Fin 307 Final

Revenue Bond

Revenue bonds are sold to finance a specific revenue-generating project and are backed by cash flows from that project. For example, a revenue bond may be issued to finance an extension of a state highway. To help pay off the interest and principal on that bond, tolls collected from the use of the highway may be pledged as collateral. If rev- enue from the project is insufficient to pay interest and retire the bonds on maturity as promised—perhaps because motorists are reluctant to use the highway and pay the tolls— general tax revenues may not be used to meet these payments. Instead, the revenue bond goes into default and bond holders are not paid. Thus, revenue bonds are generally riskier than GO bonds.

Standby letters of credit

- perform an insurance function similar to commercial and trade letters of credit. The structure and type of risk covered differ, however. FIs may issue SLCs to cover contingencies that are potentially more severe, less predictable or frequent, and not necessarily trade related. These contingencies include performance bond guar- antees by which an FI may guarantee that a real estate development will be completed in some interval of time. Alternatively, the FI may offer default guarantees to back an issue of commercial paper or municipal revenue bonds to allow issuers to achieve a higher credit rating and a lower funding cost than otherwise would be possible. Both LCs and SLCs are essentially guarantees to underwrite performance that a depository institution sells to the buyers of the guarantees (such as a corporation). In eco- nomic terms, the depository institution that sells LCs and SLCs is selling insurance against the frequency or severity of some particular future event occurring. Further, similar to the different lines of insurance sold by property-casualty insurers, LC and SLC contracts differ as to the severity and frequency of their risk exposures.

Fixed Rate Mortgage

-A fixed-rate mortgage locks in the borrower's interest rate and requires monthly payments over the life of the mortgage, regardless of how market rates change.

What are voting rights? What do they vote on? What do they not have control of? What is the typical voting rights arrangement?

-A privilege of common stock -Vote on board of directors (to control firm indirectly) and major changes of the firm (mergers and dividend changes) -Do not have control over the firm's daily activities -1 vote per 1 share of stock

Preemptive rights? Rights offering?

-Corporate law in some states, and some corporate charters, gives shareholders preemptive rights to the new shares of stock when they are issued. -This means that before a seasoned offering of stock can be sold to outsiders, the new shares must first be offered to existing shareholders in such a way that they can maintain their proportional ownership in the corporation. -A "rights offering" generally allows existing stockholders to purchase shares at a price slightly below the market price. Stockholders can then exercise their rights (buying the allotted shares in the new stock) or sell them. The result can be a low-cost distribution of new shares for a firm (i.e., the issuing firm avoids the expense of an underwritten offering).

Why do corporations find preferred stock beneficial?

-Corporations find preferred stock beneficial as a source of funds because, unlike coupon interest on a bond issue, dividends on preferred stock can be missed without fear of bankruptcy proceedings. -Additionally, preferred stock is beneficial to an issuing firm's debt holders. -Funds raised through a preferred stock issue can be used by the firm to fund the purchase of assets that will produce income needed to pay debt holders before preferred stockholders can be paid.

What is a dual class firm? Why are they used?

-Corporations that have 2 classes of common stock outstanding with different voting/dividend rights assigned to each class. -Dual-class firms have often been used in corporations owned and controlled by a single family or group turning to the public market to raise capital through the issue of new shares. To retain voting control over the firm, the family or group issues the dual classes of stock, keeping the high voting stock for themselves and selling the limited voting shares to the public. In all other respects the shares of the two classes are often identical.

Preferred stockholder dividends

-Dividends on preferred stock are generally fixed (paid quarterly) and are expressed either as a dollar amount or a percentage of the face or par value of the preferred stock.

Loans sold

-Loans sold are loans that a bank has originated and then sold to other investors that may be returned (sold with recourse) to the originating institution in the future if the credit quality of the loans deteriorates. Banks and other FIs increasingly originate loans on their bal- ance sheets, but rather than holding the loans to maturity, they quickly sell them to outside investors. These outside investors include other banks, insurance companies, mutual funds, or even corporations.In acting as loan originators and loan sellers, banks are operating more as loan brokers than as traditional asset transformers ......?

