Unit 3 - KSIE Debt Securities
Debt securities have a par value of
$1,000
An investor purchases an 8% corporate bond at 93. The bond is scheduled to mature in 2028. What will the investor receive at maturity?
$1,040 The investor will receive $1,040 at maturity. This amount comprises the principal repayment of $1,000 plus the final semiannual interest payment of $40.
A bond with a 3% stated yield and a $1,000 par value would pay how much in annual interest?
$30
High yield bonds
(junk bonds) with ratings lower than Baa, bonds that have a substantial probability of default carry high interest rates
Congress authorizes who else to issue debt securities?
- Farm credit administration (FCA) -Govt national mortgage association (Ginnie mae) -Private operations: Federal home loan mortgage corporation (Freddie Mac) Federal national mortgage association (Fannie MAE) Student loan marketing association (Sallie Mae)
Nominal yield
-Nominal, coupon, or stated yield is set at the time of issue. -Remember that the coupon is a fixed percentage of the bond's par value.
Federal funds loan
1. Fed mandates the reserve requirements 2. Loans between banks to meet reserve requirements 3. Very short term (overnight) highly liquid -- very safe -- not suitable for long term investors
Order of liquidation
1. secured debt 2. unsecured debt 3. subordinated debt 4. preferred stock 5. common stockholders
How do zero coupons pay interest and how are they taxed? 1- Pays annually 2- Pays at maturity 3- Taxed annually 4- Taxed at maturity
2 & 3
Given bonds are interest-rate sensitive, which of the following statements regarding put and call features for bonds are true? 1 The put feature would likely be exercised if interest rates fall. 2 The put feature would likely be exercised if interest rates rise. 3 The issuer will likely call bonds if interest rates fall. 4The issuer will likely call bonds if interest rates rise.
2 &3
Which of the following debt securities has interest that is subject to federal income tax but not state income tax?
26-week Treasury bill
An investor is in the 30% tax bracket. a muni bond currently yields 7%. To offer an equivalent yield, what must the corporate bond yield?
= 7% / (100% - 30%) = 10%
Current yield
= a bond's annual coupon divided by / market price
An investor has purchased a bond where the issuer will repay the bond's principal in a series of substantially equal portions representing 10% of the issue over a period of five years, then the remaining 50% in the final year. This is
A balloon maturity schedule
Regarding different types of debt security maturities available to issuers, which of the following is accurate?
A balloon maturity uses elements of both serial and term maturities.
Which of the following statements regarding put and call features on debt securities is not correct?
A callable bond is likely to be called when interest rates are rising. Call features benefit the issuer allowing them to call existing issues in when interest rates are falling.
Banker's Acceptance (BA)
A money market instrument used to finance international and domestic trade. 1- 270 days referred to as Letter of Credit
Coupon rate
Also known as nominal yield Interest rate the bond issuer has agreed to pay the investor
All of the following are considered money market instruments except
American depositary receipts (ADRs).
The repayment or maturity date of a banker's acceptance is normally which of the following?
As short as 1 day or as long as 270 days
Most municipals pay interest that is tax free at the federal level. Which one of the following is a taxable municipal bond?
BABs are Build America Bonds that were issued without the tax free status. The others are tax-free municipal notes. Though BABs are not covered in the SIE material, the other three items are, and are all tax free. Note that industrial development revenue bonds (IDRs or IDBs) are also taxable for investors subject to the alternative minimum tax (AMT).
Which of the following statements regarding bond interest is true?
Bond prices have an inverse relationship to interest rates.
General Obligation Bonds (GOs)
Bonds issued by a municipality that are secured by the full faith and credit of the issuer used for capital improvements -- do not produce revenues
Jumbo certificate of deposit
CDs with fixed interest rates and min face values of $10,000 most mature in one year or less longer maturities pay interest every 6 months traded on secondary market are negotiable CDs
One of your new clients explains that she prefers investments paying income with a fixed rate of return, but also allows for the possibility of realizing greater gain potential. She would likely favor investments in
Convertible bonds Bonds pay a semiannual interest payment based on the nominal rate. Convertible bonds allow the owner to exchange the bonds for a fixed number of shares of the issuing corporation's common stock. Common shares enjoy a greater gain potential than debt securities. Therefore, convertible bonds have both of the features favored by this investor. The customer seems like a good fit for convertible bonds.
