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Tutorial: Senior bonds

What are senior bonds?

Bonds are - from the investor's point of view - so-called debt securities and may be issued by different issuers (e.g., banks, sovereigns, corporates, residential banks, supranational institutions such as the World Bank). In principle, bonds differ in terms of the issuer's credit rating, rank, coupon, currency and maturity.

The credit rating provides information about the default probability of a debtor. The amount of the interest on a bond depends u. a. from the credit rating. The higher the coupon, the higher the default probability.

In terms of rank, we distinguish between covered bonds (mortgage and municipal bonds), unsecured (senior) bonds and subordinated bonds. The liabilities from normal bonds are considered direct, unconditional and non-subordinated (also called senior debt). In the case of bankruptcy, these are first-ranked, i.e. having their claims satisfied before all other creditors.

How do senior bonds work?

With a bond the investor lends to the issuer the nominal amount of the bond and in return receives interest payments and at the end of the term the invested capital at 100% of the nominal amount.

The type of interest (= coupon) is defined from the beginning for each bond. Fixed-rate interest bonds offer a fixed interest over the entire term. Floating rate bonds are linked to a reference interest rate (such as EURIBOR) and are regularly adjusted to the new interest rate level. The coupons are paid on the coupon date (e.g., quarterly, semiannually, annually) and are calculated on the nominal amount. A special form are zero coupon bonds. They pay no continuous coupon. The yield from a zero coupon bond is the difference between the initial issue price and the redemption price of the bond.

A bond can be issued in different currencies. In addition, the currency risk is to be considered here.

Your benefits

A senior bond is interesting for you if you want to invest your money in the medium to long term. For having the money invested for that term you receive a certain coupon payment. Senior bonds can be added to an investment portfolio for strategic reasons like balancing the portfolio.

Your advantages

  • With a fixed-rate bond investors benefit from an interesting, regular and calculable coupon payments.
  • With a floating-rate bond investors benefit from regular coupon payments, which vary depending on the respective reference interest rate.
  • Redemption is at 100 % of nominal amount by the issuer upon maturity.

Risks you should be aware of

  • Between issue date and maturity, price fluctuations are possible, premature sale may result in a loss.
  • The redemption at 100 % of nominal amount by the issuer only applies at maturity. Investors bear the issuer risk.
  • Senior bonds are not covered by any deposit guarantee scheme. The investor is exposed to the risk that Erste Group Bank AG may not be able to meet its obligations arising from the bond in the event of insolvency or over-indebtedness or from an official order (bail-in regime). A total loss of invested capital is possible.

How do senior bonds react to…

... rising interest rates?
Senior bonds with fixed interest rate fall when interest rates are rising. If you sell the bond prior to maturity, you may record a loss.
Senior bonds with floating interest rate, on the other hand, benefit from rising interest rates. Given that these bonds ("floaters") have their interest rate periodically adjusted to a referential rate such as the EURIBOR, an increase in the level of interest rates also means a rising interest rate for the bond. The price of the bond tends to oscillate around face value.

... stable interest rates?
In the case of stable interest rates, neither the price nor the coupon of the bond changes (if other criteria, e.g. the rating of the issuer, stays unchanged).

... falling interest rates?
Senior bonds with fixed interest rate increase when interest rates are falling. If you sell these bonds prior to maturity, you may record a profit.
Falling interest rates, on the other hand, have a negative impact on senior bonds with floating interest rate. Given that these bonds ("floaters") have their interest rate periodically adjusted to a referential rate such as the EURIBOR, a decrease in the level of interest rates also means a falling interest rate for the bond. The price of the debentures tends to oscillate around face value.





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