Chapter 2- Debt Securities Flashcards
Bonds are…
Loans (represent a debt obligation of the issuing organization)
Bonds Trade at…In the secondary market (3 levels)
A discount… market price is less than par value
Par…market price equals par value
A Premium…market price is greater than par value
A Coupon Rate/Coupon is…
The fixed interest rate of the bond
Interest on bonds is paid…
Semi-Annually
Par Value of a bond is
1000 dollars
One Point on a Corporate Bond is..
$10
Maturity Date on Bond
The date the bond is due for repayment to the investor
Series Bonds
Have different issue dates and usually have the same maturity date
Term Bonds
Entire issue of bonds will have the same maturity date
Sinking Fund (Definition, Uses)
Money set aside to redeem the company’s bonds or debentures
Frequently used on bond issues where a large amount of money is gonna be due at once and can also be used for Preferred Stocks
(May be a mandatory debt retirement provision of a bond indenture)
Indentures
Rules associated with a particular bond
How does sinking find provision effect a bond
Increases Safety on bond but can decrease the yield of the bond
Serial Bonds
Issue of bonds that have one issue date and staggered maturity dates…scheduled at regular intervals until the issue is paid in full
(This causes interest costs to issuer to go down progressively over the life of the bond)
Balloon Maturity
Bonds with a large amount of the issue that comes due at or near the final maturity date
Funded Debt (Does not include)
Corporate debt that Is due more than one year from the issue date and includes corporate bonds, notes and
bank loans
Does not include (preferred stock, government bonds, or municipal bonds)
Registered Form of Bond
Bonds are registered in investors name and interest payments are sent directly to investors through corporations paying agent
- All bonds are currently issued as this
- Principal is sent directly to owner at maturity
- To sell investor must sign the back of the registered certificate and deliver it to the broker-dealer
Bearer Form of Bond
Not registered in the investors name and have interest coupons attached
- Bonds are no longer issued in this form
Bonds with physical Coupons attached must be redeemed for interest
by…
Clipping coupons and presenting them to an authorized paying agent (usually a bank)
Registered “as to Principal Only” form of bond
Registered in the investors name with interest coupons attached
- No longer issued in this form
Book Entry Form of a Bond
Ownership is represented electronically (no physical certificate needed)
Most Bonds Today are in what form
- Registered on Book Entry Form (in investors name electronically)
Bond Rating Companies
Standard and Poors, Moody’s, and Fitch
NOT AM best they do insurance
Bond Ratings
(Investment Grade)- conservative investors seek AAA AA A BBB
(Speculative Grade) - bonds or issuer are questionable BB B CCC CC C DDD DD
Investment= Reputation for paying back interest and principal
Speculative= questions as to whether principal is paid back or interest is on time (high yield bonds, junk bonds)
Three Basic Categories of Bonds
- Corporate
- Government
- Muncipal
Yield of a Bond or (Yield to Maturity)
What does it take into account?
Actual rate of return an investor receives based on the price paid for the bond
Takes into account…purchase price, interest payments, and redemption value of bond
Bonds Purchased at a Discount (YTM Effect) (Yield)
Yield > Coupon Rate
Bonds Purchased on Par (effect on YTM)(Yield)
Yield = Coupon Rate
Bonds Purchased at a Premium (effect on YTM)(Yield)
Yield < Coupon Rate
Risk Effect on Yields for Types of Bonds
Higher Risk = Higher Yields
If a quotation is a % it represents…
Yield To Maturity quote style (YTM)
Key Differences in Types of Bonds (refer to chart in images) (reference flash card)
Go through a couple times
How much do you get @ maturity on a bond
Par Value no matter how much you paid!!
What is hearing just “yield” a reference to
Yield To Maturity or Basis
What is Yield To Maturity used interchangeably with
Basis
Nominal Yield
Coupon rate or interest rate of the bond
Current Yield (and formula)
Actual income the investor will receive (snapshot)
OR
Annual Interest Payout/ Market Price = Current Yield on bonds
Yield To Maturity (Basis)
Long term yield on a bond that is expressed as an annual rate (big picture) (considers time remaining till maturity)
Biggest difference between YTM and Current Yield
YTM considers time remaining until maturity and current yield does not
What is the market price decrease effect in YTM
Increases b/c what you put in your pocket over the long term is going up as the price of a bond goes down
What is the effect of a market price increase on YTM
Yield To Maturity goes down (as you pay more for the bond the less you put in your pocket)
What type of security are bonds and preferred stock?
