Glossary


Please see below for a glossary of commonly used financial terms. 

Asset backed securities (ABS) – debt securities backed by a pool of assets, which can range from loans and mortgages to credit card receivables. Residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) are common types of ABS. 

Breakeven rate - the difference between the yield on a conventional (fixed rate) bond and that of an inflation-linked investment of comparable maturity and credit quality. If you think inflation will be greater than the breakeven rate, you would buy an inflation-linked security and sell a conventional security. If you think inflation will be less than the breakeven rate, you would sell the inflation linked security and buy the conventional security. 

Callable bonds - bonds where the issuing entity has the power to ‘call’ (i.e. buy back) the bond, usually on specific dates or within a specified timeframe. The issuer may want to call a bond in order to re-borrow at a lower rate by issuing a new bond (this has been a common tactic in the ongoing environment of low interest rates). Bonds can also be ‘puttable’, which gives the bond holder (investor) the option to ‘put’ the bond back by selling it back to the issuer. Puttable bonds are less common.

Certificates of deposit (CDs) – negotiable savings certificates for fixed-term deposits, paying a fixed or variable rate of interest until maturity, usually at a higher rate than a savings account. CDs are liquid and offer a high level of capital protection, and are often appropriate instruments for cash funds. 

Covered bonds – corporate bonds secured both against the issuer and a collateralised pool of assets, such as mortgages or loans. Covered bonds offer an extra layer of protection compared with corporate bonds, as in the event of default or insolvency investors have a claim on the pool of assets as well as the issuer.

Duration – the sensitivity of a bond’s price to changes in interest rates. If rates increase, a ‘short’ duration portfolio will experience less of a price decline than a ‘long’ duration portfolio. If rates fall, a ‘short’ duration portfolio will experience less of a price increase than a ‘long’ duration portfolio. To put it another way, if rates increase by 1%, the price of a bond with a 10-year duration will lose 10%, but a bond with a 5-year duration will lose only 5%. A bond with -5-year duration will rise in price by 5%.

Floating rate notes (FRNs) - bonds issued with a variable coupon that is reset quarterly, thereby offering inflation and interest rate protection. Coupons of sterling FRNs are referenced against 3-month LIBOR and carry low interest rate. 

High yield bonds – bonds rated below investment grade (BBB- or lower). These bonds offer higher yields to compensate investors for taking additional risk. However, ratings are not the only measure of risk, and some high yield bonds may offer attractive risk/return profiles for active investors who can conduct their own research and analysis.

Investment grade bonds - bonds rated BBB and higher. These bonds offer lower yields than those of high yield bonds, reflecting their relatively lower risk. However, ratings are not the only measure of risk, and investment grade bonds may not always offer an attractive risk/return profile.

Index linked bonds – securities with coupons linked to inflation, and are usually issued by governments. Unlike conventional bonds, they provide protection against inflation, which can be a key risk for investors with long-term liabilities. 

MBS and RMBS - ‘Mortgage Backed Securities’ and ‘Residential Mortgage Backed Securities’. These are securities whose cashflows derive from a pool of mortgages. 

Treasury bills (T-bills) – zero coupon debt instruments issued by governments, T-bills are offered at a discount to their par (face) value. The investor receives the difference between the purchase price of the security and par value when the bill matures.

Treasury Inflation Protected Securities (TIPS) – index linked bonds issued by the US government. 

Unrated corporate bonds – bonds which are not rated by any of the ratings agencies. This is not necessarily a reflection of their riskiness – there a many reasons why an issuer may choose not to pay an agency to rate its bonds. Unrated bonds will not appear in bond indices, and may offer attractive, off-benchmark opportunities to active investors who are able to conduct their own research and analysis. 

Weighted Average Life - a measure which shows how long (in years) it takes to receive half the amount of the outstanding (unpaid) principal of a fixed income security (or portfolio). WAL is calculated by multiplying the total cashflows for each future year by the number of years until they are paid (i.e. cashflows for the first year ahead are multiplied by 1, those for the second year ahead are  multiplied by 2, etc.). This value is then divided by the simple sum of the future cashflows. 

Weighted Average Maturity - a measure of the maturity of the portfolio, calculated by taking the time to maturity (time outstanding) of each individual asset in the portfolio, multiplied by the weight (percentage holding) of that asset in the portfolio. 

Yield curve – a graph that plots the yields of bonds from the shortest-maturity to the longest-maturity. It is also known as the ‘term structure of interest rates’. A ‘normal’ yield curve slopes upward as maturities increase, as investors in longer-dated bonds demand a higher yield in return for higher interest rate risk. An ‘inverted’ yield curve occurs when investors believe that economic growth will slow, reflecting the risk of future interest rate cuts.