Fixed Income Security Characteristics

Maturity

One of the most important features of any bond is its maturity. Inflation, and expected interest rates, have their greatest effect on coupon or principal payments that are far off in the future; bonds with longer maturities typically exhibit more volatile price behavior than bonds with shorter maturities. Longer maturities also increase the possibility that there can be a change in the credit quality of the issuer.

Coupon

The level and timing of coupon payments also has an effect on the pricing and yield of a bond. Although coupons are quoted at an annual rate, they are most frequently paid to the investor twice a year. Bonds also may pay interest monthly, quarterly, or annually, but these payment schedules are less common. Some bonds are issued as zero coupon bonds and repay only the initial principal amount at maturity. These bonds trade at a fraction of their principal, or maturity value. Coupons on bonds can be floating instead of fixed. The coupons on floating or adjustable rate bonds are reset at periodic intervals that vary depending on the individual bond. These bonds reset at periodic intervals that vary depending on the individual bond. These bonds reset at a stated spread above a given index. The spread and the index are characteristics of the bond and may vary from bond to bond.

Issuer

The characteristics of the issuer also have an effect on the behavior of the bond. The characteristics of
the issuer most directly impact the likelihood of repayment, or credit risk, of a bond. Treasury securities carry the highest credit rating, followed by government agencies and then corporate issuers. Both corporate and public ( municipalities, sewer districts, housing authorities, bridge and tunnel authorities, etc.) debt issuers are rated as to the degree of credit risk of their bonds by one or both of the major credit rating agencies, Moody's and Standard and Poor's. Bonds rated AAA, AA, A and BBB by S&P are regarded as investment grade securities, while bonds with ratings below BBB are termed high yield, speculative, or junk bonds.

Put or Call Features

Bonds may have put or call features that can have a significant effect on the behavior of a bond. Bonds with a put option allow the holder to redeem a bond at a specified time or during a specified time period at a predetermined price. The put feature provides price support to the bond and serves to effectively limit the amount the bond will decrease below the put price. The closer a bond is to its eligible put date, the less likely it is to trade significantly below the put price.

A call feature on a bond limits a bond's potential upward price movement much the way a put option limits a bond's downward price movement. A call option gives the issuer the ability to redeem the bond prior to its maturity date at a specified price; most often at par. If a bond is worth more than par when it is called ( the most common occurrence, since a bond will be called when the call is in the best interest of the issuer, or individual holding the call option), the investor will have to reinvest the proceeds from the call at less favorable terms currently existing in the market. The holders of the individual mortgages supporting mortgage backed securities hold call options that they can exercise by refinancing their mortgages. By refinancing their mortgages, these individuals are calling their old mortgages and redeeming them at par. The effect that this call option has on the price of mortgage backed securities will be more fully discussed in the section on mortgage backed securities.