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CFP 3 - Investment Planning > 103-2 Debt Investments > Flashcards

103-2 Debt Investments Flashcards

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CFP® flashcards
1
Q

Preferred stock

A

Features of common stock and debt

Dividends not contractual obligation

Typically makes fixed periodic payments to investors

No voting rights

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2
Q

3 ways a bond can be issued

A
  1. Registered form: payments made to the owner of record
  2. Bearer form: payments made to whoever holds or possesses the bond
  3. Book-entry form: has its record of ownership held electronically in a central depository
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3
Q

Bond indenture

A

Formal agreement or contract between the issuer and the bond holder

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4
Q

Sinking fund

A

Separate fund established and funded each year by the bond issuer designed to accumulate an amount required to pay off the debt at maturity

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5
Q

Par Value (face value)

A

The amount of principal that the bond owner of bolder will receive at the time of maturity

This par value is assumed to be $1k unless stated otherwise

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6
Q

Coupon rate / nominal yield

A

The stated annual interest rate that will be paid each period for the term of the bond and is stated as a % of the par value of the bond

For the CFP assume semiannual coupon payments unless stated otherwise

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7
Q

Basis point

A

A measurement of the bond’s yield and is equal to 1/100 of 1% of yield

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8
Q

Call Provision

A

Included in the bond indenture allows the issuer to pay off the bond principal after a specified period, usually at a stipulated price higher than par value

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9
Q

Secured bond, such as a mortgage bond or collateral trust bond

A

Pledges specific assets that may be sold by the bond purchaser in the event that the bond issuer defaults in paying either the interest or the principal on the bond

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10
Q

Debenture

A

A bond that promises payments of interest and principal but pledges no specific assets

Debenture is an unsecured bond

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11
Q

Investment grade bond

A

BBB- or higher by S&P

Baa or higher by Moody’s

Generally is a high quality bond w/ little risk of default by the issuer

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12
Q

High-yield bond

A

Aka junk bond

BB+ or lower by S&P
Ba or lower by Moody’s

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13
Q

Primary risks bonds are subject to:

A
  1. IR risk
  2. Purchasing power risk
  3. Reinvestment rate risk
  4. Default (credit) risk
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14
Q

Effect of rating changes of bond yields

A

Upward revision will cause the market yield on the bond to decline, reflecting the bond’s improved quality

Downward revision will cause the market yield on the bond to increase; reflecting the bond’s decline in quality

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15
Q

U.S. Treasury Notes

A

Issued w/ maturity dates of 2, 3, 5, 7, 10 years

Issued at stated par value
Provide semiannual coupon payments

Exempt from income taxation at state and local levels

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16
Q

U.S. Treasury Bonds

A

Maturity of 30 years

Issued at stated par value
Provide semiannual coupon payments

Exempt from income taxation at state and local levels

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17
Q

Original Issue Discount (OID)

A

If the U.S. bond or note was originally issued at a discount after July 1, 1982, any investor who did not pay more than the face value must include in income each year a calculated share of this OID

The investor pays tax on income that has not yet been received in cash (i.e. phantom income)

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18
Q

Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)

A

Zero-coupon bond’s creates by separating the semiannual coupon payments and the principal portions of a U.S. Treasury note or bond

Issued at a deep discount

Extremely sensitive to IR changes because the investor receives all the proceeds from the investment at maturity

Interest is taxed as ordinary income as it accrues, even tho no actual interest is paid until the bond matures (or is sold). For this reason, best to put in tax advantaged account

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19
Q

Treasury inflation-protected securities (TIPS)

A

Marketable securities whose principal is adjusted by changes in the CPI
Issued in terms of 5, 10, 30 years

Semiannual interest payments received by the investor are determined by multiplying the inflation-adjusted principal value by 1/2 of the fixed IR (because the interest payments are payable semiannually)

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20
Q

Savings Bonds

A

A part of the federal government debt structure

May be purchased and used for funding education costs and gifting

Include Series E, EE, H, HH, and I bonds

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21
Q

Series EE bond

A

The electronic EE bond is sold at 100% face value in any denomination from $25 to $10,000 and is eligible to earn interest up to 30 yrs
Must be held a minimum of 12 months, and a 3-month interest penalty is assessed if the bond is redeemed within 5 years of issue

22
Q

Series H/HH bonds

A

Pay semiannual interest for up to 20 years in cash

No penalty for early redemption

23
Q

Series I Savings bond

A

An inflation-indexed, or inflation-protected, debt security that is purchased electronically in any denomination from $25 to $10,000

IR combination of 2 separate rates:

1) fixed rate of return that remains the same for the life of the bond
2) semiannual inflation rate based on changes in the CPI during the previous six-month period

May be redeemed any time 12 months after the issue date for the principal plus interest accrued to that date
If redeemed within the first 5 years, there is a 3-month interest penalty

24
Q

How to exclude Series EE and Series I bond interest from income tax

A

Can be done if the bond proceeds are used to pay for qualified higher education costs

