0
Q
Bond Ratings - S&P - uses a + or -
A
AAA AA A BBB ------------- BB B C D - default
above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds
1
Q
Credit Risk
A
- also known as business risk
- also known as default risk
- the issuer may become insolvent and forced into bankruptcy
2
Q
Bond Ratings - Moody’s - uses 1, 2, 3 with ratings
A
Aaa Aa A Baa --------- Ba B Caa D
above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds
3
Q
Interest Rate Risk
A
- Longer the duration, the greater the risk
- lower interest rates carry a higher interest rate risk
4
Q
Zero Coupon Bond or OID
A
- purchased at a steep discount and gains in value every year.
- the difference between what the investor pays for the bond and what is received at maturity is considered interest income.
- Original Issue Discounts
5
Q
Inflation risk
A
- also known as purchasing power risk
- created by too many dollars chasing too few goods
6
Q
Reinvestment Risk
A
- if rates drop, will have less income
- a zero coupon bond does not have reinvestment risk
7
Q
Why purchase a callable bond
A
They have higher stated, or nominal, interest rates
8
Q
Why would an issuer pay a higher interest rate by issuing a callable bond?
A
to have he privilege to refinance at lower future interest rates
9
Q
What price are callable bonds called at
A
frequently above par, which is called the call premium.
10
Q
Liquidity Risk
A
- The degree to which an asset can be quickly converted to cash
- the risk that an asset cannot be sold quickly
- selling quickly could result in a substantial loss
11
Q
Marketability Risk
A
- risk of being unable to buy or sell a security, thus sustaining a loss
- similar to liquidity, except it is not concerned with the price, only the ability to buy or sell
12
Q
Legislative Risk
A
- also know as “regulatory or political” risk
- changes in law will negatively impact the value of a security
13
Q
Term Bonds
A
- also called “dollar bonds”
- all bonds are issued at once and mature at once
- priced in points as a percentage of par value, each point equals $10
- term bond quote of 98 = 98% of par value = $980
- pays interest only, at maturity pays par
- Basis = price to maturity
14
Q
Serial
A
- quoted in basis points
- all bonds are issued at once.
- They mature in increments over several years,
- ex: $1,000,000 of bonds matures in $200,000 increments over 5 years.
- pays principal and interest
- basis = yield to maturity
15
Q
What are the terms for the interest an issuer will pay until the bond matures?
A
- Stated Rate
- nominal yield
- coupon rate
16
Q
Current Yield
A
= (annual dollar interest paid)/(current market price)
17
Q
Yield to Maturity (YTM)
A
-Economic benefit that would be realized if a bond or other fixed income security was held until maturity date.
= (Annual Interest +/- Annualized Gain/Loss)/((Purchase Price + Redemption Price)/2)
18
Q
Yield to Call (YTC)
A
- Evaluates the performance of a callable bond
- uses the call price instead of par value
19
Q
Par Bond
A
The nominal yield, current yield, and yield to maturity are the same
20
Q
Discount Bond
A
the highest yield is the yield to maturity, followed by the current yield, then the nominal yield is the lowest
21
Q
Premium Bond
A
The highest yield is the nominal yield, followed by the current yield, with the yield to maturity being the lowest.
22
Q
Discount and Premium Chart for Yields (includes calls)
A
Discount Bond
- Highest yield is Call (cannot quote call) - Next highest is Maturity or Basis - Third yield is Current - Lowest yield is nominal
Premium Bond
- Highest yield is NOMINAL - Next highest Yield is CURRENT - Third yield is MATURITY or BASIS - Lowest yield is CALL (most quote this)
23
Q
Standardized Yield (SEC Yield)
A
- measure of the current net market yields on a mutual fund’s investment portfolio.
- net investment income for the 30 day period ending on the last day of the previous month DIVIDED by the highest offering price on that last day
24
Accrued Interest
- Bond interest is paid in arrears
- an investor purchases a bond and holds it for six months before receiving the first semi annual interest payment
- when a bond is sold in between the interest payments, the buyers pays the sell for the accrued interest
25
Corporate, muni, and gov agency bonds calculation of interest
every month has 30 days
every year has 360 days
Regular way settlement is T+3
26
Gov notes and Bonds calculating accrued interest
- actual number of days in the month
- each year, the actual number of days
- regular way settlement is T+1 (or next biz day)
27
Corporate Bond payment dates of F and A 15
Pays February and April 15
28
Open and Closed end Bonds
- open - corporation can issue subsequent bonds at a later time
- Closed - specify maximum indebtedness the corp can issue
29
Bond Trust Indenture
- specifies if the secured bonds are open or closed
- contract between issuer and trustee, who acts on behalf of the bondholder
- open end bonds have equal claim or parity of title to the collateral with each new bond
30
Equipment Trust Certificates
- usually issued by railroads and airlines, and are secured by railroad cars and airplanes.
