Debt Securities

Section 2.2: Debt Securities — Bonds and Fixed Income Estimated study time: 55 minutes Content: Debt securities are instruments through which issuers borrow money from investors and promise to repay principal at maturity while making periodic interest payments. They are a cornerstone of the SIE exam's Products and Risks section. When a corporation, municipality, or government issues a bond, it is selling a debt obligation. The key terms of any bond are: (1) par value (face value, typically $1,000 per bond), the amount returned to the investor at maturity; (2) coupon rate, the annual interest rate expressed as a percentage of par (a 5% coupon on a $1,000 bond pays $50 per year, typically in $25 semiannual installments); and (3) maturity date, when the principal is repaid and the bond ceases to exist. Bond prices move inversely with interest rates — this is the most tested relationship in all of fixed income. When market interest rates rise, existing bonds with lower coupon rates become less attractive, so their prices fall. When rates fall, existing bonds with higher coupons become more valuable, and their prices rise. This relationship can be remembered with the simple phrase: "rates up, prices down." The sensitivity of a bond's price to interest rate changes is measured by duration — longer-duration bonds experience larger price swings for a given change in rates. U.S. Treasury securities are issued by the federal government and are considered the safest debt instruments available because they are backed by the "full faith and credit" of the United States — essentially the government's power to tax. Treasury Bills (T-Bills) mature in one year or less and are sold at a discount (paying…