Debt Securities

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debt securities: -bonds
-money loaned to a corporation loaned by investors
-corporation must pay interest and repay principal
-speculative capitalization
conservative investment
funded debt: long-term debt, money borrowed, minimum of 5 yrs, investor=lender
What is the par value of a bond?: -$1000
-interest paid is always fixed as a percentage of it
Who is the largest issuer of debt securities?: US Government
municipal bonds: money borrowed by state, city, county, town
Describe par value: -it is what the interest payment based upon
-amount of principal repaid at maturity
mortgage bonds: real estate & physical assets pledged as collateral
equipment trust certificate: secured by the equipment purchased
collateral trust bonds: secured by stocks and bonds
debentures: -debt obligation backed by word and general credit worthiness
-depends on assets & earnings of the corporation
senior: -priority of a claim of a security
-secured bonds senior to unsecured
-bonds & preferred stock senior to common stock
subordinated debenture: -has claim behind any other creditor
-still senior to any stockholder
types of municipal bonds: -general obligation (GOs) bonds
-revenue bond
-industrial revenue bonds
general obligation (GOs) bonds: -type of municipal bond
-backed by pledge of full faith & credit
-plege of ad valorem (property) taxes
-bondholder supreior claim above mortgages & mechanic's liens
-very safe
revenue bond: -payable from earnings of revenue producing enterprise
-water, sewer, toll bridge, airport
-historic or potential
-high yield
industrial revenue bond: -finance contruction of manufacturing or commercial facility
-benefit of a private user
safety based on credit standing of corporation facility built for
Series EE Bonds: -not negotiable
-purchased at a discount
-mature at face value
-must hold until maturity to receive interest at full rate
-registered form
Series HH Bonds: -not negotiable
-issued at par value
-pay semi-annual interest
Treasury Bills: -direct short term obligations of the government
-pay no interest
-issued at discount from par value
-maturity of 4 wks, 13 wks, 26 wks
-book entry form
Treasury Notes: -direct debt obligation of the Treasury
-pay sem-annual interest
-interest % of stated par value
-maturity of 1 to 10 years
-mature at par value
-book entry format
Treasury Bonds: -direct debt obligation of the Treasury
-pay semi-annual interest
-interest % of stated par value
-maturity of 10 to 30 years
-mature at par value
-book entry format
US Federal Agency Securities: -issued by US Govt agencies
-authorized by Congress to issue debt securities
-moral obligation
-interest rec'd exempt of state & local income taxes
What 2 principal US Federal Agencies issue debt securities?: -Federal Farm Credit Bank
-Federal Home Loan Bank (FHLB)
2 mortgage backed securities: -Federal National Mortgage Association (FNMA)
-Government National Mortgage Association (GNMA)
Federal National Mortgage Association (FNMA - Fannie Mae): -privately owned corporation
-purcahses & sells real estate mortgages insured by FHA or VA
Government National Mortgage Association (GNMA - Ginnie Mae): -federally owned corporation
-known as modified pass through certificate
-backed by full faith & credit of the US Govt
modified pass through: principal & interest from a GNMA "pass through" to the investor monthly as homeowne makes mortgage payment
supply and demand: -a lot of people want to borrow mooney & not a lot to go around, interest rates go up
-determines current market price ofa bond
prime rate: -measurement of supply & demand
-rate charged by banks to most credit-worthy customers
risk-reward relationship: -more risk investor takes, the more uncertainty
-greater must be the reward
-lower-rated bonds carry higher rates of return
taxable equivalent yield: -municiapl bonds tax free for state & local taxes
-tax-free yield divided by (100% minus the tax bracket)
-7.5% divided by (100% - 28%) = 10.42%
What does it mean when a bond is selling at a premium?: -bond is selling at a price above par
-buy bond at premium, receive a rate of return less than the coupon or nominal yield stated on the face of the bond
What does it mean when a bond is selling at a discount?: -bond is selling at a price below par
-purchase bond at a discount, get more than the rate stated on the face of the bond (12.5% is greater than 10%)
What happens when you pay more?: you get less
What happens when you pay less?: you get more
yield-to-maturity (true yield: takes into consideration the gain or loss the investor will have when the bonds are redeemed at maturity
What interaction to interest rates and bonds prices have?: -interest rates go up, outstanding bond prices fall
-interest rates fall, bond prices rise
current market price: -may fluctuage
-may be at par, above par, or below par
What value does a bond mature at?: par value
What is the result of purchasing a bond at a premium?: will get back par, which means less than your original investment (a loss)
What is the result of purchasing a a bond at a discount?: will get back par, which means more than your original investment (a profit
How are corporates and municipals and governemnts and agency bonds quoted?: as a percentage of par
bond point: $10 or 1% of $1,000 par value
