SIE: Bonds & Debt Securities

Corporate Debt Securities Pay Accrued Interest Based On:

30-Day Month / 360-Day Year

Municipal Securities Pay Accrued Interest On aa

30-day month / 360-day year

Corp and Municipal Calculation Dates (X/X)

30-day month / 360-day year calculation. 30/360

Treasury Receipts

A Brokerage Firm created bond. BDs buy Treasury securities, place them in a trust, and sell *separate receipts* against the principal and coupon payments. This separation of the coupon interest payments from the principal creates new securities (the receipts) and provides investors with several maturities to choose from. Although these securities that are held in a trust collaterize the original treasury securities, the Treasury Receipts are issued by BDers and are NOT backed by the full faith and credit of the U.S. government.

Subordinated Debt

A class of debt securities that has a junior claim to any other creditor. However, any form of debt is still senior (above) any stockholder.

Collateral Trust Bonds

A company deposits securities it owns into a trust to serve as collateral for the lenders. This can be done because the corporation has neither real estate or equipment to back a mortgage bond or equipment trust. These securities can be securities issued by the company itself (such as stock) or by the stocks/bonds of other issuers. Regardless of the issuer, all deposited coollateral securities must be marketable (readily able to be liquidated). This is a secured loan, as the loan is backed by the collateral deposited in the trust. The better the quality of the securities, the better quality of the certificate/loan.

Mortgage Bonds

A corporation borrows money and pledges real estate and physical assets that it owns. The value of the real assets pledged by the corporation will be in excess of the amount borrowed under that bond issue. If the company is unable to pay the interest on the bonds, those real assets pledged as collateral will be sold to pay off the bondholders. This puts the investor in a position of safety. This is a secured loan.

Accrued interest on Treasury Securities is based on:

Actual calendar days elapsed.

Current Yield (Bond)

Annual coupon payment (interest) relative to it's MARKET price. Annual Coupon Payment / Market Price = Current Yield

How Do Interest Rates Affect Bond Prices on the Secondary Market?

As interest rates fall, bond prices rise. As interest rates rise, bond prices fall. With lower interest rates, investors would prefer to put their money in bonds that can give them reliable payments. Additionally, issuers would rather issue new bonds at the lower interest rate so they can pay less in coupon payments. As interest rates rise, investors would prefer to put their money in higher-return investments. So the prices in the secondary market fall.

3 Common Bond Features

Call - Issuer can Call the bond and will pay the principal back before the maturity date. Often done when interest rates fall. Example: Interest rates fall to 4%, so an issuer calls its 6% bonds to reissue them at 4%. Investors receive their principal back early, but are out any future interest payments. Put - Investor can put the bond back to the issuer at any time and receive par value of the bond. Example: Interest rates rise to 8%, so an investor uses the put feature on their 6% bond to get their investment back so they can take advantage of investments with the higher interest rate. Convertible - Allows the investor to convert bonds into shares of common stock. Generally considered a benefit for the investor. Note: Features that benefit the issuer can mean a higher coupon rate to encourage investors, while features that benefit the investor can mean a lower coupon rate with the features working as compensation in exchange for the lower rate.

Tax and Revenue Anticipation Notes (TRANs)

Combination of Tax Anticipation Notes (TANs) Revenue Anticipation Notes (RANs)

Secured Corporate Debt Securities

Corporate debt securities that are backed by various kinds of assets owned by the issuing corporation. Such as equipment, securities, or mortgages.

Unsecured Corporate Debt Securities

Corporate debt securities that are only backed by the reputation, credit record, and financial stability of the corporation. Commonly referred to as being backed by the corporation's -full faith and credit-.

Equipment Trust Certificates

Corporations, such as railroads, airlines, and other transportation companies, finance the acquisition of capital equipment used in the course of their business. IE: A railroad company issues equipment trust certificates to purchase their locomotives. Title to the newly acquired equipment is held in trust, usually a bank, until the certificates have been paid in full. .When the company has finished paying off the loan, it receives the title from the trustee. If the company cannot make the payments, the lender repossesses the collateral and sells it for his benefit. This is a secured loan, as the obligation to pay the investor is secured by the equipment.

Debentures

Debt obligation of a corporation that is backed ONLY by its word and general creditworthiness. They are written promises to pay the principal at its due date and interest on a regular basis. This promise is just as binding of a promise as any secured bond, however they are not secured by any pledge of assets or property. Because they are sold on the general good faith and credit of the company, they are unsecured loans. NOTE: Despite being unsecurued, there are some issuers whose credit standing is so good that their debentures may be considered safer than secured bonds of less creditworthy companies.

Government National Mortgage Association (GNMA / Ginnie Mae)

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. Many of these securities have a 30-year life, but because mortgages are often retired early, the securities are sold based on average life expectancy instead. If a mortgage is paid off before the stated maturity, the GNMA investor will receive back all outstanding principal of that loan at par.