Fixed Income Securities
What happens to market price of a preferred stock or bond when interest rate increases?
Decreases?
It moves in the opposite direction
Changes in Yields are measured in?
And that is equal to…
Basis Points
Equal to 1/100th of a point (.01% of the 1000 par value)
Change of 1% in Yield is equal to __ basis points
100 basis points
Bonds trading at a discount will always have a basis that is ____ than the coupon rate
(Think Inverse Seesaw)
Higher
Bonds trading at a premium will always have a ____ Basis (YTM) than the coupon rate
(Think Inverse Seesaw)
Lower
Bonds trading at par will always have a Basis (YTM) that is ____ as the coupon rate
The same
Short Term Bond Relationship with Interest Rate Changes
Quickest Reaction (reacts the quickest to interest rate changes)
Due to less interests payment until bond maturity
Long Term Bond Relationship with interest Rate Changes
Greatest Reaction (Reacts the greatest to interest rate changes)
Due to more interest payments until bond is matured
Risk Comparison of Long Term and Short Term bonds
Short Term bonds are considered to be safer and more stable of an investment
While
Long Term bonds carry more risk than short term bonds
(Due to the length of time it’s effected by interest rate changes and other things)
Duration when it comes do bonds is…
What does a “duration of 5 mean”?
A measure of the sensitivity of a bonds market price to changes in interest rates
Bond with a duration of 5 will have a price movement of 5% for every 1% of movement in interest rate
I’m bond trading “M” means…
5M meaning?
“M” is the Roman number for 1,000 and is used to signify the dollar value of a quantity of bonds
5M= $5,000 worth of bonds
Corporate Bonds are…
An instrument of debt issued by a corporation (bond issued by a corporation)
Does not make bondholders equity owners
Tax on corporate bonds
Fully taxable at the federal, state, and local level
Most Corporate Bonds are traded
Over the Counter as a dealer/principal transaction
(OTC means not being traded on the physical exchange floor)
(dealer principal means the dealer works into and out of their own inventory not act as a middle man)
Corporate Bonds are quoted in…
Points and 1/8ths of points as a % of Par
Dollar Value Of A Corporate Bond Is
Formula
Quoted Price X $10
A Leveraged Buy-Out is…
The takeover of a company using borrowed funds
Generally the assets of the target company are used as a security for the loans
A “Spin-Off” is…
A corporate divestiture that results in the subsidiary of a company becoming an independent company operating on its own
(Subsidiary to independent)
A Holding Company is…
A corporation that owns enough of the voting shares of another corporation that it can influence that companies:
- Policies
- Management
- Board Of Directors
Trust Indenture Act Of 1939
What must the issuer do under this act?? (Who does it protect)
Requires that Corporate bonds and debentures be issued under an “indenture” or “deed of trust”
(This indenture specifies the rights and duties of the issuer, underwriter, and investor)
Under this act… issuer is required to appoint a trustee who will represent and protect the BOND HOLDERS and their interests
The Trust Indenture Act of 1939 does not regulate
- Federal Government Issues
- Municipal Issues
- Private Placements
- Unit Investment Trusts (UITs)
What is a secured bond?
Bonds that are more conservative investments…that are secured by a guarantee or collateral
Types Of Secured Bonds (5)
Mortgage Bond Equipment Trust Certificate Collateral Trust Certificate Guaranteed Bonds Parity Bonds
Mortgage Bond
Closed-End, Open-End, General
Bond (instrument of debt) secured by a mortgage on the real property (and sometimes even the underlying property) owned by the issuing corporation
(Largest type of secured securities)
Closed-End = property used to secure the loan can not be used as collateral for future loans unless lesser in claim
Open-End = Property used to secure the loan can be used as collateral for future loans and all debts hold equal claims against assets (creates more risk and higher yield)
General = names all mortgageable properties as collateral guy does not name any specific lots
Equipment Trust Certificate
(What are they secured by?)
(what happens to the title?)