25
Q

Farm Credit Adminstration

A

Provides American agriculture w/ a source of credit

Has direct backing and guarantee of the U.S. government

26
Q

Government National Mortgage Association (GNMA, or Ginnie Mae)

A

Guarantees investors the timely payment of principal and interest on mortgage-backed securities backed by federally insured loans

Has direct backing and guarantee of the U.S. government

Buys Federal Housing Administration and Department of Veterans Affairs mortgages and auctions them to private lenders, which pool the mortgages to create pass-through certificates for sale to investors

27
Q

Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac)

A

Purchases mortgage loans and mortgage related securities for investment and issues guaranteed mortgage-related securities

Indirect backing and guarantee of the U.S. government

Created to promote the development of a nationwide secondary market in mortgages by purchasing conventional mortgages from financial institutions and packaging them into mortgage-backed securities for sale to investors

28
Q

Federal National Mortgage Association (FNMA, or Fannie Mae)

A

Keeps funds flowing to the mortgage market, helps distressed homeowners, and encourages sustainable lending

Indirect backing and guaranteed of the U.S. government

Competes w/ FHLMC for investor money in the secondary marketplace

29
Q

Student Loan Marketing Association (SLMA, or Sallie Mae)

A

Offers solutions to help families save, plan, and finance college expenses

Indirect backing and guarantee of the U.S. government

30
Q

Municipal bonds

A

General Obligation and Revenue Bonds

Excluded from the recipient’s taxable income for regular income tax purposes, usually both for federal and state income tax purposes, if the bondholder is also a resident of the state or muni issuing the bond

31
Q

General Obligation Bonds (GOs)

A

Municipal bonds that are issued to finance capital improvements benefiting the community

Often referred to as full faith and credit bonds

32
Q

Revenue Bonds

A

May be used to finance any municipal facility (e.g., community airport) that generates sufficient income to satisfy the ongoing debt obligation
These are more risky than GOs and offer higher yields for similar maturities

33
Q

Private activity (private purpose) bond

A

Part of a state or local government bond issue for which more than 10% of the proceeds of the issue are to be used for a private business use (such as the financing of a sports stadium)

34
Q

Qualified private activity bonds

A

Tax-exempt bonds issued by a local or state government, the proceeds of which are used for a defined qualified purpose by an entity other than the government issuing the bonds

35
Q

Insured Municipal Bonds

A

Insured against default, have reduced credit risk associated with the bond
Muni may insure its debt issue in hopes of increasing the bond rating, which, in turn, will allow the muni to lower the coupon rate on the issue

36
Q

Taxable equivalent yield (TEY)

A

Used to compare the advisability of investing in municipal, tax-exempt issues to taxable, corporate issues

TEY = tax-exempt yield / 1 - marginal rate

37
Q

After-tax yield

A

Used to compare the advisability of investing in taxable issues with that of investing in municipal tax-exempt issues

After-tax yield = pretax return x (1 - marginal tax rate)

38
Q

Corporate bonds

A

Debt securities issued by public and private companies to raise capital

39
Q

Subordinated debentures

A

Feature higher coupon (interest) rates than corporate secured bonds, muni bonds, or other U.S. Treasury securities

40
Q

Market Discount Bond

A

A bond acquired at a discount

41
Q

Zero-coupon bonds

A

Sold at a deep discount to their face value
Referred to as original issue discount (OID) bonds

Their prices are more volatile than other bonds of similar quality and they are not subject to reinvestment rate risk

42
Q

Phantom Income

A

Zero-coupon bonds are issued in taxable form by corporations, meaning that the investor must include the accrued interest in his taxable income annually, even though no cash is received until the bond matures, is sold, or is called

Usually most appropriate if they are positioned within a retirement plan or other tax-deferred account

43
Q

Yankee Bonds

A

Foreign bonds payable in U.S. dollars

44
Q

Eurodollar Bonds

A

A second type of U.S. pay bond, but unlike Yankee bonds, they do not have to be registered w/ the SEC because they are issued and traded outside the U.S.

45
Q

Promissory Note

A

A promise to pay a certain sum of money or make a series of payments to others, usually individuals

All of the interest is taxable to the investor at ordinary income rates in the year earned

46
Q

Convertible bonds

A

Corporate bonds that may be exchanged for a fixed #of shares of the issuing company’s common stock

Pay lower IR than do non-convertible bonds

Good diversifier in a portfolio

A convertible bond will always sell for no less than the greater of its straight value or its conversion value

47
Q

Conversion price

A

The stock price at which a convertible bond can be exchanged for shares of the issuer’s common stock

48
Q

Conversion ratio

A

aka the conversion rate, expresses the # of shares of stock into which a bond may be converted

Conversion ratio = par value of convertible security / conversion price

49
Q

Conversion Value calculation

A

conversion value = conversion ratio x market price of common stock

50
Q

Convertible preferred stock

A

Can be exchanged for common stock at a conversion ratio determined when the shares are originally issued

CFP 3 - Investment Planning (10 decks)

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