Chapter 2 Debt Securities Flashcards
Convertible bond price movement compared to stock
if a bond is convertible into common stock, the price of the bond will tend to move with the price of the stock. When the underlying stock increases the yield on the bond will decrease. (as bond prices increase bond yields decrease)
What would a company use to stabilize cash flow
Commercial Papers- this is unsecured short term corporate debt which has a maximum maturity date of 270 days
Bonds par value
$1000
Bond, coupon rate
Fixed rate percentage of par paid semi annually
Maturity Date
The date at which a bond comes due, The principal (par value) is generally repaid to the investor on the maturity date.
Series Bonds
Have different issue dates and usually the same maturity date. Used to fund different parts of a single project
Term Bonds
An entire issue of bonds that all have the same maturity date
Sinking Fund
Money will be set aside to repay the loan later. This is a provision of the stock and will increase the safety of paying it back therefore it will lower the yield (interest rate)
Serial Bonds
one issue date and multiple maturity dates
Balloon Maturity
a bond issue with a large amount of the issue that comes due at or near the final maturity date
Funded Debt
CORPORATE DEBT- must be due more that 1 year from issue date. Includes corporate bonds, notes and bank loans.
Does not include preferred stock, government bonds or municipal bonds
Registered Bonds
Bonds registered in the investor’s name and interest payment are sent directly to the investor by the corporation’s paying agent.
All bonds are currently issued as registered
Interest is paid directly to the investor
Principal sent directly to the owner at maturity
Bearer Bonds
Not registered and have coupons attached to the bond. To receive interest, investor must clip the coupon and present them to an authorized paying agent ( typically a bank). US bonds are no longer issued this way
Registered “as to Principal Only”
Investors name with coupons attached. Must present coupons to receive interest. US bonds are no longer issues in this form
Book Entry Form
Most bonds are held in this form
Ownership is represented electronically
Bond Ratings
AAA-highest rating
AA
A
BBB- lowest investment grade
BB- highest speculative grade
B
CCC
CC
C
DDD
DD- lowest rating
Bonds Ratings companies
Standard and Poor’s
Moody’s
Fitch
A.M. Best is not a bond rating agency (rates insurance companies)
Bond Maturities
Short term- 1-3 years
Medium term- 4-10 years
Long term- greater than 10 years
Accrued interest by type of bond
Corporate and Muni- 30 day calendar and 360 day year
Federal- calculated on actual days, 365 calendar days year
Coupon Rate
Fixed rate of interest that is paid to the investor based on the $1,000 bond value
Bond Yield
Takes into account the purchase price of the bond, interest rate and redemption value
Nominal Yield
Coupon or interest rate on the face of the bond
Current Yield Formula
Annual interest/market Price
This is a snap shot of gains right now
Yield to Maturity
Big Picture. This show the overall gain of the bond
takes into account purchase price, redemption value, coupon rate and time to maturity
Change in yield of a bond, basis point
1 basis point is equal to 0.01%. a change of a 1% for a bond is 100 basis points
Short term bond characteristic
React quickly to interest rate changes but do not change as much. therefore they are considered safer and more stable
Long Term Bonds Characteristics
React slower to interest rate changes but will have a greater change. This causes them to carry more risk then short term bonds
Duration
is a measure of the sesitivity of a bond’s market price to changes in interest rates. ie a bond with a duration of 5 will have a price movement of 5% for every 1% movement in interest rates
Bond Trading “M”
5M bonds would be 5 bonds or $5,000 worth of bonds not 5000 bonds each worth $1,000
Bond Quote example
6s of 28 @ 109
6% coupon rate
maturity of 2028
selling at 1090
Bond Settlement date
is 2 business days after the trade date
Accrued Interest appears on both confirmations
Added to the amount the buyer pays
Added to the amount the seller recieves
Accrued interest and basis
Accrued interest paid is not added to basis
it is deducted from interest received on the years taxes that interest is next paid
Bondholder and owners
Bond are a debt interest so the bond holder is not considered an equity owner
Corporate Bond interest taxes
Fully taxable to federal, state and local level
Corporate bond trading
Most are traded over the counter
Corporate bonds- Leveraged buy outs
A takeover company borrows funds and uses the assets of the company being taken over as collateral
Holding Company
When a corporation owns enough voting rights of another that it can influence the companies policies, management and board of directors
Trust Indenture act of 1939
Requires all corporate bonds must specified the rights and duties of the issuer, underwriter, and investor. Also the issuer must appoint a trustee to represent and protect the bondholder.
