FIN 310- Exam 2

Collateralized Mortgage Obligation (CMO)

A fixed income security that uses mortgage-backed securities as collateral. Like other structured securities, they are subdivided into graduated risk classes, that vary in degree based on the maturity structure of the mortgages.

Duration

A measurement of the life of the bond on a present value basis. The longer a bond's duration, the greater its sensitivity to interest rate changes.

Bond Convexity

A more complete formula to estimate the percentage change in price in response to a change in yield will incorporate the property as well as modified duration

Adjustable Rate Mortgage (ARM)

A mortgage loan with the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets

Second Mortgages

A mortgage taken out on a property that is already mortgaged

First Mortgage Bond

A type of bond collateral, it has first claim on the specified assets

Chattel Mortgage Bond

A type of bond collateral, it is secured by personal property

Global Government Debt Markets

Bonds issued by foreign governments are attractive to investors because of the government's ability to meet debt obligations.

Debentures

Bonds that are unsecured by specific property, they are back only by the general credit of the issuing firm, thus there is no collateral.

Modified Duration

Can be used to estimate the percentage change in the bond's price in response to a 1 percentage point change in bond yields

Negotiable Certificates of Deposit (NCDs)

Certificates issued by large commercial banks and other depository institutions as a short-term source of funds. A secondary market for NCDs exists, providing investors with some liquidity.

Junk Bonds

Corporate bonds perceived as very high risk Primary investors - mutual funds, life insurance companies, and pension funds Offer a high yield compared to Treasury yield

International Interbank Market

Facilitates the transfer of funds from banks with excess funds to those with deficient funds.

Interest Rate Strategy

Funds are allocated in a manner that capitalizes on interest rate forecasts

Barbell Strategy

Funds are allocated to bonds with a short term to maturity as well as to bonds with a long term to maturity.

Laddered Strategy

Funds are evenly allocated to bonds in each of several different maturity classes

Greek-Debt Crisis in 2010

Greece experienced debt crisis brought on by weak economic conditions and a large government budget deficit. Credit ratings on Greece were reduced several times. Concern also spread to Spain and Portuga

Variable-Rate Municipal Bonds

Have a floating interest rate that is based on a benchmark interest rate.

Treasury Bond Auctions

Normally held in the middle of each quarter. Financial institutions submit bids for their own accounts or for their clients. Bids are submitted on a competitive or a noncompetitive basis.

Cash Management Bills

Periodically issued T-bills with terms shorter than four weeks

Treasury Inflation-Protected Securities (TIPS)

Provide returns tied to the inflation rate. The principal value is increased by the amount of the U.S. inflation rate

Call Provisions

Requires firms to pay a price above par value when it calls (buys back) its bonds

Protective Covenants

Restrictions on the issuing firm that are designed to protect bond-holders from being exposed to increasing risk during the investment period

Commercial Paper

Short term debt instruments issued by well-known, creditworthy firms, and are typically unsecured. They do not pay interest and are sold at a discount from par value.

Euronotes

Short-term securities issued in bearer form with commonmaturities of one, three, and six month

Revenue Bonds

Supported by revenues of the project (tollway, toll bridge, state college dormitory, etc.) for which the bonds were issued.

General Obligatin Bonds

Supported by the municipal government's ability to tax

Treasury Bills

The U.S Government needs to borrow funds, the U.S. Treasury issues these short-term securities. Mostly these are issued weekly at 4, 13, and 26 week maturities. They can also be issued monthly with a one year maturity. The par value of these is $1,000 and multiples of $1,000. Sold at a discount from par value, thus gain is the difference between par value and price paid Backed by the federal government and are virtually free of default risk Are liquid and can be sold in the secondary market

Treasury Notes and Bonds

The U.S. Treasury commonly issues these to finance federal government expenditures. The minimum denomination for these is now $100 Receive semiannual interest payments from the Treasury. Interest is taxed by the federal government as ordinary income, but it is exempt from any state and local taxes

Bonds

Long-term debt securities issued by government agencies or corporations. The issuer is obligated to pay interest (or coupon) payments periodically (such as annually or semiannually) and the par value (principal) at maturity. Often classified according to the type of issuer Most have maturities of between 10 and 30 years. Can be issued as bearer bonds or registered bonds. Issued in the primary market through a telecommunications network

Corporate Bonds

Long-term debt securities, issued by corporations, that promise the owner coupon payments (interest) on a semiannual basis. Minimum denomination is $1,000. Maturity is typically between 10 and 30 years.

Treasury Bond Maturities

Maturities that are 10 years or more

Treasury Note Maturities

Maturities that are less than 10 years

International Bond Diversification

May diversify foreign bond holdings among countries to reduce their exposure to different types of risk

Money Market Securities

Money market securities are debt securities with a maturity of one year or less.

