see description below) and 2) price performance. Current Yield is the amount of coupon income received, expressed as a percentage of the current market value of the bond or portfolio. Price Performance of bonds is determined by changes in interest rates. If rates rise, bond prices fall. If rates fall, bond prices rise.
Breakeven Analysis
A method of analysing investments to determine under what circumstances the returns of different securities would be equal. Commonly used in reference to the calculation of how much yield change is needed to produce identical returns among securities.
Bull Duration
A proprietary measurement developed by PIMCO that estimates the price change in a security or portfolio in the event of a rapid, 50 basis-point drop in interest rates over the entire yield curve. This tool measures the effect that mortgages and callable bonds will have on shortening (or contracting) the portfolio’s duration.
Bull Market
A market characterised by a trend of rising prices.
Bull Spread
A simultaneous purchase of a nearby delivery month and sale of a deferred delivery month fixed interest future in expectation of short-term interest rates falling, thereby increasing the relative attractiveness of the front month contract.
Bullet
1. An issue of securities with no amortisation or sinking fund features.
2. Portfolio structuring technique focusing on a particular maturity or duration.
Bullish
Optimistic about the market; anticipating a rise in prices.
Call
1. The exercise of the right of a corporation to prepay its debt and demand surrender of its bonds for redemption, refunding or sinking fund purposes on a specific date at a specified price.
2. An option contract which for a consideration, gives the holder the right to purchase from the writer of the call a specified price, good for a specified period of time.
Capital Gain/Capital Loss
A realised gain or loss calculated at the time of sale or maturity of any capital asset or security. Refers to the profit or loss attributable to the difference between the purchase and sale prices.
Carry
The cost of financing positions; the rate of interest earned from the securities held less the cost of funds borrowed to purchase them.
Cash Equivalents
Any kind of savings account, short-term bank account, commercial paper, or other type of converted to cash.
Cash Flow
Money that the client is contributing to or withdrawing from an account during a specific period, including bank and manager (PIMCO) fees.
Cash Settlement
A delivery made and settled on the day of the transaction for government securities.
CBO
Collateralised Bond Obligation
Certificate of Deposit (CD)
An interest-bearing negotiable time deposit of fixed maturity at a commercial bank. CD's trade on a yield basis with interest computed for the actual number of days held on the basis of a 360- day year.
CLO
Collateralised Loan Obligation
Collateralised Mortgage Obligation (CMO)
CMOs are bonds that are collateralised by whole loan mortgages or mortgage pass-through securities. A key difference between traditional pass-throughs and CMOs is the mechanics of the principal payment process. In a pass-through, each investor receives a pro rata distribution of any principal and interest payments made by the homeowner. Because mortgages are self-amortising assets, pass-through holder receives return of principal each month. Complete return of principal and the final maturity of the pass-through do not occur until the final mortgage in the pool is retired.
The CMO structure substitutes sequential retirement of bonds for the pro rata principal return process of pass-throughs. All principal payments go first to the “fastest-pay” tranche of bonds. Following retirement of this class, the next tranche in the sequence then becomes the exclusive recipient of principal. This process continues until the last tranche of bonds is retired.
The effect of the CMO innovation is to utilise cash flows of long maturity, monthly-pay collateral to create securities with short, intermediate and long final maturities. This broadens the range of investors for mortgage securities and ultimately forces more competitive mortgage rates for homebuyers.
Commercial Paper
Financial instruments which can be bought and settled on the same day with a minimum of complication, which have a short-term maturity, and pay interest maturity. They are cash equivalents.
Commodities
Commodities are raw materials used to create the products consumers buy, from food
to furniture to gasoline. Commodities include agricultural products such as wheat and
cattle, energy products such as oil and gasoline, and metals such as gold, silver and
aluminium. There are also “soft” commodities, or those that cannot be stored for long
periods of time, which include sugar, cotton, cocoa and coffee.
Coupon
The rate of interest to be paid on a bond, most often it is paid semi-annually. Refers to the interest payment of par, or face value. Expressed as a percentage of par.
Corporate Bond
When companies want to expand operations or fund new business ventures, they often turn to the corporate bond market to borrow money from investors. A company seeking to borrow money in the bond market determines how much it would like to borrow and then issues a bond in that amount.