- historically, these have proven to be secure investments because the bonds are retired at a faster rate than the equipment is depreciated.
- airplane equipment is know as "rolling stock", meaning major movable equipment
31
Collateral trust certificates
-suppose dell owns intel stock, it might issue dell stock as collateral to secure the bond
32
Mortgage Bonds
- most common type of secured bonds
| - corporations issue first and second mortgage bonds with first holders retaining a senior position
33
Unsecured Corporate Bonds
- also know as debentures
- only backed by the full faith and credit of the issuer
- have a lower lien priority that all other bonds
34
Guaranteed Bond
a debenture that has been "cosigned" by another entity
35
Convertible Bond
- a Debenture that is convertible into common stock at the the bondholder's discretion.
- if the price of stock rises, so will the price of the bond and vice versa
36
Convertible Bond Conversion Ratio
of shares at conversion = Par Value/
37
Step up bond or step coupon bond
- has an initial nominal rate which later increases or "steps up" to a prespecified higher rate
- typically corporate bonds
- certain gov agencies
38
Income Bond
- product of a debt renegotiation or a bankruptcy proceeding
- when a corp can no longer honor the terms of a bond issue, they renegotiate the terms of a bond issue
- trades without accrued interest
- only suitable for speculative investors
39
Treasuries
- U.S. government securities
- backed by the full faith of the U.S. gov
- highly liquid
- interest subject to federal taxation only
- capital gains realized are taxable
40
Nonmarketable treasury securities
- redeemed by treasury through banks.
- Savings Bonds:
- Series EE
- Series HH
- Series II
41
Marketable treasury Securities
- traded for value in the secondary market
- t bills
- t notes
- t bonds
42
How do Treasury Department Securities exist?
-as electronic records in computers
43
Maturity of Marketable treasury securities
- T Bills max of 1 year
- T Notes max beween 2 - 10 years
- T Bonds greater than 10 years
44
T-Bills OID
- Original Issue Discount instruments
- no state interest
- do not pay semiannual interest
- bought at a discount from par and mature at par
- quoted on a discount yield basis
- bid is a larger discount than ask
- Bid 7.45 = Ask 7.30
- Bid price = 1000-.0745*1000=$925.50
- Ask price - 1000-.0730*1000=$927.00
- Issued with the following maturities:
- 4 weeks
- 13 weeks - auctioned every week
- 26 weeks - auctioned every week
- 52 weeks - auctioned once a month
- issued with a min denomination of $1,000, with $1,000 increments
- public orders are filled from non competitive bids
- competitive bids come from the 40 primary dealers in government paper
45
Treasury Notes
- maturities of;
- 2 years
- 3 years
- 5 years
- 10 years
- issued with denominations beginning at $1,000
- have stated interest (coupon) rates
- pay semi-annual interest to their owners
- known as interest-bearing securities
- quoted in points as a percentage of par
- points broken down into 1/32
- the fractional part is expressed as a decimal
- 102.20 means 102 and 20/32 of par = 102.625
- dollar value - 102.625% * $1,000 = $1,026.25
46
T-Bonds
- issued in denominations beginning as $1,000
- State interest rates
- pay semi-annual interest
- Quoted in points as a percentage of par
- 1/32 increments
- 102.20 means 102 and 20/32 of par = 102.625
- dollar value - 102.625% * $1,000 = $1,026.25
47
Treasury Inflation Protected Security (TIPS)
- TIPs principal adjusted for inflation using the consumer price index
- stated interest rate is constant
- issued in;
- 5 year
- 10 year
- 30 year maturities
48
Separately Traded Registered Interest and Principal Securities (STRIPS)
- zero coupon bonds called
- issued at a steep discount directly from the U.S. Treasury
- STRIPS accrete in value, meaning they gain in value every year and this gain in value is considered interest income
49
Treasury Receipts TRs
-zero coupons which are issued by B/D.
-escrow receipt backed by escrowed US Treas Securities.
-difference between the purchase price and face amount is considered interest income.
-AAA rated generally
-not backed by the gov.
