2.2

Types of Money Market Securities

Commercial paper Bankers' acceptances Negotiable certificates of deposit Federal funds Money-market mutual funds Repurchase agreements (Repos)

callable

A callable security is a security with an embedded call provision that allows the issuer to repurchase or redeem the security by a specified date. ... Callable securities are commonly found in the fixed-income markets and allow the issuer to protect itself from overpaying for debt

convertible

A convertible bond is a debt instrument issued by a company that can be exchanged for shares of that company's common stock. ... Convertible bonds are also typically callable, which means the issuing company can force the investor to convert the bond for a specified number of shares of stock at a certain price.

General Obligations

A general obligation bond is secured by the full faith, credit, and taxing power of the issuer. Therefore, only issuers that have the ability to levy and collect taxes may issue GO bonds. State or local governments are able to issue general obligation bonds based on their statutory or constitutional powers. However, prior to issuing general obligation bonds, issuers must obtain voter approval. Essentially, this voting requirement is due to the fact that taxpayer money is being used to pay debt service.

S&P

AAA AA A BBB BB B CCC CC C D Investment Grade AAA-BBB

Fitch

AAA AA A BBB BB B CCC CC C DDD DD D Investment grade AAA-BBB

Moodys

Aaa Aa A Baa Ba B Caa Ca C Aaa-Baa = Investment Grade

long term

Amount owed for a period exceeding 12 months from the date of the balance sheet. It could be in the form of a bank loan, mortgage bonds, debenture, or other obligations not due for one year. A firm must disclose its long-term debt in its balance sheet with its interest rate and date of maturity.

Mortgage Backed Securities

As the name implies, mortgage-backed securities are debt instruments that are secured by pools of home mortgages GNMA FNMA FHLMC

Yield

As with any other investor, a bondholder is interested in determining her investment's return or yield. There are three different measures for determining a bond's yield—nominal yield (or coupon), the current yield (annual interest ÷ current market price), and yield-to-maturity (effective return). T

Auction

Auction rate securities (ARSs) are long-term investments that have a short-term twist—the interest rates or dividends that they pay are reset at frequent intervals through auctions. Investors who purchase ARSs are typically seeking a cash-like investment that pays a higher yield than what is available from moneymarket mutual funds or certificates of deposit

Bankers Acceptance

Bankers' acceptances are instruments that are used to facilitate foreign trade. For example, let's assume that an American food company is importing French snails. The American company may wish to pay for the snails after delivery and, therefore, it issues a time draft (i.e., a check that's payable on a future date) which is secured by a letter of credit from a U.S. bank as payment. The French company exporting the snails is able to hold the draft until its due date and receive the full amount or may cash it immediately at a bank for a discounted amount.

Collateral Trust Bonds

Collateral trust bonds are secured by third-party securities that are owned by the issuer. The securities (stocks and/or bonds of other issuers) are placed in escrow as collateral for the bonds.

Corporate Bonds

Corporations that issue bonds use the proceeds from the offering for a variety of purposes—from building facilities and purchasing equipment to expanding their businesses. The advantage to issuing bonds over issuing stock is that the corporation is not giving up any control of the company or any portion of its profits. However, the disadvantage is that the corporation is required to repay the money that was borrowed plus interest

Secured Bonds

Corporations that issue bonds use the proceeds from the offering for a variety of purposes—from building facilities and purchasing equipment to expanding their businesses. The advantage to issuing bonds over issuing stock is that the corporation is not giving up any control of the company or any portion of its profits. However, the disadvantage is that the corporation is required to repay the money that was borrowed plus interest

Treasury Receipts (STRIPS)

Dealers are able to purchase T-notes and T-bonds and separately resell the coupon and principal payments as zero-coupons (discounted securities) after requesting this treatment through a federal reserve bank. The difference between an investor's purchase price and the bond's face value is interest. STRIPS are backed by the full faith and credit of the U.S. Treasury and are quoted on a yield basis, not as a percentage of their par value.