What is Mortgage Refinancing? How do you refinance? When are mortgages refinanced? Relationship between coupon rates of new mortgages and refinancing? Benefits of refinancing? What is the decision based on?

-Mortgage refinancing occurs when a mortgage borrower takes out a new mortgage and uses the proceeds obtained to pay off the current mortgage. -Mortgage refinancing involves many of the same details and steps involved in applying for a new mortgage and can involve many of the same fees and expenses. -Mortgages are most often refinanced when a current mortgage has an interest rate that is higher than the current interest rate. -As coupon rates on new mortgages fall, the incentive for mortgage borrowers to pay off old, high coupon rate mortgages and refinance at lower rates increases. - as mortgage rates fall, the percentage of mortgages that are refinancings increases -By refinancing the mortgage at a lower interest rate, the borrower pays less each month—even if the new mortgage is for the same amount as the current mortgage -Traditionally, the decision to refinance involves balancing the savings of a lower monthly payment against the costs (fees) of refinancing.

Preferred stockholder voting rights. Exceptions?

-Preferred stockholders generally do not have voting rights in the firm. -An exception to this rule may exist if the issuing firm has missed a promised dividend payment. For example, preferred stock in Pitney Bowes, Inc. has no voting rights except when dividends are in arrears for six quarterly payments. In this case, preferred stockholders can elect one- third of the board of directors. -Further, most preferred stock may be converted to common stock in the firm at any time the investor chooses.

Relationship between convertible bond and firms asset value

-The convertible bond values rise directly with the firm's asset value. -At low firm asset values the convertible bond value acts more like a nonconvertible bond, trading at only a slight premium over the nonconvertible bond. -When the issuing firm's value is high, the convertible bond will act more like a stock, selling for only a slight premium over the conversion value.

What is a convertible bond? How does it work?

-a bond that can be exchanged for another security of the issuing firm (common stock) at the discretion of the bond holder. -hybrid securities that involve equity & debt -If market value of the security is greater than the market value of the bond, the bond holder can return bonds to the issuer in exchange for the new securities and make a profit.

What is a dividend?

-a payment out of profits to the shareholders of company.

What is a Lien?

-a public record attached to the title of the property that gives the financial institution the right to sell the property if the mortgage borrower defaults -the mortgage is secured by the lien until the loan is paid off, no one can buy the property and obtain a clear title to it.

participating preferred stock meaning

-actual dividends paid in any year may be greater than the promised dividends. -In some cases, if the issuing firm has an exceptionally profitable year, preferred stockholders may receive some of the high prof- its in the form of an extra dividend payment. -In others, the participating preferred stock pays and changes dividends along the same lines as common stock dividends. Participating preferred stock is frequently used by private equity investors and venture capital firms. -In a deal with participating preferred stock, preferred stockholders receive the full return of their investment before any other money is paid out, and then also participate in the distribution of the remaining proceeds, up to an agreed-upon multiple (often two or three times) of the investment.

Cumulative preferred stock meaning

-any missed dividend payments go into arrears and must be made up before any common stock dividends can be paid.

Why are convertible bonds attractive?

-conversion feature -They give the bond holder an investment opportunity (an option) that is not available with nonconvertible bonds.

When does it become profitable to convert convertible bonds?

-convertible bond issues are set up so that it is not initially profitable to convert to stock. Usually the stock price must increase 15 to 20 percent before it becomes profitable to convert the bond to the new security.

What is preferred stock? How is it similar to stock, How is it similar to a bond? What can the preferred stock holders do if the firm does not pay out dividends? What if the firm goes bankrupt?

-hybrid security that has characteristics of both bonds and common stock. -similar to common stock in that it represents an ownership interest in the issuing firm, but like a bond it pays a fixed periodic (dividend) payment. -Like common stock, if the issuing firm does not have sufficient profits to pay the preferred stock dividends, preferred stockholders cannot force the firm into bankruptcy. -Further, if the issuing firm goes bankrupt, preferred stockholders are paid their claim only after all creditors have been paid, but before common stockholders are paid.

non-cumulative preferred stock

-missed dividend payments do not go into arrears and are never paid. -For example, Doral Financial Corp.'s noncu- mulative preferred stock entitles stockholders to monthly dividends based on an annual rate of $0.151 per share. In 2009, Doral suspended dividend payments on the preferred stock. The dividends did not go into arrears. -Noncumulative preferred stock is generally unattractive to prospective preferred stockholders. Thus, noncumulative preferred stock generally has some other special features (e.g., voting rights) to make up for this drawback.

