CFP - Bonds Flashcards
Are US Treasury securities taxable?
NON-taxable at the state and local level
Series EE / Series E Bonds
Minimum purchase?
Annual maximum?
Face value?
Pay interest?
Redeemable?
$25 minimum purchase
$10,000 annual maximum
Offered at one-half face value
DO NOT pay interest, bond slowly increase in value over 20 years
NOT marketable/Non-transferable!!!!!!!!!!!!
Redeemable after 1 year with 3 month interest penalty if redeemed in less than 5 years
NOT taxed at the state or local level
Series HH / Series H Bonds
How often do they pay interest?
Pay interest semi-annually
*have not been issued since August 2004
Series I Bonds
Indexed against what?
Sold at what?
Interest consists of what?
Inflation indexed bonds
Sold at Face Value
No guaranteed return
NONMARKETABLE
Interest consists of what?
Fixed rate of return + inflation component
*Adjusted every six months
MARKETABLE US Treasury Bills
< 1 year
Sold at discount
No interest, just mature
Denominations of $100+
MARKETABLE US Treasury Notes
2-10 years
Interest paid semi-annually
Denominations of $100+
MARKETABLE US Treasury Bonds
> 10 years
Interest paid semi-annually
Denominations of $100+
Original Issue Discount (OID)
OID bond issued at a discount from Par Value
Ex: Zero coupon bond that is sold at a deep discount to par value
Bond increases in value over the term of the bond
Recognize income each year (even though not received)
Treasury Inflation Protected Securities (TIPS)
coupon rate does not change
rather it is adjusted annually for inflation by a factor
Separate Trading of Registered Interest and Principal Securities (STRIPS)
Coupon payment separated from the bond
low risk
highly liquid
specific time horizon
Name 2 types of bonds that mitigate against purchasing power risk?
I Bonds
TIPS
Federal Agency Securities…are they back by US government
NO, but they are a moral obligation
Exception: GMNAs
On-Budget types of Debt
GNMA
FHA
Off Budget Debt
FNMA (Fannie Mae)
FHLMC (Freddie Mac)
SLMA (Sallie Mae)
FFCB (Federal Farm)
FICB
FHLB
Types of Mortgage Backed Securities
GNMA (Ginnie Mae) (FHA/VA)
FNMA (Fannie Mae)
Biggest risk with Mortgage-backed securities?
Falling interest rates
What are MBSs backed by?
A pool of mortgages
Risk:prepayment
What are corporate Collateral Trust bonds?
Backed by an asset owned by the company issuing the bonds
What are CMOs?
Collateralized Mortgage Obligations
Short/Immediate/LT “tranches”
Types of Unsecured Corporate Bonds
Debentures (not back by asset)
Subordinated Debentures (lower claim on assets)
Income bonds
If a bond rating agency rates a bond high, what will happen to the yield?
Lowers the yield if rated high
GIC - Guaranteed Investment Contract
Issued by?
Return?
GIC - Guaranteed Investment Contract
Issued by? - Insurance Companies
Return? guaranteed rate
YIELD IS HIGHER THAN TREASURIES
Municipal bonds
Who issues?
Who taxes?
Who issues? STATE
Who taxes? NO ONE
MUNICIPAL BONDS: General Obligation Bonds
Who backs?
Backed by full, faith, and credit and taxing authority of municipality
BACKED BY TAXING AUTHORITY OF THE ISSUING MUNICIPALITY
MUNICIPAL BONDS: Revenue Bonds
Who backs?
Backed by the revenue of specific project
MUNICIPAL BONDS: Private activity bonds are used to finance
Construction of stadiums
MUNICIPAL BONDS: Insured Municipal Bonds
Companies that issue:
If insured bond is in default, what happens?
Companies that issue:
AMBAC
MBIA
If insured bond is in default, what happens?
THE INSURANCE COMPANY WILL PAY THE INTEREST AND PRINCIPAL AMOUNTS
FIXED INCOME: Corporate Bonds
RISKS?
-Default
-Reinvestment
-Interest rate risk
-Purchasing Power Risk
FIXED INCOME: US Government bond - RISKS?
-Reinvestment rate risk
-interest rate risk
-purchasing power risk
Municipal Securities - Tax equivalent yield
Formula provided
rate they need to pay to be equivalent
The lower the coupon the more
volatile the bond is.
The lowest Bond rating for Moody’s and S&P that can still be considered investment grade?
Moody’s: Baa
S&P: BBB
Coupon rate
Periodic interest received by a bond holder
Dollar amount (PMT on calculator)
Changes in the marketplace DO NOT EFFECT coupon payments
Rising interest rates mean investors can get what on new bonds?
What happens to those selling bonds?
Larger stream of cash flow
Sellers must sell at a discount
FALLing interest rates mean investors can get what on new bonds?
What happens to those selling bonds?
Coupon rates will fall
will be less than previous bonds
sellers can now sell at a premium
YTM on a bond is
Essentially the compounded rate of return if an investor buys a bond today and holds to maturity
YTC / Yield to call on a bond is
the compounded rate of return if an investor buys a bond today and the bond is CALLED by the issuer
What happens to accrued interest when purchasing a bond?
The buyer pays the seller the interest that has accrued since the last payment
Liquidity Preference Theory
Lower yields for shorter maturities because some investors prefer liquidity and are willing to pay for it
Market Segmentation THeory
Distinct buyers and sellers at each given maturity
Expectations Theory
The yield reflects investors inflation expectations
LT yields are usually higher
When is a yield curve INVERTED?
Whenever inflation is expected to be lower in the future, the LT rates will be lower than ST rates
Unbiased Expectations Theory
Holds that today’s longer term interest rates have imbedded in them expectations about ST rates
Bond Duration
Weighted average maturity of all the cash flows
The bigger the bond duration, the more
sensitive or volatile the bond is to interest rate changes
Modified bond duration is
a bond’s price sensitivity to changes in interest rates
A bond portfolio should have a duration equal to
the investor’s time horizon to be effectively immunized from interest rates
A zero coupon bond will always have a duration
equal to its maturity
Duration and term of bond have a direct/inverse relationship
DIRECT
Duration is a measure of
how sensitive the bond is to changes in interest rates
BOND STRATEGIES: Tax Swap
Involves selling a bond that has a gain and a bond that has a loss
(Offset each other)
Also involves selling a bond that has a loss position and buying a new bond.
BOND STRATEGIES: Barbells
A barbell strategy involves owning both short-term and long-term bonds
BOND STRATEGIES: Laddered Bonds
Requires purchasing bonds with varying maturities
BOND STRATEGIES: Bullets
Very little payments during the interim period and then a lump-sum at some specified date in the future
*Zero-coupon bonds, treasuries, and corporates are most likely candidates since they pay little or no coupon during the period (payoff at some predetermined date in the future)
What is the Convertible Bonds - Conversion Value?
The value of the convertible bond in terms of the stock which it can be converted
Conversion Value Formula
Par / Conversion Price
x
Price of the Common Stock
Property Valuation Formula / Capitalized Value
Net Operating Income /
Capitalization Rate
OR
NOI / Cost
What does CONVEXITY MEASURE?
The difference between duration’s estimate of a bond’s price change and the actual price change of a bond.
Lower coupon rate means what for volatility?
MORE VOLATILE
The duration of a bond is a function of its:
-current price
-time to maturity
-YTM
-coupon rate
To immunize a bond portfolio over a specific investment horizon, an investor would do what?
Match the average weighted duration of the bond portfolio to the investment horizon
