Debt

Which action will the Federal Reserve take to tighten credit?

Reverse repurchase agreement (aka "matched sale") Federal Reserve will sell government securities to bank dealers (draining the dealers of cash that could be lent out) with an agreement to buy them back at a later date. The sale is being "matched" to a future purchase and is used to temporarily drain cash from the credit markets.

As stated in the flow of funds found in a revenue bond issue's trust indenture, monies to meet debt service requirements are deposited to the:

Sinking fund

1 basis point =

$0.10

General Obligation (G.O.) bonds

- MUNICIPAL issues backed by the full faith, credit, and taxing power of the issuer. Sources of income for backing the issue are: - ad valorem taxes - back due ad valorem taxes - fines collected for late tax payments - assessments of additional taxes

A failed auction for an Auction Rate Security is constituted by:

- a lack of bids - clearing rate BELOW bid rate (bondholders are demanding an interest rate higher than what the issuer is willing to offer) Clearing Rate - HIGHEST bidded interest rate that the issuer is willing to agree to

Revenue bonds

- backed by any source of income OTHER THAN ad valorem taxes Sources can include: - revenues from facility operations - grants - excise taxes - lease rentals - enterprise activity income

Fannie Mae (Federal National Mortgage Association)

- buys VA and FHA insured mortgages from financial institutions and packages them into pass through certificates - publicly trades in the Pink OTC Markets - delisted from NYSE after '09 - government agency but NOT guaranteed by US Gov.

Freddie Mac (Federal Home Loan Mortgage Corporation)

- buys conventional mortgages from financial institutions and packages them into pass through certificates - publicly traded in the Pink OTC Markets - delisted from NYSE after '09 - government agency but NOT guaranteed by US Gov. - cannot buy VA or FHA insured mortgages

Overlapping Debt

- can ONLY be G.O. debt (never Revenue) - usually structured as SERIAL - shared by taxpayers in differing political subdivisions ex. school district that encompasses 5 different towns

If inflation rises and you hold a TIP security...

- coupon rate remains the same - principal amount is adjusted

Certificate of Participation

- issued by a state entity where lease revenues are pledged to back the issue - lease payments are received from projects (dorms, prisons, municipal office buildings, etc.) - payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds, and it is NOT LEGALLY OBLIGATED to do so - ^ because of this, they have higher credit risk and offered at a higher yield

Jumbo CD's:

- issued in amounts in excess of $100,000 - not fully insured by the FDIC - backed solely by the faith and credit of the issuing bank

Eurodollar Bonds:

- issued in bearer form outside the US, trading is centered in London - these bonds are payable ONLY in US Dollars - US corporate issuers experience NO foreign currency risk (because payments are always in US dollars) - foreign corporate issuers DO experience foreign currency risk

Variable rate municipal notes avoid:

- market risk aka interest rate risk

Commercial Paper

- maximum maturity of 270 days - quoted on a yield basis (as is all money market debt)

For a BOND TRUST INDENTURE, the bound counsel will examine:

- municipal statutes - state constitution & amendments - tax code and interpretive regulations - judicial edicts

Certificates of Participation (COP's) are:

- not subject to statutory debt limits - have lower credit rating than G.O. bonds of the same issuer A COP is issued by a state entity where lease revenues are pledged to back the issue.

Ginnie Mae (Government National Mortgage Association)

- performs same functions as Fannie Mae except its pass through certificates ARE guaranteed by the US Gov. - cannot be publicly traded unless the Gov stops guaranteeing its securities

Feasibility Study

- prepared prior to issuance of REVENUE bonds Factors studied are: - expected demand for the facility - effect of competing facilities - expected operating costs of facility A 'Bond Trust Indenture' would not be included in a feasibility study. The trust indenture analyzes legal aspects and would be evaluated by the Bond Counsel.

CMB's (Cash Management Bills)

- sold at a discount to par - sold on an "as needed" basis - sold at auction by the Treasury to meet unexpected cash shortfalls - they are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills

Industrial Revenue bonds

- subject to Alternative Minimum Tax (AMT) because it is a "non-essential use" PRIVATE PURPOSE bond - used to fund building of sport stadiums - public purpose bonds (G.O. bonds and public facility revenue issues) are NOT subject to AMT

Market Index Linked CD's

- type of "structured product" that consists of a "zero-coupon" synthetic bond component that grows based on the returns of an equity index - insured by FDIC - minimum life is typically 3 years from issuance - they HAVE market risk if redeemed prior to maturity (whereas traditional CD's do not) *** typically a 3-5% principal penalty for early withdrawal