What is the fraction for corporates and municipals?: 1/8th (each 1/8th + $1.25)
corporate or municipal quoted at 90 1/4 equals: $902.50
( $900 + 1/2 of $10.00)
corporate or municipal quoted at 101 3/4: $1017.50 ($1010 + 3/4 of $10.00)
corporate or municipal quoted at 108 5/8: $1086.25 ($1080 + 5/8 of $10.00 or 5 x $1.25)
What does :1 mean when quoting government and agency bonds?: 1/32nd ($.31 1/4)
government bond quoted at 90:8: $902.50 ($900 + 8/32 or 1/4 of $10)
government bond quoted at 101.24: $1017.50 ($1010 + 24/32 or 3/4 or $10)
government bond quoted at 87:16: $875 ($870 + 16/32 or 1/2 of $10)
term bond: -simplest form of principal repayment
-one maturity date
serial maturities: -common form of principal pay back
-mutilple maturity dates
- ex. Equipemnt Trust Certificates
-each year a portion of principal is repaid so that at no time is the outstnading debt greater than the value of the asset securing the loan
callable bonds: -method by which debt securities ar epaid off prior to their maturity date
-permits the issuer to redeem its bond (pay off principal) before maturity
sinking fund: -cash reserve systematically being established to cover the company's fnancial obligations
-portion of earnings deposited to special escrow account to retire a portion of its debt on a regular basis
How is the sinking fund used if interest rates go up (bond prices go down)?: company will buy the bonds in the open market
How is the sinking fund used if interest rates go down (bond prices go up)?: company will call in a portion of the bonds in an amount equal to the size of the sinking fund
convertible bonds: -can be converted or exchanged for the company's common stock
-exact number of shares that bond will be converted into at any point in time (or method of computing) is printed in the bond indenture at the time of issue
What are 2 advantages to investors of convertible bonds?: -opportunity for capital gains if the common stock of the issuer should rise in price
-even if the stock doesn't go up, you still own a debt security paying a fixed interest rate & maturing at $1000
What is a disadvantage of convertible bonds?: -interest rate paid on the bonds is always lower than a non-convertible of the same quality
-not a suitable investment for those seeking income as a primary objective
money market: -market for buying & Selling short-term funds in the form of securities & loans
-short-term loans that readily convertible into cash
-buyer is the lender of the money
-selling is borrower
What is maturity date of money market?: -1 year or less
-some less than 6 months
Types of money markets: -commercial paper
-bankers acceptances
-certificate of deposit
commercial paper (money market): -short-term IOUs issued by corporations
-max maturity is 270 days
-minimum denominations of $100,000
-sold to public & institutional investors
bankers acceptances (money market): -used to finance import/export businesses
-used extensively in international trade
-"letter of credit"
-bank guarantees payment on the draft
certificates of deposit (money market): -bank that issues CD redeems at face value on maturity date
-do not pay periodic interest
interest paid in full at maturity
-unsecured
negotiable CDs: -must have face value of $100,000 or more
-also called Jumbo CDs
mortgage backed securities: -debt obligations backed by a pool of mortgages
-have pass-through feature
Name the mortgage backed securities: -Federal Home Mortgage Corporation (Freddit Mac)
-Federanl National Mortgage Association (Fannie Mae)
-collateralized mortgage obligations (CMOs)
Federal Home Mortgage Corporation (Freddie Mac): -called a PC (participation certificate)
-comprised of FHOMC conventional residential mortgages on single-family homes
-not backed by full faith & credit of US Govt
-yeild generally higher than GNMA
Federal National Mortgage Association (Fannie Mae): -consist of some conventional mortgages & FHA insured mortgages
-not backed by full faith & credit of US Govt (would not permit them to default)
-yield comparable to PCs
-yield slightly higher than Ginnie Mae
collateralized mortgage obligations (CMOs): -bonds that collateralize by mortgages or by mortgage-backed securities
-issued with a stated maturity
-as principal on mortgage being paid, used exclusively for the newest maturity in sequence until each maturity has been paid off
-private mortgages, not qualified under FHA or VA
real estate mortgage conduits (REMICs): -entity that holds a fixed pool of mortgages
-issues multiple classes of interests in itself to investors
-income is taxable to the holders of the interest
REMIC regular interest: -interest in the REMIC, the terms of which are fixed when the REMIC starts & which unconditionally entitle the holder to receive a specified
principal amount
-even if issued as stock, treated as debt instruments for federal income tax purposes
REMIC residual interest: any interest that is not a regular interest
REMIC residual interest holder: -all income passes through as ordinary income & losses pass through as well
-there are limitations as to how much loss may be used to reduce taxable income
-flow-through instrument
coupon and nominal: interest rate
What affects the interest rate on a bond (coupon factors)?: -prevailing economic conditions
-issuer's credit rating--the higher the credit rating, the lower the coupon

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