Accrued Interest

Happens if a bond trades between coupon payments. The buyer (NEW Owner) must pay the seller (OLD owner) the amount of interest earned to date at the time of settlement. This means the new owner gets paid the full coupon from the issuer in the NEXT payment cycle.

Basis Points

How bond yields are measured. Basis point is a measurement of yield equal to 1/100 of 1%. So a single percentage point is 100 basis points.

Taxes on Municipal Bonds

Interest on most municipal bonds is tax free on the federal level and tax free on the state level IF the investor lives in the state of issuance.

Bond Anticipation notes (BANs)

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

Construction loan notes (CLNs)

Issued to provide interim financing for construction of housing projects.

Grant Anticipation Notes (GANs)

Issued with the expectation of receiving grant money from the federal government.

Term Bond

Matures on a single date.

General Obligation (GO Bonds)

Municipal bonds issued for capital improvements that benefit the entire community. Typically, they do not produce revenues so the principal and interest must be paid by taxes collected by the municipal issuer. Because they are not backed by revenue and only the ability of the government to raise taxes, they are known as -full faith and credit issues-. Bonds issued by states are backed by income taxes, license fees, and sales taxes. Bonds issues by towns, cities, and counties are backed by property (ad valorem) taxes, license fees, fines, and any other sources of direct income to the municipality. School, road, and park districts may also issue municipal bonds backed by property taxes.

Farm Credit System (FCS)

National network of lending institutions that provides agricultural financing and credit. Privately owned, government sponsored enterprise that raises loanable funds through the sale of Farm Credit Debt Securities to investors. These funds are then made available to farmers through a nationwide network of banks and Farm Credit lending institutions. The Farm Credit Administration (FCA), a government agency, oversees the System.

Revenue Anticipation Notes (RANs)

Offered periodically to finance currrent operatoins in anticipation of future revenues from facilities or projects.

Tax-Exempt Commercial Paper

Often used in place of BANs and Tans for UP to 270 days. Most often 30, 60, and 90 days.

Municipal Securities Settle:

On T+2

Ad Valorem

Property taxes, often in conjunction with municipal bonds.

Direct Payment BABs

Provide no credit to the bondholder, but instead provide the municipal issuer with payments from the U.S. Treasury equal to 35% of the interest paid by the issuer.

Tax Credit BABs

Provide the bondholder with a federal income tax credit equal to 35% of the interest paid on the bond in -each- tax year. If the bondholder lacks sufficient tax liability to fully use that year's credit, the excess credit may be carried forward.

Federal Home Loan Mortgage Corporation (FHLMC / Freddie Mac)

Public corporation. Created to promote the development of 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 / Fannie Mae)

Publicly held corporation that provides mortgage capital. FNMA / Fannie Mae purchases conventional and insured mortgages from agencies such as the FHA. The securities it creates are backed by it's own general credit.

Authorities

Quasi-governmental entities often tasked with building roads, tunnels, bridges, and other infrastructure. They use revenue bonds to finance their projects. Bondholders should be aware that each bond may only be backed by a SPECIFIC PORTION of the authority's overall revenue. Not the entirety of the revenue.

Yield to Call

Rate of return if a bond with a call feature is called early. Investor will receive the principal sooner than the maturity date. YTC is best for Discounted bonds because you are receiving a higher principal than what you paid, while YTC is worst for Premium bonds because you are receiving a lower principal than what you paid.

Yield to Maturity (YTM) (Bond)

Reflects annualized return of the bond if held to maturity. Takes into account the difference between the price paid for bond and the par value received when bond matures. If the bond is purchased at a discount, the investor makes money at maturity. If purchased at a premium, the investor loses money at maturity. Discount Amount INCREASES Return Premium Amount DECREASES Return

Serial Bond

Schedules portions o the principal to mature at intervals over a period of years until the entire balance has been repaid.

Municipal Securities

Securities issued by local or state governments, U.S. territories, authorities, or special districts. Money is often used for the purpose of public works and construction projects (roads, hospitals, sewers, airports, etc). In general, these securities are considered second in safety for your principal only to U.S. government and government agency securities. However, the safety of any PARTICULAR issue is based on that issuer's financial stability. Example: While in theory municipal securities are safe investment, a security issued by a municipality that is struggling would not be as safe an investment as one that is financially stable.

Seniority (Debt)

Senior means the relative priority of a security claim. Every preferred stock has a senior claim to common stock and every debt security has a senior claim to preferred stock.

Treasury STRIPS

Separate Trading of Registered Interest and Principal of Securities The Treasury's own version of Treasury Receipts. The Treasury Department designates certain issues as suitable for stripping into interest and principal components, but Banks and BDs perform the actual separation as well as trading of the security.

