Bonds Flashcards
PAC
Planned Amortization Class
Companion tranches take prepayment and extension risk
PAC is middle of the pyramid
TAC
Targeted Amortization Class
No extension risk, but if interest rates rise, not protected on the back end
Tack - pointy on one end
Prepayment risk
risk that interest rate fall, causing mortgage holder to refinance, which pays off CMOs
Extension Risk
Risk that interest rates rise, cause mortgage holders not to refinance, which makes mortgage take closer to estimated timeframe.
GNMA
Only purchase FHA and VA loans
Backed by US Gov
High wealth investors, interest payments exempt from state and local tax
FNMA
Implicitly backed, not required but assumed
Buys student loans from originating financial institutions
Higher interest than GNMA
FHLMC
Highest risk
Purchase conventional loans
Implicitly backed by US Gov
General Obligation Bonds
Issued by muni governments that are backed by full credit of US government
Revenue Bonds
Not backed by US Gov, backed by proceeds of what they’re doing
Feasibility Study is used to see if they can pay back debts
GMIB
Guaranteed Minimum Income Benefit
Can be purchased with variable annutiy contract
Guarantees the separate account will grow until guaranteed minimum rate once the contract is annuitized.
CMB
Cash Management Bill
Shortest term security by US Treasury. Maturities in lowest of 5 days
Sold in $100 minimums at a discount
Rights Offering
Preemptive rights to subscribe to newly issued common shares distributed to company’s existing shareholders
Eurodollars
US dollars held in European countries. Interest paid is based on LIBOR
Roth IRA
Not available to high net worth individuals
Max Sales Charge on mutual fund
8.5%
Elder abuse
Hold on account for 15 days, can be extended for 10 additional days
Coverdell plans
Contributions not tax-deductible
Distributions are not taxable
HSA
Health savings account
Has lower contribution limits than IRA
Are funded with tax-deductible contributions
OBO
Order book official
Exchange employee who manages the book of public limit orders
Bond appraisals
Trading market is thin, no “real time” price reporting.
True market value is uncertain, and not reported to consolidated tape
Retirement distributions
Taxable at 50% unless rolled over into an IRA
Regulation FD
Insider trading rules.
Treasury Receipts
Stripped US Gov Bond sold by brokerage firm.
Pay interest at maturity
STRIPS
Zero coupon, all repayment at the end.
Must still be accreted
Avoids reinvestment risk
Clearing house funds
Clears T+2.
Regular way trades of equities, corp and municipal bonds
Federal Funds
Government and agency bond trades settle here. Including GNMA
Treasury Bills
$100 minimum; auction weekly
Issued at a discount; zero coupon
NO purchasing power risk
Non-callable; money market instrument
Volatility
Longer maturity - greater volatility
Lower coupon - greater volatility
Callable
Occurs when interest rates drop
Call price sets ceiling on market price
Called at par plus premium
Zero coupon - par plus accreted value
Credit risk
Bonds
Risk that issuer cannot make interest and principal payments on time
Capital risk (market risk)
Risk that amount invested may not be fully recoverable
Interest rate risk
As interest rates go up and bond prices fall
Bonds most susceptible are long maturity and low coupon
Liquidity risk
Risk that selling a position will result in higher than normal transaction costs (commissions)
Typically for smaller, thinly traded issues
Timing risk
Risk that buying and selling occur at disadvantageous price levels due to poor market timing
Purchasing power risk
Risk inflation will lower value of bond interest payments and principal repayment
Marketability risk
Risk that security will be difficult to sell
Nonexistent for treasury bonds because market is so large and liquid
Reinvestment risk
Risk for long-term bond holder
Market rates fall over investment’s timeline
Debenture
Intermediate and long term corporate bond
Backed by full faith and credit of issuer
TIPS
Avoids purchasing power risk
Settlement
Treasuries - next day
Agencies - depends
Cash - same day
Debt rating agency
Moody’s, Standard and Poor, and Fitch’s
Interest income
US Gov obligations subject to federal, exempt from state and local
Mortgage backed securities subject to federal and state/local tax
Municipal income subject to state and local, exempt from federal (if purchased in another state, interest is taxable in other state)
LEAPs
Long term equity anticipation
28 month max life for stocks
36 month max life for index
American style
Exercises at any time
European style
Exercised at expiration
Bank Qualified Bonds
Free from federal tax
Bank allowed to deduct 80% of any interest paid on monies borrowed
13 D
Anyone who holds 5% or more in a publicly traded company. Indicates they might try to gain control
Additional bonds test
Earnings test must be satisfied before additional bonds can be issued against the same revenue source
Buying Power
Amount of securities that can be bought.
2 times the SMA
Selling power
Amount of additional securities that can be sold short
2 times the selling power
Revenue Bonds
Interest and principal repaid by lease payments.
Subject to AMT and regular tax
Final responsibility for debt service on corporate lessee of facility.
Construction Loan Notes
short term muni note to finance construction of building
Repaid from monies receives from a permanent take-out financing
Treasury Bonds
Advance refunded in an escrow account