-TRs that have been issued by B/Ds;
-CATS, certificates of accretion GRADED rate
-TIGRS, treasury issues GRADED rate
-PANTHERS, program of accretion notes, treasury historic earned
rate
-COAGRS, certificate of accretion GRADED rate
-LYONS, liquid yield option notes
50
GRADED or ACCRETED
OIDS or Zero coupon bonds
51
Government National Mortgage Association (GNMA)
Function - Buys FHA, VA, Farmer's home Administration insured mortgages
Bonds Issued - Modified mortgage-backed pass-throughs, Min $25k
Interest Paid - Monthly
52
Majority of Mortgage securities are issued and/or guaranteed by:
- An agency of the U.S. government
- GNMA - a government owned corporation within the Department of Housing and Urban Development;
- Government-sponsored enterprises (GSEs),such as Fannie Mae and Freddie Mac. Both are chartered by Congress but owned by Stockholders.
these agencies buy qualified mortgage loans or guarantee pools of such loans originated by financial institutions, then securitize the loans (i.e., place them in a pool and issue securities representing fractional undivided interest in the pool) and distribute the securities through the dealer community.
53
FHLB
Function - loan funds to savings and loans institutions with S&L mortgages as colateral
Bonds Issued - $10K or higher par value, short term
Interest Paid - Semi - annually
54
Fannie Mae
Function - Buys government guaranteed and insured mortgages, and conventional mortgages from the banks
Bonds Issued - conventional and short term discount bonds, $10k or higher par value bonds
Interest Paid - Semi-annually
55
Freddie Mac
Function - Buys conventional residential mortgages from financial institutions
Bonds Issued - Participation Certificates; pass through securities
Interest Paid - Semi - annually
56
Student Loan Mortgage Corporation
SLMC - Sallie Mae
57
Quasi Governmental Agencies
- line of credit from treasury
- not backed by full faith of gov
- Fannie Mae
- Freddie Mac
- Sallie Mae
58
Collateralized Mortgage Obligations (CMOs)
- derivative securities which derive their value from an underlying pool of GNMA, FNMA, OR FHLMC, or non gov agency securities
- have interest risk
- have uncertain maturities due to prepayment risk and extension risk
59
CMO Tranche
- A CMO is divided into several slices, or tranches, which is separately traded bond with its own characteristics and risks
- PAC (planned amortization class) is the safest and most certain tranche
- TAC (targeted amortization class) is a tranche with a higher yield, riskier than PAC
- Z-tranche is the riskiest and highest yielding class, receives no interest or principal till the other tranches are paid off
60
ABS - Asset Backed Security
-collateralized security backed by short term loans on assets other than real estate, such as auto loans or credit cards
61
Eurobonds and Eurodollar Bonds
- based on US Dollars in foreign repositories
- market is centered in london
- Any entity can issue Eurodollar Securities except US Governement
- range from 5-10 years in maturity
- pay interest once a year
- not subject to withholding taxes
- Following advantages to US Corp:
- No foreign exchange risk
- Lower interest rates in comparison with domestic rates
- Lower issuance expense (no SEC registration requirements)
62
Money Market Debt
-short term
-high quality
-issued by corp or muni
-types
-commercial paper
-matures from 30 to 270 days
-rating system of P1, P2, P3
-T-bills
-government paper
-banker's acceptance
-letters of credit
-import/export notes
-repurchase agreements
-collateralized paper issued for the purpose of buying and
reselling securities typically overnight to provide short term funds
63
Taxation
- Muni's interest is fed tax free, tax free to the citizen of the state (not tax free if that citizen buys a muni from another state)
- cap gains are never tax free
64
Amortization of a bond's book value
- when an investor buys any bond at a premium price, the YTM and YTC are reduced each year until maturity
- if bought at 108, 5 year till maturity then:
- $80/5 = $16 reduction in book value each year
- premium debt
65
Accretion
- opposite of ammortization
- bought at a discount
- only OID bonds (zero coupon) are accreted
- discount debt
66
Cap gain/loss treatment of municipal OID bonds
- if held to maturity, no cap gain/loss
- if sold prior to maturity, cap gain/loss must be figured
- only bond with tax-free discount accretion
67
Advance Refunding
- also known as pre-refunding
- issuer has 8% bonds issued, interest is now at 5%, bonds have two years left before call
- issuer issues new 5% bonds now, puts money in short term treasury or agency bonds
- the 8% bond is referred to as defeased, it will now trade as a 2 year bond sold on a YTC basis, regardless of old rating, it is now AAA- because it is backed by escrowed funds
68
Covenant of Defeasance
-the advance funding or prefunding is disclosed here, which is in the bond indenture
69
General Obligation Bonds (GO)
- backed by the full faith of the taxing authority
| - competitive bid basis - shows taxpayers they got the best deal
70
Overlapping Debt
- multiple taxing authorities in a same geographic area
| - schools and local gov
71
ad valorem tax
-property tax
72
Double-barreled debt
- backed by revenue collection and taxes
- but the revenue sources are considered insecure, inadequate, or insufficient.