(What happens in default)
Instruments of debt (bonds) issued by transportation companies to purchase new equipment
Secured by the new equipment (rolling stock of the issuing corporation such as railroad cars, shipping containers, and trucks)
Title is held by Trustees until the bonds are completely paid at maturity
In default bondholders have first rights to titles of equipment
Characteristics of Equipment Trust Certificates (3)
- Usually Not Callable
- Issued in Serial Form
- Rarely ever default (b/c defaulting would cause them to lose equipment they need to operate)
Collateral Trust Certificate (what is securing)
(Where are they placed)
(Generally used by/for)
An instrument of debt issued by a company that uses securities (stocks/bonds) of OTHER corporations that the issuer owns as collateral
Securities used are placed on deposit with a trustee
Generally issued by parent corporations that use the securities of a wholly owned subsidiary as collateral
Guaranteed Bonds
Most common example
Bonds guaranteed by a company other than the issuing company
A parent company might guarantee the debt of a subsidiary company
Parity Bonds
Bonds issued that have equal claim or rights as other bonds which were previously issued (Open-End Mortgage Bond is an example)
Debenture & Subordinated Debenture
What’s kinda of debt are they
An instrument of debt backed by the “good faith and credit” of the issuing corporation only
Subordinated Debenture is a debenture bond which holds a lesser or “junior” claim than other debenture bonds…therefore they would be paid only after higher level debenture claims have been satisfied
(Unsecured Debt!!)
Income, Junk, and Fallen Angel bonds are considered ____ investments and why?
Risky Investments because they represent the lack of a solid credit record or the financial distress of the issuer
(Therefore they generally offer a higher coupon rate)
Higher Coupon Rates on bonds are generally related to…
Less safety or more risk
The opposite is true of Lower coupon rates to more safety and less risk
Junk Bonds/ High-Yield Bonds
What range are they rated in?
Volatility and Yield comparison to the other range of bonds?
Used to finance what on occasion?
Issued by companies without a long track record of sales and earnings OR companies with questionable credit strength
Bonds Rated in Speculative Rating (BB or lower OR not rated at all)
(Investors prefer “high yield” to “Junk” (High Yield, Higher Coupon Rate))
More Volatile with Higher Yields than investment grade
Sometimes used to finance corporate takeovers
Fallen Angels
Bonds that were once issued as “investment grade” but have been downgraded to a “speculative grade” rating such as a “Junk Bond”
Yields & Market Prices comparison for High Quality and Low Quality Bonds
High Quality = Lower Yields, Higher Market Price
Low Quality = Higher Yields, Lower Market Price
Income Or Adjustment Bonds
What is their promise?
Characteristics….
Often issued by companies in financial difficulty trying to avoid bankruptcy (riskiest type of corporate bond)
Promise to Pay interest ONLY with sufficient earnings and if the board of directors declares interest will be paid.
…Principal is still due at maturity
…these bonds trade “flat” meaning without accrued interest
…called adjustment bonds when used for corporate reorganization
…considered risky (the riskiest corporate bond)
Zero-Coupon Bonds
Bonds sold at a deep discounts and pay NO interest while the bonds are outstanding
Zero Coupon Bonds do not pay semi annual interest therefore…
They do not have “accrued interest” which would be paid out at the time the bond was purchased or sold
The discount of a Zero Coupon Bond is representative of…
The amount of interest that the bond would pay (no interest is paid during the life)
Accretion represents…
The amount of “imputed interest” or “implied interest” which has accumulated on a bond purchased at a discount
To Calculate Accretion one would use…
4 yes and 1 no
Purchase Date
Purchase price
Dated Date (the date for a new bond issue from which interest accrues)
Maturity Date
DOES NOT use current market value of the zero coupon bond (current market value is a reflection of market conditions and not gonna be a direct reflection of amount of accretion)
Zero Coupon Pays ____ at maturity?
What does payment include?
One Lump Sum
Including investors Initial Investment plus imputed interest (interest that has accreted)
What does “Phantom Income” mean when it comes to Zero-Coupon Bonds
Bondholders are taxed annually based on the increased value of the security (even though they have received no actual income)
Ex. Bought a zero coupon bond at 750 and it matures after 5 years at 1000….you are taxed annually on the 250 as it represents the interest that will be paid out over the 5 year period
Purpose of a Zero Coupon Bond…
Purchased by investors seeking accumulation of capital often for an upcoming project or goal
Ex. Parent with a child going to college in 5 years from now so you purchase a zero coupon bond with a 5 year maturity
What causes the high volatility of the market price of Zero Coupon bonds?