Credit Default Swap (CDS)
A credit default swap is similar to an insurance contract, providing the buyer with protection against specific risks. Most often, corporate bond investors buy credit default swaps for protection against a default by the issuer of the corporate bond, but these flexible instruments can be used in many ways to customise exposure to corporate credit.
CDS contracts can mitigate risks in bond investing by transferring a given risk from one party to another without transferring the underlying bond or other credit asset.
Credit Risk
The risk that an issuer may default on its securities. Relative degrees of credit risk are delineated by the ratings of the rating agencies.
Current Yield
Amount of coupon income received, expressed as a percentage of the current market value of the bond or portfolio.
Debenture
An obligation secured by the general credit of the issuer rather than being backed by a specific lien on property.
Deflation
A progressive reduction in the price level, which would make real interest rates greater than nominal rates.
Derivative
A security which derives its value from movements in an underlying security.
Disinflation
A declining rate of inflation. Analysts are predicting modest disinflation in the U.S. in 2002.
Diversification
In simple terms, diversification means not “putting all your eggs in one basket”.
Dividend
A cash or other distribution to preferred or common stockholders.
Duration
A measure of average maturity that incorporates a bond's yield, coupon, final maturity and call features into one measurement. Duration measures the sensitivity of a bond's, or portfolio's, price to changes in interest rates.
A two year duration portfolio will rise (fall) 2% if rates fall (rise) 1%.
A five year duration portfolio will rise or fall 5%
If the outlook on bonds is "bullish", i.e., we expect the interest rates to fall, the duration is then extended.
If the outlook on bonds is "bearish", i.e., we expect the interest rates to rise, the duration is then reduced.
Bear Duration: a proprietary measurement developed by PIMCO that estimates the price change in a security or portfolio in the event of a rapid, 50 basis-point rise in interest rates over the entire yield curve. This tool measures the effect that mortgages and callable bonds will have on the lengthening (or extending) of the portfolio’s duration.
Bull Duration: a proprietary measurement developed by PIMCO that estimates the price change in a security or portfolio in the event of a rapid, 50 basis-point drop in interest rates over the entire yield curve. This tool measures the effect that mortgages and callable bonds will have on shortening (or contracting) the portfolio’s duration.
Curve Duration: a measurement of a portfolio’s price sensitivity to changes in the shape of the yield curve (i.e., steepening or flattening). A portfolio’s curve duration is considered positive if it has more exposure to the 2- to 10-year part of the curve. A portfolio with positive curve duration will perform well as the yield curve steepens, but will perform poorly as the yield curve flattens. A portfolio with negative curve duration has greater exposure to the 10- to 30-year portion of the curve. It will be a poor performer as the yield curve steepens and a strong performer as the yield curve flattens.
Effective Duration: the standard measurement that estimates the price change in a security or a portfolio when the interest rates movements are fairly small.
Spread Duration: a measurement that estimates the price sensitivity of a specific sector or asset class to a 100 basis-point movement (either widening or narrowing) in its spread relative to Treasuries.
- Corporate spread duration: applies primarily to the widening or narrowing of the spread over LIBOR in floating-rate notes. The spread duration for fixed-rate corporates is the same as standard duration.
- Mortgage spread duration: applies to the widening or narrowing of the option-adjusted spread (OAS) that takes into account the prepayment risk.
Total Curve Duration: a measurement that shows a portfolio’s price sensitivity to changes in the shape of the yield curve relative to its benchmark’s sensitivity to those same changes. [See Curve Duration above for characteristics of positive vs. negative portfolios].
Emerging Markets
The emerging markets comprise those nations whose economies are considered to be developing—or emerging from underdevelopment—as defined by The World Bank and usually include most or all of Africa, Eastern Europe, Latin America, Russia, the Middle East and Asia excluding Japan.
Equities
Securities that signify ownership in a corporation and represents a claim on part of the corporation's assets and earnings. Also called shares, equity securities or corporate stock.
Face Value (Amount)
The par value of a bond that appears on the face. This is the amount that the issuer promises to pay at maturity as well as the amount on which interest is computed.
Fallen Angels
A fallen angel is a bond that was once investment grade but has since been reduced to junk bond status.
Fixed Interest
Securities/Investments in which the interest during ownership is fixed or constant. Generally refers to any type of bond investment.
