SIE Unit 2

Take Note: though the interest payment is paid at maturity, owners of zeroes will pay taxes son the interest annually. If the interest payment is $500 and 10 years remain to maturity, then the 1099 will reflect _____ every year

$50 yearly this is called phantom income

A (debt) bond with 6% coupon is paying ___ in interest per year?

$60 (6% of 1000) remember that 1000 is the usual par value of debt bonds

Key Points for T-bills (4) -The only treasury security issued at a __________ -only treasury security issued without a ________ -They are _____ liquid -____ week T-bills are used in market analysis as the risk-free investment

-discount -stated interest rate -highly -13 week

How bonds are taxed: (list letter applicable) A. Federal B. State and local C. Frequency of tax Following: 1. Treasury 2. Municipality 3. FNMA & FHLMC 4. GNMA 5. Territory bonds

1. A, at maturity or biannually 2. sometimes B, biannually 3. A, B, biannually 4. A, B, monthly 5. biannually

Order of Liquidation (5)

1. Secured debt: paid from proceeds of sale of the assets 2. Unsecured debt: general creditors/companies owes money to (wages and taxes) 3. Subordinated debt: The increased risk for these investors is why these bonds will have a higher coupon rate. 4. Preferred stockholders 5. Common stockholders

(T-bills) example An investor purchased a $10,000, 26 week T-Bill at $9,800. The investor wouldn't receive a regular interest check, but at maturity the Treasury would send her a check for _____. Why?

10,000 interest income at maturity

X issue a zero-coupon bond at a price of 50 ($500 a bond) maturing in 20 years. The bond makes no interest payments. At maturity, it pays face value (par $1,000) to investors; $500 interest. What would the interest rate be in %

3.6%

Yield to Call

A bond that can be redeemed before maturity

yields

A bond's yield expresses the cash interest payments in relation to the bond's value. Yields are determined by the issuer's credit quality, prevailing interest rates, time to maturity and any features the bond has

Put Feature

A feature on a bond that allows the investor to redeem the bond at its face value before it matures opposite to a call, investors benefit from doing this when interest rates rise (ex: 3-6%)

Bond Ratings

A grade given to bonds that indicates their credit quality

current yield

A measure of a bond's cash return for the year; calculated by dividing the bond's annual interest payment by its current price. Bond's interest divided by current price

General Obligation Bonds (GOs)

A municipal debt issue backed by the full faith, credit, and taxing power of the issuer for payment of interest and principal. The amount of debt that a municipal government may incur can be limited by state or local statutes to protect taxpayers from excessive taxes

Federal National Mortgage Association (FNMA)

A publicly held corporation that purchases conventional mortgages and mortgages from government agencies, including the Federal Housing Administration, Department of Veterans Affairs, and Farmers Home Administration. Syn. Fannie Mae.

Your customer is in the 30% federal tax bracket. He is considering purchasing a 7% corporate bond. The after-tax yield would be? A. 4.9% B. 2.1% C. 10% D. 7%

A. 4.9% the formula for the calculation is 7% (corporate rate) x (100% - 30% (tax bracket)). 7 x (1 - 0.3) = 7 x 0.7 =4.9

If interest rates were at 6% which secondary market bond price would look more attractive to investors? A. bond paying 8% B. bond paying 4%

A. 8%

An investor who is seeking income might choose a corp bond because??? A. a corporate bond pays a steady income and are generally reliable B. bonds pay a higher dividend than stocks C. bonds can grow faster than the rate of inflation D. corporate bond interest is tax free

A. A corporate bond pays a steady income and are reliable Corporate bonds are generally reliable producers of income through interest payments. Bonds do not pay dividends nor do they grow in value through inflation. Corporate interest is fully taxable

A 6% bond trading on a 7% basis is trading: A. discount B. premium C. w/ a current yield above 7% D. w/ a coupon rate below 6%

A. Discount (trading basis above % of bond) 7% basis means that the yield to maturity (YTM) is higher than the coupon rate 6% so the bond trades at a discount Current yield (CY) must be between the coupon rate and the yield to maturity (YTM)

The Alta Loma HS district is asking voter to approve a bond to fund the purchase of new computers and software. The bond will mature in 40 years, and the interest and principal payments will be funded from real estate taxes. This is an example of: A. GO bond B. a revenue bond C. a debenture D. an equipment trust bond

A. Go bond If a municipal bond requires a vote, it is most likely a GO bond. Generally revenue bonds do not require a vote (note there is no revenue generating source here.) Debentures and equipment trust certificates are issued by corporate, not municipalities.