What type of mortgages (fixed or adjustable rate) do borrowers prefer when interest rates are low? and why?

-mortgage borrowers generally prefer fixed-rate loans to ARMs when interest rates in the economy are low -If interest rates rise, ARMs may cause borrowers to be unable to meet the promised payments on the mortgage

What are Jumbo Mortgages? Who sets the limits? What are the limits based on? Interest rates? Spread? Down payment?

-mortgages that exceed the conventional mortgage conforming limits. -Limits are set by the two government-sponsored enterprises: Fannie Mae and Freddie Mac -based on the maximum value of any individual mortgage Fannie Mae and Freddie Mac will purchase from a mortgage lender -Because the large size and the inability to sell jumbo mortgages to Fannie Mae or Freddie Mac creates more risk for mortgage lenders, interest rates on jumbo mortgages are generally higher than on conforming mortgages. -Typically, the spread in interest rates on jumbo versus conventional mortgages is about 0.25 to 0.50 percent. However, during periods of high economywide risk (e.g., during the late 2000s), the spread can be greater than 1.50 percent. -Further, to reduce the risk of these loans, lenders will often require a higher down payment on jumbo mortgages than conventional mortgages.

What type of mortgages (fixed or ADR) do lenders prefer when interest rates are low? why? What is the drawback?

-most mortgage lenders prefer ARMs when interest rates are low. -When interest rates eventually rise, ARM payments on their mortgage assets will rise. Since deposit rates and other liability rates too will be rising, it will be easier for financial institutions to pay the higher interest rates to their depositors when they issue ARMs. -higher interest payments mean mortgage borrowers may have trouble making their payments. Thus, default risk increases. Thus, while ARMs reduce a financial institution's interest rate risk, they also increase its default risk.

Adjustable Rate Mortgage

-the interest rate on an adjustable-rate mortgage (ARM) is tied to some market interest rate or interest rate index. -the required monthly payments can change over the life of the mortgage. -ARMs generally limit the change in the interest rate allowed each year and during the life of the mortgage (called caps).

Non participating preferred stock meaning

-the preferred stock dividend is fixed regardless of any increase or decrease in the issuing firm's profits.

syndicate

-the process of distributing securities through a group of investment banks -Often an investment bank will bring in a number of other investment banks to help sell and distribute a new issue—called a syndicate. -For example, in Figure 8-3, the stock issue announcement of 10,344,827 shares of common stock in Acadia Pharmaceuticals lists the syndicate of seven investment banks involved in the initial issue. The investment banks are listed according to their degree of participation in the sale of new shares. The lead banks in the syndicate (e.g., Merrill Lynch and J.P. Morgan Securities), which directly negotiate with the issuing company on behalf of the syndicate, are the originating houses. Once an issue is arranged and its terms set, each member of the syndicate is assigned a given number of shares in the issue for which it is responsible for selling. Shares of stock issued through a syndicate of investment banks spread the risk associated with the sale of the stock among several investment banks. A syndicate also results in a larger pool of potential outside investors, increasing the probability of a successful sale and widening the scope of the investor base. p.248

Straight Voting

-the vote on the board of directors occurs one director at a time. -the number of votes eligible for each director is the number of shares outstanding. -Straight voting results in a situation in which an owner of over half the voting shares can elect the entire board of directors.

Common stock dividends rights? How are they determined? What happens if a payment is missed? Drawback? How can investors avoid it?

