SIE Unit 2

High Yield bonds

(BB or Ba or lower) risk/reward

Order of Liquidation

1. secured debt holders 2. unsecured debt holders 3. subordinated debt 4. preferred stock holders 5. common stock holders (SUSPC)

Accrued interest on corporate bonds is calculated using

30 days in each month and 360 days in each year.

Term Bond

A term bond is structured so that the principal of the whole issue matures at once. Because the entire principal is repaid at one time, issuers may establish a sinking fund account to accumulate money to retire the bonds at maturity

A bond with 10 years to maturity and callable in five years at par is sold at a discount. Rank the following yields from lowest to highest. Nominal yield Current yield Yield to call (YTC) Yield to maturity (YTM)

A) I, II, IV, III The bond is trading at a discount. The lowest of all yields for a discount bond is the nominal or stated yield (coupon rate), which is a fixed percentage of par. Next would be the current yield and then YTM. The highest possible return to the owner of a bond purchased at a discount would occur if the bond were called before maturity, because less time must elapse for the investor to receive the discount.

A corporate bankruptcy liquidation took place. Of the following—general creditors, secured bondholders, subordinated debenture holders, accrued taxes—who was paid first and who was paid last?

A) Secured bondholders first, subordinated bondholders last The liquidation priority is as follows: secured debt, unsecured debt and general creditors, then subordinated debt, and then equity holders with preferred shareholders first, followed by common shareholders. Therefore, of those that are listed here, secured bondholders would be paid first, and subordinated bondholders last. General creditors and taxes are paid at the same level.

Regular way settlement for Treasury bonds is

All U.S. government issues settle next business day (T+1).

Balloon Bond

An issuer sometimes schedules its bond's maturity using elements of both serial and term maturities. 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. This bond has a balloon, or serial and balloon, maturity

Which of these statements regarding Treasury bills is correct?

B) Treasury bills are the only type of Treasury security issued without a stated interest rate. Treasury bills are always issued at a discount, without a stated interest rate. Receiving par value back at maturity represents the interest income to the investor. Because of their short-term maturities, they have the lowest interest rate risk for Treasury securities, not the highest. T-Bills are issued in initial maturities of 4, 13, 26, and 52 weeks.

A convertible feature for a corporate bond allows

B) a bondholder to convert a debt instrument into securities that give the investor ownership rights.

Bonds can typically be issued with

B) term, serial, or balloon maturities.

Treasury Receipts

BD's (brokers) buy treasury securities, place them in trust at a bank, and sell separate receipts against the principal and coupon payments. these are not backed by full faith and credit of us treasury

Five years ago your client purchased at par $100,000 of New Brunswick City GO bonds maturing in 20 years from now and callable in six months. Interest rates have gone down over the last five years. Which of these should your client do? Your client should recognize that the bonds have a high probability to be called. Your client should recognize that the bonds are unlikely to be called. Your client should expect the bond is trading at a large discount. Your client should expect the bonds are trading at a small premium.

C) I and IV If rates have declined the bonds are likely trading at a premium and very likely to be called at the first call date in six months. The proximity of the call date means the bonds premium will be small.

An income bond is also known as

C) an adjustment bond and is unsecured. Income bonds or adjustment bonds are used when a company is reorganizing. The bonds only pay interest if the corporation has enough income to meet the obligations on the debt issue and are therefore unsecured.

Your customer, Shea, has a large portfolio of bonds and dividend paying stocks. Her primary interest is generating current income. She is trying to understand how taxes work for her T-bonds. You explain that

C) the interest from her T-bonds is exempt at the state and local level, but she will still owe taxes at the federal level.

current yield (CY)

CY measures a bond's annual coupon payment relative to its market price, as shown in the following equation annual coupon payment/market price= current yield

Nominal Yield

Coupon, nominal, or stated yield is set at the time of issue. Remember that the coupon is a fixed percentage of the bond's par value

Your customer, Eleanor, purchased an InDebt Inc., 5% debenture at a price of 94. It matures in 12 years. What is the yield to maturity?

D) 5.73 You do not have to calculate YTM for this problem. You could if you really wanted to, but it is not necessary for the question. You do need to recall the bond inverse relationship chart. The bond is trading at a discount so the YTM must be higher than the coupon of 5%; that eliminates two responses. Note that YTM is higher than current yield, and that you do need to calculate CY. The bonds annual interest divided by the price (50/940) is 5.32% (the CY). Only one response is higher than 5.32%.

The United States Congress has authorized all of the following enterprises to issue securities except

D) Federal National Mortgage Association (FNMA).

