Below is a list of common investment terms with basic explanations.
Accrued Interest – Interest due from issue date or from the last coupon date to the security settlement date. Interest that has accumulated on a bond since its most recent regular interest payment date. The buyer of the security pays the accrued interest to the seller and recoups a full payment on the next payment date.
Amortization – The process where, as time passes, your fixed income investment moves inexorably to its face value or maturing value.
Balloon – The maturing principal of a bond issue.
Bank rate – The Canadian equivalent of the discount rate. This is the minimum rate of interest that the Bank of Canada charges on one-day loans to financial institutions. In December 2000, the Bank began setting the level of the Bank Rate – and with it, the target for the overnight rate – on eight fixed dates per year.
Basis point – 1/100 of a percentage point. It is often used to explain changes in bond yields. A 12 basis points increase in yield would mean a yield increase of 0.12 percentage points (e.g. 6.24 percent to 6.36 per cent is an increase of 12 basis points).
Benchmark – This refers to bonds by which others are valued. The Bank of Canada issues bonds at strategic maturity points (typically two, three, five, 10 and 30 years). When issuers bring new bonds to market, the presence of the Bank of Canada issues makes pricing easier since accurate market yields are readily available as references or benchmarks.
Bid price – The highest price a prospective buyer or dealer is willing to pay.
Bid size – The quantity (face value) of a security the highest bidding buyer wants to purchase.
Bid yield – The yield at which the highest bidding buyer is willing to purchase a security.
Bond – Evidence of a debt that is owed by a borrower who has agreed to pay a specific rate of interest, usually for a defined time period. At the end of that period the debt is repaid. Legally, a bond has assets pledged against the loan. In practice, the word is applied to any kind of term debt, collateralized or not.
Buy order– An order to purchase a security.
Callable – A bond that can be redeemed by the issuer, prior to its maturity date. Certain conditions have to be met.
Call price – The price at which a callable bond can be bought back by the issuer.
Certificate of deposit – A fixed income security issued by a chartered bank. Minimum purchase amount is usually $1000 with terms of from one to seven years.
Commercial paper – Short-term debt instruments issued by non-financial corporations. They have maximum maturities of one year.
Convertible bond– A bond containing a provision that permits conversion to the issuer’s common stock at some fixed exchange ratio.
Coupon – The annual rate of interest on the bond’s face value that a bond’s issuer promises to pay the bondholder. That portion of a bond that provides the holder with an interest payment at a pre-specified rate. Quoted at an annual rate, but usually paid semi-annually. A certificate attached to a bond evidencing interest due on a payment date.
CUSIP number – The Committee on Uniform Security Identification Procedures, which was established under the auspices of the American Bankers Association to develop a uniform method of identifying municipal, government and corporate securities.
Dealer – A dealer, as opposed to a broker, acts as a principal in all transactions, buying and selling for his own account.
Debenture – A debt that is secured solely by the general creditworthiness of the issuer and not by the collateralization or lien against specific assets.
Description – Short-form notation used to distinguish a particular issue. Typically follows the following protocol Issuer_Coupon_Maturity (i.e. CAN 8.75 12/05).
Detailed information– Information data set. Contains the CUSIP number, Description, Bid Price, Ask Price, Bid Yield, Ask Yield, Bid Size, Ask Size, Coupon, Maturity and Credit Ratings (CBRS, Moody’s and S&P).
Discount – The amount by which a bond sells below its par (or maturity) value.
Discount securities – Non-interest bearing money market instruments that are issued at a discount and redeemed at maturity for full face value; e.g. Treasury bills.
Downward yield curve – This refers to an abnormal yield curve where the shorter the term to maturity, the higher the yield. It occurs typically when a central bank is determined to snuff out an inflationary cycle.
Duration – The average life of your fixed income investment. A ten-year bond is not exactly a ten-year bond. All the interest payments shorten the average term. The bigger the interest payments, the shorter the duration. For a zero coupon bond, maturity and duration are the same since there are no cash flows to worry about. This term is used in measuring risk.
Extendible bond – An issue with a stated maturity date that under specific conditions gives the holder the right to extend the maturity for a further period.
Face value – Underlying principal amount of a security. The value of a bond that appears on the face of the certificate. It is almost always the maturity value of the bond. It is not an indication of current market value.
Flat yield curve – This refers to a yield curve where yields are the same at all maturities. ‘Flat’ can also mean that a bond is trading with no accrued interest, either because the settlement date coincides with the coupon payment date or else the issuer is not able to make interest payments.
Humped yield curve – This refers to a yield curve where some anomaly pushes yields at one or more maturity dates out of line with surrounding maturities.
Issuer – The entity (government or corporation) that borrowed the capital and is responsible for repaying the bondholder.
Income bond – A bond that pays interest only when earned by the issuer.
Inventory – To facilitate the retail and institutional clients, investment dealers maintain inventory of ‘shelf products’ financed with their own capital and which are offered at competitive prices.
Jobbers – Approved money market dealers who must bid for each week’s treasury bill auction.
Limit order – An order that is restricted in price.
Long term bond – One that matures in more than 10 years.
Make a market – A dealer is said to make a market when he quotes bid and offered prices at which he stands ready to buy and sell.
Market order – An order that is priced to move with the current market price. It must be executed as soon as possible at the best possible price.
Maturity date – The date on which the security matures is the day that the issuer must repay the amount borrowed plus interest to the holder of the note.
Medium term bond – One that matures in from 3 to 10 years.