Money Market

Debt securities with maturities of more than one year are often referred to as funded debt, while short-term debt instruments with one year or less to maturity are referred to as money-market securities. There are a significant number of securities that trade in the money market with issuers, including the U.S. government, government agencies, banks, and corporations. There is also a diverse group of participants that utilize the money market, including the Federal Reserve Board, banks, securities dealers, and corporations.

Dormitory Bonds

Dormitory bonds are issued to build housing for students at public universities and are repaid from a portion of students' tuition payments.

Double Barreled Bonds

Double-barreled bonds are backed by a specific revenue source (other than property taxes) as well as the full faith and credit of an issuer with taxing authority (a GO issuer). Essentially, debt service on the bonds will be paid by a combination of tax dollars and revenue dollars from the project being constructed. The following chart summarizes the differences between GO and revenue bond

FHLMC

Federal Home Loan Mortgage Corporation The purpose of the Federal Home Loan Mortgage Corporation, or Freddie Mac, is to provide funds to federally insured savings institutions to finance new housing. Freddie Mac raises money for its operations by issuing mortgage-backed bonds, pass-through certificates, and guaranteed mortgagebacked certificates. These securities are not backed by the U.S. government

FNMA

Federal National Mortgage Association The Federal National Mortgage Association, or Fannie Mae, raises money to buy insured Federal Housing Administration (FHA), Veterans Administration (VA), and conventional residential mortgages from lenders such as banks and savings and loan associations. Rather than being backed by the U.S. government, FNMA issues are backed by its authority to borrow from the U.S. Treasury. Interest earned on FNMA securities is subject to federal, state, and local taxes

GNMA

Government National Mortgage Association Government National Mortgage Association, or Ginnie Mae, is part of the Department of Housing and Urban Development. Since Ginnie Mae is a true government agency, it's backed by the full faith and credit of the U.S. Treasury. Ginnie Mae's purpose is to provide financing for residential housing. Although Ginnie Mae securities are direct obligations of the U.S. government, any interest earned on the securities is subject to federal, state, and local taxes. GNMA issues mortgage-backed securities and participation certificates, but its most popular securities are modified pass-through certificates. A modified pass-through certificate is backed by a pool of FHA and/or VA residential mortgages. As the homeowners in the pool make their mortgage payments (consisting of principal and interest), a portion of those payments is passed through to the investors who purchased the certificates from GNMA. GNMA guarantees monthly payments to the owners of the certificates, even if it has not been collected from the homeowners. The mortgages in the pool have maturities that range from 25 to 30 years. However, due to prepayments, foreclosures, and refinancings, the average life of the pool tends to be much shorter especially during periods of declining interest rates and the resulting prepayment risk. The estimated yield on a mortgage-backed security reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans.

Health Care Revenue Bonds

Health care bonds are used for the construction of non-profit hospitals and health care facilities.

Types of Revenue Bonds

Housing Revenue Bonds Dormitory Bonds Health Care Revenue Bonds Utility Revenue Bonds Transportation Bonds Special Tax Bonds Special Assessment Bond Moral Obligation Bonds Lease Rental Bonds Private Activity Bonds Taxable Municipal Bonds Double Barreled Bonds

Housing Revenue Bonds

Housing bonds are issued by state or local housing finance agencies in an effort to help fund single family or multi-family housing and are normally for low or moderate income families. In some cases, the proceeds of the bond offering are lent to the real estate developers that are constructing the property.

Industrial Development Revenue (IDR) Bonds

IDR bonds are a type of private activity bond that are issued by a municipality and secured by a lease agreement with a corporation. The purpose for the offering is to build a facility for a private company. The security's credit rating is based on the corporation's ability to make lease payments since the municipality does not back the bonds.

Relationship between price and interest rates

INVERSE

Private Activity Bonds

If more than 10% of the bond's proceeds will be used to finance a project for use by a private entity (e.g., a corporation or professional sports team) and if more than 10% of the bond's proceeds will be secured by property used in the private entity's business, the bonds are referred to as private activity bonds.

Prepayment Risk

In addition to the risks that are inherent in many fixed-income investments (e.g., interest-rate, credit, and liquidity risk), mortgage-backed securities are subject to a special type of risk which is referred to as prepayment risk. This is the risk that's tied to homeowners paying off their mortgages early. When interest rates fall, homeowners have an incentive to refinance and pay off their existing mortgages.

