SIE EXAM P1

things that are not securities

Cash and currency Fixed annuities Life insurance (whole and term) A personal residence Commodities and futures contracts

examples of securities

Stocks Bonds, notes, and debentures (all types of debt) Options Mutual funds Jumbo CDs Depositary receipts Units in an investment Variable life and variable annuities

An investor who is seeking income might choose a corporate bond because A. a corporate bond pays a steady income and are generally reliable. B. bonds pay a higher dividend than stocks. C. bonds can grow faster than the rate of inflation. D. corporate bond interest is tax free.

A Corporate bonds are, depending on rating, generally reliable producers of income through interest payments. Bonds do not pay dividends, nor do they grow in value with inflation. Corporate interest is fully taxable. LO 2.g

Another term for stocks and bonds is A. equity and debt. B. shares and units. C. voting and nonvoting. D. taxable and tax free.

A Equity is a common term for securities that represent ownership interest, such as stocks. Bonds are the most common type of debt security. LO 1.b

The Alta Loma High School District is asking voters to approve a bond to fund the purchase of new computers and software. The bond will mature in 40 years, and the interest and principal payments will be funded from real estate taxes. This is an example of A. a GO bond. B. a revenue bond. C. a debenture. D. an equipment trust bond.

A If a municipal bond requires a vote, it is most likely a GO bond. Generally revenue bonds do not require a vote (note that there is no revenue-generating source here). Debentures and equipment trust certificates are issued by corporations, not municipalities.

CMOs are backed by A. mortgages. B. real estate. C. municipal taxes. D. the full faith and credit of the U.S. government.

A The "M" in CMO stands for mortgage.

3. Your customer is in the 30% federal tax bracket. He is considering purchasing a 7% corporate bond. The after-tax yield would be A. 4.9%. B. 2.1%. C. 10%. D. 7%.

A The formula for the calculation is 7% (corporate rate) × (100% ‒ 30% (tax bracket)). 7 × (1 - 0.3) = 7 × 0.7 = 4.9%.

A 6% corporate bond trading on a 7% basis is trading A. at a discount. B. at a premium. C. with a current yield above 7%. D. with a coupon rate below 6%.

A The term "a 7% basis" means that the YTM is 7%. YTM is higher than the coupon rate (6%), so the bond trades at a discount. Current yield must be between the coupon rate and the YTM. LO 2.b

All of the following securities are issued the U.S. Treasury except A. treasury receipts. B. STRIPS. C. T-bills. D. TIPS.

A Treasury receipts are created and issued by broker-dealers acting as investment bankers. T-bills, STRIPS, and TIPS are issued by the U.S. Treasury.

Yield to Maturity (YTM)

A bond's YTM reflects the annualized return of the bond if held to maturity. In calculating yield to maturity, the bondholder takes into account the difference between the price that was paid for a bond and par value received when the bond matures. If the bond is purchased at a discount, the investor makes money at maturity (i.e., the discount amount increases the return). If the bond is purchased at a premium, the investor loses money at maturity (i.e., the premium amount decreases the return).

Options

A contract that represents the right to buy or sell a security or futures contract at a specified price within a specified time. The purchaser acquires a right, and the seller assumes an obligation. Options are derivative securities. This means that they derive their value from that of an underlying instrument, such as a stock, stock index, interest rate, or foreign currency. Option contracts offer investors a means to hedge, or protect, an investment's value or speculate on the price movement of individual securities, markets, foreign currencies, and other instruments. The amount paid for the contract when purchased, or received for the contract when it is sold, is called the contract premium. The buyer (owner of the contract) who pays the premium for the contract is often called the owner, the holder, or the party who is long the contract. The buyer has the right to exercise the contract. Buyers risk losing the premium paid for the contract if the option expires as worthless. Buyers begin the process with an opening purchase of the contract. If they decide to sell the contract later, the second transaction is called a closing sale. The seller (writer of the contract) who receives the premium for the contract is called the writer or party who is short the contract. The seller will be obligated to perform if the buyer chooses to exercise the contract. Sellers can potentially profit by the amount of premium received for the contract if the option expires as worthless Sellers begin the process with an opening sale of the contract. If they decide to buy back the contract later, the second transaction is called a closing purchase.

