Debt Questions Flashcards
Trades of U.S. Government bonds settle
next business day in Federal Fund
trades of corporate and municipal bonds settle
“regular way” in 2 business days in Clearing House Funds.
Accrued interest on U.S. Government bonds is
- actual day month / actual day year basis
- Interest accrues up to but does not include, settlement date, with regular way settlement taking place the next business day.
accrued interest for agencies is
30-day month / 360 day year basis.
U.S. Government securities (except for Treasury Bills) are quoted
in 32nds
Treasury Bills are quoted
- a yield basis.
- No accrued interest is paid from buyer to seller since these securities do not make periodic interest payments
Treasury Notes and Bonds pay interest
semi-annually
If a customer is buying a bond, the price that the customer pays is the
“Ask” price, not the “Bid”
Agency issues are taxed at
Federal, State, and Local levels.
U.S Government taxed at
Federal, State, and Local levels.
Zero-coupon bonds most suitable for
retirement plan accounts, where the account is tax-deferred. That way, the annual accretion is not taxable until the funds are withdrawn from the account at retirement.
Interest received from mortgage-backed pass-through certificates is
taxable at the Federal, State, and Local levels.
Interest income received from Treasury Inflation Protection Securities
subject to Federal income tax, but is exempt from State and Local tax.
If the principal amount of a Treasury Inflation Protection Security is adjusted upwards due to inflation
that amount is treated as taxable interest income in the year of adjustment.
If the principal amount of a Treasury Inflation Protection Security is adjusted downwards due to deflation
that amount is treated as tax-deductible interest expense in the year of adjustment.
General Obligation bonds are backed by
the faith, credit and unlimited taxing power of the issuer.
limited tax bond
a limit placed on the tax rate.
ad valorem” taxes
taxes based on property value
Capital Appreciation Bond (CAB)
principal counted against the issuer’s debt limit is the discounted principal amount and the discount earned is considered to be interest income.
Tax Levy
If a GO bond defaults, bondholders have the right to make a legislative appropriation to make a payment on a debt
Makes GO Bonds the safest municipal debt
Revenue Bond
Bond not backed by tax powers
Self Supporting
Backed by a specific source of revenue
Greater credit risk
Trade at higher yields
Feasibility Study
- Performed by an independent consultant
- Projects anticipated revenues versus operating expenses, to make sure there is enough net revenue to service the debt
Trust Indenture
- Legal Requirement, hard to sell Revenue Bond without one
- A contract between the issuer and the trustee for the benefit of bondholders
Income source to service revenue bonds
- any enterprise activity, tolls, water and sewer charges, lease payments, and excise taxes
- any tax other than an ad valorem tax, such as an income tax or sales tax.
Maintenance covenant
- promise to maintain the facility in good repair
Rate Covenant
-that promises to increase charges for the use of the facility as operation and maintenance costs rise.
Segregation of funds covenant
- to keep the revenue monies collected from and monies expended on running the facility separate from all other municipal accounts
Books and Record Covenant
- Promise to maintain proper record keeping of accounts
No Sale Covenant
- Promise not to sell the facility, or palce any liens on facility
Additional bonds covenant
- promise not to issue additional bonds against the facility unless specified earnings tests are met
- if earnings are high enough parity bonds may be issued
- only if the bond is an open-end lien
Catastrophe Covenant
- a promise to call in the bond if the facility is destroyed
- principal is paid back to bondholders by insurance coverage
Flow of funds
- revenue fund
- operation and maintenance fund
- sinking fund
- debt service reserve fund
- reserve maintenance fund
- renewal and replacement fund
- surplus fund
Revenue Fund
All gross revenues from the facility are placed in the fund and all disbursements are from this fund
Net Revenue
Gross revenues - operations and maintenance
Net Revenue Pledge
After operations and maintenance are paid, bondholders are paid
Sinking Fund
- Deposits are made by the issuer to meet annual debt service requirements
- deposits are made to fund mandatory calls
- Once in this fund they have no other purpose rather than to make payments to bondholders
Debt Service Reserve
- fund of extra money to pay bondholders in case revenues are insufficient