- must be underwritten in a competitive bid process
73
Revenue bonds
- self supporting
- backed by user fees, revenues or special assessments that are collected from the facility or project.
- hospitals, toll roads, toll bridges, shipping ports, airports, and water and sewer systems
- negotiated basis
74
Moral Obligation Bonds
- revenue bonds where the state legislative authority can appropriate money to pay off the bond issue
- not a legal obligation
- hospitals in a rural area, if it were to default, the state would vote to pay off the bond to keep the hospital going
75
Industrial development Revenue bonds: IDR debt securities
- bonds issued to construct sports stadiums and parking lots
| - they are taxable as they are often backed by a corporation
76
Rate Covenant
issuer promises to set user rates so that they are sufficient to pay interest and repay principal in the bonds
77
Closed end or open end covenant
- open end also the new bonds to be issued with the same lien priority using the same collateral
- closed end are at a junior level
78
Maintenance Covenant
issuer promise to maintain the facility so that it continues to generate revenues to repay the bond holders
79
Catastrophe covenant
if an extraordinary event occurs, issuer collects on an insurance policy
80
Sinking Fund Covenant
- eventually used to retire the bonds at maturity or call event
- issuer is not allowed to make money on the sinking fund
81
Net Revenue Pledge
operation and maintenance are paid first, then debt is serviced
82
Gross Revenue Pledge
debt service is paid first, then operating and maintenance expenses are paid
83
MIG Ratings (Moody's Investment Grade)
-ratings on muni notes or short term munis
-MIG1, 2 or 3
-ex of muni notes
-TANS (tax anticipation notes issued in anticipation of future tax
collection, MIG 1, because of tax backing
-RANS (revenue anticipation notes
-BANS (bond anticipation notes, riskiest
-TRANS (tax and revenue anticipation notes
-VRN (variable rate notes
84
Auction rate securities (ARSs)
long term bond with an interest rate that regularly resets through a dutch auction
85
Build America Bonds (BABs)
- taxable munis that offer either a federal subsidy to the issuer or a tax credit to the investor
- Credited by ARRA, issued from feb 2009 to dec 2010.
- they trade in the secondary market
86
Issuing Muni
-Competitive Bid - underwriters determined by legal process
-the adviser, who now is underwriter, must simply disclose to any
investor the involvement as both adviser and now as underwriter
-Negotiated - underwriters determined by issuer through negotiation
-the adviser must
-terminate as adviser in writing
-discloser the total compensation as both adviser and as
underwriter
-state in writing to the issuer that there is a strong potential
conflict of interest in this dual capacity
87
Preliminary official statement
the prospectus like document for muni underwriting
88
Control Issue
such as the county assessor working for the underwriter
89
Legal opinion
- verify legal authority to issue, whether the bond interest is federally tax exempt, and whether the bonds are exempt from reg with the SEC
- Qualified - a potential issue is found
- Non-Qualified - a clean opinion. the issuers bond counsel sees no potential issues which jeopardize the bond's status
90
Ex-legal
-bond is missing its legal opinion
91
Daily Bond Buyer (information also available on Munifacts)
- Primary Municipal Market Information
- 30-day visible supply
- placement ratio - number of bonds place divided by the number of bonds offered over the previous week
- RevDex - yield index of 25 revenue bonds with 30-year maturities.
- GO index - yield index of 20 GO Bonds with 20 year maturities
- Bond Buyer Municipal Bond Index (40 bond index), and index of the average price of 40 recently issued bonds with an average maturity of 20 years
- The 11 bond index, comprised of 11 GO bonds that are AA rated with 20 years to maturity and is used as a benchmark for municipal bond yields
92
Munifacts
wire service that provides the most up to date info on any news affecting the municipal industry
93
Underwriters who read the Daily Bond Buyer:
- respond to an invitation to bid by submitting a competitive bid to the issuer
- winner submitted the lowest net interest cost to the issuer. (true interest cost is a superior calc as it considers the time value of money)
94
What happens when bonds are oversold?