(3 things)
What does this mean for interest rate effect?
- Issued at a discount
- Do not pay interest semi-annually
- Accrete Value from imputed interest (not paid until maturity)
Interest rates effect zero coupon bonds more than regular interest or coupon bearing bonds
Why do interest or coupon bearing bonds offer more price stability than zero coupon bonds?
- Issued at or near par value
- Pay interest semi annually
- Market value does not reflect any imputed interest or accrued interest
Quote for a Zero-Coupon bond
What does “ABC zr 27” mean?
“ZR” in the quote
Zero coupon bond is generally identified with “zr”
ABC zero-coupon bond maturing in 2027
Callable Bonds
Bonds that can be “called” at the option of the issuer at a specified premium price after a specified date
What specifies the callable date and the price at which the bond will be called?
The “Call Provision”
Call Protection is..
What do bondholders want for interest rates and market price during this time?
The fixed time period where bonds may not be called by the issuer
Bondholders want interest rates to decline during this period AND prices to rise during this period
How does coupon rate of a bond effect the chance of it being called?
Why?
The higher the coupon rate the greater the chance the issuer will call the bond
the issuer can retire the higher interest bond with a new bond at a lower rate
Calling a bond is similar to…
Think house debt and car debt
Refinancing a house or a car loan to replace the current interest rate with a lower one
Bonds and Preferred stock may be ____ but common stock is never ____
Callable
Bondholder receives what when bonds are called?
What is the effect of this on the companies credit worthiness and it’s debt to net worth ratio?
“Call Premium” PLUS the accrued interest
Credit worthiness improves (less debt)
Debt the net worth ratio improves (decreases)
After “Notice of Call” but before the call is date investors may…
(What option do investors typically choose?)
Convert the bonds (if convertible)
Sell the bonds
Wait for the redemption date
(The option that puts the most money in their pocket)
Callable Bonds will usually trade at a lower price because…
Call features are undesirable to investors
How are bonds called in on a “partial call”?
On a random basis
Convertible Bonds
Bonds that can convert into shares of stock at the option of the bondholder
When would converting a convertible corporate bond into common stock be considered a taxable event??
When the stock is sold
More Options for the investor does what to price and/or coupon rate
Pay a higher price or accept a lower coupon rate (fixed interest rate)
Conversion Price is…
What does it tell you?
The specified rate bonds are converted at
Tells you how many shares of common stock the investor would receive upon conversion
Formula for shares upon bond conversion is…
(Par Value/Conversion Px) = Common Shares Received
Coupon Rate of a convertible bond is usually ____ than in non convertible bonds of the same quality
Lower (More Choice/Options)
Convertible Securities typically have a _____ volatile market value than non-convertible securities
Why?
More
B/c the value is tied more closely to the market value of common shares which fluctuate more than preferred stock values
Refunding Bonds (goes hand and hand with callable bonds but not always)
The sale of a new issue of bonds (at a lower issue rate) and the proceeds of it go to retire an outstanding issue (which is at a higher interest rate)
Therefore it’s generally done when there is a sharp decline in interest rates
What is a CMO or Collateralized Mortgage Obligation?
A bond that is secured by a pool of mortgage loans (mortgage backed security)
CMOs provide a secure income on a ____ basis
Monthly
The Principal of a CMO is paid back in…
Varying amounts/degrees over the life of the CMO
Interest in a mortgage is typically ____ loaded…what does this mean?
Front
You pay a lot more interest at the beginning of a mortgage than at the end
CMOs are considered ____ securities and why?
Derivative Securities….because the cash flow of the CMO is dependent on the performance of a pool of mortgages
Issuers of CMOs
(Who ISNT an issuer)??
Ginnie Mae
Fannie Mae
Freddie Mac
FHA Mortgage Loans
Conventional/Private Mortgage Issuers
(Sallie Mae)
Planned Amortization Class (PAC) is
PACs are CMOs which most resemble bonds because they have a sinking fund structure
Meaning investors will receive payments over a predetermined period with stable cash flow
PACs have companion bonds or (non pac bonds) which bear the risk
Less than average exposure to call risk
Pro-Rata means…
Divided according to an exact formula
CMO tranches generally pay investors ____
Monthly
Interest payments from a CMO are subject to ____ income tax
And how is it allocated to each tranche?