Taxable municipal securities

In certain cases, a municipality may not be able to issue bonds that are exempt from federal income tax. This may occur when the bonds are issued to finance projects that don't provide a significant benefit to the general public. Some examples of situations in which a bond may lose its tax exemption include 1) an offering in which the proceeds are being used to build a sports facility or certain types of housing, or 2) an offering designed to allow an issuer to borrow funds in order to replenish its unfunded pension liabilities

Lease Rental Bonds

Lease rental offerings involve one municipal entity leasing a facility from another. For example, a state building authority may issue bonds to build a college dormitory and then the authority will lease the dorm to the college. The bonds issued by the building authority will be paid from the revenues that are generated through lease payments received from the college.

Asset Backed Securities

Many loans that are held by financial institutions (banks and finance companies) are not permanently held by the lender; instead, some are securitized and offered to investors. This securitization is done with credit card receivables, home equity, as well as automobile and student loans. In the process of securitizing the loans, the lender sells its receivables to a trust that creates a security which represents an interest in the trust and is backed by the subject receivables. In many cases, the investor receives a monthly payment that reflects both interest and principal amortization

Ratings and rating agencies

Moodys and S&P/Fitch

Moral Obligation Bonds

Moral obligation bonds are first secured by the revenues of a project; however, if revenues are insufficient to pay debt service requirements, the state (or a state agency) is morally obligated (but not legally required) to provide the needed funds. Prior to issuing the bonds as moral obligation bonds, the legislative approval of the state government must be obtained.

Mortgage Bonds

Mortgage bonds are secured by a first or second mortgage on real property; therefore, bondholders are given a lien on the property as additional security for the loan.

CD

Negotiable Certificates of Deposit (CDs) Banks and savings and loans issue certificates of deposit, which are time deposits that carry fixed rates of interest and mature after a specified period. Although most CDs mature in one year or less, they essentially have a minimum maturity of seven days with no maximum maturity. Holders of CDs are penalized if they redeem them prior to their stated maturity. Negotiable CDs have a minimum denomination of $100,000, but often trade in denominations of $1,000,000 or more (also referred to as jumbo CDs). There is an active secondary market in these securities. CDs of up to $250,000 are currently insured by the Federal Deposit Insurance Corporation (FDIC). Long-Term CDs Long-term or brokered CDs generally have maturities that range from two to 20 years and are not considered to be money-market securities. These long-term CDs may have additional risks that are not associated with traditional bank-issued CDs, including: Either limited or potentially no liquidity The possibility of experiencing a loss of principal if the CD is sold prior to maturity The potential existence of call features that limit capital appreciation and subject the investor to reinvestment risk The possibility of no FDIC insurance

Negotiated Offering

Negotiated underwriting is a process in which the issuer of new securities and a single underwriter settle both the purchase price and the offering price. In negotiated underwriting, a security issuer works with an underwriting bank to facilitate bringing the new issue to the market

Treasury Bills

Non interest bearing Treasury bills are short-term securities that mature in one year or less. T-bills are always sold at a discount from their face value and, unlike Treasury bonds and notes, T-bills don't make semiannual interest payments. The difference between a T-bill's purchase price and its face value at maturity represents the investor's interest. Consequently, T-bills are referred to as discount securities or non-interest-bearing securities T-bills are quoted on a discounted yield basis, not as a percentage of their par value. The yield represents the percentage discount from the face value of the security. An example of a T-bill quotation is shown below: Along with the bid and asked quotation, the column titled asks yield signifies the bond or coupon equivalent yield.

Coupon Rate

Obviously, investors don't buy bonds just to receive their principal back at some future date. The issuer must also agree to pay investors interest on the loan until the bond matures. The rate of interest is generally fixed at the time the bond is issued and, with some exceptions, remains the same for the life of the bond. This fixed rate of interest is also referred to as the bond's coupon rate. The interest paid is calculated based on the bond's $1,000 par value, not the price paid for the bond. Ultimately, the primary reason that investors purchase bonds is to generate income represented by their bond's coupon rate.