-they have no special or guaranteed dividend rights. -The payment and size of dividends are determined by the board of directors of the issuing firm (who are elected by the common stockholders). -a corporation does not default if it misses a dividend payment to common stockholders. Thus, common stockholders have no legal recourse if dividends are not received, even if a company is highly profitable and chooses to use these profits to reinvest in new projects and firm growth. -Taxed twice. Once at the firm level (at the corporate tax rate, by virtue of the fact that dividend payments are not tax deductible from the firm's profits or net earnings) and once at the personal level (at the personal income tax rate). -Investors can partially avoid this double taxation effect by holding stocks in growth firms that reinvest most of their earnings to finance growth rather than paying larger dividends. Generally, earnings growth leads to stock price increases. Thus, stockholders can sell their stock for a profit and pay capital gains taxes rather than ordinary income taxes on dividend income. Under current tax laws, capital gains tax rates are lower than ordinary income tax rates.

How and when do shareholders vote? What are the two methods?

-votes are casted at the issuing firm's annual meeting or by mailing in a proxy vote -Cumulative & Straight voting

Drawbacks of preferred stock on corporations?

1) if a preferred dividend payment is missed, new investors may be reluctant to make investments in the firm. -Thus, firms are generally unable to raise any new capital until all missed dividend payments are paid on preferred stock. -In addition, preferred stockholders must be paid a rate of return consistent with the risk associated with preferred stock (i.e., dividend payments may be delayed). Therefore, preferred stock may be a costlier source of funding for the issuing firm than bonds 2) unlike coupon interest paid on corporate bonds, dividends paid on preferred stock are not a tax- deductible expense—preferred dividends are paid out of after-tax earnings. -This raises the cost of preferred stock relative to bonds for a firm's shareholders. -Specifically, this differ- ence in the tax treatment between coupon interest on debt and preferred stock dividends affects the net profit available to common stockholders of the firm.

Inferior voting rights of dual class firms are assigned by? and to offset the reduced voting rights?

1). limiting the number of votes per share on one class relative to another (e.g., Berkshire Hathaway Class B shares are entitled to 1/10,000th vote per share, while Class A shares are entitled to one vote per share) 2)limiting the fraction of the board of directors that one class can elect relative to another (e.g., Reinsurance Group of America Class B common stock has the right to elect at least 80 percent of the members of the board of directors, while the holders of Class A common stock have the right to elect no more than 20 percent of the members of the board) 3)a combination of these two (e.g., the Molson Coors Brew- ing Company allows holders of Class B common stock the right to elect three directors to the Molson Coors board of directors and the right to one vote per share on other specified transactional actions, while the right to vote for all other activities remains exclusively with Class A common stock). -To offset the reduced voting rights: inferior class shares are often assigned higher dividend rights.

Cumulative Voting

Cumulative voting is : -required by law in some states and is authorized in others. - all directors up for election, as nominated by the shareholders and selected by a committee of the board, are voted on at the same time. -The number of votes assigned to each stockholder equals the number of shares held multiplied by the number of directors to be elected. -A shareholder may assign all of his or her votes to a single candidate for the board or may spread them over more than one candidate. -The candidates with the highest number of total votes are then elected to the board. -Cumulative voting permits minority stockholders to have some real say in the election of the board of directors, since less than a majority of the votes can affect the outcome.

Typically preferred stock is ______________ & ________________

Nonparticipating and cumulative

Net Interest Margin

interest income minus interest expense divided by earning assets Net interest margin (ratio 6 in Table 12-5) measures the net return on the bank's earning assets (investment securities and loans and leases) and is defined as follows: N.I.M = Net int income/ earning assets net int income = interest income- interest expense earning assets = Investment securities + Net loans & leases

General Obligation Bonds

municipal bond. General obligation (GO) bonds are backed by the full faith and credit of the issuer—that is, the state or local government promises to use all of its financial resources (e.g., its taxation powers) to repay the bond. GO bonds generally have neither specific assets pledged as collateral backing the bond nor a specific revenue stream identified as a source of repayment of the bond's principal and interest. Because the taxing authority of the government issuer is promised to ensure repayment, the issuance of new GO bonds generally requires local taxpayer approval. Possibly because of this requirement, and taxpayers' reluctance to have their taxes increased, general obligation bonds represent a small portion of municipal bonds issued (44.0 percent in 2016).

What is the rule of thumb for mortgage re-financing?

the interest rate for a new mortgage should be 2 percentage points below the rate on the current mortgage for refinancing to make financial sense