Federal, State, and Local income tax
Pro-Rata
Tranches are paid off ___ at a time in order of ____?
One
Maturity
A Z-Bond (Accrual Bond, Accretion Bond) is…
When do they revive cash?
The final tranche of a CMO
After other tranches are paid in full
CMO tranches with a variable rate of interest are usually measured to the ____
LIBOR (London Interbank Offered Rates)
CMOs trade ____ with ____ and ____?
Over the Counter
With Mark Ups
And Mark Downs
Credit Risk of CMO
Little or none…most are guaranteed by US government sponsored enterprises or agencies or have carried AAA ratings
(Riskier than Treasury Securities)
Interest Rate and Market Risk of a CMO
Decline/Increase of Rate
If rates decline, CMO prices will increase, mortgages will be refinanced and prepayment will occur
If rates rise, mortgages are typically held through maturity and lower rate CMOs may be less desirable than newer, higher rate CMOs
Implied Call Risk (Prepayment Risk) of CMO
The risk that principal will be returned sooner than originally anticipated
Caused by:
Sharp Interest Rate declines and increases in refinancing activities
Also may occur if mortgage holders pay off their loans ahead of schedule
Extension Risk of CMO
The risk that the maturity on the CMOs may be extended or end up longer than expected
Advertisements of CMOs must not contain ____ between CMOs and any other investments including CDs
Comparisons
Advertisements must prominently display ____
The final maturity date of the security
Advertisements must include a description of ___
The initial issue tranche
Agency CMOs are…
Securities guaranteed and/or issued by Fannie Mae (FNMA), Freddie Mac (FHLMC), and Ginnie Mae (GNMA)
Guarantees associated with agencies enhance the credit quality of CMOs
Ginnie Mae pass-through securities are comprised of FHA and VA mortgages that are guaranteed against default
Private CMOs are…
Who are they backed by?
Securities issued by private institutions (such as banks, investment banks, and home builders)
Backed only by the issuer of the product, not but any government guarantee (private label CMOs)
(Ratings based on collateral and issuer)
Collateralized Debt Obligations (CDO) are…
A structure debt security backed by a pool of assets (ABS) including mortgages, auto loans, corporate debt, and credit card debt
ABS= Asset Backed Security
(Tranches like a CMO but divided based on risk generally)
Treasury Bills (T-Bills) are… (usual max time)
Direct Short Term Debt obligations of the federal government (not longer than a year)
T-Bills are referred to as a ___ free investment and are Highly ____
Risk Free
Marketable
Treasury Bills are sold at a ____ at competitive bid ____ and redeemed at ____ on maturity
Discount
Auction
Par
Marketable but not redeemable means?
What can and can’t you do
You can sell the treasury bill on the secondary market but nobody can go to US government and redeem for face value
What are the available maturities for T-Bills? (5 different times)
(Can be listed in what instead)
1 month, 2 Month, 3 Month, 6 month and 12 month
Can be listed in weeks too
T-Bills offer the investor an ____ liquid investment of the ___ quality
Extremely
Highest
(US GOV can print more money if they need to)
Long term policy of investing in T-Bills long term would result in a ____ principal and a ____ fluctuating rate of return
Stable
Fluctuating
Return earned on ALL U.S. government securities is exempt from ____ and ____ income taxes but subject to ____ income taxes
State
Local
Federal
T-Bills are issued with a minimum denomination of ____
$100
T-bills are _____ callable prior to maturity and do not carry a ___ rate of interest
Not
Fixed
T-bill discounts are taxed as _____ to investors and NOT as a ____
T-Bills are quoted on a yield basis which means?