All of the following securities are issued the US treasury EXCEPT A. Treasury reciepts B. STRIPS C. T-bills D. TIPS

A. Receipts created and issued by broker-dealers acting as investment bankers. T-bills/strips/tips are issued by the US treasury

Which is more volatile? A. 3% (coupon) bond with five years remaining B. 6% (coupon) bond with five years remaining

A. lower coupon rate = more volatile (3%)

call feature

Allows the issuer to call in a bond before maturity Issuers will generally do this when interest rates are falling, benefits the issuer ( 6% interest on purchase, pulled out at 4% by issuer to avoid paying higher)

yield to maturity

Annualized return of the bond if held to maturity. Difference between the price paid for it and par value received when the bond matures

If a bond has a feature that allows the issuer to pay off bondholders prior to maturity, the bond has A. A put feature B. A call feature C. a conversion feature D. a presale feature

B. Call Call: issuer calls bond before maturity Put: investor puts bond before maturity Conversion: investor converts the bond to the issuer's common stock

1. Which of the following securities is NOT backed by the full faith and credit of the US treasury? A. GNMA B. FNMA C. Strips D. T-bills

B. FNMA gov sponsored but their debt is not directly backed by the fed

A BB-rated 6% callable bond matures in 12 years that is trading at 100.25 is priced at: A. Discount B. Premium C. current yield above 7% D. coupon rate below 6%

B. Premium (bond is trading at the price above par (100), so it's a premium

A newly issued treasury security that matures in 5 years is A. t-bill B. t-note C. t-bond D. treasury receipt

B. t-notes maturities between 2-10years (t-bills 1yr, t-bonds over 10yrs, receipts not issued by treasury)

gauranteed bonds

Backed by company other than the issuing corporation value of the guarantee is only as good as the strength of the company making it If the issuer defaults, the guaranty kicks in and the company must make the interest or principal payments

What is the default risk in debt back by the US treasury?

Basically zero. Treasury backed securities are the safest investment for US investors

basis point vs point

Basis point: 1/100 of 1% (100 basis points) point: 1% of face value (par) or $10 per bond

nonrated bonds

Bonds that are not rated; does not dictate quality means the lender is too small to pay for rating process

income bonds

Bonds that pay no interest unless the issuing company is profitable. Used when a company is coming out of bankruptcy (unsecured debt securities)

T-bills may be issued with all of the following maturities EXCEPT A. 4w B. 13w C. 39w D. 52w

C. 39 weeks

Which of the following bonds would have the MOST price volatility? A. 3% 10 year T-note B. 2% 5-year T-Note C. 5% 20 year T-bond D. 5% 15-year corporate bond

C. 5% 20 year T-bond The more time left to maturity, the more volatile the bond tend to be. Even though the 20-year T-bond is safer than the corporate, its price will be more volatile.

Interest from a zero-coupon bond: A. Pays monthly and is taxed annually B. pays annually and is taxed at maturity C. pays at maturity and is taxed annually D. pays and is taxed at maturity

C. pays at maturity and is taxed annually A zero is purchased at a deep discount and pays no interest until it matures; the interest is taxed on an annual basis, called "Phantom Income"

balloon bonds

Combination of serial and term bonds. Issuer repays part of the bond's principal before the final maturity date, like serial, but pays off the major portion of the bond at full maturity like term.

