Chapter 3 Bond Basics and Terminology Flashcards
What is a bond?
is essentially a loan between the lender/creditor, or investor, and the borrower, or bond issuer. Issuer borrows money for a fixed rate. (Fixed income security). Par Value = $1,000
What is Principal?
The amount of money borrowed.
Whats a Term Bond Structure?
Every bond has the same Interest Rate and Maturity Date
What is serial bond Structure?
Has varying maturities and interest rates
What is balloon Maturity?
Large amount of bonds maturing on a specific date
What is a Series bond?
Has varying dates of issuance all maturing on the same date
What is Coupon Rate?
- Bonds annual interest rate.
- Interest is paid semiannually
- Also known as nominal Yield
What is a Zero-Coupon Bond?
- Bonds that have no coupon and is discounted from par.
- Interest is paid at maturity and taxed annually.
-Taxed as ordinary income each year
What is accreted value?
- The value at any given time of a debt instrument that accrues interest over multiple years.
- (Basically asking what the current accumulated value is)
What is redemption?
It is the repayment of principal on the maturity date
(The principal amount + last semiannual payment)
What is considered short term?
A debt instrument with a maturity date of 2 years or less is considered short term.
What is considered intermediate term?
A maturity of 2-10 years.
What is early retirement?
Paid off the bond before stated maturity. This typically happens during periods of falling interest.
What happens when bonds are traded in the secondary market?
The change of ownership is recorded with the transfer agent.
When do Corporate and Municipal bonds accrue interest?
30/360 year
When does government bonds accrue interest?
Actual day/365
What is interest Rate Risk?
Investors with bonds that have coupons below the current rate must offer their bonds at a reduced price.
What is volatility?
Refers to the frequency and degree of interest rate and credit rating changes.
Most volatile bonds are deep discounted long-term bonds and zero coupon bonds.
What is bond quote?
1 point =$10
To calculate price multiple quote by $10.
Decimals are multiplied by $10
What does ABC 8s 2025 was at 105 mean?
8% bond maturing in 2025 was traded at 105 ($1,050)
What is default risk?
The perceived risk of nonpayment or default.
What are the two most popular bond rating agencies?
Standard and poor’s and Moody’s
What is an Investment Grade Bond?
Very strong capacity to meets financial commitments
What is a Speculative Bond?
The issuer has an adequate vulnerable capacity to meet its financial commitments
What are bond Yields?
The benefit received from holding a bond
100 basis points represents a 1% interest rate change
What is Nominal Yield?
- is the stated return, or coupon, rate that is printed on the face of the bond.
- 10% nominal yield pays $100 in interest per year (10% of $1,000).
What is the current Yield?
- The annual return the investor can expect to receive from a bond
- Current Yield = Annual Interest ÷ Current Market Price
What is Yield to maturity?
- Computes the investor’s expected annual return over the life of the investment
- Yield to Maturity= (Annual Interest + Annualized Gain OR - Annualized Loss)/ (Purchase Price + Redemption Price)/2
What is Yield to Call (YTC)
Computes the expected return when called back
What relationship does yields and Prices have with each other?
They have an inverse relationship
Par= (CY,YTM, YTC)
Premium < (CY, YTM, YTC)
Discount > (CY, YTM, YTC)
What are Corporate Bonds?
Debt instruments issued by a corporation and sold to investors
- Source of capital
What is a Trust Indenture?
- Legal agreement outlining the terms of the loan between the corporation and the bondholders.
- Compliance with Trust Indenture Act of 1939 (anything over $5,000,000 and 1 year or greater)
What are Secure Bonds?
Backed by specific collateral to reduce the risks associated with lending
What are Mortgage Bonds?
Bonds backed by corps real estate
What are Equipment Trust Certificates?
Secured bonds backed by equipment
What is a Collateral Trust Certificate?
bonds backed by another company.
What are Debentures?
Unsecured Bond
- Backed by the general creditworthiness and reputation of the issuer
What are Subordinated Debentures?
Unsecured Bonds
- They have a secondary claim in the event of bankruptcy. Have high interest rates
What is a Guarantee Bonds?
Unsecured Bond
- Backed by the promise of the issuer + parent company.
What’s a High Yield Bonds?
Unsecured Speculative Bond
- Just has a high default risk.
Whats an Income Bond?
Unsecured Bond
- Corp coming out of bankruptcy. Not obligated to make interest payments
Whats a convertible bond?
Bonds that can convert to common stock.
Typically accept a lower coupon on the bond during conversion
What’s a Call Feature?
- Allows the issuer to end the contract early
- Call protection between the issue date and the first potential call.
- Must be at or above face value
Whats a Call Risk?
- Interest rates in the market goes down.
- Bondholder might be forced to accept a lower coupon rate on a new investment
Whats a Put Provision?
Allows the bondholder to sell the bond back to the issuer at par value on specific dates
What is a Treasury Bill?
Short term debt securities with maturities of 1 year or less.
- Issued at discount
- Maturities of 4, 13, 26, or 52 weeks
- For conservative investors with short time horizons
What a Treasury Note?
Government debt securities that mature in 2-10 years
- Pay semiannual interest income (federally taxable)
Whats a Treasury Bond?
Government debt instruments with maturities greater that 10 years
- Pay Semiannual interest income (federally Taxable)
Whats T-STRIPS?
Zero coupon instruments backed by the U.S. government.