Zero-coupon bonds (zeroes)

A corporate or municipal debt security traded at a deep discount from face value. The bond pays no interest; rather, it may be redeemed at maturity for its full face value. an issuer's debt obligations that do not make regular interest payments. Instead, zeroes are issued, or sold, at a deep discount to their face value and mature at par. The difference between the discounted purchase price and the full face value at maturity is the return, or accreted interest, the investor receives. Though the interest payment is paid at maturity, owners of zeroes will pay taxes on the interest annually. The total interest payment is divided by the years remaining to maturity and a 1099 Interest form will be sent to the owners. If the interest payment is $500 and 10 years remain to maturity, then the 1099 will reflect $50 every year. This is called "annual accretion of the discount" or "phantom income." You will not be required to do the calculation, but the concept of phantom income is a testable point.

certificate of deposit (CD)

A debt instrument issued by a bank that pays a fixed interest rate over a specific time period. CDs are insured up to $250,000 by the FDIC. Most mature in one year or less. Some that can be traded in the secondary market are known as negotiable CDs Do not confuse these with the typical CD that a customer would buy from a bank. Those CDs, called retail CDs, are difficult to transfer (not liquid), are often for specific amounts, and any minimum is set by the bank selling the CD.

Debenture

A debt obligation backed by the issuing corporation's general credit. Syn. unsecured bond. A debenture is a debt obligation of the corporation backed only by its word and general creditworthiness. Debentures are written promises of the corporation to pay the principal at its due date and interest on a regular basis. Although this promise is as binding as a promise for a secured bond such as a mortgage bond, debentures are not secured by any pledge of property. They are sold on the general good faith and credit of the company, unsecured. Although debentures are unsecured, there are issuers whose credit standing is so good that their debentures might be considered safer than secured bonds of less creditworthy companies.

duration

A way of measuring a bond's volatility that combines maturity and coupon rate is called "duration." A higher duration means a more volatile price; lower duration brings less price volatility. Duration may also be used to measure the overall volatility of a portfolio of bonds. You may need to recognize the concept of duration but will not need to calculate it.

Guaranteed bond

A debt obligation issued with a promise from a corporation other than the issuing corporation to maintain payments of principal and interest. Guaranteed bonds are backed by a company other than the issuing corporation, such as a parent company. The value of the guarantee is only as good as the strength of the company making that guarantee. The primary responsibility for the debt belongs to the issuer, but if the issuer defaults, the guaranty kicks in and the guarantying company must make the interest or principal payments. Because there is no asset held as security, these are unsecured debt.

Mortgage bond

A debt obligation secured by a property pledge. It represents a lien or mortgage against the issuing corporation's properties and real estate assets. Just as a home ordinarily would have a market value greater than the principal amount of its mortgage, the value of the real assets pledged by the corporation will be in excess of the amount borrowed under that bond issue. If the corporation develops financial problems and is unable to pay the interest on the bonds, those real assets pledged as collateral are generally sold to pay off the mortgage bondholders.

Income bonds

A debt obligation where the coupon interest is paid only if the corporation's earnings are sufficient to meet the interest payment. Syn. adjustment bond. See also flat. Income bonds, also known as adjustment bonds, are used when a company is reorganizing and coming out of bankruptcy. Income bonds pay interest only if the corporation has enough income to meet interest on debt obligations and if the board of directors (BOD) declares that the interest payment be made.