Your customer holds a callable bond currently trading at $955. Which of the following is true?
Current yield (CY) is lower than yield to maturity (YTM).
Money Market securities
Fixed-income debt securities with maturities at issuance of one year or less.
Federal Home Loan Mortgage Corporation (FHLMC)
Freddie mac secondary market for mortgages for financial institutions Govt sponsored enterprise
Federal, state, and local income tax would be due on the interest from which of the following issues?
GNMA certificate Interest from a GNMA certificate is taxed at all levels. Municipal bonds are tax free at the federal level. Treasury issues are tax free at the state level.
When the interest rates in the marketplace moves up or down, the price of all bonds move
Inversely
Put feature
Invest can put (sell) the bond back to the issuer before it matures generally occurs when interest rates are rising -- benefits the bondholder These bonds will have a lower coupon rate
Treasury Inflation-Protected Securities (TIPS)
Issued with maturities of 5, 10, 20 years fixed coupon rate and pay interest every 6 months -- adjusted based on inflation rate will never be less than $1,000 par
Regarding filing for corporate bankruptcy, which of the following is true?
Liquidation means that property will be taken and sold to repay all debts.
Which of the following are fixed at the time a bond is issued?
Nominal yield
Your customer is a resident of the State of California. Which of the following debt issues would generate interest that would be taxable to your customer at the state level but not taxable at the federal level?
Phoenix, Arizona, Municipal Water District revenue bond A municipal bond's interest is received tax free at the federal level but is only tax free at the state level to residents of the state from which the bond was issued. Treasury issues are taxable at the federal level but not the state level. A corporation's interest payment is taxed at all levels.
Subordinate debentures are senior to which of the following fixed income securities?
Preferred stock All debt securities are senior to equity securities.
Equipment Trust Certificates
SECURED DEBT bonds secured with factory and equipment as collateral ex: railroads/transportation
Mortgage bonds
SECURED DEBT corp will borrow money backed by real estate as collateral
Collateral Trust Bonds
SECURED DEBT bonds backed by financial assets
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?
Secured bondholders first, subordinated bondholders last
The BBB Corporation is liquidating under a Chapter 7 bankruptcy. What is the order of payout?
Secured bondholders, senior bondholders, subordinated bondholders, and then common shareholders
Which of the following earn interest but don't pay interest?
T-bonds T-bills are sold at a discount and pay par at maturity. The difference between the discounted price and par is considered interest, but T-bills don't make interest payments.
Which of the following is the highest bond rating?
The highest rating is Aaa (Moody's), which is the same as AAA (S&P and Fitch).
All of the following are backed by the full faith and credit of the U.S. government except
Treasury receipts -- they are issued by broker dealers
What are the safest investment for U.S. investors
Treasury-backed securities
In safety of principal, municipal bonds are considered second only to
U.S. government and agency bonds.
Subordinated debt
UNSECURE DEBT with an inferior claim (relative to senior debt) to venture assets Lowest level of unsecured debt
Guaranteed bonds
UNSECURED DEBT Backed by a parent company -- no collateral beyond financial strength of the corporation
Debentures
UNSECURED DEBT Debt obligation backed by its word and general creditworthiness
Income bonds
UNSECURED DEBT Used when company is reorganizing and coming out of bankruptcy -- do not provide income
All of the following are money market instruments except
Warrants Money market instruments are liquid debt securities maturing within a year. Warrants are equity securities.
If a bond is trading at a premium, rank the following rates from low to high.
Yield to call, yield to maturity, current yield, nominal yield
Treasury receipts
Zero coupon bond created by brokerages. B/D basket of treasury bonds *Not backed by the U.S. Government
A convertible feature for a corporate bond allows
a bondholder to convert a debt instrument into securities that give the investor ownership rights.
An issuer has issued bonds with a call feature. It is likely that these bonds have
a higher coupon than similar bonds without the feature. When bonds are issued with features that benefit the issuer, such as a call feature, the issuer generally will need to pay a slightly higher coupon rate of interest to make the bond attractive to new investors.