Money market – A wholesale, financial market specializing in low risk, highly liquid debt instruments (bills, commercial paper, bankers’ acceptances and corporate paper) with terms to maturity of less than 1 year.
Moody’s rating – Method of credit analysis. A guide of relative bond value.
Municipals – Securities issued by local governments and their agencies.
Municipals (MUNI) notes – Short term notes issued by municipalities in anticipation of tax receipts, proceeds from a bond issue, or other revenues.
Offer price – The price at which a dealer will sell the securities.
Offer size – The quantity (face value) of a security that is offered for sale.
Offer yield – The yield at which a security is offered for sale.
Off the run – This refers to a bond issue that is not a ‘benchmark issue’. It may have a very high or low coupon, it may be a small illiquid issue, its ownership may be concentrated in few hands or it may have a feature, which makes it unattractive to trade. The bid-ask spread will be wider for such an issue, because dealers either do not wish to hold them in inventory or if they do, find it difficult to sell them quickly.
Order – An order is an expression of interest to either buy or sell an instrument.
Over the counter – This essentially means ‘not centralized’. Unlike the equity market, which has a recognizable physical location to trade stocks, the bond market is decentralized, without one meeting place; transactions occur verbally or electronically between markets.
PAR – Price of 100%. The principal amount at which the issuer of a debt security contracts to redeem that security at maturity, face value.
PAR value – The stated face value of a bond. It has no connection with the same expression that sometimes relates to common stocks. Also referred to as Face Value or Par.
Positive yield curve – This refers to a ‘normal’ yield curve, one in which the longer the term to maturity, the higher the yield.
Price – The dollar amount one or more parties are willing to pay/receive to purchase/sell a security. Price is typically expressed per $100 of Par Value.
Principal – What you lend. This value is expected to be returned to you at the bond’s maturity date.
Provincials – Securities issued by provincial governments and their agencies.
Quote – An indication of interest to either buy or sell.
Redeemable – This is similar to callable bonds but with one huge difference. Normally issued by corporations, a redeemable bond may be ‘called’ by the issuer but not for financial advantage; in other words, the issue may not be redone at a lower coupon rate. Rather, should a company have surplus cash or in the event of a corporate development the bond issue may be retired prematurely.
Reinvestment risk – There are two basic risks. The first is that the yield to maturity quoted on a bond may not be realized, since all interest payments never get reinvested at the same rate. Second, you will experience this risk if you have your entire portfolio maturing at the same time, and rates have fallen dramatically.
Residuals – The principal portion left over after all the interest payments have been stripped away.
Retractable – An issue that gives the holder the option, under certain circumstances, to redeem his holdings at their face value, prior to the final maturity date.
Sell order – An order to sell a security.
Settlement date – The month, day, and year the transaction will settle. As per industry standards, settlement usually occurs 3 business days after trade date (“T+3”) for Equities.
Fixed Income securities settle as follows:
Canadian, US T-Bills and Commercial Paper: T+1
GOC Bonds with an unexpired term of 3 years or less to maturity: T+2
All other Fixed Income instruments, including all Strip Bonds: T+3
Short sale – The sale of securities not owned by the seller in the expectation that the price of these securities will fall or as part of an arbitrage. A short sale must eventually be covered by a purchase of the securities sold.
Sinking fund – Indentures governing corporate issues often require that the issuer make annual payments to a sinking fund, the proceeds of which are used to retire randomly selected bonds in the issue.
Spread – Difference between bid and offered prices on a security.
Difference between yields on (or prices of) two securities of differing sorts or differing maturities.
In underwriting, difference between price realized by the issuer and price paid by the investor.
Difference between two prices or two rates. What a commodities trader would refer to as the basis.
Stripped bonds A bond that has had all its coupons removed, thus creating a series of zero coupon issues, the maturity dates of which are the interest payment dates of the coupon, as well as the originally established maturity date. Generally sold at a discount.
Summary information – Information data set. Contains the CUSIP number, Description, Bid Price, Offer Price, Bid Yield, Offer Yield, Bid Size, Offer Size.
Trade – A trade is a transaction. A trade has a buyer and a seller as well as a price and quantity.
Trade date – The date on which a transaction is initiated. The settlement day may be the trade date or a later date.
Treasury bill – Discount instruments issued by the federal government at a weekly auction. The T-bills generally have original maturities of 13 weeks (3 months), 26 weeks (6 months) and 52 weeks (1 year).
Two-sided market – Market in which both a bid and an offered price, good for the standard unit of trading, are quoted.
Two-way market – Market in which both a bid and an offered price are quoted.
Volatility – How much the price of a bond changes for a given movement in yield.
Yield – The interest rate expressed as an annual percentage that the funds will earn or cost over the term of the security.
Yield curve – The relationship between the various maturities of same credit quality issues. The curve for Government of Canada bonds sets the base of relationships for the Canadian market. For a description of the various forms of yield curves, please see Downward yield curve, Flat yield curve, Humped yield curve and Positive yield curve.
Yield to maturity – The rate of return yielded by a debt security held to maturity when both interest payments and the investor’s capital gain or loss on the security are taken into account. The return that an investor will receive if an issue is held to its maturity date and all coupons, as they are received, are re-invested at that yield level.
Zero coupon bond – A bond that pays no interest throughout its life. Zero Coupon Bonds (Zeros) sell at a discount to maturity value. The discount represents the return on the original investment, if the bond is held to its maturity date. The bonds are usually created using interest payment dates of a regular issue.
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