Treasury Bills (T-Bills)

Short-term direct obligations, issued with maturities of 4, 13, 26, and 52 weeks. Always issued with a year or less maturity. T-bills pay NO interest. Instead, they are issued at a discount from par value and are redeemed for at par. A $10,000 26-week T-bill is issued at $9,800. Upon redemption/maturity, the investor would receive $10,000. The difference between the purchase price and redeemed/par price would be considered interest income, although the investor never

Short-Term Municipal Obligations (Anticipation Notes)

Short-term securities that generate funds for a municipality that expects other revenues soon (such as through taxation). They are repaid when the municipality receives the anticipated funds. They typically have less than 12-month maturities, although maturities may range from 3 months to 3 years.

Local Government Investment Pools (LGIPs)

States establish these to provide government entities, such as cities, counties, school districts, and agencies, with a short-term investment vehicle to invest funds. They are generally formed as a trust in which municipalities can purchase shares or units in the investment portfolio. While not a money market fund, they operate similar to one. For instance, an LGIP may be permitted to maintain a fixed $1 net asset value (NAV). Maintaining a stable NAV, similar to a money market mutual fund, facilitates liquidity and minimum price volatility. They are not required to register with the SEC and are not subject to the SEC's regulatory requirements, because they fall within the governmental exemption just like municipal securities. With no SEC registration required, there is no prospectus. However, they do have disclosure documents., which generally include information statements, investment policy, and operating procedures. The information statement typically details the management fees associated with participation.

Treasury Securities Have an X Settlement Date/Cycle

T+1

Corporate Debt Securities Settle On

T+2 (Trade Date + 2)

Build America Bonds

TAXABLE Bonds that were created under the Economic Recovery and Reinvestment Act of 2009. Bondholders pay tax on interest received, but tax credits are provided in lieu of the tax-exempt status usually afforded for the purchase of municipal securities. These bonds attracted investors who traditionally did not buy tax-exempt municipal bonds, and expanded the pool of investors to include those in lower-income tax brackets, investors funding retirement accounts, public pension funds, and foreign investors. Two types of BABs were issued: Tax Credit BABs and Direct Payment BABs. This program expired on December 31st, 2010. However, it could be reinstated at some time in the future and the types of BABs and the credits they provide could be amended.

U.S. Government Issue Agencies

The U.S. Congress authorizes two other agencies of the federal government to issue debt securities. *Farm Credit Administration *Government National Mortgage Association (GNMA / Ginnie Mae) The follow agency-like organizations are operated by private corporations. They have ties to the government (such as sponsorship) but are not official government agencies. *Federal Home Loan Mortgage Corporation (FHLMC / Freddie Mac) *Federal National Mortgage Association (FNMA / Fannie Mae) *Student Loan Marketing Association (SLMA / Sallie Mae)

Debt Limits

The amount of debt that a municipal government may incur may be limited by this. It is often a state or local statute to protect taxpayers from excessive taxation. This can actually make a safer for investors. The lower the debt limit, the less risk of excessive borrowing and default. If an issuer wishes to issue General Obligation bonds that would put it above its statutory debt limit, a public referendum is required. Because of debt limits, GO bonds are often associated with requiring voter approval.

Treasury Securities are backed by:

The full faith and credit of the United States Government. These securities are considered to be among the highest in quality regarding safety of principal and credit risk.

Balloon Bond

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. Ballon, or serial and balloon, maturity.

Treasury Bonds (T-Bonds)

The longest term maturities from the U.S. Treasury. They pay SEMIANNUAL interest like Treasury Notes, but have maturity dates between 10 and 30 years.

Coupon

The stated interest payment made on a bond

Guaranteed Bonds

These bonds are backed by a company OTHER than the issuer. The value of the guarantee is only as good as the strength of the company that makes that guarantee. NOTE: Don't be fooled by the name. These bonds are still unsecured debt securities.

Revenue Bonds

These bonds can be used to finance any municipal facility or project that generates sufficient income. These bonds are considered to be self-supporting debt because principal and interest payments are made EXCLUSIVELY from revenues generated by the project. Because these bonds are NOT supported by the issuers' authority to tax, they are not subject to statutory debt limits and therefore do not require voter approval.

Tax Anticipation Notes (TANs)

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

Variable Rate Demand Notes

These notes have a fluctuating interest rate and are usually issued with a put option. This means the investor could periodically (weekly, monthly) return the security for its stated value.

Nominal Yield (Bond)

This is the stated rate at time of issue. A fixed percentage of the bond's PAR value. A 4% bond has a 4% nominal yield. Also called Coupon or Stated.

Treasury Notes (T-Notes)

Treasury securities that pay SEMIANNUAL interest as a percentage of the stated par value and mature at par value. T-notes have intermediate maturities of 2-10 years.

Income Bonds

Used when company is reorganizing and coming out of bankruptcy. They pay interest ONLY if the corporation has enough income to meet the debt obligations AND if the Board of Directors declares that the interest payment be made. This is an unsecured debt. NOTE: Income bonds are badly named. If an investor wants income, an income bond is rarely (if ever) the right recommendation. They do not guarantee income, and the name only comes from the income the company MAY earn.