- once depleted must be refunded ASAP
Gross Revenue Pledge
- issuer pays the bondholder their annual debt service requirements before they pay anyone else
Double Barrelled
- a revenue bond that is also backed by ad valorem taxing power
- non-self-supporting debt
Special Tax Bond
- an issue secured by any taxes besides ad valorem
- cigarette, gasoline
- excise taxes, sales taxes, income taxes
Special Assesment Bond
- pays for a municipal improvement, and the people who benefit from it are the only ones who pay an additional tax
Moral Obligation
- cannot use conventional financing because credit is too shaky
- obligates a local issuer to pay, but also has the moral obligation of the state legislature
- state legislature is not legally obligated
Certification of Patricipation
- way to get around debt limit and voter approval
- issued by a state entity where lease revenues are pledged to back the issue
- lease payment is made based on the governing body making an annual appropriation based on tax collections, not legally obligated
- higher yield than GO bonds bc more credit risk
Industrial Revenue Bond
- issued by the state to build an industrial facility to lease to a private company, brings jobs to the area
- revenues are lease payments
- corporation guarantees the bond
- taxable
Build America Bonds ( BABs)
- to recover from 2008 recession
- taxable bond issues
35% interest subsidary ( 10% bab = 3.5% is credited by government, so issuers net interest is 6.5%) - can be sold at higher interest rates and no additional cost to the issuer
- public buildings, courthouses, transportation infrastructure, government hospitals, public safety facility, water and sewer, environmental, public utilities.
- idea was to create jobs
Short Term Municpal notes
- 3 month to 3 year maturity, common for less than 12 months
- temporary financing of capital improvements
- even out cash flows
Municipal notes are issued at ____
par with state interest and redeemed at par plus accrued interest
BANS
- short term financing for a building project when final cost is unkown
issued in anticipation of repayment from an upcoming bond sale
TANS
- issued to “pull forward” source of income before actually collected
- issued in anticipation of upcoming tax collections
Construction Loan Note
- issued to start the building of a multifamily house project
- paid off by payments from a long term bond issue
2-3 years, usually issued when interest rates are high
RANS
- issued to “pull forward” source of income before it is actually collected
- issued in anticipation of repayment from upcoming revenue, received from a quality source like the Federal Government
GANs
- issued to “pull forward” source of income before it is actually collected
- issued in anticipation of receiving grant monies, such as mass transit, energy conservation, pollution control improvements
Variable Rate Demand Notes/ Step up- Step DOwn
- interest rate is reset daily or weekly by the issuer based on a given index, bond-holder has the option of holding for next term or redeeming at par
- long term bonds at short- term rates
- NO market Risk
In Whole Calls/ Optional Calls
- the whole issue is callable at preset dates and prices
Mandatory Calls/ In Part/ Sinking Calls
obligates the issuer to call some of the bonds at preset dates and prices, as established in the bond contract. This is demanded by bondholders if they think the issue is risky
Extraordinary Mandatory Call
- issue is a catastrophe call, requires the issuer to call in the bonds if a facility built with the proceeds is destroyed
Extraordinary Optional Call
- option to call if an unusual event specified in the contract occurs.
Example : housing bond issue where the revenues are mortgage payments, if prepayment occurs faster than expected, the issuer can call in bond and receive monies rather than pay needless interest
Most likely bonds to be called
- High interest, low call premiums
Least likely bonds to be called
- Low interest, high call premiums
Refunding
Issue new bonds and use the proceeds to retire old bonds
Defeasance Covenant/ ETM
- allows the issuer to shift the claim that the bondholders have on collections onto another acceptable form of collateral
- sell new debt prior to maturity of the old bonds, using the collections of these bonds to be the income backing the new bond
- when interest rates fall, locks in low current rate by selling new long term bonds before maturity of old bonds
Acceptable securities for Defeasing Debt
- Defease its debt with U.S government securities, agency securities and sometimes Bank certificates of deposits.