Denomination of Commercial Paper

Usually $100,00 and can be multiples of $1,000,000, and maturities are normally between 20 and 45 days, but can be as short as 1 day or as long as 270 days

The rate at which depository institutions effectively lend or borrow funds from each other is the ____. a. federal funds rate b. discount rate c. prime rate d. repo rate

a. federal funds rate

Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at ____ yields. a. higher; lower b. lower; lower c. higher; higher d. none of the above

a. higher; lower

Commercial paper has a maximum maturity of ____ days. a. 45 b. 270 c. 360 d. none of the above

b. 270

Lisa can purchase bonds with 15 years until maturity, a par value of $1,000, and a 9 percent annualized coupon rate for $1,100. Lisa's yield to maturity is ____ percent. a. 9.33 b. 7.84 c. 9.00 d. none of the above

b. 7.84

Devin is a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Devin will hold the bonds until maturity. Thus, he will earn a return of ____ percent. a. 12 b. 9 c. 10.5 d. more information is needed to answer this question

b. 9

During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods. a. True b. False

b. False

Treasury bond auctions are normally conducted only at the beginning of each year. a. True b. False

b. False (They are held in the middle of each quarter)

If an investor buys a T-bill with a 90-day maturity and $50,000 par value for $48,500 and holds it to maturity, what is the annualized yield? a. about 13.4 percent b. about 12.5 percent c. about 11.3 percent d. about 11.6 percent e. about 10.7 percent

b. about 12.5 percent

Assume that you purchased corporate bonds one year ago that have no protective covenants. Today, it is announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will likely ____ as a result. a. rise b. decline c. be zero d. be unaffected

b. decline

At any given time, the yield on commercial paper is ____ the yield on a T-bill with the same maturity. a. slightly less than b. slightly higher than c. equal to d. A and B both occur with about equal frequency

b. slightly higher than

Municipal general obligation bonds are ____. Municipal revenue bonds are ____. a. supported by the municipal government's ability to tax; supported by the municipal government's ability to tax b. supported by the municipal government's ability to tax; supported by revenue generated from the project c. always subject to federal taxes; always exempt from state and local taxes d. typically zero-coupon bonds; typically zero-coupon bonds

b. supported by the municipal government's ability to tax; supported by revenue generated from the project

Assume investors require a 5 percent annualized return on a six-month T-bill with a par value of $10,000. The price investors would be willing to pay is $____. a. 10,000 b. 9,524 c. 9,756 d. none of the above

c. 9,756

A repurchase agreement calls for an investor to buy securities for $4,925,000 and sell them back in 60 days for $5,000,000. What is the yield? a. 9.43 percent b. 9.28 percent c. 9.14 percent d. 9.00 percent

c. 9.14 percent (With a 360 day year, with a 365 day year it is 9.26)

Which of the following is not a money market security a. Treasury bill b. negotiable certificate of deposit c. common stock d. federal funds

c. common stock

Bonds that are not secured by specific property are called a. a chattel mortgage. b. open-end mortgage bonds. c. debentures. d. blanket mortgage bonds.

c. debentures.

____ are sold at an auction at a discount from par value. a. Treasury bonds b. Repurchase agreements c. Banker's acceptances d. Commercial paper

d. Commercial paper

Par Bonds

If coupon rate equals the required rate, the price of the bond is equal to par value (PV = 1,000)

Discount Bonds

If coupon rate is below required rate, the price of the bond is below par (PV < 1,000)

Premium Bonds

If the coupon rate is above the required rate, the price of the bond is above the par (PV > 1,000)

LIBOR Scandal

In 2012, some banks falsely reported their rates that they periodically report in the interbank market

Tax Advantages of Municipal Bonds

Interest income is normally exempt from federal taxes. Interest income within a particular state is normally exempt from the income taxes (if any) of that state

Tax Ramifications of Corporate Bonds

Interest paid by the corporation to investors is tax deductible to the corporation. Interest income earned on corporate bonds represents ordinary income to the bondholders and is therefore subject to federal taxes and to state taxes

Matching Strategy

Involves estimating future cash outflows and then developing a bond portfolio that can generate sufficient coupon or principal payments to cover those outflows.

Low and Zero Coupon Bonds

Issued at a deep discount from par value. They are purchased mainly for tax-exempt investment accounts.

Federal Agency Bonds

Issued by federal agencies such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Association (Freddie Mac) who use the proceeds to purchase mortgages in the secondary market.

Municipal Bonds

Issued by state and local governments. Typically promise semiannual interest payments. Minimum denomination of municipal bonds is usually $5,000. Most municipal bonds contain a call provision.

Savings Bonds

Issued by the Treasury, but they can be purchased from many financial institutions. Can be purchased with as little as $25. Interest income on savings bonds is not subject to state and local taxes but is subject to federal taxes.

Euro-commercial Paper

Issued without the backing of a banking syndicate. Maturities can be tailored to satisfy investors.

Eurodollar CDs

Large, dollar-denominated deposits (such as $1 million) accepted by banks in Europe

Caps on Adjustable Rate Mortgages

Limitations on an ARM based on three characteristics of the mortgage: -frequency of the interest rate change -periodic change in interest rate -total change in interest rate over the life of the loan

Variable Rate Bonds

Long term debt securities with a coupon rate that is periodically adjusted.

Denomination of NCDs

The minimum denomination is $100,000. Maturities normally range from 2 weeks to 1 year.

London Interbank Offered Rates (LIBOR)

The rate charged for a loan from one bank to another in the international interbank market

Bond Price Elasticity

The sensitivity of bond prices to changes in the required rate of return

Where are Money Market Securities Issued, and by Whom?

They are issued in the primary market through a telecommunications network by the U.S. Treasury, corporations, and financial intermediaries that wish to obtain short-term financing

Convertible Bond

This bond allows investors to exchange the bond for a stated number of shares of the firm's common stock