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Securities Industries Essentials Exam > Debt > Flashcards

Debt Flashcards

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1
Q

What is the Purpose of the Federal Farm Credit System?

A

To provide funding to farmers, such as short-term loans for planting and harvest; intermediate term loans to buy equipment; and long term loans to buy land and buildings.

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2
Q

The US Government promotes home ownership through which agencies?

A

Federal Home Loan Banks (FHLB), Federal National Mortgage Association (“Fannie Mae”), Government National Mortgage Association (“Ginnie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”)

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3
Q

Which home loan agency is directly backed by the US government?

A

Ginnie Mae: Government National Mortgage Association

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4
Q

FHLB issues what types of bonds, to loan, funds to saving and loan institutions?

A

Discount Notes: short term, 1 year or less, minimum 100,00 face amount, and deliver a higher yield.

Callable Bonds / Non-Callable Bullet bonds: Fixed rate bonds with a 10,000 minimum face amount. Up to a 30 year maturity, with semi-annual payments.

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5
Q

What do Freddie, Fannie, and Ginnie mainly issue?

A

Mortgage Backed Securities - “MBS” i.e.: Mortgage Backed Pass Through Certificates

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6
Q

Mortgage Backed Pass Through Certificates

A

Government Housing agencies purchase mortgages from originating banks. Once enough mortgages are pooled they are divided in 25,000 minimum certificates.

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7
Q

Why do Mortgage Backed Pass Through Certificates have such a high minimum face amount?

A

To discourage small investors, who may not have a good understanding of the associated risks.

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8
Q

Prepayment Risk

A

A mortgage can be payed off before the set payoff date (Decreasing the payout length, and amount of interest earned), therefore the certificates maturity date is unknown.

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9
Q

The who and what of Fannie Mae

A

Buys VA and FHA guaranteed mortgages, as well as conventional mortgages from banks.

It’s a “Privatized” corporation

Due to is bankruptcy in 2008, it is now placed under government conservatorship.

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10
Q

The who and what of Ginnie Mae

A

The only housing agency directly owned and backed by the Feds.

Only buys government insured mortgages - FHA, VA, and Farmer’s Home Administration (FmHA).

Note! : It still pays Federal, State, and Local

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11
Q

Freddie Mac (FHLMC)

A

Only buys conventional Mortgages

Publicly traded

Placed under government conservatorship after its 2008 bankruptcy.

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12
Q

Sallie Mae

A

Student Loan Marketing Association

purchases insured student loans from qualified institutions.

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13
Q

How are government and agency securities traded? Who trades them?

A

Solely OTC

Primary dealers - Goldman Sachs, J.P. Morgan, Citigroup - Only designated once a firm has consistently purchased Treasury Securities, and then resold them.

Secondary dealers - Buy and sell treasuries in the market through primary dealers.

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14
Q

“Open Market Operations”

A

Fed reserve buys and sells large quantities of government securities from Primary dealers.

This is done to manage interest rates.

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15
Q

Fed Loosening

A

Purchases Treasury securities from primary dealers to help lower market interest rates due to banks now having more cash to lend.

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16
Q

Fed Tightening

A

Sells Treasury securities to primary dealers to raise market interest rates due to banks now having less cash.

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17
Q

What is the “regular way” settlement time for treasuries

A

1 business day after the trade date

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18
Q

Regular way settlement for agencies

A

depends, but usually settles “regular way” ( 1 business day)

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19
Q

Tax Status of US Government Debt

A

Only federally taxable

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20
Q

Agencies Tax Status

A

both state, local and federally taxable.

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21
Q

What does M stand for in Bonds

A

1000; 5M = 5000

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22
Q

Municipal bonds are exempt from what taxes?

A

Exempt from federal taxes. Exempt from state taxes, when purchased by a resident of the state.

BABs are the one exception. They are Federally taxable, but not state or local.

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23
Q

What does a bond council do?

A

The bond counsel examines the bond issue to make sure that it is legally binding on the issuer, is valid, and that the interest is exempt from federal tax under current law.

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24
Q

Unqualified opinion

A

Issuers want this opinion. It means there are no problems with the bond.

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25
Q

Level Debt Service

A

The combined annual payments of interest and the principal equal the same total amount each year.

Usually interest payments start high and decrease overtime, and vice versa for the principal payment.

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26
Q

General Obligation Bonds - GO

A

A bond that is backed by the full faith, credit, and taxing power of the issuer.

