Ch. 3

Revenue bond

-public utility -may be issued by political entities or government agencies that generate operating expenses or revenues. -CANNOT BE FREE hotel occupancy taxes are used for backing revenue bond issues because they are more of a user fee.

What is a major difference between a retail bank certificate of deposit (CD) and a banker's acceptance (BA)?

Although the bank deposits on which BAs are drawn generally are FDIC-insured, BAs themselves are not FDIC-insured. If both the issuer and bank file bankruptcy, the BA could default.

Ad Valorem tax

Counties, cities, towns, and villages rely on ad valorem taxes to back their GO bond issues. These taxes are assessed on property owned by individuals or businesses that is within the municipality.

Money market instruments

Debt maturing in one year or less trades in the money market. Money market investments are attractive to investors because they offer high liquidity. Many investors access this market through money market mutual funds. Commercial paper, bankers acceptances and large time deposits

A municipality is planning to raise money to finance a large government building complex. It hires a financial advisor to provide assistance in planning the new issue. If the advisor believes that interest rates may soon trend higher, the advisor would most likely recommend which one of the following?

GO bonds with long-term maturities Because interest rates are on the rise, the financial advisor will most likely recommend locking in the lowest possible rate for the long-term. Therefore, it is likely to recommend long-term bonds to finance the project. GO bonds are used to finance public projects like government buildings.

U.S. Government Agency Securities

Ginnie Mae and Fannie Mae are second in credit quality to that of U.S. Treasuries. Due to the underlying mortgages, they do carry pre-payment risk. Also, they are quoted in 1/32nds.

asset-backed securities (ABS)

Home equity loans, student loans, auto loans and credit card receivables typically backed by pooled consumer debt like credit card debt or auto loans. Investors who purchase these debt instruments receive a monthly stream of income. They do subject investors to pre-payment risk, as the underlying debt may be paid off prior to its due date.

A $10,000 U.S. Treasury bond is quoted as Bid 102.8, Ask 16. How much would an investor pay to buy this bond?

Investors purchase at the ask price of 102.16. Treasuries are quoted in 32nds, so the asked price is actually 102 16/32nds (½) for each $100 of face value. 102.50 x 100 = $10,250.

means of backing general obligation bonds

Property (ad valorem) taxes and sales taxes, along with acts of state legislature for appropriation of funds are common backing for GO bonds.

Tax-free Equivalent Yield

Taxable Yield (1 - Tax Rate) ex.An investor is interested in the purchase of a taxable bond that yields 5%. If the investor is in a 25% tax bracket, how much interest must a tax free municipal bond pay to equal the 5% taxable yield? To solve, calculate the tax-free equivalent yield using the formula:Tax-free Equivalent Yield = Taxable Yield (1 - Tax Rate)5(.75) = 3.75%. An investment with tax free interest must yield 3.75% to equal the tax free yield of 5%.

quotations of government securities

Treasury bills are unique from notes and bonds because they are purchased at a discount from their face value. The interest is the difference between the price paid to purchase the bill and the face amount received at maturity. Treasury notes and bonds typically pay interest semi-annually.

main credit risk in a BA

bank guarantor fails not covered by FDIC insurance.

convertible debentures adv

bond will pay a lower rate of interest than a similar non-convertible because the investor has an opportunity to share in the upward appreciation of the underlying common stock.

moral obligation bond

can be revenue or GO bonds. Issuers can make a budget recommendation for additional funding if there are insufficient funds to pay debt service, but the legislature is not obligated to approve the funding. Voter approval is not required for issuance of moral obligation bonds.

Special tax bond

financed by a tax on certain items such as cigarettes, liquor, or gasoline

Double barreled bonds

general obligation bonds that may receive additional funds for debt service from a defined revenue source. Toll roads are examples of projects often funded by double barreled bonds.

Agency CMOs

hold MBS paper guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac

private activity bonds.

interest from private activity bonds may be included in the computation of alternative minimum taxes. These bonds are issued by municipalities for the benefit of private corporations.