Your customer calls you to tell you that they received a phone call from the bond desk telling them that a trade to purchase 20 bonds at 100 has been executed for the customer's account. The customer would like to know how much they paid for the bonds before any commission or other charges: A. 2,000 B. 200,000 C. 1,000 D. 20,000

D. 20,000 Paying 100 means they paid 100% of par ($1,000) per bond. 1,000 X 20 = 20,000 Q asked how much they paid for, not price per bond

According to the S&P ratings, the four highest grades of bonds (from best to lowest) are: A. Aaa, Aa, A, Baa B. A, Aa, Aaa, B C. B, A, AA, AAA D. AAA, AA, A, BBB

D. AAA, AA, A, BBB (A if it asked for Moody's)

Below which of the following S&P rating would a bond be considered speculative? A. A B. B C. BB D. BBB

D. BBB The investment-grade ratings, considers anything below a BBB to be speculative

X issues a bond collateralized by a trust holding the company's Las Vegas HQ, this type of bond is called???? A. a collateral trust bond B. a guaranteed bond C. a HQ debenture D. a mortgage bond

D. mortgage bond A secured bond backed by real estate is called a mortgage bond. Collateral trust bonds hold other securities in trust as collateral. A guaranteed bond is an unsecured bond backed by a third party. A HQ debenture is not a thing

Risks of owning debt securities (3)

Default: The issuer fails to pay interest or principal when due Interest Rate Risk: Debt will fluctuate in response to changes in interest rates Purchasing power risk (inflation): Rise in price of goods over time. Fixed payments stay the same while prices are rising, the amount of goods the payment will buy decreases.

An investor is in the 30% tax bracket. A municipal bond currently yields 7%. To offer an equivalent yield, what must a corporate bond yield?

Divide the municipal yield by %100 minus the investor's tax bracket 7% divided (100% - 30%) = 10% Assume that the same investor is in the 30% tax bracket. If a corporate bond currently yields 11%, what would be the equivalent municipal yield? Multiply the corporate yield by 100% minus the investor's tax bracket (TAX FREE EQUIVALENT YIELD FORMULA) 11% x (100%-30%) = 7.7%

Q: Your customer owns one share of X $8 preferred, which she purchased in 1985. In that year, the $8 annual dividend would pay for two tickets to a movie and two sodas, not a bad date. What would you guess inflation's effect on that preferred $8 would be for the movies?

Due to inflation, the $8 now would probably not even cover one ticket to the movies

list the three major credit (bond) rating agencies

Fitch, Moody's, Standard and Poor's (S&P)

What can a bond issuer do to make their feature more attractive if they offer calls? What if they offer put/conversion?

For calls, issuers will pay a higher coupon rate interest to make up for the risk investors take on if the issuer calls the bond before maturity put/conversion, issuers will pay a lower coupon rate of interest to make up for the lower return of an investor putting or converting the bond before maturity

What does the price of a zero-coupon bond reflect?

General interest rate climate for similar maturities going up and down in a n inverse relationship with interest rates. As the coupon rate is zero, these bonds tend to be more volatile than other bonds with similar maturities

Which of the following are considered sources of debt service for GO bonds A. Personal property taxes B. Real estate taxes C. Fees from delinquent property taxes D. Liquor license fees E. A & D F. B & C G. B & C & D H. A, B, C, D

H. All of the above All of these are taxes or fees that pay into the general fund of a municipality and may be used

TEST TOPIC ALERT Income bonds are a true oxymoron, why?

If an investor is seeking income, an income bond is not likely a suitable recommendation

Which is senior and subordinated debt (priority)? Guaranteed or income bonds

Income then guaranteed bonds

Benefits of owning debt securities (2)

Income: bonds produce a steady and predictable income and are obligated to the holder Safety: bonds have higher priority than stock, the senior position combined with the obligation to make interest payments make these investments safer and less volatile

Volatility

Indicates how much and how quickly the value of an investment, market, or market is sensitive to changes.

prices of bods react to market forces (interest rate/supply,demand) how does this affect coupons of par value?