- interest earned on these securities is income used backing new bonds
Defeasance is also called
advanced refunding
Advance refunded bonds are backed by
escrow government and agency bonds
Credit ratings of advanced refunded bonds
AAA, safest securities, more marketable due to decreased credit risk
Advanced refunded a.k.a
- escrowed to maturity
pre-refunded
- escrowed to the upcoming call date
Net Direct Debt Formula
= gross direct debt- sinking fund deposits and self-supporting debt
Overall Net Debt
= Net Direct Debt - Overlapping Debt
Gross Direct Debt-
All indebtedness of the issuer
Net Direct Debt
The amount of debt of the issuer that is ultimately the responsibility of the taxpayers
Overlapping Debt
The issuers share of debt of other governing bodies which are wholly or partly within the same geographic location.
Ex. Debt issued in the school district will be shared by 3 towns
debt per capita
overall debt/ population
debt to the assessed valuation
overall net debt/ assessed valuation
debt per capita
a most common measure to compare one municipality to another
Factors to consider when evaluating a GO Bond
- attitude toward its debt
- tax base
- diversification of the local economy
- its financial condition
- population trends in the area
- ability to collect taxes
Collection ratio
- measures the municipality’s ability to collect taxes
- anything over 90% is desirable
- taxes collected/ taxes assesed
Debt Service Coverage
= Pledge revenues/ debt service requirement
- should be above 1
Municipal bond insurers
AMBAC
MBIA
FGIC
FSA
AAA, RATED 1/2 PERCENT
Munipal bonds trade
- over the counter
- The participants included bank municipal dealers, general securities broker-dealers, municipal broker-dealers, and municipal broker’s brokers.
Bona Fide
- all municipal securities must be sold bona fide
- must sell at indicated price at time of offer
Municipal broker’s brokers
- buy and sell large blocks of bonds for institutions, keeping the institution’s identity secret.
- do not take inventory positions - they act as agent only.
A firm quote
-that will not be changed for a specified time period; and one which the dealer will honor during that time period.
Nominal Quote
no quote - it is simply an approximation of a price.
Firm Recall
If a recall is added to the firm offer, e.g., a 5 minute recall, the selling dealer is adding to the offer the stipulation that he reserves the right to call any time during the 1/2 hour, and demand that a purchase decision be made within the next 5 minutes.
Municipal Workable
- likely price at which a dealer will buy bonds - note that the bid is not “firm
Municipal secondary market joint accounts
a group of firms who pool their capital to buy a large block of bonds at a good price.
- only one quote allowed
Market Rate and Interest Rates have ____
same effect as each other on bonds, up and down
municipal bonds are subject to the following risks
Credit risk Market risk Marketability risk Liquidity risk Purchasing power risk Legislative risk
Interest on long Term Municipal Bonds
30/360, up to but not including the settlement
Interest on Municipal Notes
accrues on an actual day/actual day year basis
Bonds with Enhanced Credit
- Pre-refunded bonds
- insured bonds
Seperate listings
- special tax status
- enhanced credit
- zero-coupon issues
- corporate/ agency issues
If the basis rate is the same as coupon
The bond is being offered at par
If the basis rate is higher than the coupon
the bond is at discount
if the basis rate is lower than coupon
the bond is at a premium
To find the price of a bond quoted on a yield basis
divide coupon by basis
Munifact
Newswire service distributed by the daily bond buyer, mainly announces new issues offerings
- also includes general news items affecting the issue
Interest Income received from U.S Government and Agency bonds is
subject to federal taxes, exempt from state and local
Interest income received from corporate bonds
subject to federal, state and local taxes
Interest income received from privatized agencies
subject to federal, state and local taxes
Commercial paper
-short term unfunded corporate debt.
quoted on a yield basis.
mainly purchased by institutional investors, such as money market funds.
xempt security under the Securities Act of 1933, and is sold without a prospectus, as long as its maturity does not exceed 270 days.
Banker’s Acceptance
The instrument used to finance imports and exports
Prime BA
The highest quality BA eligible for Fed Trading
Long Term Negotiable CDs
maturities over 1 year.
- accrue interest and pay semi- annually
- subject to re-investment risk, market risk
- can be variable rate, can be callable
Negotiable CDs
- are $100,000 minimum face amount certificates that are issued by banks, and are very often issued in minimums of at least $1,000,000.
- these are issued at face and accrue interest above the face amount.
- are not FDIC insured for any amount that exceeds the $250,000 insurance limit.