Interest Income, Capitol Gains
The discount from par
Treasury Notes, Bonds, and Tips are issued in minimum denominations of…
$100
Treasury Notes, Bonds, and TIPs pay a ____ rate of interest semi-annually which is only exempt to ____ income tax
Fixed Rate
Federal
For Treasury Notes, Bonds, and TIPs…Regular way settlement is ____ in the secondary market. Regular way settlement is ____ in the Primary Auction Market
T+1
T+3
Treasury Notes have maturities of ___ to ____ years and are ____ issued as callable
2-10
Not issued as callable
Treasury Bonds have maturities of ____ to ____ years and ____ be issued as callable
10-30 years
May be callable
A point on a treasury note or bond is equal to ____ and fractions of points are quoted in ____
$10
32nds
TIPs (Treasury Inflation-Protected Securities)
Bonds who’s interest and redemption payments are indexed to the current inflation rate based on the CPI
Fixed Rate of a TIP is not applied to the par of 1000 but to ____
The inflation-adjusted principle value of the bond
Principal for a TIP is adjusted to CPI _____
Semi-Annually
Final Payment on a TIP can’t be ___ than the investor originally paid
Less than (no deflation)
Appreciation on the principle value of the TIP must be reported ____
Annually
TIPS are auctioned in ____, ______, ______
July, October, and January
STRIPS (Separate Trading of Registered Interest and Principal Securities) or Treasury Receipts or Zero Coupon Treasury Bonds or Stripped Treasuries
Offer investors the ability to purchase certificates which represent a portion of a trust with treasury bonds as the underlying security
(Trust buys a large quantity of treasury bonds, strips the coupons and then offers certificates or receipts with varied maturities to investors)
Treasury Receipts are _____ treasury bonds
Stripped Coupon
STRIPS trade at ____ which are accreted and taxed annually and are very volatile
Deep Discounts
All interest on STRIPS is paid ____
At maturity
Purchasers are able to lock in a rate of return for a pre-determined period (Example of this)
A 20 year US treasury bond is transformed into…
40 semi-annual interest payments
And the final principal payment
Therefore 41 separate Zero Coupon treasury receipts are created
Interest and Principal payments on the stripped bonds are ____ by the US Treasury and therefore are of the highest quality
Guaranteed
Interest on Treasury Receipts is taxable ____ on accrual even though the investor receives only one payment at maturity
Annually
Individuals normally purchase treasury receipts for retirement plans such as ____ and ____ that have no current tax liability
IRA’s and Keoghs
Regular Way settlement for US Government Securities in the secondary market is and payment is normally required in ____
T+1 (business day after trade date)
Federal Funds
Series EE Savings Bonds
Non-Marketable Federal Government debt (can not be traded in secondary market)
Series EE Savings Bonds are issued at ____ and earn interest. Interest received is taxed when the bonds are ____. They are offered in denominations of ____ to ____ (max per calendar year limit)
Face Value
Redeemed
$25 to $10,000
Series EE Savings Bonds are ____ registered in the investors name. They are ____ (must be redeemed back to government) and ___ subject to market fluctuations (no secondary market)
Electronically
Non-Marketable
Not
Series EE Savings Bonds are ____ prior to maturity after one year and are ____ eligible to be used as collateral for a loan because they are not marketable
Redeemable
Not
Fannie MAE (FNMA), Freddie Mac (FHLMC), and Ginnie MAE (GNMA) are government sponsored corporations that profile financing for the housing market
They….
Buy Mortgages from lenders
Put the mortgages into pools
Offer Securities to the public which are backed by the mortgages in the pool
Agency and Sponsored Issues are considered ____ risk investments. And outstanding shares are available in ____ form or ____ form with interest coupons attached.
New issues of these issues are not available in ____ form
Low Risk
Registered Form
Bearer Form
Bearer
Government Agency Issues are not ____ obligations of the US government but they are ____ obligations of the agencies themselves
(The exception is….)
Direct
Direct
(Ginnie Mae which is guaranteed by the federal government)
(3 G….Ginnie, Gov’t, Guaranteed)
Government Agency and Sponsored Issues are quoted in ____ as a % of par value.
Are considered to be ____ assets for banks
Are exempt from registration requirements of the securities act if 1933
And generally have ____ yields than direct obligations of the US government
32nds
Non- Risk
Higher
Municipal Bonds are…
Bonds issued by state and local government entities such as cities, counties, school districts, authorities, and the state
Interest in a municipal bond is exempt from _____ income taxes and may also be exempt from _____ and _____ income taxes
For exam purposes they are ____ exempt from all taxes
Federal
State and Local
(Fully)(Tax Free)
General Obligations Bonds are…
Are also called “_____”
Bonds that are a general obligation of the issuing municipality (state, county, city, school district, etc.)
