Debt Instruments 16% Flashcards
Bond Ratings - S&P - uses a + or -
AAA AA A BBB ------------- BB B C D - default
above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds
Credit Risk
- also known as business risk
- also known as default risk
- the issuer may become insolvent and forced into bankruptcy
Bond Ratings - Moody’s - uses 1, 2, 3 with ratings
Aaa Aa A Baa --------- Ba B Caa D
above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds
Interest Rate Risk
- Longer the duration, the greater the risk
- lower interest rates carry a higher interest rate risk
Zero Coupon Bond or OID
- purchased at a steep discount and gains in value every year.
- the difference between what the investor pays for the bond and what is received at maturity is considered interest income.
- Original Issue Discounts
Inflation risk
- also known as purchasing power risk
- created by too many dollars chasing too few goods
Reinvestment Risk
- if rates drop, will have less income
- a zero coupon bond does not have reinvestment risk
Why purchase a callable bond
They have higher stated, or nominal, interest rates
Why would an issuer pay a higher interest rate by issuing a callable bond?
to have he privilege to refinance at lower future interest rates
What price are callable bonds called at
frequently above par, which is called the call premium.
Liquidity Risk
- The degree to which an asset can be quickly converted to cash
- the risk that an asset cannot be sold quickly
- selling quickly could result in a substantial loss
Marketability Risk
- risk of being unable to buy or sell a security, thus sustaining a loss
- similar to liquidity, except it is not concerned with the price, only the ability to buy or sell
Legislative Risk
- also know as “regulatory or political” risk
- changes in law will negatively impact the value of a security
Term Bonds
- also called “dollar bonds”
- all bonds are issued at once and mature at once
- priced in points as a percentage of par value, each point equals $10
- term bond quote of 98 = 98% of par value = $980
- pays interest only, at maturity pays par
- Basis = price to maturity
Serial
- quoted in basis points
- all bonds are issued at once.
- They mature in increments over several years,
- ex: $1,000,000 of bonds matures in $200,000 increments over 5 years.
- pays principal and interest
- basis = yield to maturity
What are the terms for the interest an issuer will pay until the bond matures?
- Stated Rate
- nominal yield
- coupon rate
Current Yield
= (annual dollar interest paid)/(current market price)
Yield to Maturity (YTM)
-Economic benefit that would be realized if a bond or other fixed income security was held until maturity date.
= (Annual Interest +/- Annualized Gain/Loss)/((Purchase Price + Redemption Price)/2)
Yield to Call (YTC)
- Evaluates the performance of a callable bond
- uses the call price instead of par value
Par Bond
The nominal yield, current yield, and yield to maturity are the same
Discount Bond
the highest yield is the yield to maturity, followed by the current yield, then the nominal yield is the lowest
Premium Bond
The highest yield is the nominal yield, followed by the current yield, with the yield to maturity being the lowest.
Discount and Premium Chart for Yields (includes calls)
Discount Bond
- Highest yield is Call (cannot quote call) - Next highest is Maturity or Basis - Third yield is Current - Lowest yield is nominal
Premium Bond
- Highest yield is NOMINAL - Next highest Yield is CURRENT - Third yield is MATURITY or BASIS - Lowest yield is CALL (most quote this)
Standardized Yield (SEC Yield)
- measure of the current net market yields on a mutual fund’s investment portfolio.
- net investment income for the 30 day period ending on the last day of the previous month DIVIDED by the highest offering price on that last day
Accrued Interest
- Bond interest is paid in arrears
- an investor purchases a bond and holds it for six months before receiving the first semi annual interest payment
- when a bond is sold in between the interest payments, the buyers pays the sell for the accrued interest
Corporate, muni, and gov agency bonds calculation of interest
every month has 30 days
every year has 360 days
Regular way settlement is T+3
Gov notes and Bonds calculating accrued interest
- actual number of days in the month
- each year, the actual number of days
- regular way settlement is T+1 (or next biz day)
Corporate Bond payment dates of F and A 15
Pays February and April 15
Open and Closed end Bonds
- open - corporation can issue subsequent bonds at a later time
- Closed - specify maximum indebtedness the corp can issue
Bond Trust Indenture
- specifies if the secured bonds are open or closed
- contract between issuer and trustee, who acts on behalf of the bondholder
- open end bonds have equal claim or parity of title to the collateral with each new bond
Equipment Trust Certificates
- usually issued by railroads and airlines, and are secured by railroad cars and airplanes.
- historically, these have proven to be secure investments because the bonds are retired at a faster rate than the equipment is depreciated.
- airplane equipment is know as “rolling stock”, meaning major movable equipment
Collateral trust certificates
-suppose dell owns intel stock, it might issue dell stock as collateral to secure the bond
Mortgage Bonds
- most common type of secured bonds
- corporations issue first and second mortgage bonds with first holders retaining a senior position
Unsecured Corporate Bonds
- also know as debentures
- only backed by the full faith and credit of the issuer
- have a lower lien priority that all other bonds
Guaranteed Bond
a debenture that has been “cosigned” by another entity
Convertible Bond
- a Debenture that is convertible into common stock at the the bondholder’s discretion.
- if the price of stock rises, so will the price of the bond and vice versa
Convertible Bond Conversion Ratio
of shares at conversion = Par Value/
Step up bond or step coupon bond
- has an initial nominal rate which later increases or “steps up” to a prespecified higher rate
- typically corporate bonds
- certain gov agencies
Income Bond
- product of a debt renegotiation or a bankruptcy proceeding
- when a corp can no longer honor the terms of a bond issue, they renegotiate the terms of a bond issue
- trades without accrued interest
- only suitable for speculative investors
Treasuries
- U.S. government securities
- backed by the full faith of the U.S. gov
- highly liquid
- interest subject to federal taxation only
- capital gains realized are taxable
Nonmarketable treasury securities
- redeemed by treasury through banks.
- Savings Bonds:
- Series EE
- Series HH
- Series II
Marketable treasury Securities
- traded for value in the secondary market
- t bills
- t notes
- t bonds
How do Treasury Department Securities exist?
-as electronic records in computers
Maturity of Marketable treasury securities
- T Bills max of 1 year
- T Notes max beween 2 - 10 years
- T Bonds greater than 10 years
T-Bills OID
- Original Issue Discount instruments
- no state interest
- do not pay semiannual interest
- bought at a discount from par and mature at par
- quoted on a discount yield basis
- bid is a larger discount than ask
- Bid 7.45 = Ask 7.30
- Bid price = 1000-.0745*1000=$925.50
- Ask price - 1000-.0730*1000=$927.00
- Issued with the following maturities:
- 4 weeks
- 13 weeks - auctioned every week
- 26 weeks - auctioned every week
- 52 weeks - auctioned once a month
- issued with a min denomination of $1,000, with $1,000 increments
- public orders are filled from non competitive bids
- competitive bids come from the 40 primary dealers in government paper
Treasury Notes
- maturities of;
- 2 years
- 3 years
- 5 years
- 10 years
- issued with denominations beginning at $1,000
- have stated interest (coupon) rates
- pay semi-annual interest to their owners
- known as interest-bearing securities
- quoted in points as a percentage of par
- points broken down into 1/32
- the fractional part is expressed as a decimal
- 102.20 means 102 and 20/32 of par = 102.625
- dollar value - 102.625% * $1,000 = $1,026.25