Revenue Bonds

Revenue bonds are issued for either projects or enterprise financings in which the issuer pledges to repay the bondholders using the revenues that are generated by the project or facility. Issuers of revenue bonds may be authorized political entities (e.g., state or local governments), an authority (e.g., the Port Authority of New York and New Jersey), or a commission that's created to issue bonds for purposes of building and operating a project. Revenue bonds may be issued when voter approval for general obligation bonds cannot be obtained. Also, revenue bonds may be issued to finance capital projects when statutory or constitutional debt limitations prevent a municipality from issuing general obligation bonds.

short term

Short-term debt, also known as short-term or current liabilities, refers to any financial obligation that is either due within a 12-month period or due within the current fiscal year. The value of the short-term debt account is very important when determining a company's performance.

short term obligations

Short-term debt, also known as short-term or current liabilities, refers to any financial obligation that is either due within a 12-month period or due within the current fiscal year. The value of the short-term debt account is very important when determining a company's performance.

Special Assessment Bonds

Special assessment bonds are payable only from a specific charge on those who directly benefit from the facilities. Examples include bonds that are issued to develop or improve water and sewer systems, sidewalks, and streets

Special Tax Bonds

Special tax bonds are backed by special taxes (e.g., taxes on tobacco, gasoline, hotel/motel stay) for a specific project or purpose, but not by ad valorem (property) taxes. For example, highway bonds that are payable from an excise tax on gasoline are considered special tax bonds.

Federal Funds (Fed Funds)

The monies borrowed overnight on a bank-to-bank basis are referred to as fed funds. This interbank borrowing is usually done to allow a bank to meet the reserve requirement which is set by the Federal Reserve. One bank with excess reserves may lend them to another bank that's in need of reserves. This allows the bank with excess reserves to earn interest on funds that would otherwise remain idle.

Par Value

The par value of a bond (also referred to as the principal or face value) is the amount that the issuer agrees to pay the investor when the bond matures. An investor who buys a bond with a par value of $1,000 expects to receive $1,000 when the bond reaches maturity. Regardless of the amount an investor pays for a bond, if it's held to maturity, the issuer is obligated to pay the par value. Most bonds are issued in multiples of $1,000, but some (e.g., U.S. Treasury securities) may be issued in denominations as small as $100

Equipment Trust Certificates

These are bonds secured by a specific piece of equipment that's owned by the company and used in its business. The trustee holds legal title to the equipment until the bonds are paid off. These bonds are usually issued by transportation companies and backed by the company's rolling stock (i.e., assets that move), such as railroad cars, airplanes, and trucks

Transportation Bonds

Transportation bonds are used to finance projects such as bridges, tunnels, toll roads, airports, and transit systems. User fees (e.g., tolls) are used to pay the debt service on these bonds.

Treasury Notes and Bonds

Treasury notes are interest-bearing securities that have all the attributes of traditional fixed-income investments pays a fixed rate of interest semiannually and the investors receive the face value at maturity Treasury notes have initial maturities that range from 2 to 10 years, while Treasury bonds are issued with maturities of more than 10 years. T-notes and T-bonds are both issued in book-entry (electronic) form and in minimum denominations of $100. However,

Utility Revenue Bonds

Utility bonds are issued to finance gas, water and sewer, and electric power systems that are owned by a governmental unit. The bonds are normally backed by the user fees that are charged to customers.

Commercial Paper

When corporations need long-term financing, they issue bonds. Short-term needs are met by the issuance of commercial paper. Commercial paper is short-term, unsecured corporate debt which typically matures in 270 days or less. Due to its short maturity, commercial paper is exempt from the registration and prospectus requirements of the Securities Act of 1933. Similar to T-bills, commercial paper is usually issued at a discount; however, some issues are interest bearing. The standard minimum denomination is $100,000.

Long Term Obligation

company that become due more than one year. In accounting, they form a section of the balance sheet that lists liabilities not due within the next 12 months including debentures, loans, deferred tax liabilities and pension obligations.

Competitive Offering

contractors compete against each other for the lowest possible price a competitive bid method where the best price is presented