Chapter 2- Debt Securities Continued 16-25 Flashcards
US government and agency securities
How they are issued
Interest on gov securities is usually exempt from state and municipal tax
Largest borrower, best credit
Book- Entry Form= no physical security is issued
T-Bills
Short term debt issued at discount from par
Maturities of 4, 13, and 26 weeks and auctioned weekly
Example of a zero-coupon security
Treasury Notes
Pay interest every 6 months
Sold at auction every 4 weeks in denominations of $100-$5mm just like tbills
2 to 10 year maturity
Mature at par or are refunded meaning the investor receives a new security at different coupon
Traded in percentages of 1/32s
Example: Quote of 98.24 means 98.75%
Tbonds
10 to 30 years, interest every 6 months
$100-5mm
Sell same way as T-Notes
Treasury receipts
Created by brokerage firms, they are zero coupon bonds of US treasury notes and bonds
Not backed by US government
Can purchase receipts for any of the treasury payments or the principal
10yr bond would have 21 receipts available
STRIPS
Seperate Trading or Registered Interest and Principal of Securities
Backed in full by Us government
Similar in nature to a Reciept
Zero coupon bonds issued at deep discount
Treasury Inflation Protection Securities (Tips)
Fixed interest rate but the Principal is adjusted semiannually= to the amount change in CPI
Interest payment is equal to new principal times the rate
Sold at lower price
Taxable event when inflation is present
Government/private agencies that are able to issue debt securities
- Farmers Credit Administration
- Ginnie Mae (GNMA)
- Freddie Mac (FHLMC)
- Fannie Mae or FNMA
- Student Loans Sallie Mae or SLMA
Agency Issues
Higher yield than treasury obligations but lower than corporate
Mortgage backed issues are taxed at all three levels, others at Fed only
Quoted as a percentage of par and trade actively
Government National Mortgage Association (GNMA)
HIGHLY TESTED
Backed fully by government, for the department of housing and urban development
Purchase pooled mortgage loans as a security
Only backs single and multi family homes
Guarantees timely payments of monthly interest and principal
Issued with face of 25,000, but can be purchased at $1,000 minimums
Assumes repayment in 12 years and yield is stated as such
Risk associated with mortgage backed securities include prepayment and extended maturity risk, along with typical interest risk
Taxed at all levels
Example of pass through certificate and has significant reinvest risk
Farm Credit System (FCS)
Agricultural financing and credit
Raises loanable funds by selling securities
Offer discount notes, bonds and master notes ranging from 1 day to 30 years
Exempt from local and state taxes
Federal Home Loan Mortgage Corp (Freddie Mac)
Created secondary market for mortgages by packaging them into securities
Pass through security- passing interest and principal payments from mortgage holder to the investors
Two Types: Mortgage participation certs (pcs) and Guaranteed Mortgage Certs (GMCs)
Pcs= once a month Interest and principal are paid GMCs= Twice a year interest, once principal
Income is subject to All 3 tax levels
Federal National Mortgage (Fannie Mae)
Publicly traded corporation
Purchases insured mortgages from FHA and VA
Debentures, short discount notes, and mortgage backed securities
5k, 25k, 100k, 500k, 1mm
3-25 year maturity for debentures and sold in incriminates of 5000 over 10k, interest semiannual
Book-entry form
Student Loan Marketing Association
Issues discount notes and short term floating rate notes
Floaters have 6 month mature
Listed on market for trading at SLM
Interest is paid semiannually and exempt from state and local tax
Bidding for government securities
Two types of bids:
1. Competitive bids- Placed by primary dealers in US government securities. Usually large banks and are required to bid.
- Non competitive bids- Smaller banks, brokers, insurance companies, individuals
Always filled but usually pay the lowest accepted competitive bid (stop out price)
Dutch Auction
Though competitive and noncompetitive bids are made, the lowest price bid is what everyone pays
Make bids in yields
Stop out price is last bid accepted
When does settlement take place?
Thursday of that week for Tbills and Thursday of following week for tnotes
Accrued interest
Bonds are usually traded at price and interest
Starts accruing interest on the dated date
Seller will receive interest up to but not including the settlement date
2 methods to calculate:
1. 30 day month (All corporate/municipal)
Principal x interest rate x elapsed days/ 360
2. 365 day (all US gov bonds)
Principal X interest rate x elapsed/ 365
Settlement time
Settlement on a US gov bond is the next business day after a trade
The interest date is included as a day in both calculations
Never assume a leap year
Zero coupon, income bonds trade flat (no accrued interest)
Basics of a CMO
Asset backed security, usually auto loans
Are sometimes backed by government agencies so are highly rated
Structured in security classes called tranches
Repays principal to one traunch at a time
A CMOs yield and maturity is estimated by the Public Securities Association (PSA)
Cannot be compared to anything but itself
Plain Vanilla CMO
Pays interest to all tranches but only repays principal to one tranches at a time in $1000 increments
Principal only CMO (POs)
Sells at discount to par, market value is volatile
Value rises as interest rates drop
Income comes from principal payments and prepayments