Chapter 3: Key Terms

All of the following statements about municipal revenue bonds are TRUE EXCEPT:

The maturity of the revenue bond usually coincides with the useful life of the facility being built.

eurodollar deposits

US dollars held overseas

subordinated debt

debt with an inferior claim (relative to senior debt) to venture assets

Examples of revenue bonds

entities that provide an essential public service (i.e., transportation systems, power systems, sewer systems), water systems, nonprofit organizations, private-sector corporations

debt limits

establishes the total amount of GO principal that can be outstanding at any time

Corporate bonds

issued by commercial and industrial entities to raise money for expansion

spread

the difference between the bid and ask

pass-through certificates

A certificate that represents a portion of ownership in a pool of federally insured mortgages

A bond is quoted at 99 1/8. From this quote, which of the following can be reasonably concluded?

Corporate bonds are quoted in 1/8th increments, so a quote of 99 1/8 represents 99.125% of par ($1,000), or $991.25. Treasuries are typically quoted in 1/32nd increments (e.g. 99 10/32).

mortgage bonds

Corporate bonds that are secured by property, such as land, equipment, or buildings.

municipal securities

Debt of state and local governments Varying degrees of default risk, rated similar to corporate debt Interest received is tax-exempt at the federal level

Investors that purchase Ginnie Mae, Fannie Mae or Freddie Mac mortgage-backed securities will benefit from which of the following?

Income that is slightly higher than income from U.S. Treasury securities

Characteristics of commercial paper include all of the following EXCEPT

Issued only by banks and other financial institutions; commercial paper is issued by corporations for short term financial needs. It is unsecured and usually matures in 270 days or less. It is usually sold in minimum denominations of $100,000 and is highly liquid.

Tax Anticipation Notes (TANs)

Municipalities issue these to finance current operations in anticipation of future tax receipts. This helps municipalities to even out cash flow between tax collection periods.

Revenue Anticipation Notes (RANs)

Offered periodically to finance current operations in anticipation of future revenues from revenue producing projects or facilities.

Biggest purchasers of T-Bills?

Primary dealers

Which of the following securities is quoted on a discounted yield basis?

Treasury bills are quoted on a discounted yield basis. Treasury notes & bonds are quoted as a percentage of par.

treasury receipts

Zero coupon bond created by brokerages but backed by cash flows from treasury securities

bond indenture

a legal document that details all the conditions relating to a bond issue; because they are backed by user charges, rather than the taxing power of the municipality, revenue bonds are generally issued with this

extension risk

a risk that prepayments will be slower than expected

ad valorem

according to value; property and real-estate taxes are the most common types of ad valorem taxes used to redeem GO bond issues

Why is extension risk bad?

as interest rates increase, bond prices decrease and because this is a long-term bind, which is extremely sensitive to changing rates, its price will decrease significantly; also, because the underlying mortgages will remain outstanding for longer than initially anticipated, the investor will be stuck in this investment for longer

Why are people attracted to CDs?

because principal and interest is insured up to a limit (currently $250,000 per depositor) by the FDIC

mortgage-backed securities

bonds backed by mortgage payments

equipment trust obligations

debt instruments that are secured by equipment or physical assets such as airplanes, trucks, and trains

eurodollar bonds

dollar-denominated bonds sold outside the United States

the secondary market for municipal bonds is...

highly illiquid because each issuance is unique, with its own credit structure, terms, and conditions

notes

medium-term maturity instruments

commercial paper (CP)

negotiable, unsecured debt instrument issued by a corporation to finance short-term operating expenses and working capital needs most are issued in the form of "promissory notes"

liquidation priority

secured bondholders unsecured bondholder and general creditors subordinated debt and convertible bonds preferred stockholders common stockholders

agency securities

securities of GSE's; not issued y the US Treasury and are not fully guaranteed by the US gov

securitization

the process of converting mortgages into bonds

General Obligation Bonds (GO bonds)

-Used to raise funds for municipal capital improvements that benefit the entire community-public schools, a library, a jail, a bridge, or a courthouse, for instance -Known as full faith and credit bonds because the interest and principal payments are backed by the full faith and credit of the issuer -Backed by income taxes, license fees, and sales tax -Voter approval is required prior to issue because backed by taxing power

conversion ratio

=par value/conversion price this is the number of common shares that the bondholder will receive upon conversion

banker's acceptance (BA)

A money-market instrument used to finance international and domestic trade. It is a check drawn on a bank by an importer or exporter of goods representing the bank's unconditional promise to pay the face amount of the note at maturity

collateral trust bonds

Bonds backed by financial assets owned by the corporation, such as stocks, bonds, or other securities

Analysis of the tax collections of a municipality are most relevant to

GO bonds; the tax collections of municipal bonds are used to pay debt service on their general obligation bonds. U.S. Treasury bonds are backed by federal income taxes

Unsecured bonds are typically backed by the

Good faith of the business

GNMA (Ginnie Mae)

Government National Mortgage Association. A secondary money market player which is government owned and purchases loan pools of FHA and VA loans.

When a bond is secured, investors

Have rights to collateral pledged by the company; A secured bond is one where investors have the right to certain collateral in the event the issuer is unable to meet regular interest and principal payments.