“Full faith and credit bonds”
Payment of principal and interest with general obligation bonds is not limited to the revenues derived from ____.
The payments of Principal and Interest are secured by/from ____ collected by the municipality.
Most states require ____ to issue G.O. bonds.
Any one specific project
Taxes
Voter approval
Revenue Bonds are…
They ___ require a vote of the citizens
They ___ count towards any constitutional or statutory limit on the amount of debt a municipality may incur
They are ____ payable from taxes and will ___ contribute to any possible future increase of taxes
Bonds where the payment of bond interest and principal depends on revenues generated from a particular facility (such as a toll road or bridge, rather than the taxing powers of a city or town)
Do Not
Do Not
Not
Not
Industrial Development Bonds OR Industrial Revenue Bonds
This enables the company to borrow at ____ rates
Interest and Principal is payable solely by ___
The companies for whom the bonds were issued are ______
Substantial users may be ____ if they buy the bonds
The municipality approves the sale of bonds on “behalf of” a corporation to construct or purchase facilities that are then purchased by or leased to a private user
Tax Free
The Company
Responsible for the debt
Taxed on interest
Taxable Equivalent Yield shows
The comparable returns on corporate and municipal bonds
Taxable Equivalent Yield Formulas
(Municipal Yield to Corporate Equivalent)
CROSS MULTIPLY TO GET TO THE OTHER
(Corporate Yield to Municipal Equivalent)
1) Municipal Yield / (100%-Investors Tax Rate) = Corporate Equivalent Yield
CROSS MULTIPLY TO GET TO THE OTHER
2) Corporate Yield X (100%-Investors Tax Rate) = Municipal Equivalent Yield
Alternative Minimum Tax (Designed for, applied to)
What muni bonds can it apply to?
Designed to make sure that even the wealthiest individuals, trusts, estates, and corporations pay some income tax
Is applied to “Tax Preference” items
May be applied to some muni bonds which are issued for private industry purposes such as waste management companies which provide a public service
The Official Statement (OS) is…
What must happen if provided? Or doesn’t have to happen if not?
The disclosure document that can be provided by the issuer and is like a prospectus (it is not required)
(Contains the most detailed financial information on a new issue of municipal bonds)
Must be provided to all customers who purchase the new issue and be provided to broker dealers upon request
If not provided broker dealers do not need to provide it to purchasers of the bond or other broker dealers
Negotiated Deals is…
Underwriting agreement does?
The municipality hires a managing underwriter to handle the distribution of a new issue of revenue bonds
Describes terms and interest costs for the offering which are negotiated directly between the municipality and the managing underwriter
Competitive Bidding is…
Bonds are awarded to…
Net Interest Cost is (NIC)…
How to determine NIC
The municipality requests sealed bids from underwriters or underwriting syndicates
Bonds go to the group that offers the municipality the lowest net interest cost
NIC is the total amount of interest that the municipality will pay on the bond issue
Any premium over par that is received when the bond is sold is subtracted from the interest cost on the issue
Most General Obligation bonds are awarded on the basis of ____
Competitive Bidding
Issuers are also interested in knowing the “_____” because it considers the time value of money, whereas net interest cost does not
True Interest Cost
Municipal Notes
Short term debt instruments for temporary or interim financing
Tax Anticipation Notes (TAN) are…
Used to raise monies which will be paid off with tax receipts in the near future
Revenue Anticipation Notes (RAN) are…
Raises monies which will be paid off when certain revenues are realized or received
Tax & Revenue Anticipation Notes (TRAN) are…
A combination of a tax and revenue note
Bond Anticipation Note (BAN) are…
Used to raise money which will be paid off from the sale of bonds in the future
In the meantime it will issue notes to carry it through until the long term bond revenues are received
Grant Anticipation Notes (GAN) are…
What are they dependent on?