Collateralized Debt Obligation (CDO)
a security comprised of a bundle of collateralized mortgages or other debt from multiple sources pool of bonds, loans, or assets -- higher the risk the more the CDO pays can be made liquid through securitization
A bondholder has invested in a certificate backed by equipment that the issuer owns and utilizes in its daily operations. This issuer is most likely
a transportation company
Collateralized mortgage obligation
a type of asset-backed security that contains a pool of mortgages bundled together "tranches"
Yield to Maturity (YTM)
annualized return of the bond if held to maturity
Money market securities can be associated with which of the following characteristics?
being highly liquid
Balloon bond
both serial and term -- pays off major portion at bond maturity and repays parts of bonds principal before final maturity date
A corporation deposits 20-year Treasury bonds into a trust in order to secure a loan. The loan for this type of arrangement would be facilitated by the corporation issuing
collateral trust bonds
Which of the following securities carries the greatest amount of risk in conjunction with a corporate liquidation?
common stock
T-notes
direct obligation of U.S. Government. Pay semiannual interest. PRICED AT % OF PAR Immediate term -- Between 2 and 10 year maturities
T-bills
direct obligation of U.S. Government. Sold at discount, mature at face amount. maturities 4 weeks, 8 weeks, 13 weeks, 26 weeks - one year or less highly liquid T-bills and STRIPS are only treasury securities issued at discount
Zero coupon bonds
do not make regular interest payments tend to be more volatile issues by corporations, municipalities, and the U.S. treasury (STRIPS) taxed annually
An investor purchases a bond offered at par. The bond has a coupon rate
equal to its current yield.
bonds are higher in priority than
equity securities if a corp fails conservative investors prefer bonds
Default risk in bonds
fail to pay interest when principal is due
Short Term Municipal Obligations (Anticipation Notes)
generates funds for a municipality that expects other revenues soon -- less than 12 month maturities -- repaid when they receive anticipated funds
Bond pricing
if a bond is priced at 90 multiply by 10 the dollar amount is $900
purchasing power risk
inflation fixed payments that are subject to inflation preferred stock (not a debt) does produce a fixed payment that is subject to inflation
Income from an investment in debt securities is known as
interest
U.S. Treasury notes are U.S. government-issued
intermediate-term debt securities with maturities of 2-10 years.
The relationship between fixed-income prices and prevailing interest rates is
inverse
Municipal bonds
issued by state and local governments tax free at FEDERAL LEVEL -- tax free at state if investor LIVES IN STTE OF ISSUANCE settle in T +2 days Categories: general obligation and revenue bonds
Call feature
issuers will generally exercise when interest rates are falling -- call before maturity bonds with a call feature will have a slightly higher coupon rate than bonds without
Farm Credit System
lending institution that provides agricultural financing and credit
T-bonds
long term debt obligations with maturities between 10 and 30 years PRICED AT % OF PAR
Government National Mortgage Association (Ginnie Mae)
only agency securities backed by full faith and credit backed by mortgages -- prepayment risk
Convertible feature
permits the bondholder to convert the bond into shares of common stock at a fixed price benefits the investor reaches parity if equal to the value of shares
Serial bond
portions of the principal to mature in intervals until fully paid
Federal National Mortgage Association (Fannie Mae)
purchases conventional and insured mortgages from agencies Govt sponsored enterprise
A financial institution, in order to raise cash on a short-term basis, sells some of the securities it owns, with an agreement to buy them back at a later date at a slightly higher price. This is known as
repurchase agreement
Corporate bonds
secured: mortgage bonds, equipment trust certificates, collateral trust bonds. unsecured: debentures, guaranteed bonds, income bonds, subordinated debt
Repurchase agreements
short-term sales of securities with an agreement to repurchase the securities at a higher price
Commercial paper
short-term unsecured debt issued by large corporations maturities from 1- 270 days
The higher the investment grade rating (Moodys, Standard and Poors..)
the lower the yield
The more time left to maturity
the more volatile a bonds price will be
The lower a bonds coupon rate
the more volatile it is high duration = more volatile
Yield to Call (YTC)
the rate of return earned on a bond when it is called before its maturity date investor receives principal back sooner than expected
The coupon payable on a bond may also be referred to
the stated or nominal yield.
Which one of the following best describes a debenture?
unsecured debt obligation
Revenue bonds
used to finance any municipal facility that generates sufficient income. self-supporting. ex: utilities, housing, transportation (toll roads and airports) education, health (hospitals), industrial and sports. no debt limits. no voter approval needed
Asset backed securities
value and income payments are derived from or backed by a specific pool of underlying assets pooling assets
Term bond
when the entire principal is paid at one time -- issuers may establish a cash reserve to accumulate to retire bonds at maturity