It doesn't, coupons are fixed percentage of par value; a 6% coupon pays $60 of annual interest, no matter the current market value of the bond is

Identify the definition of these ratings: (Moody's or S&P?) Aaa Aa A Baa Ba B Caa D

Moody's Bank-grade (investment-grade) bonds Aaa: Highest capacity to prepay principal and interest Aa: Very strong capacity to prepay principal and interest A: slightly more sensitive to adverse market conditions Baa: adequate capacity to prepay principal and interest, slightly speculative Speculative (noninvestment-grade) bonds Ba: Speculative. Significant chance that issuer could miss an interest payment B: issuer has missed one or more payments Caa: No interest is being paid on bond D: issuer is default. Unpaid debt

Government National Mortgage Association (GNMA)

Only agency security backed by the full faith and credit of the Fed. A federal government agency that promotes affordable housing by buying subsidized mortgages in the secondary market. This agency also guarantees mortgage-backed securities issued by private FHA and VA lenders.

Features (and list the 3)

Paying higher coupon rates to add either a call, put, or convertible attachment on a bond

Identify the definition of these ratings: (Moody's or S&P?) AAA AA A BBB BB B C D

S&P's Bank-grade (investment-grade) bonds AAA: Highest capacity to prepay principal and interest AA: Very strong capacity to prepay principal and interest A: slightly more sensitive to adverse market conditions BBB: adequate capacity to prepay principal and interest, slightly speculative Speculative (noninvestment-grade) bonds BB: Speculative. Significant chance that issuer could miss an interest payment B: issuer has missed one or more payments C: No interest is being paid on bond D: issuer is default. Unpaid debt

Interest is generally paid on a ______ basis. Ex: if 6% coupon bond would would pay what in total and what interval

Semiannual 6% coupon bond would pay $30 each 6 months for a total of $60 at the end of the year.

Short-term municipal obligations

Short-term securities that generate funds for a municipality that expects other revenues soon. Usually, notes have less than 12-month maturities, but can range 3 months-3years repaid when the municipality receives the anticipated funds.

Market forces affecting bond prices

Supply and demand, since they are debts they have higher sensitivities to the changes in market INTEREST RATES. Bond prices have an inverse relationship to interest rates. If rates go up, price goes down and vice versa

T/F The interest from bonds issued by or from a territory of the US is tax free to US taxpayers.

T

List and define the categories of short term municipal obligations (anticipation notes) (8)

Tax anticipation notes (TANs): 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) are offered periodically to finance current operations in anticipation of future revenues from revenue-producing projects Tax AND Revenue anticipation notes (TRANs) a combination of both RANs and TANs Bond anticipation notes (BANs) sold as interim financing that will eventually be converted to long-term funding through a sale of bonds Tax-exempt commercial paper is often used in place of BANs and TANs for up to 270 days, though maturities are most often 30, 60, and 90 days Construction loan notes (CLNs) issued to provide interim financing for the construction of housing Variable-rate demand notes: fluctuating interest rate and are usually issued with a put option. This means that the investor could periodically (e.g. weekly, monthly) return the security to the Issuer for its stated value Grant anticipation notes (GANs) issued with the expectation of receiving grant money from the fed gov.

What happens if the 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.

What are maturities? list the three

The date the investor receives the loan principal back. Common maturities range 5-30 years 1.Term 2.serial 3.Balloon

term bonds

The principle of the whole issue matures at once; repaid at one time.

duration

The way of measuring a bond's volatility that combines maturity and coupon rate (way to measure the volatility of a portfolio Higher duration means more volatile price

Treasury STRIPS

Treasury securities that are sold in bulk to large dealers, who then strip out the coupons from principal, repackage the cash flows, and sell them separately as zero-coupon bonds; Coupon strips are strips created from coupon payments stripped from the original security; Principal strips refer to principal payments with the coupons stripped off; Taxed on their implicit interest rate

Treasury Inflation-Protected Securities (TIPS)

U.S. Treasury securities that protect investors against inflation because the amount to be repaid rises with inflation

Treasury Bonds

United States government bond with maturity of 30 years semiannual interest as a percentage of the stated par value they mature at par value

Treasury Notes

United States government obligation with a maturity of 2 to 10 years semiannual interest as a percentage of the stated par value they mature at par value

Define administrative claim holders and what their purpose is

Usually attorneys, the courts, property appraisers, auctioneers and liquidators) They are brought in to assist with the liquidation and they are paid BEFORE even the secured debtors

If a question refers to a bond that is trading "on a basis of" and the Q provides you a yield, that yield will be what kind?