Equipment trust certificate

A debt obligation, generally issued by transportation companies such as railroads, that is backed by equipment (rolling stock). Syn. equipment bond; equipment note When the railroad has finished paying off the loan, it receives clear title to its equipment from the trustee. If the railroad does not make the payments, the lender repossesses the collateral and sells it for his benefit. By lender we are referring to the trustee acting on behalf of the bondholders. the obligation to pay the investor is secured by the equipment.

municipal bond

A debt security issued by a state, municipality, or other subdivision (such as a school, park, sanitation, or other local taxing district) to finance its capital expenditures. Such expenditures might include the construction of highways, public works, or school buildings. Syn. municipal security. Municipal securities are considered second in safety of principal only to U.S. government and U.S. government agency securities, but the safety of any particular issue is based on the issuing municipality's financial stability. Interest on most municipal bonds is tax free on a federal level and tax free on a state level if the investor lives in the state of issuance. (Please note that capital gains or trading profits on these securities would still be taxable.)

Derivative

A derivative is a contract that derives its value from an underlying asset. There are two parties to the contract: a buyer and a seller. The buyer has the right to take an action (buy or sell) the underlying asset from the seller. In some derivative contracts (futures), the buyer will be obligated to buy the asset on a specific date. Derivatives are often used for commodities, such as oil, gasoline, or gold (these are called futures). Another asset class is currencies, often based on the value of a foreign currency versus the U.S. dollar. There are derivatives based on stocks and stock indices. Still others use interest rates, such as the yield on the 10-year Treasury note. An investment vehicle, the value of which is based on the value of another security. Futures, forwards, swaps, and options are among the most common types of derivatives. Derivatives are generally used by institutional investors to increase overall portfolio return or hedge portfolio risk. Derivatives are a type of security whose value is based on its relationship to another asset or referenced value. They are used primarily for speculation or protection. Futures are derivatives that have a commodity as the underlying asset. Futures are not classified as securities.

Bond

A legal obligation of an issuing company or government to repay the principal of a loan to bond investors at a specified future date. Corporate bonds are usually issued with a par or face value of $1,000, and municipal bonds with a par of $5,000, representing the amount of money borrowed. The issuer promises to pay a percentage of the par value as interest on the borrowed funds. The interest payment is stated on the face of the bond or its description at issue.

corporate bond

A long-term debt security issued by a corporation to finance its capital improvements and operations. May be secured or unsecured debt

Treasury bill

A marketable U.S. government debt security with a maturity of 52 weeks or less. Syn. T bill. T-bills pay no interest in the way other bonds do; rather, they are issued at a discount from par value and redeemed at par. For example, an investor might purchase a $10,000, 26-week T-bill at a price of $9,800. Key points to remember regarding T-bills include knowing that T-bills are the only Treasury security issued at a discount; T-bills are the only Treasury security issued without a stated interest rate; T-bills are highly liquid; and the 13-week (a.k.a. 90-day) T-bills are used in market analysis as the stereotypical risk-free investment.

Treasury notes

A marketable, fixed-interest U.S. government debt security with a maturity of between 2 and 10 years. Syn. T-note. They pay semiannual interest as a percentage of the stated par value, and they mature at par value. T-notes have intermediate maturities (2-10 years).

Treasury bond

A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. U.S. T-bonds are direct debt obligations of the U.S. government. They pay semiannual interest as a percentage of the stated par value and mature at par value. These government obligations have long-term maturities, greater than 10 years and up to 30 years.

basis point

A measure of a bond's yield, equal to 1/100 of 1% of a yield. A bond whose yield increases from 5.0% to 5.5% is said to increase by 50 basis points. A basis point is equal to 10 cents. A basis point is a measurement of yield equal to 1/100 of 1%. A full percentage point is made up of 100 basis points (bps). Remember not to confuse basis points with points. As discussed previously, a point is a measurement of the change in a bond's price, which equals 1% of face value, or $10 per bond. YTM is sometimes called a bond's basis. For example, a bond trading at a 5.83 basis means the bond has a YTM of 5.83%.

Banker's acceptance

A money market instrument used to finance international trade. A banker's acceptance is a time draft drawn on a bank by an importer or exporter of goods, and it represents the bank's conditional promise to pay the face amount of the note at maturity (normally less than three months).

general obligation bond (GO)

A municipal debt issue backed by the full faith, credit, and taxing power of the issuer for payment of interest and principal. Syn. full faith and credit bond. See also revenue bond.