Treasury Bond

interest income on a Treasury bond is subject to federal taxation, but not state or local taxation.

banker's acceptances (BA

international transactions 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. Both the borrower and bank are each liable for paying promised interest and repaying principal at maturity of a BA.

private-label CMOs

invest in privately issued MBS that do not carry the backing of a government agency.

Commercial paper

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.

Treasury securities

issued by the U.S. Government. They are backed by the government's full faith and credit.

Grant anticipation notes

issued in anticipation of receiving federal grants

BANs banker acceptance notes

issued in anticipation of receiving long term funding from a bond issue short-term negotiable debt instruments guaranteed by a commercial bank. Issues usually can be sold on the secondary market at any time prior to maturity.

municipal revenue bonds

issued to support long-term infrastructure projects. Bonds that are issued to build them usually mature before the facility is no longer of use. Municipal revenue bonds do not have debt limitations like general obligation bonds. Revenue bonds can be issued by states, political subdivisions (such as counties or townships), interstate authorities and intrastate authorities. The interest and principal owed to bondholders is paid from the revenue received from the facility.

Treasury v municipal

market for U.S. government securities is the largest in the world. It is also highly liquid. Although the municipal securities market is also very large, it does not have the same worldwide participation. It is not nearly as liquid, because many municipal issues are relatively small in size and may be issued by relatively small municipalities.

CMOs

minimize the negative impacts of prepayment and extension risk Distributions from a CMO are made on monthly basis and are taxed at the federal, state, and local level. Their monthly distributions make them appropriate for investors who are seeking income on a monthly basis.

Mortgage bond v corporate debenture

mortgage bond is backed by real property owned by the corporation, while a corporate debenture is backed by the good faith and credit of the issuer. Because of the greater degree of safety, mortgage bonds pay a lower rate of return than unsecured corporate bonds. Secured bonds like mortgage bonds have higher priority in a corporate liquidation.

Proceeds from the sale of commercial paper

must be used to finance current transactions, not permanent obligations, fixed assets or long-term financing needs. The maximum maturity allowed is just 270 days.

government sponsored enterprises (GSEs)

not backed by the full faith and credit of the U.S. government. However, they are considered of very high credit quality, because of their government affiliation. Securities that are issued by GSEs can be short, medium or long term, callable or non-callable and fixed or floating rate. They can be denominated in foreign currencies or U.S. dollars.

Negotiable CDs

often have multi-year maturities and are priced like bonds on secondary markets. Prices rise when interest rates decline and fall when interest rates increase. But they always pay face value at maturity date.

Ginnie Mae

only mortgage-backed securities that are backed in full by the U.S. Government. Like other mortgage backed securities, they are subject to prepayment risk, as homeowners are likely to prepay mortgages or refinance when interest rates decline. Ginnie Mae and other mortgage-backed securities offer no relief from federal, state or local taxation.

municipal security

pay interest that is generally tax exempt at the federal level, and may also be exempt at the state tax level. Capital gains are fully taxable.

Construction loan notes

repaid when permanent financing is acquired after the project is finished.

mortgage-backed security

represents investments in a pool of mortgages, backed by specific mortgage loans.

Brokered certificates of deposit (CDs)

sold by third-party non-bank providers, usually brokerage firms. They generally are negotiable and can be sold on secondary markets. Because they are structured by broker-dealers and not issued directly by banks, they are not always FDIC insured. They usually are all-electronic transactions that can be consolidated on a client's brokerage statement. If they are considered securities, they will not be covered by the FDIC, but rather by SIPC. Their yields will typically be higher than yields on traditional CDs purchased from a bank. There may be a limited secondary market for these products, suggesting that that a customer may receive less than the original purchase price upon redemption.

If an investor living in one state purchases a municipal bond issued by a different state,

they will generally be required to pay taxes on the interest they receive to their home state. The interest will remain exempt from federal income taxes.

Revenue anticipation notes

typically funded by non-tax revenue

Municipal notes

used for interim, or temporary financing, in anticipation of funding received from another source. They are issued in both coupon and discount form.

General obligation bonds

used to fund infrastructure projects that are free to the public. backed by the taxing power of the municipality and provide tax-free interest.