Chapter 5 - Bonds Flashcards
US Treasury Securities
- Nontaxable at state & local level
- Two kinds: nonmarketable & marketable treasury issue
*Exam Tip: Series EE Bonds are NOT marketable securities
Nonmarketable US Treasury Issues
Not easily bought or sold.
1) Series EE/Series E Bonds: Sold at FV $25 min & $10,000 max (annually & only online). Slowly increases value over 20yr period based on rate at time of purchase. Redeemable after 1yr but with 3 month int penalty if redeemed in < 5yrs. NOT marketable securities.
2) Series HH/Series H Bonds: Pay interest semi-annually. Not issued since 2004.
3) Series I Bonds: Inflation-indexed bonds. Sold at FV & no guarantee of return.
Marketable US Treasury Issues
1) US Treasury Bills: maturity < 1yr
2) US Treasury Notes: maturity between 2-10yrs
3) US Treasury Bonds: maturity > 10yr
All sold in denominations of $100 or more.
Original Issue Discount Bond (OID Bond)
Issued at a discount from par value
- Prime example: Zero-coupon Bond
Treasury Inflation Protection Securities (TIPS)
- Provide inflation and purchasing power protection/
- Coupon rate does not change. Principal/par value adjusts for inflation
Federal Agency Securities
- Agency bonds are moral obligations of the US Gov BUT
are NOT back by full faith & credit of the US Gov. - One EXCEPTION - GNMA’s (Gov Natl Mortgage Assoc)
Mortgage-backed Securities
GNMA - Government National Mortgage Association: each GNMA distributes interest and principal payments to investors
- biggest risk of MBS is falling interest rates. Mortgages could get repaid early, the bond retires early, and leaves investors with reinvestment problem
**Exam TIp: Agency Bonds are NOT backed by the full faith and credit of the US Gov. The exception to this rule is GNMA’s (Ginnie Mae).
GNMA bonds ARE backed by US Gov.
Corporate Bonds
Secured Bonds:
- Mortgage Back Securities
- Collateral Trust Bonds
Unsecured Corporate Bonds:
- Debentures: unsecured debt not backed by any asset
- Subordinated Debentures: lower claim on assets - riskier
- Income Bonds: interest only paid beginning at specific income attained
Bond Rating Agencies
1) Moody’s: Aaa - C
- Aaa are investment quality bonds
- Ba and below are junk
2) Standard and Poor’s: AAA - D
- AAA-BBB are investment quality bonds
-BB and below are junk
- the higher the bond rating, the lower the yield
Municipal Bonds (3 types)
Nontaxable bonds at federal, state (if living there), & local level.
3 Types:
1) General Obligation Bonds: backed by the full faith, credit, & taxing authority of the municipality that issued the bond
2) Revenue Bonds: backed by the revenue of a specific project.
NOT backed by full faith, credit, & taxing authority of entity who issued.
3) Private Activity Bonds: used to finance construction of stadiums
Insurance Company’s of Municipal Bonds: (if insured bond is in default, they will pay interest & principall)
- AMBAC: American Municipal Bond Assurance Corp
- MBIA: Municipal Bond Insurance Association Corp
*Exam Tip: General Obligation Bond is backed by the taxing authority of the issuing municipality
Corporate vs. Gov. Bond Risk
- US Gov. Bond Risk: NOT subject to default risk.
- Corp Bond Risk: Municipal bonds are considered to have default risk unless they’re insured
Corporate vs Municipal Bond
- Municipal Bond: debt obligation issued by a nonprofit organization, a private-sector corporation, or another public entity using the loan for public projects, such as constructing schools, hospitals, and highways
- Corporate Bond: debt issued by a company in order for it to raise capital.
Tax-Equivalent Yield & Tax-Exempt Yield (T.E.Y)
Tax-Equiv Yield: the yield a taxable, corporate bond would need to pay for the yield on a tax-exempt municipal bond to be equivalent to a taxable corporate bond.
Tax-Exempt Yield (TEY): the after-tax rate of return a taxable corp bond pays.
If bond is double or triple tax free, then combine Federal, State, and Local/Municipal income tax rates:
- If double-tax free: holder must live in state that issued muni
- If triple-tax free: holder must live in local municipality
*Formula provided on exam
Formula restated: TEY = (Corporate Rate) x (1 - Marginal Tax Rate)