Which of these reasons would allow for a municipality to issue revenue bonds easier instead of general obligation bonds? Revenue bonds do not require voter approval. Revenue bonds generally have a higher rating than GO bonds from the same issuer. Revenue bonds are not constrained by a statutory debt limit. Revenue bonds are supported by ad valorem taxes.

D) I and III

A CMO consists of

D) an FNMA, FHLMC, and other mortgage backed securities. (not the mortgages directly)

Your customer asks to buy a bond that carries a very attractive yield. When checking the bond you see that it has a B rating from the major credit rating agencies. When communicating this information to the customer, all of these terms might be used to describe the bond except

D) lower grade.

maturities of bonds

Each bond has its own maturity date. This is the date the investor receives the loan principal back (5 to 30 years)

What is not backed by the full faith and credit of the U.S Treasury?

FNMA, it is not a government sponsored entity

Volatility

Indicates how much and how quickly the value of an investment, market, or market sector changes.

coupon rate (stated yield, nominal yield)

It is calculated from the bond's par value (normally 1,000 per bond) meaning that each bond will be redeemed for 1,000 when it matures. Therefore, a bond with a 6% coupon is paying $60 in interest per year (6% x $1,000 par value = $60 annually)

Par Value, principal, or face value

Most debt securities have a par value of 1,000 dollars.

coupon

Represents the interest rate the issuer has agreed to pay the investor.

Municipal Anticipation Notes

Short-term securities that generate funds for a municipality that expects other revenues soon.

Treasury Inflation-Protected Securities (TIPS)

They are issued with maturities of 5, 10, or 20 years. They have a fixed coupon rate and pay interest every six months based on inflation rate. increase during inflation, decrease during deflation

TIPS (Treasury Inflation Protected Securities)

They are issued with maturities of 5, 10, or 20 years. They have a fixed coupon rate and pay interest every six months. The principal value of the bond is adjusted every six months based on the inflation rate. Maturity is also adjusted in terms of inflation

Which of the following shows Treasury bills, Treasury bonds, and Treasury notes listed in ascending order of maturity?

Treasury bills have a maturity of less than one year, Treasury notes mature in 2 to 10 years, and Treasury bonds mature in 10 years or more. Therefore, in ascending order, short-term to long-term, they are T-bills, T-notes, T-bonds. A) Bills, notes, bonds BNB

municipal bond investment's tax benefit

Yield/ (100% - % tax bracket)

zero coupon bond

a bond that makes no coupon payments and is thus initially priced at a deep discount

Yield to Call (YTC)

a bond with a call feature may be redeemed before maturity at the issuer's option. Essentially, when a callable bond is called in by the issuer, the investor receives the principal back sooner than anticipated (before maturity). accelerated discount gain or premium loss

Bond prices have

an inverse relationship to interest rates

Federal funds loans

any deposits in excess from federal reserve board are loans. they can be loaned from one member bank to another.

Speculative bonds

anything under BBB

Treasury Receipts

are created and issued by broker/dealers acting as investment bankers

T-notes

are direct debt obligations of the U.S government. They pay semiannual interest as a percentage of the stated par value and they mature at par value. They have intermediate maturities

bonds (BBB or Baa and higher)

are investment grade (higher the rating the lower the yield)

General Obligation Bonds (GOs)

are municipal bonds issued for capital improvements that benefit the entire community. Typically, these projects do not produce revenues, so principal and interest must be paid by taxes collected by the municipal issuer. (Backed up by taxing power)

municipal bonds

are securities issued by state or local governments or by U.S territories, authorities, and special districts. Investors who buy such bonds are lending money to the issuers for the purpose of public works and construction projects.

Interest on Muncipal bonds

are tax free on a fed and state level if the investor lives in the state of issuance

Income Bonds (Adjustment Bonds)

are used when a company is reorganizing and coming out of bankruptcy. They pay interest only if the corporation has enough income to meet interest on debt obligations and if the board of directors declares that the interest payment be made.

both treasury and strips

are zero coupon bonds

collatorized debt obligations (CDOs)

asset backed securities that are non mortgage loans or bonds.

Collateralized mortgage obligations (CMO)

asset backed security, which are whose value and income payments are derived from or backed by a specific pool of underlying assets.

