Chapter 3: Types of Bonds
Maximum political contribution allowed for municipal finance professional in a single election
$250
Maturity of typical municipal notes
12 months or less
Collateralized Mortgage Obligation (CMO)
A MBS security that has been structured by a BD and cut up into different pieces called tranches. Each tranche will vary based on expected maturity, credit quality, and exposure to prepayments.
Series I Bond
A Series I bond is a non-marketable US Treasury savings bond. It pays a combination of fixed and variable interest (linked to the rate of inflation).
Self-Supporting Debt
A bond issue, such as a municipal revenue bond, where principal and interest payments are funded entirely from revenue that is generated by the project that was facilitated by the issue.
Repurchase Agreement
A contractual agreement between two parties, in which one party agrees to sell securities to another party at a specified price with a commitment to buy them back at a later date at a slightly higher price. The higher repurchase price reflects interest to the lender. Repos are considered money market instruments
Secured Corporate Debt
A corporate bond that is backed by a collateral
Fannie Mae
A former government sponsored enterprise, now a publicly traded corporation, that issues MBS.
Ginnie Mae
A government agency, which has the explicit backing of the US government, that issues MBS.
Municipal Advisor
A person or firm that provides advice to a municipality with respect to the issuance of municipal securities or the investment proceeds generated from an issuance. Municipal advisors typically have as fiduciary responsibility to act in the best interest of the municipality.
Industrial Development Revenue Bonds
A private activity bond. A type of taxable municipal security that is issued by a municipality on behalf of a corporation. Specifically, the municipality will issue to debt to build a facility on behalf of a corporation and then lease that facility to the corporation. Because the bonds are backed by lease payments made by the corporation, the debt is the responsibility and credit quality of the corporation. The type of municipal issue most concerned with competing facilities.
Bond Anticipation Note (BAN)
A short-term municipal bond issued in anticipation of a future bond sale
Revenue Anticipation Notes (RANs)
A short-term municipal note that is issued in anticipation of receiving future non-tax revenue
Tax-Anticipation Note (TAN)
A short-term municipal note that is issued in anticipation of receiving future tax receipts.
Convertible Bonds
A type of corporate bond where the investor has the right to convert the bond into the company's underlying common stock. Because of this conversion benefit for the investor, convertible bonds pay a lower rate of interest compared to similar non-convertible bonds.
Typically secured by other securities owned by the corporation
Collateral Trust Bond
Commercial Paper
Commercial paper is a corporate debt instrument, issued by corporations at a discount. It typically has a maximum maturity of 270 days.
Interest on bonds of these two issuers is taxable at the federal, state, and certain local levels
Corporations and agencies
Secured by physical assets owned by the company
Equipment trust certificates
Tax treatment of municipal debt interest
Exempt from taxation at the federal level; may be taxable at the state level.
Why the price of a convertible bond could rise, even when the interest rates are stable
The underlying common stock, into which the bond is convertible, rises in value.
Tranches
The unique class of a CMO, each consisting of different credit qualities, expected maturities, and exposures to prepayments.
Convertible Bond Pricing
The value of a convertible bond is based on the value of the underlying common stock, since the investor can exchange the bond for the shares. The parity price is the value at which the investor is mathematically indifferent between owning the bond or converting into the underlying shares.
Money market instruments include
Treasury bills, commercial paper, repurchase agreement, bankers acceptances, tax anticipation notes
The type of income tax investors pay on interest received from US Treasury bonds and notes
Treasury interest is taxable as ordinary income at the federal level. It is not taxable at the local or state levels.
Eurodollar deposit
U.S. Dollars held in a depository (bank) abroad. E.g. A swiss bank account denominated in U.S. dollars would hold Eurodollar deposits. These are used by foreign corporations (or individuals) who have US currency abroad.
Interest on bonds of this issuer is taxable at the federal level but exempt from taxation at the state and local level
U.S. Government
Taxable at the federal level; may be exempt from taxation at the state level
US Government bonds and notes
Safest form of debt issued in the US
US Government bonds, notes and bills
Non-marketable US government securities held by investors
US savings bonds
Bonds backed only by the good faith of the issuing corporation
Unsecured bonds or debentures
Unsecured Corporate Debt
Unsecured corporate debt is not backed by collateral or a specific asset of the corporation. Instead, it is backed by the good faith and credit quality of the company. It is also referred to as a debenture bond.
Subordinated Debt
Unsecured corporate debt that has a lower claim on assets in a liquidation. In return for taking on more risk, the investors receive a higher yield
Can US Treasury bonds and notes trade in the money market?
Yes, when they have one year or less remaining until maturity.
Annual Coupons Paid by Treasury Receipts
Zero. These receipts are zero-coupon bonds, stripped of their coupons, structured by BDs, and backed by the cash flow from Treasury securities.
Farm Credit System (FCS)
a government sponsored enterprise that provides loans to different entities within the agricultural sector
Alternative Minimum Tax (AMT)
a second method of calculating the tax liability for certain wealthy individuals to ensure they pay an appropriate amount of taxes
Eurodollar bonds
bonds issued outside the United States (e.g. Argentina) but denominated in U.S. dollars. Par is $1,000 USD; coupon payments are made in USD. These are issued and trade outside the U.S. and are not registered with the SEC. Issuers use Eurodollar bonds to make their securities more marketable (e.g. the issuer's home currency is unstable).