Revenue Bond

A municipal debt issue whose interest and principal are payable only from the specific earnings of an income-producing public project. See also double-barreled bond; general obligation bond; municipal bond; special revenue bond. utilities (water, sewer, and electric); housing (public housing projects); transportation (airports, bridges, tunnels, and toll roads); education (college dorms and student loans); health (hospitals and retirement centers); Unit industrial (industrial development and pollution control); and sports (stadium facilities).

Put feature

A put feature for a bond is the opposite of a call feature. Instead of the issuer calling in a bond before it matures, with a put feature, the investor can put the bond back to the issuer before it matures. Investors will generally do this when interest rates are rising. From the investor's perspective, why accept 6% interest on a bond one owns if current interest rates have risen to 8%? It is better to put the 6% bond back to the issuer, take the principal returned, and invest it in a new bond paying the current interest rate of 8%. This feature benefits the bondholder.

Repurchase agreements (REPOs)

A sale of securities with an attendant agreement to repurchase them at a higher price on an agreed-upon future date. The difference between the sale price and the repurchase price represents the interest earned by the investor. Repos are considered money market instruments and are used to raise short-term capital and as instruments of monetary policy.

collateral trust bond

A secured bond backed by stocks or bonds of another issuer. The collateral is held by a trustee for safekeeping. Syn. collateral trust certificate. Sometimes, a corporation wants to borrow money and has neither real estate (to back a mortgage bond) nor equipment (to back an equipment trust) to use as collateral. Instead, it deposits securities it owns into a trust to serve as collateral for the lenders. The securities the corporation deposits as collateral for a trust bond can be securities issued by the corporation itself or by stocks and/or bonds of other issuers.

The Howey Test

A security is 1. an investment of money made into 2. a common enterprise 3. with the expectation of profit 4. through the efforts of a third party. So, if people pool their money together with the expectation that a third party (usually a manager) will make a profit for them, a person's interest in that enterprise is a security.

Serial Bond

A serial bond issue schedules portions of the principal to mature at intervals over a period of years until the entire balance has been repaid.

Term bond

A term bond is structured so that the principal of the whole issue matures at once. Because the entire principal is repaid at one time, issuers may establish a sinking fund account to accumulate money to retire the bonds at maturity.

Government National Mortgage Association (GNMA, or Ginnie Mae)

A wholly government-owned corporation that issues pass-through mortgage debt certificates backed by the full faith and credit of the U.S. government. Syn. Ginnie Mae. The Government National Mortgage Association (GNMA) is a government-owned corporation that supports the Department of Housing and Urban Development. GNMAs are the only agency securities backed by the full faith and credit of the federal government.

Bond rating

An evaluation of the possibility of a bond issuer's default, based on an analysis of the issuer's financial condition and likelihood of meeting all obligations. Standard & Poor's, Moody's Investors Service, and Fitch Investors Service, among others, provide bond rating services. Ratings of municipal bonds may be found on the EMMA System operated by the Municipal Securities Rulemaking Board.

Security

An intangible financial asset that may be bought, sold, or gifted between persons. It may be represented by a paper certificate or held in an electronic record.

Balloon Bond

An issuer sometimes schedules its bond's maturity using elements of both serial and term maturities. The issuer repays part of the bond's principal before the final maturity date, as with a serial maturity but pays off the major portion of the bond at maturity. This bond has a balloon, or serial and balloon, maturity.

Farm Credit System (FCS)

An organization of 73 customer-owned lending institutions that provide credit services to farmers and mortgages on farm property. Included in the system are the Federal Land Banks, Federal Intermediate Credit Banks, and Banks for Cooperatives. The Farm Credit System (FCS) is a national network of lending institutions that provides agricultural financing and credit. The system is a privately owned, government-sponsored enterprise that raises loanable funds through the sale of Farm Credit Debt Securities to investors.

negotiable certificate of deposit (CD)

An unsecured promissory note issued with a minimum face value of $100,000. It evidences a time deposit of funds with the issuing bank and is guaranteed by the bank. Syn. Jumbo CD.

