Chapter 12 Part 9 Flashcards
Commercial paper is
short-term unsecured corporate debt that typically matures in 270 days or less. Therefore, commercial paper would be exempt from the prospectus requirements of the 1933 Act. Commercial paper is usually issued at a discount as with Treasury bills, although some issues are interest bearing
Commercial paper is usually issued by corporations with
high credit ratings and is consequently considered very safe.
Moody’s and Standard & Poor’s issue credit ratings for commercial paper
P-1 (also called Prime 1) is the highest rating that Moody’s will assign to commercial paper. Intermediate ratings are P-2 and P-3. Speculative commercial paper would receive a rating of NP (not prime). S&P will assign ratings from A1 (highest) to A3, and Fitch assigns ratings from F1+ (highest) to F3
Some large issuers of commercial paper sell their issues
directly to the public using their own sales force. This is known as directly placed commercial paper. Most other issuers sell to large commercial paper dealers who then resell the issue to the public. This is known as dealer-placed commercial paper. The minimum denomination is typically $100,000.
Bankers’ acceptances are used to
“facilitate foreign trade. For example, suppose that an American food company is importing French snails. The American company wishes to pay for the snails after delivery and issues a time draft (a check that is good at a future date) secured by a letter of credit from a U.S. bank as payment. The French snail manufacturer can hold the draft until its due date and receive the full amount, or cash it immediately at a bank at a discount. The bank then has the draft guaranteed by the issuing bank and it is now called a banker’s acceptance. The bank can hold
the BA until the instruments due date or sell it in the market”
BAs are actively
traded and are considered quite safe since they are secured both by the issuing bank and by the goods originally purchased by the importer
In a repurchase agreement, a dealer
“sells securities (usually T-bills) lo another dealer and agrees to repurchase them at a specific time, at a specified price. In effect, the first dealer is borrowing money from the second dealer and securing the loan with securities (a collateralized loan). The second dealer (the lender) receives the difference between the purchase price and the resale price of the
securities in return for making the loan.”
reverse repo or matched sale
If a dealer purchases securities and agrees to sell them back to the other dealer at a specific date and price, this is known as a reverse repo or matched sale. In that situation, the first dealer would lend money (with securities as collateral) to the second dealer and earn the difference in sales prices. Many corporations and financial institutions, as well as dealers, engage in repos and reverse repos. Repos and reverse repos are typically short-term, with most being overnight transactions
Banks and savings and loans issue certificates of deposit. They are
time deposits carrying fixed rates of interest that mature after a specified period. While most CDs mature in a year or less, the minimum maturity is seven days and there is no maximum. CDs of up to $250,000 are currently insured by the Federal Deposit Insurance Corporation (FDIC), although the maximum FDIC coverage is scheduled to be reduced to $100,000 in January of 2014. Holders of CDs are penalized if they redeem them prior to their stated maturity
Also known as jumbo CDs
negotiable CDs have a minimum denomination of$100,000 but typically trade in denominations of one million dollars or more. There is an active secondmy market in these securities. A negotiable CD is normally not covered by FDIC insurance since it exceeds $250,000, which is the current maximum amount the FDIC will insure
Long-term or brokered CDs generally have maturities from
2 to 20 years and are, therefore, not considered money-market securities. They also may carry additional risks not associated with traditional bank-issued CDs
Long-Term CDs
There may be limited liquidity, or potentially no liquidity; Investors may experience a loss of principal if CDs are sold prior to maturity; Brokered CDs may have call features that limit capital appreciation and subject the investor to reinvestment risk; FDIC insurance may not apply; Unique features, such as variable rates, step-ups and step-downs, may affect future interest payments
Long-Term CDs These instruments are issued by
banks and, although sold by broker-dealers, they are insured up to certain limits by the FDIC if the issuing bank declares bankruptcy. The amount of FDIC insurance and tax considerations are different depending on whether the CD is purchased in a retirement account. If the broker-dealer that sold the brokered CD to the client declared bankruptcy, SIPC coverage would apply since these products are defined as securities
Broker-dealers or deposit brokers that offer long-term CDs must insure that
“potential customers understand the difference between these products and traditional bank-issued CDs, and disclose any potential risks. These disclosures would be based on the potential risk and investment considerations relevant to the client. The features that establish the interest rate of the security, such as an index of fixed-income or equity securities, is relevant to the client. For example, a step-down, long-term certificate of deposit will offer an investor an interest rate that is initially higher than current market rates will pay for that maturity period. Subsequent interest rates paid to investors would be lower and may be adjusted more than once. An RR should disclose to the client that he will not receive the higher interest rate for the life of the CD. In addition, a broker-dealer is not required to maintain a secondary market or act as a market maker in a CD that was sold to the client. this will
limit the liquidity of the security if the client needs the funds prior to maturity”
If a brokered CD is callable, the following disclosures should be made
The issuer at its sole discretion may decide to call in the CD prior to maturity; therefore, the client does not have the right to redeem the CD prior to maturity. If the CD is called prior to maturity, the client may be unable to reinvest the funds and receive a comparable rate of interest (if rates have declined). A CD that is called prior to maturity may offer a client a return that is less than the yield to maturity. The CD may not be called by the issuer, requiring the client to hold the security until maturity
