An Introduction to the Bond Markets

2

Types of Bonds and Other Instruments

This chapter describes many of the different types of fixed-rate, floating-rate and index-linked bonds and short-term money market instruments that have been issued, together with some other financial instruments that work in a similar way. Some of the more common embedded bond options, such as the ability of the issuer to call (redeem early) a bond or of the holder being able to convert the bond into another issue, are described in a later chapter.

2.1 FIXED-RATE BONDS

This section looks at some of the principal types of fixed-rate bonds. In particular, it looks at straight coupon paying bonds, zero-coupon bonds, undated or irredeemable bonds, strippable bonds and strips, bonds with sinking funds, step-up or graduated-rate bonds and annuities.

2.1.1 Straight coupon bonds

These are the most common type of bonds. They are one of the easiest to understand and often the easiest to value.

A vanilla ‘bullet’ straight bond or ‘option-free’ bond gives the holder the right to receive interest periodically and have the capital returned on an agreed single date. Neither the issuer nor the investor has the right to demand early repayment of the bond.

Most fixed-rate straight bonds pay coupons once or twice a year, although a few (often older issues) pay interest four times a year. The majority of bonds in a specific market sector tend to have the same coupon payment frequency.

In the UK, US, Australian, Canadian, Italian and Japanese domestic markets, ...