Act does not regulate:
Federal Government issue
Municipal issues
Private placement
Unit Investment Trusts (UITs)
Secured Bonds
Bonds secured by a guarantee or collateral of some sort
Mortgage Bonds
Secured bonds that a back by real property as collateral
Closed end
Open end
general mortgage bonds
Closed end- Can not be used as collateral for another loan unless the new loan has a lesser claim
Open end- All Debts have an equal claim on the collateral
General- A mortgage bond that pledges all mortgageable properties of a corporation as collateral but does not name a specific lot
Equipment Trust Certificate
Generally used by transportation companies (trains, airplanes, trucks) to purchase new equipment and uses the new property to secure the loan. Usually not callable, issued in serial form and rarely even default
Collateral Trust Certificate
Uses securities of another corporation that the issuer owns as collateral
Guaranteed Bonds
Bonds that are guaranteed by a company other than the company that is issuing them, typically a parent company
Parity Bonds
Bonds that have equal claims on assets as bonds that were previously issued. Similar to open end mortgage bond
Debentures
Debt obligation of a corporation backed only by the full faith and credit of the corporation itself and not by any specific asset of the corporation
Subordinated Debentures
holds a lesser or “junior” claim than other debentures
Fallen Angles bonds
Bonds that were originally issued as investment grade but have been downgraded to a junk bond rating
Zero Coupon Bonds
Bonds that sell at a large discount but do not pay semi-annual interest
At maturity they pay 1 lump sum
create “phantom interest that is taxed annually
Used for investors seeking to accumulate capital
are the most volatile of all fixed income securities
Zero Coupon bond example:
ABC zr 27
ABC- is the corporation
zr- is that it is a 0 coupon
27 - it matures in 2027
Callable bonds
A bond that is callable at the option the issuer.
Not a positive to investors (not good for investors on a fixed income)
The higher the coupon rate on the bond the more likely it will be called
Bond and Preferred stock may be callable, common stock is NEVER callable
Call Protection
a time period in which bonds may not be called by the issuer
When a company calls a bond…
Bondholder recieves a call premimum plus the accrured interest
The company’s credit worthiness improves (less debt)
debt to net worth ratio improves (since it decreases)
Prior to calling a bond, issuer must…
Give a notice of call that states the date the bond will be redeemed. The investor can then convert (if convertible), sell the bond, or wait for the redemption date.
Convertible Bond
Bonds that can converted to shares of the common stock at the option of the bondholder
Not taxable until the common stock is sold
Parity Calculation
Par Value/Conversion price=Common shares produced
Market price of bonds or preferred shares/common shares produced= parity of common stock
OR
Common Shares produced * mtk price of common shares= parity of bond or preferred stock
Par for bond = $1,000
Par for preferred stock = $100
Refunding Bonds
The sale of a new issue of bonds used to pay off (retire) and outstanding issue of bonds
Does not change capitalization since debt remains the same
Why refund bonds?
Sharpe decline on interest rates
To pay of convertible bonds to reduce the prospective dilution effect on common stock if they were converted
Collateralized Mortgage Obligations (CMOs)
a bond that is secured b a pool of mortgage loans. These are a mortgage-backed security
Historically has been a safe investment
pays income on a monthly basis
Often used by investors in a low tax bracket to supplement monthly income
Considered a derivative security
Issuers of CMOs
Ginnie Mae
Freddie Mac
Fannie Mae
FHA mortgage loans
Conventional/private mortgage issuers
NOT issued by Sally Mae
CMO Tranches
CMOs pay off 1 tranche at a time in order of maturity.
Z-Bond is the final tranche of a CMO and recieves no cash until earlier tranches are paid in full
CMO tranches that pay a variable interest rate are usually measured to the LIBOR
CMOs trade over the counter with mark ups or mark down
CMO Risk Considerations
- Credit Risk- Historically low since they are guaranteed by US government sponsoring agencies and have a AAA rating
- Interest rate/Market Risk- If rates decline CMO prices will increase, mortgages will be refinanced and prepayment will occur. If rates rise cmos with lower rates will be less desirable
-Maturity risk- implied call risk- risk the principal will be returned earlier than anticipated.
Extension risk- The maturity of the risk will be extended further then originally expected
CMO advertising
Must not contain comparison to CDs
Must prominently display the final maturity date of the securities
Must include a description of the initial issue tranche
Agency CMOs
CMOs guaranteed by Fannie Mae (FNMA), Freddie Mac (FHLMC) and Ginnie Mae(GNMA)
Ginnie Mae are comprised of FHA and VA mortgages that are guaranteed against default
Collateralized Debt Obligations (CDOs)
Structured debt that is backed by a pool of assets (including mortgages). Generally traded by their average life rather then stated maturities
Money Market
High quality, short term (12 months or less) debt instrument. Can be treasury bill, CDs, Commercial paper, or Banker’s acceptance
Treasury Bills
Most liquid of all money market instruments
Negotiable Certificates of Deposit (CDs)
Time deposits
Guaranteed by commercial banks
$100,000 minimum
Usually trade +interest (interest is added on top of the sold certificate price
Eurodollar CDs are used by banks outside the US but the interest and principal are paid in US dollars
(Not all CDs are short term can be 3, 5, and 10 years as well)
Commercial Papers
Unsecured Promissory note issued at a discount
Repaid from account receivables
Maturity maximum of 270 days
NOT FDIC INSURED
Bankers Acceptance
Used to finance foreign trade
Least liquid of al money market instruments
Exchange risk
Is associated with foreign and sovereign debt instruments, not US or domestic debt issues