Company A and Company B are multinational corporations whose typical business interests are in the import/export fields. The international transactions in which these businesses engage might be financed through the use of

International transactions can be financed through the use of banker's acceptances (BA). These are typically checks drawn on a bank by an importer or exporter of goods and represents the bank's promise to pay the face amount of the note at maturity, which is usually within a three month time period. Banker's acceptances are frequent investments in money market funds.

Commercial paper, bankers acceptances and large time deposits are part of what segment of the fixed income market?

Money market instruments

collateralized mortgage obligations (CMOs)

Mortgages are segmented into tranches (classes), according to their maturity, and the cash flows provided by each tranche are typically structured in a sequential manner.

All of the following statements are true of the municipal securities market EXCEPT

Most municipal securities are readily available in the secondary market

Certificates of Deposit (CDs)

Savings accounts that guarantee a depositor a set interest rate over a specified interval as long as the funds are not withdrawn before the end of the period—six months or one year for example

Bond Anticipation Notes (BANs)

Sold as interim financing that will eventually be converted to long-term funding through a sale of bonds.

All of the following types of U.S. Treasuries pay interest through periodic coupons except

T-bills pay interest that is the difference between the purchase price and the par value at maturity i.e., as a discount to maturity value. They do not pay periodic coupon interest.

What securities are considered the safest?

US government securities because default risk is nearly absent (supported by gov's ability to raise tax revenues and print currency)

STRIPS

Zero-coupon Treasury securities with maturities longer than one year that trade in the bond market; t-notes, t-bonds, and TIPS can be separated or stripped into individual STRIP investments

All of the following statements are true about convertible bonds EXCEPT

a bond cannot be both callable and convertible; Issuers may add call provisions to convertible bonds. The bond indenture specifies the terms under which a bond can be converted. The conversion ratio specifies the number of shares a bond holder will receive per bond exchanged; the conversion price is the price of the underlying stock at which the bond can be converted to common. Because convertible bonds offer a choice to bondholders, issuers can pay a lower rate, and reduce their fixed costs for borrowing money from investors.

bond referendum

allows school districts to borrow money stipulated for specific projects

unsecured corporate debt

also known as debentures; pays more interest than secured debt because it is not backed by a specific asset

Government Sponsored Enterprises (GSEs)

authorized to raise money through issuing debt securities

revenue bonds

backed by a specific source of revenue associated with the project for which financing has been secured

secured corporate debt

backed by corporate collateral; investors have rights to the collateral if the issuer defaults on principal and interest pauments

prepayment risk

if interest rates decrease, homeowners will likely prepay their mortgages and refinance at a lower rate

TIPS

inflation-indexed bonds; coupon rate is constant - aimed to protect holder against inflation

How often do MBS pays interest to investors?

monthly

convertible bond

offers an investor the option of converting the bond into common stock (equity) of the issuer; pay a lower coupon rate than comparable nonconvertible bonds; in a period of stable interest rates, the price of the convertible bond will be more volatile than that of other types of debt - this is because the convertible bond will fluctuate in price with the underlying stock

taxation of municipal securities interest

one of the primary benefits of investing in municipal bonds is that interest paid on these bonds is generally exempt from federal income tax, and it may also be exempt from state and local taxes

money market

part of the global fixed-income market that issues and trades debt instruments with the shortest maturities - typically less than one year generally considered the safest possible investment - so much so that they are often referred to as "cash in a brokerage account

Why is prepayment risk bad?

reinvestment rate risk: investors receive their money back early and are forced to reinvest at a lower rate AND the bond sees no increase in market value, despite the decline in rates, since the bond is acting as a sort-term security, which is less impacted by changing interest rates

Treasury Bills (T-Bills)

short-term debt obligations the U.S. government sells to raise money; mature in one year or less; sold at a discount and mature at par; quoted on an annualized discount percentage basis

repurchase agreements (repos)

short-term sales of government securities with an agreement to repurchase the securities at a higher price

municipal note

short-term, high-quality municipal issue that is sold by municipality to help manage its cash flow

public purpose municipal bond

the interest received on these bonds are is fre from federal income tax - capital gains, however, are taxable

commercial paper

the name often used for corporate instruments with a maturity of no more than 270 days

negotiable commercial paper

the owner of the commercial paper can sell it without the consent of the borrower, such as when a bank can sell a business's loan to another bank without its consent

non-negotiable commercial paper

the owner of the commercial paper cannot sell the commercial paper without the consent of the business, such as when a bank cannot sell a business's loan to another bank without the consent of the borrower

conversion parity

the point at which neither a profit nor loss is made at conversion - investor is mathematically indifferent

Reverse Repo

the purchase of securities by one party with an agreement to sell them

asset-backed securities (ABS)

the securitization of financial assets, not of hard corporate assets (i.e., a pool of student loans, auto loans, and equipment leases) **BUT a piece of equipment itself cannot be securitized

treasury securities (5 types)

treasury bills, treasury notes, treasury bonds, treasury inflation-protected securities (TIPS), separate trading of registered interest and principal securities program securities (STRIPS)

Treasury Notes (T-Notes)

type of government bond issued with shorter maturities than T-bonds

Treasury Bonds (T-Bonds)

type of treasuries which have the longest maturities of all government bonds