Type of tax depends on the issuer, local governments back their bonds with Ad Valorem (property taxes).

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27
Q

Limited Tax Bonds

A

A municipal bond that has a limit placed on the rate that the issuer uses to assess taxes.

Have a higher interest rate due to the associated risk.

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28
Q

Mill Rate

A

Ad Valorem taxes are assessed based in Millage.
one mill = 1/10th of 1 percent or .001
Roughly $1 for every $1,000 of property value

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29
Q

What taxes do most state level governments use to back bonds?

A

Sale and Income tax.

Note!: Ad Valorum is usually used on the local government level.

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30
Q

Constitutional Debt Limit on Municipal GO Bonds

A

The imposed debt limit on the dollar amount of GO bonds that can be issued. More cannot be issued if the municipality is at its limit.

Note!: People don’t want to be over taxed!

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31
Q

Capital Appreciation Bond (CAB) Hint: “with a twist!”

A

A municipal zero coupon bond where the amount counted against the issuers debt limit is the discount principal amount.

Note: This is a way for municipal governments to deal with the debt limit on GO bonds.

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32
Q

Parity Bond

A

A bond that has an issue of a later date has the same claim on tax collection as a bond from an earlier issue.

Note: A way to add more protection to a bond.

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33
Q

Revenue Bond

A

A municipality bond backed by specified revenue.
Example: Stadium, Water Treatment Plant, a Dam

A feasibility study must be done to show the need for the project the bond is funding, along with the economic viability of said project.

Usually issued under a trust indenture due to the higher amount of risk.

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34
Q

Bond Contract/ Bond Resolution

A

All municipal bonds are issued under a bond contract that the bond counsel produces - gives general information regarding the bond.

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35
Q

Lease Rental Bond

A

Issue used to finance office construction where the user is a STATE or CITY agency. The rents paid by the user are the revenue source and the user is generally obligated to appropriate the funds for the lease payments from general tax revenues.

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36
Q

Industrial Development Bonds - IDBs

A

Bonds issued by a state, city, or local agency to build an industrial facility that is leased to a private company.

Funded by the final users rent.

Considered the users liability and not the issuers.

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37
Q

Bond Anticipation Notes - BANs

A

A short term issue to kick-start funds for new projects, the bond being paid off, usually in 1 year, by a final long term bond issue.

Examples: building highways, bridges, or sewage systems.

Backed by the general obligation pledge of the issue.

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38
Q

Construction Loan Notes - CLNs

A

Issued to start the building of a multifamily housing projects, note is paid off with the placement of a long term bond issue.

Example of use: If a city experiences a boom in population, it may need to build additional housing quickly.

Typically 2-3 years in length, usually when interest rates are high, the borrower hoping the rate will drop by the time the take loan is issued.

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39
Q

Tax Anticipation Note - TANs

A

Issued in anticipation of future property (ad valorem) tax receipts; paid off from those receipts.

TANs are secured by the general obligation pledge of the issuer.

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40
Q

Revenue Anticipation Note - RANs

A

Issued in anticipation of future revenue collections from a project. Lenders are paid with revenue generated by that same project.

Example: Stadium renovations or recreation center improvements.

Note: Is usually used to pay for federal highway funding while waiting for those funds to arrive, instead of a GAN

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41
Q

Tax and Revenue Anticipation Notes TRANs

A

Issued in anticipation of both future tax collections and revenue collections. This is really a combination of a TAN and RAN offering.

42
Q

Grant Anticipation Note - GANs

A

Issued in expectation of receiving grant monies, usually from the federal government for mass transit, energy conservation, and pollution control programs.

43
Q

Variable Rate Demand Notes

A

Also known as variable rate demand notes.
The issuer resets the interest rate daily or weekly based on a given index.
At the reset point, the note holder has the option of redeeming the note at par or holding it until the next adjustment period.

44
Q

Tax Status of Territory and Possession Issues (Guam, Puerto Rico, US Virgin Islands.)

A

Always triple tax exempt no matter where you live when you purchase them.

45
Q

Bankers Acceptance/ Time Draft

A

Money market instrument used to finance import and exports.

46
Q

Prime BA

A

The highest quality bankers acceptances which are eligible for fed trading.

47
Q

Brokered Certificate of Deposit (CD) - Long Term CDs

A

A broker buys a large $10,000,000 CD from a bank and breaks it up into 10,000 units to be sold to customers.

Long term CDs are negotiable, unlike traditional bank CDs.