According to Standard and Poor's rating system, the four highest grades of bonds (from best to lowest grade) are A. Aaa; Aa; A; Baa. B. A; Aa; Aaa; B. C. B; A; AA; AAA. D. AAA; AA; A; BBB.

Answer: D Choice A would be correct if the question referred to Moody's.

Call feature

As noted previously, a call feature allows an issuer to call in a bond before maturity. Issuers will generally do this when interest rates are falling. From the issuer's perspective, why pay 6% interest to investors on an existing bond if current interest rates have fallen to 4%? It is better to call in the 6% bond and simply issue a new bond paying the lower current interest rate. This feature benefits the issuer. If called, the (former) bondholder now has the dilemma of finding a similar rate of return in a lower interest rate environment.

If a bond has a feature that allows the issuer to pay off bondholders prior to maturity, the bond has A. a put feature. B. a call feature. C. a conversion feature. D. a presale feature.

B A feature that allows an issuer to pay a bond off earlier than the maturity date is a call feature. A put feature allows the holder of the debt to force the issuer to pay off the bond. A conversion feature allows the owner to convert the bond to the issuer's common stock. A presale feature has nothing to do with bonds. LO 2.d

Which of the following money market instruments are routinely used in import/export activities? A. GNMA B. BAs C. T-bills D. Repurchase agreements

B Banker's acceptances (BAs) are used for this purpose

Which of the following securities is not backed by the full faith and credit of the U.S. Treasury? A. GNMA B. FNMA C. STRIPS D. Treasury bills

B Federal National Mortgage Association is a government-sponsored entity. Its debt is not directly backed by the federal government.

A newly issued treasury security that matures in five years is A. A T-bill. B. a T-note. C. a T-bond. D. a treasury receipt.

B T-notes are issued with maturities between 2 and 10 years. T-bills longest maturity is 1 year and T-bonds have maturities over 10 years. Treasury receipts are not issued by the Treasury.

A BB-rated 6% corporate callable bond that matures in 12 years that is trading at 100.25 is priced at A. a discount. B. a premium. C. with a current yield above 7%. D. with a coupon rate below 6%.

B There are a lot of words, but the only thing you need to understand in order to answer this question is that the bond is trading at a price above par (100), so it's at a premium. LO 2.b

Opening purchase >>>> closing sale

Buyers begin the process with an opening purchase of the contract. If they decide to sell the contract later, the second transaction is called a closing sale.

Interest from a zero-coupon bond A. pays monthly and is taxed annually. B. pays annually and is taxed at maturity. C. pays at maturity and is taxed annually. D. pays and is taxed at maturity.

C A zero is purchased at a deep discount and pays no interest until it matures; however, the interest is taxed on an annual basis, called "Phantom Income" LO 2.e

Which of the following is not a security that an investor would purchase? A. Common shares of ABC Petroleum, Inc. B. Debt issue by ABC Petroleum C. Bitcoins D. Windmill Growth Fund

C Bitcoin is considered a commodity, not a security. LO 1.a

Your customer would like current monthly income from a very safe investment. Which of the following would you recommend? A. T-bonds B. FNMA C. GNMA D. T-notes

C GNMA certificates pay monthly income and principal payments and are directly backed by the federal government.

Treasury bills may be issued with all of the following maturities except A. 4 weeks. B. 13 weeks. C. 39 weeks. D. 52 weeks.

C T-bills may be issued with 4-, 13-, 26-, and 52-week maturities. They are not issued with a 39-week maturity.

Which of the following bonds would have the most price volatility? A. 3% 10-year T-note B. 2% 5-year T-note C. 5% 20-year T-bond D. 5% 15-year corporate bond

C The more time left to maturity, the more volatile the bond tends to be. Even though the 20-year T-bond is safer than the corporate, its price will be more volatile. LO 2.c

Your customer, Mr. Garcia, lives in Scottsdale, Arizona. He owns general obligation bonds issued by the city of San Juan, Puerto Rico. The interest from the bonds will be taxed at A. the federal, but not the state, level. B. the state, but not federal, level. C. neither the state nor the federal Level. D. both the state and federal levels.

