Bonds (Lesson 5) Flashcards
US Treasury securities are nontaxable at the
- state and local level
Are Series EE/ Series E Bonds marketable securities
- no they are nonmarketable securities
Series EE bonds are sold at
face value
Do Series EE bonds pay interest periodically
- No bond slowly increases in value over 20 years based on fixed rate at time of purchase
When is the interest on Series EE taxable
- not until the bond is redeemed
When does Series HH pay interest
- semiannually
- not issued since August 2004
What are Series I bonds
- inflation indexed bonds issued by the US government
- Adjust the interest paid for inflation
What are series I bonds sold at and is the rate or return guaranteed
- Sold at face value
- no guaranteed rate or return
What is the interest portion on series I bonds consisted of
- Fixed rate of return
- Inflation component that is adjusted every six months
What are nonmarketable US Tresuries
- Series EE
- Series HH
- Series I
What are marketable US tresuries
- US Treasury Bills
- US Treasury Notes
- US Treasury Bonds
What are US Treasury bills maturities
- less than 1 year
How are US Treasury bills sold
- On a discounted yield basis which means they do not pay interest
- Bonds mature at par value
What are US Treasury notes maturities
- between 2 and 10 years
When is interest paid on US Treasury Notes
- Semi annually
What are US Treasury bonds maturities
- greater than 10 years
When is interest paid on US Treasury Bonds
- Interest is paid semi annually
How are treasury securities sold
- on an auction basis with the lowest yield winning the auction
How is an OID bond issued
- at discount from par value
- EX: A zero coupon bond that is sold at a deep discount to par value. A $1,000 par value zero coupon bond may sell for $600 and the bond will then increase in value over the term of the bond until it matures at par value
When must an investor recognize interest on zero coupon bond
- Every year which is why the bond increases in value each year even though no interest is paid
What type of protection do Treasury Inflation Protected Securities offer
- inflation and purchasing power protection
Does the coupon rate change on a TIPs
- no coupon rate does not change
- principal/par value adjusts for inflation and then the coupon rate is applied to the new principal amount
What are separate trading of registered interest and principal securities (STRIPS)
- periodic coupon payments are separated from the bond and each coupon payment including the par value trade separately
Treasury STRIPS are essentially
- zero coupon bonds
STRIPS are appropriate for investors looking for
- Low risk
- High liquid investment
- Specific time horizon
What are federal agency securities
- are moral obligations of the US government but are not backed by the full faith and credit of the US government
What is the exception to an agency bond that is backed by the full faith and credit of the US governement
- GNMAs
Is the below agency a on budget or off budget debt
GNMA - Ginnie Mae
On Budget
Is the below agency a on budget or off budget debt
Farmers Home Administration (FHA)
On Budget
Is the below agency a on budget or off budget debt
FNMA - Fannie Mae
Off Budget
Is the below agency a on budget or off budget debt
FHLMC - Freddie Mac
Off Budget
Is the below agency a on budget or off budget debt
SLMA - Sallie Mae
Off Budget
Is the below agency a on budget or off budget debt
FFCB - Federal Farm Credit Banks
Off Budget
Is the below agency a on budget or off budget debt
FICB - Federal Intermediate Credit Banks
Off Budget
Is the below agency a on budget or off budget debt
FHLB - Federal Home Loan Bank
Off Budget
What is a GNMA or Ginnie Mae
- Mortgage backed security
- consists of a pool of FHA/VA guaranteed mortgages
- Each month GNMA distributes interest and principal payments
Are the FNMA or Fannie Mae and FHLMC or Freddie Mac backed by the US government
- Not backed by the US government
What is the biggest risk to mortgage backed securities
- falling interest rates
- causes repayment of mortgages early
What are mortgage backed securities (MBS)
- backed by a pool of mortgages
- payments consist of both interest and principal
- biggest risk to bond holder is prepayment risk
What is a collateral trust bond
- backed by an asset owned by the company issuing the bonds
- asset is held by a third party
- in the event of default the bond holders are entitled to the asset being held in trust
What are collateralized mortgage obligations (CMOs)
- investors are divided into tranches which determines which investors will receive principal repayment
- interest form the pool of mortgages is distributed pro rata and the principal repayments are used to retire tranches sequentially
Do short term or long term tranches in a CMO get principal first
- short term tranche receive principal repayment first
What risk are CMOs meant to mitigate against
- prepayment risk associated with mortgage backed securities
What is a debenture
- are simply unsecured debt that is not backed by an asset
- backed on the belief of the creditworthiness that the issuing company (or government) will repay the debt
What are subordinate debentures
- have a lower claim on assets than other unsecured debt
- have more risk because of the lower claim on assets if the company defaults on the bond repayment
What are income bonds
- stipulate that interest is only paid when a specific level of income is attained
What ratings agencies rate bonds
- Moody’s
- Standard and Poors
- both rate on the company’s default risk and investment quality
The higher the bond rating means the _____ the yield
- the lower the yield
What do bond rating agencies analyze
- Liquidity
- Total amount of debt
- Earnings and stability of those earnings
What are Moody’s ratings for investment grade bonds
- Aaa - Baa are investment quality bonds
- Ba and below are junk bonds
What are Standard and Poor’s ratings for investment grade bonds
- AAA - BBB are investment quality bonds
- BB and below are junk bonds
What are Guaranteed Investment Contract (GIC)
- issued by insurance company’s with a guaranteed rate of return
- insurance company agrees to repay the principal and guaranteed rate of return for a period of time
- yield is higher than treasury securities
What are the three types of municipal bonds
- General obligations
- Revenue bonds
- Private activity bonds
What is a general obligation bond
- backed by the full faith, credit, and taxing authority of the municipality that issued the bond
What is a revenue bond
- not backed by the revenue of a specific project
- not backed by the full faith, credit, and taxing authority of the entity that issued the bond
What are private activity bonds
- used to finance construction of stadiums
What companies insure municipal bonds
- American Municipal Bond Assurance Corp (AMBAC)
- Municipal Bond Insurance Association Corp (MBIA)
What happens when an insured municipal bond is in default
- the insurance company will pay the interest and principal amounts
What risks do corporate bonds have
- default risk
- reinvestment rate risk
- interest rate risk
- purchasing power risk
What risks do US government bonds have
- reinvestment rate risk
- interest rate risk
- purchasing power risk
How do you calculate the the tax equivalent yield for a triple tax free bond
- add all of the tax rates together and use that as the marginal rate
TEY = r / (1-t) What is r and what is t
- r = tax exempt yield
- t = marginal tax rate
What is the formula for a double tax free bond if a client itemizes
Tax Exempt yield / (1 - (FT + ST(1 - FT))
- FT = Federal tax rate
- ST = State tax rate
If the yield ratio is Rtf(Tax free) / Rt(Taxable) how does a higher ratio affect the attractiveness of a municipal bond
- As the tax free return increases the ratio becomes bigger so the higher the ratio the better - the closer the tax free rate is to the taxable rate the investor will always choose the tax free rate