48
Q

Series EE Bonds

A

Savings Bonds

Minimum purchase amount $25.00

Any interest earned will be added to the bonds value
No stated maturity - interest is only paid fo 30 years

Only redeemable

49
Q

Funded Debt

A

Applies to long term corporate obligations/debt.

50
Q

Capital Market

A

A debt obligation with a maturity longer than one year. This is a source of long term capital for the issuer, hence the name.

51
Q

Parity Price of Bond Formula

A

Conversion Ratio x Stock’s Market price

52
Q

Conversion Ratio Formula

A

Par Value of Bond / Conversion Price (stocks conversion price)

53
Q

Parity Price of Stock Formula

A

Bond Market Value / Conversion Ratio

54
Q

Cash Management Bill (CMB)

A

5 day to 6 month maturity, with a $100.00 minimum. Used to smooth at cash flow.

Auctioned on an as needed basis

Slightly higher interest rates than T-bills due to their as needed basis.

55
Q

Treasury Bills - T-Bills

A

Mature up to 12 months, auctioned in increments of 1, 2, 3, 6 or 12 months.

They are purchased at discount from par ($100.00), and mature at par. The discount earned is considered the interest income.

Quoted on a discount yield basis

56
Q

Treasury Notes

A

Maturities ranging from over 1 to 10 years.

Minimum denominations of $100.00, quoted in 32nds.

pay interest semi-annually, and are non-callable.

57
Q

TIPS - Treasury Inflation Protection Securities

A

Fixed interest rate over life of the bond, but the
Principal amount is adjusted every 6 months by a amount equal to the change in the consumer price index.

Avoids purchasing power risk (inflation risk).

Pays the higher or par at maturity.

58
Q

STRIPS - Separate Trading of Registered Interest and Principal Security

A

Zero coupon bond

Avoids reinvestment risk - highly susceptible to interest rate risk

The predecessor were Treasury Receipts

59
Q

Treasury Bonds

A

Longer term securities issued with maturities of 30 years.

Quoted as a percentage of par, minimum increments of 1/32nds

Minimum denomination of $100.00 but usually are sold in minimums of 1000.00

Non-callable

60
Q

Convertible Debentures

A

A type of corporate bond that at the option where the owner can convert the bond par amount into common stock.

At time of issuance a conversion price is set per share, and is set at a premium to the current market rate.

61
Q

Income Bonds

A

Termed “adjustment bonds”

Issued usually when a company goes bankrupt, only obligates the issuer to pay if it has sufficient earnings .

Often given a greater principal than the original amount, but trade Flat in the market (without any accrued interest).

62
Q

Guaranteed Bonds

A

The bonds are issued by a subsidiary company.

The corporate parent company guarantees payment of interest and principal as due.

Bond takes on the parent companies credit.

63
Q

Debenture

A

Intermediate to long-term corporate debt which is backed solely by full faith and credit of the issuer.

Issued by “blue chip” corporations with high credit ratings.

Issued by lower credit companies in the form of high yield “junk bonds.”

64
Q

Commercial Paper

A

Very short term maturities, sold in large units $100,000 plus, usually ranging 14 to 90 days. However they do not exceed 270 days.

30 day is most common maturity length.

Sold at a discount and matures at face value.

65
Q

Collateral Trust Certificate

A

A portfolio of marketable securities is placed in a trust as collateral.

Usually a parent company will use a subsidiaries stock as collateral. (i.e. Johnson and Johnson would offer Gillette stock.)

Additional collateral must be given if securities drop in value

66
Q

Equipment Trust Certificate

A

Commonly issued by transportation companies, airlines, taxi services, etc.

Issued in serial form, and are non-callable.

67
Q

Mortgage Bond

A

Real-estate is pledged as collateral for the bond issue

The real estate pledged is worth more than the bonds that have been issued.

68
Q

Senior/Junior Lean

A

Liquidation of assets are received first by senior and then junior bond holders.

Senior also know as first mortgage bond, while junior is known as second and third mortgage bonds.

69
Q

Secured Corporate Debt

A

Specific collateral is pledged to back a bond issue.
Can be sold at lower interest rates, due to the lower risk.

Usually issued with long term securities

70
Q

Funded Debt

A

Long-term corporate debt. Have access to funds well before it is due back.

71
Q

Book Entry Bond

A

No physical certificate is issued.
Holder’s name, address, and purchase amount are listed with the transfer agent.
All new issues of bonds in the US are book entry.