Revenue Anticipation Notes (RAN) are:

- unfunded debt - source of temporary financing A Revenue Anticipation Note (RAN) is issued by a municipality that wishes to borrow short-term against revenues that are expected to be received in the near future

If spread between government bonds and corporate bonds WIDENS:

- yields on corp. bonds are higher than usual (people don't want them... too risky) - more people are buying gov. bonds, pushing the yields down ***this is typical when a recession is expected

Market Index Linked CD (4 facts):

1. Early redemption can result in the imposition of a penalty of 3-5% of the principal amount invested 2. The CD can only be redeemed on a specified date during each calendar quarter 3. The rate of return may be capped to a limit that is lower than the return of the reference stock index 4. Market index linked CDs typically have a minimum life of 3 years

3 companies that provide fundamental analytical information about MUNICIPAL issues and their credit risk:

1. Moody's 2. Standard & Poor's 3. Fitch's ("Best's" rates INSURANCE companies for credit risks)

GNMA Pass Through certificates: (4 things)

1. quoted on a % of par basis in 32nd's 2. minimum denomination of $25,000 3. certificates trade "and interest" 4. accrued interest calculated on 30/360 basis *** #4: although it is insured by Gov (actual/365), agency securities have a 30/360 basis

A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive:

103% x $500 = $515 If a zero-coupon bond is called prior to maturity, it receives the accreted value PLUS the call premium specified in contract

Equivalent Taxable Yield formula:

= Tax Free Yield / (100% - Tax Bracket)

Equivalent TAX-FREE Yield formula:

= Taxable Yield x (100% - Tax Bracket)

CMO interest income is taxed at:

BOTH federal and state income tax levels

Corporate bonds are quoted on what basis?

Dollar price basis

The lower the coupon rate, the _________ the bond price volatility

GREATER

Long stock position/long put is a ________________ strategy Short stock position/long call is a ________________ strategy

HEDGING; HEDGING

Short stock position/short put is a ______________ strategy Long stock position/short call is a _______________ strategy

INCOME; INCOME

Overnight repurchase agreements still have _________ risk, despite the fact they happen in such a short amount of time.

INTEREST RATE RISK If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth! If the borrower of the funds defaults, the lender can sell the collateral - but it will still be worth less than the original loan amount!

CMO holders are paid interest:

MONTHLY - CMO's are a "derivative" security, because the value of each tranche is "derived" from the cash flow allocation scheme.

Constitutional debt limits are imposed on:

Non-self supporting debt. Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). These are non-self supporting debts that are carried on the "backs" of taxpayers.

New conversion price =

Old Price / New factor (new factor reflects the stock dividend)

The ratio of pledged revenues to debt service requirements is:

Pledged revenues / annual interest expense and mandatory sinking fund deposits The ratio should be comfortably above 1, meaning the issuer can easily pay from pledged revenues.

Yield measures (scale)

Price, Nominal, Coupon, YTM, YTC ^ Nominal sometimes called "stated" YTM sometimes called "basis"

When a municipal dealer gives a customer a "bond appraisal," he is disclosing:

a likely price at which the bonds can be sold based on the market prices of similar securities

Accrued Interest

accrues UP TO, but not including, the SETTLEMENT date

Term bond offering

all bonds issued on same date and all same maturity dates Quoted on a percentage of par

Serial bond offering

all bonds issued on same date, but with DIFFERING maturities - most municipal bond issues and corporate equipment trust certificates are serial bonds; quoted in yield

The obligor on a municipal bond issue is the:

borrower of the bond proceeds

The short term money market instrument issued by corporations is:

commercial paper

From an issuer's standpoint, level debt service serial bonds have:

declining interest payments equally offset by rising principal repayments

Municipal TERM bonds are usually quoted on a:

dollar price basis

Municipal broker's brokers perform specialized trades for _______________________ on an agency basis only - they ____________________________ nor do they ____________________________.

institutional investors; do not carry inventory positions; deal with the public

Funded debt is corporate bonds that are long term. Example:

mortgage bonds

Auction Rate Securities

preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction ("Dutch Auction")

For plain vanilla CMO's, as payments are received from the underlying mortgages, interest is paid ___________________________; but principal repayments are paid _______________________________________.

pro-rata to all tranches; sequentially to the first, then second, then third tranche, etc.

To be bank qualified, the issue must be a _________________________. The purchasing bank can deduct ____ of the interest expense it incurs on deposits used to fund the purchase of the bonds

public purpose issue; 80%

G.O. bonds are typically issued WITHOUT a _____________.

trust indenture revenue bonds have trust indentures