C U.S. taxpayers pay no income tax on interest paid by U.S. territories and municipalities of those territories

Collateralized debt obligations (CDO)

CDOs are typically complex asset-backed securities. While CDOs do not specialize in any single type of debt, usually their portfolios consist of nonmortgage loans or bonds. The assets backing the CDOs can be a pool of bonds, auto loans, or other assets, such as leases, credit card debt, a company's receivables, or even derivative products of any of the assets listed. While the individual assets may be small and not very liquid, pooling the assets facilitates them being sold to individual investors in the secondary markets. This pooling or repackaging of assets is sometimes called securitization. Securitization allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the entire diverse pool of assets.

CH#3

CH3

collateralized mortgage obligation (CMO)

CMOs are a type of asset-backed security A mortgage-backed corporate security. Unlike pass-through obligations issued by FNMA and GNMA, its yield is not guaranteed, and it does not have the federal government's backing. These issues attempt to return interest and principal at a predetermined rate.

Current Yield (CY)

CY measures a bond's annual coupon payment (interest) relative to its market price, as shown in the following equation: annual coupon payment ÷ market price = current yield

Commercial Paper (CP)

Corporations issue short-term, unsecured commercial paper, known as promissory notes, to raise cash to finance accounts receivable and seasonal inventory gluts. Commercial paper maturities range from 1 to 270 days, although most mature within 90 days. Typically, companies with excellent credit ratings issue commercial paper. A short-term, unsecured debt instrument primarily issued by corporations and banks, typically for the funding of short-term liabilities such as payrolls, accounts payable, and inventories and normally priced at a discount and redeemed at face value. Maturities are 270 days or less.

Nominal Yield

Coupon, nominal, or stated yield is set at the time of issue. Remember that the coupon is a fixed percentage of the bond's par value.

Lando Entertainment, Inc., issues a bond collateralized by a trust holding the company's Las Vegas headquarters. This type of bond is called A. a collateral trust bond. B. a guaranteed bond. C. a headquarters debenture. D. a mortgage bond.

D A secured bond backed by real estate is called a mortgage bond. Collateral trust bonds hold other securities in trust as collateral. A guaranteed bond is an unsecured bond backed by a third party. A headquarters debenture is not a thing. LO 2.f

Which of the following are considered sources of debt service for GO bonds? I. Personal property taxes II. Real estate taxes III. Fees from delinquent property taxes IV. Liquor license fees A. I and IV B. II and III C. II, III, and IV D. I, II, III, and IV

D All of these are taxes or fees that pay into the general fund of a municipality and may be used to service GO debt.

All of the following would most likely be found in a money market fund's portfolio except A. T-bills. B. T-bonds with less than one year to maturity. C. negotiable CDs. D. common stock.

D Common stock does not meet the criteria for a money market. Though highly liquid, it has no maturity date nor is it relatively safe compared to debt instruments.

Your customer calls you with a question. The customer tells you that they received a phone call from the bond desk telling the customer that a trade to purchase 20 bonds at 100 has been executed for the customer's account. The customer would like to know how much they paid for the bonds before any commission or other charges. The answer to the customer's question is A. $2,000. B. $200,000. C. $1,000. D. $20,000.

D Paying "100" means they paid 100% of par ($1,000) per bond. They purchased 20 bonds, so a total of $20,000. Note that the question concerned "how much they paid for the bonds," not the price per bond. LO 2.a

Below which of the following S&P ratings would a bond be considered speculative? A. A B. B C. BB D. BBB

D The investment-grade ratings, from highest to lowest, are AAA, AA, A, and BBB. All ratings below BBB are speculative bonds. LO 2.c

An investor is in the 30% tax bracket. A municipal bond currently yields 7%. To offer an equivalent yield, what must a corporate bond yield?