72
Q

General Types of Corporate Bonds

A

Long-term bonds, intermediate-term notes, and short-term notes know as commercial papers.

73
Q

Purchase Power Risk

A

The risk that inflation will lower the value of bond interest payments and principal repayment, there by forcing prices to fall.
Significant inflation causes interest rates to rise, forcing bond prices down.
Long term and low coupon bonds hurt most.

74
Q

Sinking Fund Provision

A

A feature that requires an issuer to regularly deposit funds into an escrow account that will eventually be used to redeem or repurchase the outstanding preferred issue or bond issues.

75
Q

Legislative Risk

A

The risk that new laws will reduce the value of a security.

76
Q

Liquidity Risk

A

The risk that the security can only be sold by incurring large transaction costs.

Mostly affects long term, low quality bonds.

77
Q

Marketability Risk

A

The Risk that the security will be difficult to sell.
Can be affected by issue’s size, number of traders in the market, etc.

Mostly affects fragmented, illiquid municipal market.

78
Q

Interest Rate Risk

A

Risk that rising interest rates will cause bond prices to fall.

Long-term maturities, low coupon rate, and deep discount bonds are most susceptible,.

79
Q

Moody’s Short Term Municipal and Corporate Bond Rating

A

Commercial Paper: P1, P2, P3, NP (P=Prime, NP=Not Prime)

Municipal Notes: Mig1, Mig2, Mig3, SG (Mig=Moody’s investment grade, SG=Speculative grade)

80
Q

Long Term Corporate and Municipal Bond Rating System

A

Standard/Poor’s: Investment Grade - AAA, AA, A, BBB adjusted with = or -) Speculative Grade - BB, B, CCC, CC, C
Moody’s: Investment grade - Aaa, Aa, Baa, (adjusted with 1, 2, 3) Speculative Grade - Ba, B, Caa, Ca, C

81
Q

Alternate Name for Speculative Grade Bonds

A

Junk Bonds

82
Q

Treasury Debt Rating

A

AAA rated

83
Q

Yield to Call

A

The return a bondholder receives if the security is held until the call date, before the debt instrument reaches maturity.

84
Q

Callable

A

Issuer has the right to “call in” the shares or bonds after a set date - usually at par

85
Q

Call Protection

A

Investors are protected from calls for a stated period of time after the bond is issued.

Usually 10 years.

86
Q

Call Provision

A

The issuer has a right to redeem (“call in”) the bond at a predetermined price prior to maturity. However, they are not obligated to do so.

87
Q

Yield to Maturity Formula (YTM)

A

YTM = Annual Income (+ or - Annual capital gain/loss) / (Purchase Price + Redemption Price)/2

88
Q

Annual Accretion

A

The amount of time the discount on a bond is earned.

89
Q

Formula for the Approximate Price of a Long Term Bond in Yield Basis

A

Coupon/basis

90
Q

Series Bond

A

A bond issue where bonds have the same maturity, but different dates of issuance.

Usually for long-term projects where all money is not needed upfront.

91
Q

Balloon Maturity

A

When the majority of serial bonds issued reaches maturity.

92
Q

Serial Bond

A

A bond issue with differing maturity dates, and usually differing interest rates.

93
Q

Term Bond

A

A bond issue where every bond has the same interest and maturity.

Most corporate and federal bonds.

94
Q

Current Yield

A

Annual interest in dollars/ Bonds market price

95
Q

Nominal yield

A

Annual Interest/ Par - is the stated rate on a bond

96
Q

1 basis point

A

= .01

97
Q

Two types of Portfolio Risk

A

Systematic Risk: Cannot be diversified away, also known as “market risk.”

Non-systematic Risk: Can be diversified away. Occurs when a portfolio is too small. Decreases as the portfolio become larger.

98
Q

Political Risk

A

The risk of investing in countries that have weak political and legal systems.

99
Q

Reinvestment Risk

A

The risk for a long-term bond investor that market interest rates will fall over the investments time horizon

100
Q

Risk Disclosures for Long Term CDs

A

Market Risk, pre-maturity sale price may be less than purchase price, callable CDs are subject to reinvestment risk, step-up/step-down CDs yields may not reflect current market rate, FDIC insured only if titled in the customer’s name.

101
Q

Eurodollars / LIBOR

A

Deposits denominated in dollars held in a bank branch outside the U.S.

LIBOR - The interest rate charged on Eurodollar loans between major international banks is “LIBOR” - the London Interbank Offered Rate.

Securities Industries Essentials Exam (2 decks)

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