Yield to maturity

Treasury Receipts

Zero coupon bond created by brokerages. B/D buy treasury securities and place them in trust at a bank and sell seperate "receipts" against the principal. *Not backed by the U.S. Government

zero coupon bond

a bond that makes no coupon payments and is thus initially priced at a deep discount. Issuer's debt obligations that do not make regular interest payments. Zeros are issued at a deep discount to their face value and mature at par. Investor receives the difference between the discounted purchase price and the full face value at maturity

Basis Point

a measurement of yield equal to one-hundredth of a percentage point = 100 basis points basis points are not the same as points

Revenue Bonds

a municipal bond whose interest and principal payments are backed by the revenues generated from the project being built by the proceeds of the bonds. Toll roads for example, are usually built with revenue bonds backed by the tolls collected.

par value

a value assigned to a share of stock and printed on the stock certificate Most DEBT securities have a par value of $1,000

Mortgage bonds (secured bonds)

backed by collateral such as land or buildings that is pledged to bondholders if interest or principal isn't paid when promised

Debentures (unsecured bonds)

backed only by general credit-worthiness of issuing company, no collateral. these can be considered safer if the credit standing with he lender is very good

Pricing

bond pricing is measured in points, with each point equaling 1% of face value (par) = $10.

Investment-grade debt

bonds in the top four rating categories only acceptable bonds for institutions higher liquidity higher the rating the lower the yield

high-yield bonds

bonds with low credit quality that offer a high yield to maturity.

saving bonds

debt issued by the Fed. that may be purchased and redeemed at banks, they do no trade and are not considered a security

subordinated debt

debt that may be repaid in bankruptcy only after senior debt is paid, but STILL senior to any shareholder

Affect on returns with yield to maturity if bought at a discount vs premium

discount: investor makes money upon maturity premium: investor loses money upon maturity

If a bond is purchased for $900 (discounted) and is held to maturity, at maturity how much will the investor receive in par? If a bond is purchased for $1,100(a premium) and is held to maturity, at maturity how much will the investor receive in par?

discounted: $1,000 par (gains 100) Premium: $1,000 par (loses 100)

accrued interest

interest on a bond or loan that has accumulated since the principal investment, or since the previous coupon payment if there has been one already.

convertible feature

investor converts the bond into shares of common stock

Corporate Bonds

long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity

The lower a bond's coupon rate the ____ volatile it is

more

Farm Credit System (FCS)

national network that provides financing and credit, privately owned and gov sponsored/overseen Provides loans to farmers, ranchers, rural homeowners, agricultural cooperatives, rural utility systems, and agribusinesses

Federal Home Loan Mortgage Corporation (FHLMC)

packages residential mortgages for sale to investors A publically owned agency which buys mortgages in the secondary money market from commercial banks and federally insured savings and loan associations: "Freddie Mac"

serial bonds

portions of a bond issue that mature on different dates over the years. NOT a type used on debt securities

Coupons

represents the interest rate the issuer has agreed to pay the investor. (aka stated/nominal yield) Calculated: a percentage of par value

Secured vs. Unsecured Loans

secured: backed by various kinds of assets owned by the issuer, unsecured: backed by reputation, credit record and financial stability of the issuer.

Equipment Trust Certificates

serial bonds issued by transportation companies that are secured by the equipment purchased with the proceeds of the loan

Treasury Bills (T-Bills)

short-term debt obligations the U.S. government sells to raise money with maturities of 4, 13, 26, and 52 weeks. pay no interest, issued at a discount from par value and redeemed at par.

municipal bonds

tax-exempt bonds issued by state and local governments -Lending money to issuers for the purpose of public works and construction projects. -Considered the second safest principal behind Gov agency securities

Nominal Yield

the interest rate, also known as the "coupon rate" which is named on the bond certificate set at the time of issuing and is a fixed percentage of the bond's par value

Define agency

used to refer to entities that are not technically gov agencies but that have ties to the gov

Collateral Trust Bonds

without estate or equipment to use as collateral, use deposits securitites owned into a trust to serve as collateral for the lenders