- the underwriter must follow an established procedure in allocating bonds among orders
- priority is
- Pre-sale, often not allowed due to favoritism
- Syndicate or Group net,
- Designated Net
- Member-related orders
95
Eastern Syndicate
-unsold bonds are divided amongst original participation
96
Western Syndicate
- Divided
| - once a dealer sells its allocated bond, it is not responsible for any unsold bonds
97
Municipal Underwriting Spread
- compensation paid for underwriting
- typically expressed in points where 1 point = $10
- takedown is the compensation to the syndicate members, doesn't include management's fee
- takedown + manger's fee = the spread
98
Syndicate fee
-additional takedown paid to the syndicate members, part of the total takedown
99
Selling Concession
- paid to the syndicate members and selling group that sell the bond.
- if the syndicate has 80% retention, then the other 20% is being sold by the selling group
100
How do Muni Bonds trade?
-OTC, which is a negotiated market
101
How are Muni Bonds Quoted?
- Bid wanted or offer wanted - is not binding, just a gauge of interest or availability/price on a bond it wants to buy
- working or workable indication - not binding - just an estimate to value a bond in its inventory
102
Can a dealer advertise a bond not in its inventory?
Yes, as long as the dealer can get the bonds if asked
103
"out firm, with five minute recall"
-dealer has given a firm quote which is good for a specified time(usually an hour) with the dealer reserving the right to accelerate the deadline to 5 minutes.
104
EMMA
- Electronic Municipal Market Access
| - provides info on muni issuers to public customers and professionals
105
SHORT system
- Short-term obligation rate transparency system
- provides last trade info about instruments with short term rates
- based on input from at least 3 professionals who access SHORT through a password protected website
106
MSRB
- Municipal Securities Rule Making Board
- the SRO for muni bond industry
- has no staff to monitor or enforce rules, SEC and FINRA do that part
- requires registered by series 7 or 52, for anyone in the firm (except clerical and ministerial)
- requires an apprenticeship for municipal finance professionals (MFPs).
- 90 days from employment
- not allowed to talk to the publich
- nor compensated for transactions
- have 180 days to pass either Series 52 (municipal sales rep, required for any function other than sales of munis) or 7 (general securities sales rep)
107
Bond investment objectives
- stable income stream - debt instrument or bond
- set period to invest and concerned about reinvestment risk - zero coupon bonds
- conservative investors - US gov bond, note, or bill
108
Bearer Bond
unregistered bond certificates with coupons attached. The bearer is considered the owner. have not been issued in the US since 1982
109
Repurchase Agreement
- The seller loses control of securities.
- There is no liquidity risk.
- Interest rates most closely follow the fed funds rate.
- An overnight repo is still debt, and all debt has interest rate risk.
110
the following are true of negotiable certificates of deposit:
Denominations of a negotiated CD are $100,000 minimum, and they are too short-term to be callable.
111
Pre-Sale
involves accumulation accounts being established prior to offering unit investment trust or bond mutual funds.
112
Syndicate or Group Net
benefits every member of the syndicate and the name of the buyer must be disclosed
113
Designate net
an order in which the managing underwriter designated specific firms complete the sale of the bonds and specified to those firms their takedown or compensation
114
member-related orders
the lowest possible priority, they are for the accumulation account. they are generally for only one member of the syndicate
115
```
18: Which bond has the greatest market risk?
A 6%, 30-year callable, rated Baa
B 7%, 15-year noncallable, rated BBB
C 7%, 30-year callable, rated A-1
D 6 1/2%, 15-year noncallable, rated A
```
The 30-year has lowest coupon and is lowest of the investment grade rating. Although the rating is equal to the rating of the 7 percent, 15-year noncallable BBB bond, the bond with the lower coupon/higher price has greater market risk.
Series 7
flashcards
Decks in class (12)
# Cards
-
Issuing - Primary Markets 8%60
-
Trading - Secondary Market 6%82
-
Option Contracts 16%88
-
Customer Accounts 6%46
-
Investment Companies 7%62
-
Direct Participation Programs 6%24
-
Insurance Contracts 4%18
-
Retirment Plans end Education Plans 6%17
-
Analysis - 9%59
-
Regulations 10%20
-
Equity securities24
-
Debt Instruments 16%116