Divide the municipal yield by 100% minus the investor's tax bracket. This is known as the tax-equivalent yield formula. 7% ÷ (100% - 30%) = 10%

Issued stock

Equity securities authorized by the issuer's registration statement and distributed to the public.

Outstanding stock

Equity securities issued by a corporation and in the hands of the public. Issued stock that the issuer has not reacquired.

Cryptocurrencies

If you are wondering what bitcoin and the other cryptocurrencies are defined as, it is still an open question. It appears that cryptocurrency would likely meet our basic definition of a security, but you should note that there is no third-party management. Currently the Securities and Exchange Commission (SEC) treats cryptocurrency as a commodity. If you should see cryptocurrencies on the exam, remember that they are a commodity, not a security.

Investment-grade debt

In the industry, bonds rated in the top four categories (BBB or Baa and higher) are called investment grade. Investment-grade bonds are generally the only quality eligible for purchase by the institutions (e.g., banks or insurance companies) and by fiduciaries and, therefore, have greater liquidity than lower-grade instruments.

High-yield bonds

Lower-grade bonds, known in the industry as junk bonds, are now more commonly called high-yield bonds. Because of their lower ratings (BB or Ba or lower) and additional risk of default, high-yield bonds may be subject to substantial price erosion during slow economic times or when a bond issuer's creditworthiness is questioned. Their volatility is usually substantially higher than investment-grade bonds, but they may be suitable for sophisticated investors seeking higher returns and possible capital appreciation from speculative fixed-income investments.

Convertible feature

Much like our discussion of convertible preferred stock, convertible bonds are issued by corporate issuers, allowing the investor to convert the bond into shares of common stock. Giving the investor the opportunity to exchange a debt instrument for one that gives the investor ownership rights (shares of common stock) is generally considered a benefit for the investor.

Short-term municipal obligations (anticipation notes)

Municipal anticipation notes are short-term securities that generate funds for a municipality that expects other revenues soon. Usually, municipal notes have less than 12-month maturities, although maturities may range from 3 months to 3 years. They are repaid when the municipality receives the anticipated funds. Municipal notes fall into several categories.

Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)

The Treasury Department designates certain issues as suitable for stripping into interest and principal components. Banks and BDs perform the actual separation of interest coupon and principal and trading of the STRIPS. Both Treasury receipts and STRIPS are zero-coupon bonds.

Tranches

One of the classes of securities that forms an issue of collateralized mortgage obligations. Each tranche is characterized by its interest rate, average maturity, risk level, and sensitivity to mortgage prepayments. Neither the rate of return nor the maturity date of a CMO tranche is guaranteed. See also collateralized mortgage obligation. A pool of mortgages is structured into maturity classes called tranches.

asset-backed security (ABS)

One whose value and income payments are backed by the expected cash flow from a specific pool of underlying assets. Pooling the assets into financial instruments allows them to be sold to investors more easily than selling them individually. This process is called securitization. These pools of assets can include expected payments from different types of loans, such as mortgages, as is the case with CMOs. Pooling the assets into financial instruments allows them to be sold to general investors more easily than selling them individually.

Order of liquidation

Secured debt holders are first Unsecured debt (debentures) and general creditors are second Subordinated debt (debentures) are third in line. Preferred stockholders come in next Common stockholders are last

Secured debt

Secured debt securities are backed by various kinds of assets owned by the issuer, Mortgage Bonds Equipment Trust Certificates Collateral Trust Bonds

Opening sale >>>> closing purchase

Sellers begin the process with an opening sale of the contract. If they decide to buy back the contract later, the second transaction is called a closing purchase.

Yield to call (YTC)

Some bonds are issued with what is known as a call feature. A bond with a call feature may be redeemed before maturity at the issuer's option. Essentially, when a callable bond is called in by the issuer, the investor receives the principal back sooner than anticipated (before maturity). YTC calculations reflect the early redemption date and consequent acceleration of the discount gain if the bond was originally purchased at a discount, or the accelerated premium loss if the bond was originally purchased at a premium.