Floating Rate Note (FRN)
A fixed interest security which has variable coupon rates, periodically changed according to the rise and fall of a certain interest rate index or a specific fixed interest security which is used as a benchmark. Also known as a "floater".
Future
A contract to buy or sell a specific amount of securities or commodities for a specific amount of securities or commodities for a specific price or yield on a specified future date.
Future Value
The assumed amount of cash at a future point in time. a present value becomes a future value through the process of reinvestment.
Futures Contract
Agreement to buy or sell a specific amount of a commodity or financial instrument at a particular price and a stipulated future date.
Futures Delivery
The process of meeting an obligation to deliver or receive securities or commodities on a date, in a location as specified by the terms of the contract.
Government Bonds
Bonds backed by the federal government, whether issued by the Treasury or one of the government agencies.
Hedging
1. The temporary purchase or sale of a contract calling for future delivery of a specific security at an agreed upon price to offset a present or anticipated position in the cash market.
2. The technique of making offsetting commitments to minimise the impact of contrary adverse movements.
High Yield
A high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.
Implied Yield
A forecasted yield derived from present yields and based on the theory that the yield curve on one day is an excellent prediction of itself in the future.
Index-Linked Bond
A bond whose coupon payments are a function of some index. For example, coupons on index-linked gilts are linked to the Retail Price Index.
Inflation
A general rise in prices, usually measured by changes in prices of major indices, such as the Consumer Price
Index. An increase in a particular price may or may not be inflationary, depending on how it affects other prices and on how promptly it brings to market additional supplies of a product. As of December 2001, the year-over-year percentage change in the CPI was 1.9%, which in historical terms is a modest rate of inflation.
Inflation Linked Bond
Fixed interest securities whose principal value is periodically adjusted according to the rate of inflation. The interest rate on these bonds is fixed at issuance, but over the life of the bond this interest is paid on an increasing principal value, which has been adjusted for inflation.
Interest
An amount charged to a borrower by a lender for the use of money, normally expressed in terms of an annual percentage rate of the principal amount.
Interest-Rate Risk
When interest rates rise, the market value of fixed-interest securities (such as bonds) declines. Similarly, when interest rates decline, the market value of fixed-interest securities increases.
Interest Rates
The percentage paid as a fee for the use of money, expressed as an annual percentage of the principal amount. Influenced by a variety of factors including economic growth, inflation, supply/demand and international factors.
Investment Grade
Bonds rated in the top four rating categories (AAA, AA, A, BBB) are commonly known as investment grade securities and are considered eligible for bank investment under present commercial bank regulations issued by Comptroller of the Currency.
Leverage
1. The effect of the use of senior capital (bonds and preferred stocks) over junior capital (common stock) in capitalisations.
2. A measurement of a portfolio's exposure to market risk.
Liquidity
1. The degree to which an asset can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.
2. The ability to convert an asset to cash quickly. Also known as “marketability.”
Local Currency Emerging Market Debt
A term used to encompass bonds issued by less developed countries which are denominated in their own currency.
Market Risk
The risk that current interest rates may change and thus adversely affect current market prices.
Market Value
Market price times quantity.
Mortgage-Backed Securities
Bonds which are a general obligation of the issuing institution but are collateralised by a pool of mortgages.
Nominal Bond
A bond whose value does not adjust to compensate for the impact of inflation.
Nominal Return
Describes any change in value, including the artificial rise in prices that comes with inflation.
Nominal Yield
The rate listed on the face of a bond; the coupon rate.
Option
1. An agreement, or privilege, which conveys the right to buy or sell a specific security at a stipulated price and within a stated period of time. If not exercised during that time, the money paid for the option is forfeited.
2. Right to buy or sell property that is granted in exchange for an agreed-upon sum.
Par Value
1. The value of a security as expressed on its face value without consideration to any premium or discount. Also signifies the dollar value on which bond interest is figured.
2. A price of 100 percent of face value.
3. The face value assigned by a corporation to common or preferred stock.
4. The principal amount or denomination at which the obligor (issuing corporation) contracts to redeem the bond at maturity. This amount is stated on the face of the bond.
Put Option
The right to sell a security at a predetermined price on or before a specified future date.
Quality
Rating assigned to issue based upon issuer's credit worthiness. Investment grade issues are BAAA - AAA (Moody's rating).