Grants received by municipalities from the federal government generally from the “federal transit authority” program for the purchase of buses, trains, ferries, vans and support equipment
Congressional Appropriation
Other Types of short term obligations of a municipality include… (3 kinds)
Construction Loans Notes (CLN)
Demand Notes
Tax-Exempt Commercial Paper
Construction Loans notes are…
Notes typically issued to fund housing projects
Demand Notes are…
Used for short term financing that are callable on demand
Tax Exempt Commercial Paper is…
What are its uses (3) and what is it NOT used for (1)
“Paper” that is issued for a max of 270 days (short term)
- Raise Working capital
- Cover extraordinary expenses
- Cover construction or maintenance costs
NOT USED to refund outstanding bonds (you’d want long term bonds to refund those)
Build America Bonds (BABs)
Can not be used to refinance _____
Interest payments are ____ to investor
Interest paid by the municipality is subsidized either by the federal government paying back ____ of paid out interest or the bondholder may take a federal tax credit equal to ____ of the interest expense
Expands the market for municipal bonds to ____ plans and ____ investors
Taxable Municipal bonds issued for infrastructure rebuilding
Outstanding debt
Fully Taxable
35% and 35%
Pension Plans, Foreign Investors
Municipal Fund Securities include…
Local Government Investment Pools (LGIPs), ABLE Programs, and 529 Plans
Local Government Investment Pools (LGIPs) are…
A form of fund that is created under individual state law to allow smaller government entities, such as cities and counties, to pool assets in order to achieve better diversification, portfolio management, lower costs, and still provide liquidity to contributing entities
Exempt from registration with SEC providing flexibility but reducing level of protection for investing entities
MSRB political contribution limits (MSRB Rule G-37) does what?
“Official of the issuer is”
Governs political contributions made by municipal finance professionals, municipal dealers, or political action committees controlled by the broker-dealer or MFL to officials of an issuer
Any person (including election committee for such person) who was at the time of the contribution an incumbent, candidate, or successful candidate (even if they lose)
Contributions per MSRB can not exceed ____ per election and the municipal finance professional must be ____ in the election.
If a violation occurs the municipal dealer with whom the MFP is associated is prohibited from engaging in municipal securities business for ___ years with the issuer to which the improper contribution was made
Each municipal dealer must file a form ____ with the MSRB ____ with information about contributions to officials of issuers and political parties and bond ballot campaigns in excess of permitted contributions
$250/Able to vote
2 years
G-37/ Quarterly
Municipal Variable Rate Securities are…
Debt securities which have floating or fluctuating interest rates (rates usually reset at specified intervals but normally have a final maturity which is more than 10 years from date of issuance)
Municipal Variable Rate securities include… (3)
- Variable Rate Demand Obligations or Notes (VRDO) or “floaters”
- Floating Rate Notes (FRNs)
- Auction Rate Securities (ARS)
Variable Rate Demand Obligations and Floating Rate Notes can be offered with a ____ feature allowing the investor to sell security back to the issuer generally at full face value plus accrued interest.
Auction Rate Securities are NOT offered with a ____ feature
Put
Money Market Instruments are
High quality, short term (mature in 12 months or less) debt instruments
Money Market Instruments include (4)
Treasury Bills
Negotiable Certificates of Deposit
Commercial Paper
Bankers Acceptances
Treasury Bills are the ___ liquid off all money market instruments
Most
Negotiable Certificates of Deposit (CDs) are ___ deposits
Issued and guaranteed by ____
____ minimum deposits
Fixed maturity of ___ year or less
Usually trade ____ and are in ____ form
Penalties may be incurred if cashed ___ to maturity
Time
Banks
$100,000
One
“Plus Interest”….registered
Prior
Eurodollar certificates of deposit are short term instruments issued by banks ____ the US. Interest and principal is paid in _____
Outside
US dollars
Long Term CDs may have maturities of ____, _____, and _____ years
3,5,10
Commercial Paper is….
Commercial Paper is repaid from _____. Issued for a ____ amount and has a maturity date with a max maturity of ____ days.
It is ____ guaranteed by the FDIC (Federal Deposit Insurance Corporation)
An unsecured promissory note issued at a discount by corporations generally used to finance daily operations (not international trade)
Accounts Receivable, Specific, 270
Not
Bankers Acceptances are used to finance ____ trade and are similar to a letter of credit
They are the ____ liquid of all money market instruments
Foreign
Least
Exchange Risk is associated with ____ and ____ debt issues but NOT ____ or ____ debt issues
Foreign/Sovereign
US/Domestic