Certificate of deposit (CD)

banks issue and gurantee certificates of deposit with fixed rates and minimum face values of 100,000 (jumbo CDs), although face values of $1 million or more are common. Most mature in one year or less)

Revenue Bonds

can be used to finance any municipal facility 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 or facility for which debt was issued such as: utilities, housing, transportation, education, health, industrial, and sports

Regarding bankruptcy proceedings,

courts protect both corporate and individual filers from creditors. Bankruptcy is a general term for court procedures available to both individuals and businesses. During the proceedings, filers are protected by the court from creditors. Protection is granted independent of any actions to liquidate or file a plan for reorganization.

A bond's rating is used primarily as a measure of its

default risk.

T-bonds

direct debt obligations of the U.S government. They pay semiannual interest as a percentage of the stated par value and mature at par value. These government obligations have long-term maturities, greater than 10 years and up to 30 years.

Negotiable jumbo CDs are characterized by all of the following except

each issue generally matures in 5-10 years. Negotiable jumbo CDs are issued in denominations of $100,000-$1 million and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. These CDs are unsecured promissory notes backed only by the credit standing of the issuing institution.

Prepayment risk

early payout

bond yield

expresses the cash interest payments in relation to the bond's value.

three major credit rating agencies

fitch ratings, inc moody's investors service standard and poor's rating service

When is interest paid?

generally paid on a semiannual basis. Using previous example, the %6 coupon bond would pay $30 in interest every six months- a total of $60 per year

Accrued Interest

interest accumulated at a given time but not yet due or paid

Put feature (bond)

investor gives bond back to issuer and purchases a new bond with a higher interest rate

Debenture

is a debt obligation of the corporation backed only by its word and general creditworthiness

Government National Mortgage Association (GNMA or Ginnie Mae)

is a government owned corporation that supports the department of housing and urban development. The only agency securities backed by the full faith and credit of the federal government.

Basis Points (BPS)

is a measurement of yield equal to 1/100 of 1%.

Farm Credit System (FCS)

is a national network of lending institutions that provides agricultural financing and credit. The system is privately owned, government-sponsored enterprise that raises loanable funds through the sale of Farm Credit Debt Securities to investors. (FCA) farm credit administration is a government agency that oversees them

Federal Home Loan Mortgage Corporation (FHLMC or Freddie MAC)

is a public corporation. It was created to promote the development of a 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 or Fannie Mae)

is a publicly held corporation that provides mortgage capital. They purchase conventional and insured mortgages from agencies such as the Federal Housing Administration (FHA) and the Veterans Administration.

Banker's Acceptance (BA)

is a short term time draft with a specified payment date drawn on a bank. Essentially, a BA is a postdated check or line of credit. They payment date of a BA is normally between 1 and 270 days (9 months).

yield

is determined by the issuer's credit quality, prevailing interest rates, time to maturity, and any features the bond may have, such as a call feature

coupon

is fixed

A full percentage point

is made up of 100 basis points

secondary market

market for reselling financial assets

Yields are...

measured in basis points

Bond Pricing

measured in points, with each point equaling 1% of face value, or $10. (multiply the quoted price by 10 to get the dollar amount) For example, a bond trading at 90 is worth $900, while a bond trading at 103 is worth $1,030

premium bond/par

old owner trades for above 1,000 and sells maybe at 1,200

discount par/bond

old owner trades for under 1,000 and sells maybe at 800

Series

refers to types of savings bonds.

Yield to Maturity (YTM)

reflects the annualized return of the bond if held to maturity. In calculating yield to maturity, the bondholder takes into account the difference between the price that was paid for a bond and par value received when the bond matures. (if bond is purchased at discount, the investor makes money at maturity) (if the bond is purchased at a higher price, the investor loses money at maturity)

Serial Bond

schedules portions of the principal to matured at intervals over a period of years until the entire balance has been repaid

T-Bills

short term debt obligations of the U.S government. Buy at discount and receive full at maturity. no interest rate. Less than one year for maturity. maturities of 4, 13, 26, and 52 weeks

U.S. Treasury bills (T-bills)

short term debt obligations with maturities of 4, 13, 26, and 52 weeks

repurchase agreements (repos)

short-term sales of government securities with an agreement to repurchase the securities at a higher price

commerical paper

short-term unsecured debt issued by large corporations. maturity occurs from 1 to 270 days, although most mature in 90 days.

guaranteed bonds

still unsecured debt securities

Paying 100 means what

they paid 100% of par (1,000) per bond

Treasury STRIPS (separate trading of registered interest and principal of securities)

treasury's own version of receipts.

Savings bonds

type of debt issued by the federal government that may be purchased and redeemed at banks or from the treasury department. They do not trade in the secondary market and are exempt from several security laws. Series is not a type of maturity used with debt securities.