Repurchase Agreements (RP's)
A method of borrowing by using a security as collateral for a loan. The interest rate and term of the loan are agreed upon in advance, an upon repayment of the loan the security Is returned to the owner. The borrower retains possession of the security and continues to receive any interest payments during the term of the agreement. Also known as a repo.
Rising Stars
Bonds that started out as high yield names but have become investment grade companies either through acquisition or through a deleveraging exercise.
Risk
A measure of the probability of financial loss. In the fixed interest markets there are several types of risk:
Credit risk: is the risk that an issuer will default on its bonds at some time prior to maturity
Market risk: is the risk that an investor will experience a financial or book loss from an adverse change in market prices.
Liquidity risk: is the risk that an issue will be illiquid and force an investor to take a loss if he attempts to sell the issue prior to maturity.
Prepayment risk: is the risk that a pass-through issue will have an adverse paten of prepayments (i.e., low prepayments for discount issues, high prepayments for premium issues).
Reinvestment Risk: is the risk that an investor will be forced to reinvest cash flow from an issue at substantially lower rates that the yield of the original investment.
Risk can be either systematic or unsystematic (diversifiable).
Risk-vs-Return
Risk measures the probability of financial loss. Investors often compare risk, as measured by standard deviation of returns, to historical or expected return when making investment decisions. Typically, investors demand higher returns for investments they consider more risky.
Riskless
Without credit risk. Treasury issues and government-guaranteed issues are regarded as the only riskless issues.
With respect to bond trading, simultaneous buying and selling so as to eliminate market risk.
Speculative Grade Bonds
A bond rated BB or lower because of its high default risk. Also known as a “high yield” or “junk” bond.
Standard Deviation
Statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. In portfolio theory, the past performance of securities is used to determine the range of possible future performances and a probability is attached to each performance. The standard deviation of performance can then be calculated for each security and for the portfolio as a whole. The greater the degree of dispersion, the greater the risk.
Swap
The sale of one security for the purchase of another. Bond swaps fall into three basic categories, although a given swap may have aspects of two or more of these:
Substitution Swaps: swaps done in order to improve upon one or more characteristics of the original bonds. Swaps done for yield pickup, quality improvement or change in call protection are in this category.
Intermarket Spread Swaps: swaps done in anticipation of a (favorable) change in the price or yield spread between the two issues from two different sectors of the market.
Rate Anticipation Swaps: swaps done in anticipation of a (favorable) change in the overall level of interest rates. Rate anticipation swaps generally consist of lengthening maturity and/or lowering coupon when bullish and shortening maturity and/or increasing coupon when bearish.
TIPS
Inflation-indexed securities issued by the U.S. Treasury Department (commonly known as Treasury Inflation-Protection Securities). TIPS have been issued in the U.S. since January 1997. These securities adjust both their principal and coupon payments upward with any rise in inflation. Like all Treasuries, they enjoy the full guarantee of the U.S. government.
Total Return
The aggregate increase or decrease in the value of the portfolio resulting from the net appreciation or depreciation of the principal of the fund, plus or minus the net income or loss experienced by the fund during the period.
Trade Date
The date when a transaction is effected or executed.
Treasury Bond
A coupon security of the U.S. Treasury which may be issued with any maturity but generally carries a maturity of more than 10 years.
Treasury Note
A coupon security issued by the U.S. Treasury with a maturity of not less than one year not more than 10 years.
Upgrade
The changing of a rating by a rating agency to a higher (more credit worthy) rating.
The sale of one block of bonds and the purchase of another block with a higher rating.
Volatility
Measures the variation of bond returns and/or interest rates over a set time period. It can be integral to pricing many issues with call options.
Yield
The rate of annual income return on an investment expressed as a percentage. Income yield is obtained by dividing the current dollar income by the current market price of the security.
Yield Curve
A graphic depiction of interest rates across all maturities, 0-30 years. The shape of the curve is largely influenced by the Federal Reserve Policy as well as factors listed under "Interest Rates" above.
Yield Curve Risk
Price exposure that a security or portfolio has in the event of nonparallel shifts in the yield curve.
Yield to Maturity
The return a bond earns on the price at which it was purchased if it were held to maturity. It assumes that coupon payments can be reinvested at the yield to maturity.
Yield to Worst
The yield resulting from the most adverse set of circumstances from the investor's point of view; the lowest of all possible yields.