-Maturity up to 30 years
- Earn phantom or imputed interest
What are Treasury Receipts (T-Receipts)
Zero coupon security backed by the interest and principal of treasury securities
- Not of direct obligation o the U.S. Government
What is a Treasury Inflation Protected Securities (TIPS)
Security where the principal amount is adjusted every 6 months based on CPI
- Pay Semiannual interest
What are Dutch Auctions?
Institutions that use a competitive bid system.
- The last yield that is accepted will be the yield that all accepted bids are awarded
What is the Government National Mortgage Association?
- part of the department of housing and Urban Development that originate mortgages.
-Only MBS that is guaranteed by the full faith, credit, and taxing power of the U.S. Government
What does the Federal National Mortgage Association do (Fannie Mae)?
Issues mortgage-backed pass through securities comprised of conventional and insured mortgages from other agencies
- Not backed by the U.S. Government just sponsored
What does the Federal Home Loan Mortgage Corporation ( Freddie Mac)?
Issue mortgage backed pass-through securities comprised of residential mortgages issued by financial institutions
What is Collateralized Mortgage Obligations?
A pool of mortgages that divides interest and principal into separate classes called tranches
- Designed to provide the investor with greater predictability of interest and principal payments
-Based on Average Life method.
What’s an asset-backed security?
Form of pooled fixed-income investment.
- Auto loans, credit card debt, and consumer loans
- Typically only for institutional investors
- To take advantage of high rates
What is Prepayment Risk?
The principal is paid back by lenders ahead of schedule.
- Occurs when interest rates decline in the market
What is Extension Risk?
A risk that the principal will be paid back at a slower rate.
-When Interest Rates in the market rise
What are Municipal Bonds?
Debt instruments issued by state and local governments. Federally tax exempt - through the opinion of legal counsel
- Interest rate may appear lower. The next interest payment occurs 6 months later.
- In the book-entry form
- Pay semiannual interest
What are General Obligation Bonds?
Bonds are issued by a state, counties, cities, and other political subdivisions. Voter approval is required.
- Backed by the issuer
- Considered very safe (the issuer can increase taxes to help repay the bondholders)
What are Revenue Bonds?
Finance specific projects (Toll roads, parking stuct.) Does a feasibility study to determine if funding is enough.
-Self-supporting (revenue generated from the project)
What are Double-Barreled Bonds?
Bond backed by two or more sources of repayment.
- Revenues generated from an income-producing facility and the full taxing power of the municipality.
What are Moral Obligation Bonds?
Bonds requested to local government entities to help pay debt services
What re Industrial Development Revenue bonds?
Private activity bonds and are a type of revenue bond issued to finance the construction of a commercial facility that will be leased to a private entity.
-Could be subject to federal income tax
What is Variable Rate Securities?
Long term debt issues with interest rates that are reset at specific intervals or after specific event has occurred
- Maturities are more than 10 Years
- Less sensitive to price movements
What are Variable Rate Demand Obligations (VRDO)?
Long Term municipal bonds that are created with market funds and tied to money market rates.
- Has floating rates and reset
- $100,000 minimum
What are Auction Rate Securities?
Long-term investments that offer liquidity on specified interest reset dates.
- Reset on every 7, 14, 28, 35 days
- Hold at market
- lowest bid wins and establishes the current rate
- Liquidity Risk
What are Municipal Notes?
Short term debt obligations.
- Maturities from 3 months to 3 years
Tax Anticipation Notes (TANS)
Issued with the expectation of future tax revenues from property taxes.
Revenue Anticipation Notes (RANs)
Used in anticipation of receiving actual revenue from an enterprise at a future date
Tax and Revenue Anticipation Notes (TRANs)
A single issue that expects a future stream of a combination of taxes and revenues to pay off the notes
Bond Anticipation Notes (BANs)
Issued ahead of an expected long-term bond issue
Tax Exempt commercial Paper
A promissory note issued by municipalities, backed by a line of credit from a commercial bank.
- Matures in 270 days
Tax Equivalent Yield
To compare the after-tax return of the different bonds
Tax Equivalent Yield= Interest on Municipal Bond / (100% - Tax Bracket)
Net Yield = Interest on Corporate Bond x (100% - Tax Bracket)
What is EMMA (Electronic Municipal Market Access System)?
Website to find valuable information
Municipal Advisor
Will act in a fiduciary capacity for the state or local government, assisting in developing the plan of finance and the related transaction
- Provides advice, selection of underwriter, and underwriter compensation
Bond Counsel
Group of lawyers to provide an objective legal opinion on bonds.
Underwriter
Primary role is the distribution of securities to investors through an arms length arrangement with the issuer.
- Obtains funds and provides them to issuers at closing.
-
Underwriting Counsel
Represents the underwriter in the offering with legal needs.
Underwriting Syndicate
Under managing underwriter, additional underwriters are contracted to assist in the distribution of the bonds to investors.
Competitive Bid
The new Issue of bonds goes up for bid among underwriters, and the lowest interest rate bid wins.
Money Market Securities
Short term debt instruments maturing in one year or less.
- Highly liquid
Commercial Paper
short term debt instrument issued by a corporation to help finance accounts receivable and seasonal inventory overages.
- matures 270 days
- Minimum face value of $50,000
Bankers Acceptances
debt securities used to finance foreign trade.
-Sell debt to bank as a letter of credit
Negotiable Certificates of Deposit (CD)
- This is to attract deposits outside of client bases
- Minimum denomination is $100,000
- Maturity is less than 1 year
Eurodollars
U.S. Dollars deposited in banks outside the United States
Which of the following allow bondholders to sell their bonds back to the issuer at par value prior to maturity?
Bonds with put provisions