A Repurchase Agreement
overnight agreement where a government securities dealer sells part of its inventory overnight (to get cash) to another dealer; the other dealer earns interest on a 1 day loan. The next day, the repurchase agreement is closed-out with the return of the securities at a slightly higher price
Repurchase agreements have no
credit risk, and virtually no liquidity risk
Repo
Loosen Credit by Federal Reservce
injects cash into the money supply
Buys
Reverse Repo
Tightens Credit
Drain cash
Sells
Risks associated with Repos and Reverse Repos
Market Risk
Purchasing Power Risk
Eurodollars
deposits denominated in dollars held in a bank outside the U.S
Brokered CD
A convential CD of $100,000 chopped up into $25,000 segments
CDs are subject to
Market Risk
- Reinvestment risk (callable)
- Secondary Market is limited
- FDIC is only insured if it is issued in the Customer’s name not the banks
- No penalty for early withdrawal
Structured Debt
- securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies.
- bond” portion, which pays interest based on the performance of a well-known index such as the S&P 500 Index or NASDAQ 100 Index.
- derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity, protecting principal.
Risks associated with Structured Products
Market Risk
Liquidity Risk
Credit RISK
- Cap on Return ( place a cap on the amount that you can earn)
Suitability and Structured Products
Reasonable Basis
- determine the securities potential rewards and risks
Customer Specific
- offer to the customer it is only suitable for
ETN
- Type of structured product offer by banks that gives a return tied to a benchmark index
- set maturity, backed by the credit rating of issuing bank
- exchange listed, can be traded
- No interest or dividend payments
ETN Risk
Has credit risk, if issuing bank fails, no payments
NO LIQUIDITY RISK, NO REINVESTMENT RISK(does not make periodic payments)
CAN GET OUT AT ANY TIME
TAX EFFICIENT
Reverse Convertible Note
- created for customers looking for an enhanced yield in a low interest rate environment
- along with enhanced yield comes higher risk
- linked to price movements of an underlying stock
- at maturity, holder receives par vale as long as it is in the “knock in price” (70-80% of knock in price)
- if falls below, only receives shares of stock
- 1 year maturity
Maximum gain for RCN
- Coupon Rate and 100% of principal back
Maximum loss for RCN
- getting shares of the stock and the stock being worthless
Risk of RCN
Takes on the credit risk of the issuing bank, bank fails so does RCN
Auction Rate Securities
long-term debt issues where the interest rate is reset weekl
- they cannot be “put” back to the issuer at the auction reset date.
- marketibility risk
Dutch Auction
- each bid and order sized is ranked from lowest to highest minimum bid rate
- bonds are auctioned from lowest interest bid on up until the whole amount is filled
Clearing Rate
All winning bids are filled at the highest interest rate that completed the sale
-thus it is the lowest rate purchasers are willing to buy
ARS are usually for
sophisticated investors, sold in $25,000 minimums
failed auction
there are more sellers than buyers. Thus, if there are offers (sellers) of the securities without corresponding buyers (bidders), then the auction will fail.
-interest rates set forth are too high
Credit Default Swap (CDS)
the buyer pays a premium to the seller, where the seller agrees that if the reference loan defaults, the seller will pay the face amount of the loan to the buyer
- if loan does not default, seller wins
- if loan does default, buyer wins
naked CDS
allow the buyer to speculate, betting that the reference loan will default during the life of the contract. The seller, on the other hand, is betting that the contract will not default over the life of the contract.
Eurodollar bonds
- Denominated in US dollars
- held in currency outside the US, mainly London
- not registered w SEC, issued in bearer form
- interest paid annually and in U.S Dollars
Eurodollar and Bearer form
- maturity 5-10 years, call protection longer than average
Issuers of EUrodollars
Issuers of Eurodollar bonds include:
U.S. Corporations
Foreign Corporations
Foreign Governments
U.S. Municipalities (e.g., New York City bonds are popular in Europe!)
The U.S. Government does not issue Eurodollar bond
Eurodollars attraction
No Currency Exchange Risk for US investors since denominated in dollars, however, the risk still exists for foreign investors
Lower than domestic interest rates
Does not have to be registered with SEC so lower issuance expenses