Treasury Receipts
long term zero-coupon bonds that are structured by broker-dealers, but backed by the cash flows from treasury securities.
Typically backed by real estate holdings of a corporation
mortgage bond
General Obligation Bonds
municipal securities used to finance non-revenue facilities, such as public parks, public schools, and public libraries. The interest and principal is backed by the full taxing power of the issuing municipality. May require voter approval through a referendum. Considered the safest type of municipal issue.
A money market instrument is defined as a debt security with a maturity of
one year or less
Most senior form of a corporate bond
secured
Securitization
the process of converting a pool of financial instruments, such as mortgages or credit card loans, into bonds.
Prepayment Risk
The fact that as interest rates decrease, homeowners will refinance their mortgages in order to reduce their interest expense. As these mortgages and therefore the MBS are paid off, investors will receive the proceeds back at a time when rates are falling.
Extension Risk
The risk that when interest rates rise, fewer prepayments will occur because homeowners are reluctant to give up the benefits of a contractual interest rate that now looks low. As a result, the security becomes longer in maturity than anticipated at the time of purchase.
Conversion Ratio
The stated number of common shares the bondholder receives upon conversion. Calculated as the bond's par value divided by the conversion price.
Triple-tax-free
The tax status of a public purpose municipal bond that is purchased a resident of the state of issuance. The bond is tax-exempt at the federal, state, and local levels
Tax treatment of capital gains from municipal bonds
Taxable
Trustee
An entity, typically a large bank, that is legally empowered to act in the best interest of bondholders by ensuring the issuer meets its covenants. This term is also used to describe the individual that is legally appointed to manage and act in the best interests of the beneficiary of a trust.
Difference between regular US savings bonds and Series I bonds
Both are non-marketable. But Series I bonds pay a combination of fixed and variable interest vs. fixed interest only in US savings bonds
The security that stands behind Treasury receipts is
Cash flows from specific Treasury securities. However, these securities are issued by BDs not directly backed by the full faith and credit of the US government.
MBS securities with the implied backing of the US government
Fannie Mae and Freddie Mac
Covenants
Found in the trust indenture of a bond, they are promises by the issuer that are designed to protect the interests of bondholders. These covenants are established between the issuer and trustee, which is typically a large bank acting on behalf of the investors. They are required for corporate issuances in excess of $50 million, though many municipal revenue bonds have them as well.
Agency debt that is backed in full by the US government
Ginnie Mae
Three government entities that issue mortgage-backed securities
Ginnie Mae, Fannie Mae and Freddie Mac
TIPS
Inflation-indexed bonds issued by the U.S. Treasury. Treasury securities that help protect against inflation by having their principal increase semiannually based on the CPI.
Reinvestment Risk
Investment risk that coincides with early payment of a MBS.
The advantage of holding marketable US government securities, compared to holding non-marketable government securities
Liquidity. Marketable securities can be freely traded in secondary markets.
T-Bonds
Marketable, long-term Treasury securities that typically mature in 30 years. They pay a fixed coupon and are quoted as a percentage of par value in increments of 32nds of a point.
T-Notes
Marketable, medium-term Treasury securities that typically mature within 2 to 10 years. They pay a fixed coupon and are quoted as a percentage of par value in increments of 32nds of a point.
T-Bills
Marketable, short-term Treasury securities that mature in one year or less. They are zero-coupon bonds that are issued at a discount and mature at par; they do not pay fixed interest. Regarded as one of the safest and most liquid debt securities.
Tax treatment of IDRBs
May be federally taxable
Money Market Instruments
Money market securities are short-term debt instruments with maturities of one year or less. Because of their short-term nature, they tend to be relatively liquid and low risk compared to longer- term bonds. Examples include Treasury bills, commercial paper, negotiable CDs, and banker's acceptances. Additionally, once a Treasury bond has only one year or less remaining until maturity, it can trade in the money market.
Frequency of interest payments on MBS
Monthly
The security that stands behind a debenture bond is
Only the issuer's promise to pay and the good faith and credit of the company - i.e. no specific collateral
Type of tax that backs GO bonds issued by cities and counties
Property taxes (ad valorem taxes)
Trust Indenture
Protects bondholder through written agreement between issuer and trustee
Trust Indenture Act of 1939
Requires that corporate debt issuances of more than $50mm include a trust indenture, which is a set of covenants that detail the obligations of the issuer and rights of the bondholder. These covenants are established between the issuer and trustee, which is typically a large bank acting on behalf of the investors.
STRIPs
STRIPS are zero coupon bonds that are issued and backed by the US Government. They are issued at a discount and mature to face value.
Senior Securities
Securities, such as bonds and preferred stock, that have priority over common stock in liquidation
Debt Limit
Statutory limits on the amount of debt a municipality can carry. The purpose is to protect residents from overbearing a tax burden, though the debt limit can typically be increased by a referendum.
US Government instruments that typically mature between 20 to 30 years
T-Bonds
U.S. Government instruments that mature within 2-10 years
T-Note
U.S. Government instruments that are quoted in 32nds
T-Notes and T-Bonds