Subordinated debt

Sometimes the term subordinated is used to describe a class of debt securities. This means "belonging to a lower or inferior class or rank; secondary." It is usually used in describing a type of debenture. A subordinated debenture has a claim that is behind (junior to) that of any other creditor. However, no matter how subordinated the debenture, it is still senior to any stockholder. Sometimes the term senior debt is used for debentures and junior debt for subordinated debentures.

Treasury Inflation Protected Securities (TIPS)

TIPS are a special type of treasury security. They are issued with maturities of 5, 10, or 20 years. They have a fixed coupon rate and pay interest every six months. What is different is that the principal value of the bond is adjusted every six months based on the inflation rate. The interest payments will increase with the principal during periods of inflation and decrease during periods of deflation. Also, the final principal payment at maturity will have been adjusted for inflation over the term of the bond. Note that the final principal payment will never be less than the original $1,000 par.

Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac)

The Federal Home Loan Mortgage Corporation (FHLMC) is a public corporation. It was created to promote the development of a nationwide secondary market in mortgages by buying residential mortgages from financial institutions and packaging them into mortgage-backed securities for sale to investors.

Federal National Mortgage Association (FNMA, or Fannie Mae)

The Federal National Mortgage Association (FNMA) is a publicly held corporation that provides mortgage capital. FNMA purchases conventional and insured mortgages from agencies such as the Federal Housing Administration (FHA) and the Veterans Administration (VA). The securities it creates are backed by FNMA's general credit. Fannie Mae and Freddie Mac are publically owned (held) corporations. They are sometimes called government-sponsored entities (GSEs).

Coupon

The coupon represents the interest rate the issuer has agreed to pay the investor

Maturity Date

The date on which a bond's principal is repaid to the investor and interest payments cease.

par value

The dollar amount assigned to a security by the issuer. Par for common stock usually bears no relationship to the market price. Par for debt security is usually $1,000, while par for preferred is usually $100. Syn. face value; principal; stated value.

Treasury receipt

The generic term for a zero-coupon bond issued by a brokerage firm and collateralized by the Treasury securities a custodian holds in escrow for the investor.

accrued interest

The interest that has accumulated since the last interest payment, up to but not including the settlement date, and that is added to the contract price of a bond transaction. Also called stated yield or nominal yield

Yield

The rate of return on an investment, usually expressed as an annual percentage rate. Yields are measured in basis points Yield is determined by the issuer's credit quality, prevailing interest rates, time to maturity

Nonrated

The rating organizations rate those issues that either pay to be rated or have enough bonds outstanding to generate constant investor interest. The fact that a bond is not rated does not indicate its quality. Many issues are too small to justify the expense of a bond rating.

The two basic securities:

The two basic securities are called stocks (also called equities) and bonds (debt). Though there are several different types of debt, bonds are the most common.

Assume that the same investor is in the 30% tax bracket. If a corporate bond currently yields 11%, what would be the equivalent municipal yield?

To find the answer, multiply the corporate yield by 100% minus the investor's tax bracket. This is known as the tax-free equivalent yield formula. 11% × (100% - 30%) = 7.7%

U.S. Treasury bills

U.S. Treasury bills are direct short-term debt obligations of the U.S. government. They are issued weekly with maturities of 4 weeks, 13 weeks, 26 weeks, and, at times, 52 weeks. Though T-notes and T-bonds are issued with longer maturities than T-bills, once the notes and bonds have only a year left to maturity, they are considered to be money market instruments.

Volatility

bond prices move in an inverse direction to interest rates. A bond's sensitivity to these movements is called "volatility." The more a bond moves in response to a change in interest rates, it is said to be more volatile; the less it moves, the less volatility it has. Secondarily, the lower a bond's coupon rate, the more volatile it is. A 3% bond with five years remaining will be more volatile than a 6% bond with the same five years left.

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unsecured debt

unsecured debt securities are backed only by the reputation, credit record, and financial stability of the issuer. Debentures Guaranteed Bonds Income Bonds Subordinated Debt