Debt Securities Flashcards
In addition to selling stock, corporations may issue what in order to raise capital?
Debt
Debt securities come in what forms?
They come in bonds, notes, certificates, and various market making instruments .
What is one characteristic that is true for all debt securities?
The issuer owes interest and principal to the owner of the debt( the investor)
Trade in the market like all equites.
Debt securities
What are bond issuers
Corporations, the federal government and municipal governments.
Also called principal or Face value.
Par value. Most debt securities have a par of $1000 unless otherwise specified.
The amount paid to investors as principle at maturity.
Par value.
What are some common maturity dates for Maturities?
Common maturities are in the range of 5 to 30 years. Some can be more shorter and others longer.
What is a bond structure so that the principal of the whole issue matures at once?
Term bond
What type of bond schedules portions of the principal to mature at intervals over a period of years until the entire balance has been paid?
Serial bond
What type of bond has a maturity using elements of both serial and term maturities? In this instance the issuer pays part of the principal before the final maturity date, but pays off the majority off the portion before the final maturity date.
Ballon bond.
Types of savings bonds.
Series bonds
A type of debt issued by the federal government that may be purchased and redeemed at banks or from the treasury department.
Savings bond. They do not trade in the secondary market although they are securities. They are also exempt from many several securities laws
Though there is a series bond series…
Is not a type of maturity used with debt maturities
A coupon rate is also known as?
Nominal yield, stated yield, face value.
What is the interest rate the bond issuer has agreed to pay the investor?
A) The Coupon Rate
B) The Nominal yield
C) Stated Yield
D) All of these
E) none of these
D
How is the stated yield calculated?
It is calculated from the bonds par value( face value), and usually stated as a percentage of par.
What will the bond price be if the interest rate was at 6%?
( 6% x $1000 par value= $60)
What happens if bonds trades in between coupon payments?
The new owner gets paid the full coupon from the issue on the next pay cycle. Also known as accrued interest.
Corporate and municipal trades use what month year model to calculate for accursed interest?
30-day. 360 month.
Which transactions employ the actual number of days elapsed when calculating the accrued interest due?
Treasury bonds and treasury notes.
When a buyer owns a zero coupon bond which of the following is true?
A) They incurred interest based on a annual interest base
B) they are not interest bearing
A
Please note interest for coupons and accrued interest are generally paid?
On a semi annual basis. For example A 6% coupon bond pays $60 per year and $30 every 6 months .
Bonds pricing are measured in …
Points
Once upon is trading in the secondary market, make a trade at a price of par, a premium to par or …..
A discount to par.
Example:
If par equals $1000 and is selling at $1200. Is the bond selling at par, premium to par, or at a discount to par.
Premium to par
Example: A bond trading at $800 if the par is $1000 is selling at ?
A discount
Example:
A bond trading at 900 is worth?
A) $9
B) 9%
C) Cannot be determined with the information provided.
D)$900
D. Bond pricing is measured in points with each point equaling to 1% of face value.
Example a bond trading at 103 is equal to?
$1030. Multiply quoted price10 to get dollar amount.
Bonds have a particular sensitivity to ?
Market changes in the interest rate. Bond prices fall as interest rates in the market fluctuate
True or False. The investor pays the issuer an interest rate for the cost of borrowing money.
False. The issuer.
If Interest rates go up ,bond prices for those trading in the secondary market will?
Go down
Conversely if interest rates are going down bond prices trading in the secondary market will…
Go up.
Though bond prices will react to market forces the coupon rate will?
Always stay the same. The coupon rate is a fixed percentage of par value.
What expresses the cash interest payments in relation to the bonds value?
The bonds yield.
This is determined by the the issuer’s credit quality, prevailing interests rates, time to maturity and any features a bond may have
Yield
True or false. A bond can be traded at other prices other than par.
True. The price discount or premium par is taken into consideration when calculating overall yield.
Coupon or stated yield that is set at the time of issue is also called.
Nominal yield.
What measures a bonds animal coupon payment (interest) relative to its market price?
Current yield or (CY).
What is the equation for (CY)?
Annual coupon payment/market price = current yield ( CY)
This reflects the annualized return of the bond of held to maturity.
Yield to Maturity (YTM) . The bond holder takes into account the difference between the price that was paid for the bond and par value when the bond matures.
If a bond is purchased at a discount the investor makes money at maturity. This increases or decreases the return?
The discount increases the return.
If a bond is purchased at a premium the investor loses money at maturity. Does this increase or decrease the amount of the return?
Decreases.
Basis of us also used to define
Yield to maturity. The yield of provided will be the YTM.
Yields are measured in what?
Basis points. This is a measurement of yield equaling to 1/100 of 1%.
What are points:
A measurement of the change in a bonds price which 1% of face value or $10 per bond.
What is a bonds basis?
Also called Yield to Maturity or YTM. Example a bond trading at 5.83 basis means the bond has a YTM of 5.83% ( 5.83 x 100).
Example: If a bond purchased for $900 ( A discount) and is held to maturity, at maturity the investor will receive par $1000. Conversely,If the bond is purchased at $1100 par ( a premium). This premium paid…
Reduces the amount of the return.
What is being described in the following diagram?
The inverse relationship between price and yields. ( Hint: memorize this chart.
Allows an issuer to call in a bond before maturity.
Call feature.
An investor can put the bond back to the issuer before it matures.
Put feature.
Issued by corporate issuers allowing the investor to exchange debt for one’s that give’s ownership rights like common stock.
Convertible feature
Parity is
When the value of a convertible bond equals the value of shares are equal to the value of shares and the conversion feature were exercised.
Bonds that benefit the issuer
Call feature.The issuer generally needs to pay a slightly higher coupon rate.
When bonds are issued with features that benefit the bond holder:
A put feature. The issuer would pay slightly lower coupon rate of interest because the fear will compensate for the lower return
Issuers debt obligations that do not pay regular interest payments.
Zero coupon bonds. The difference between the discounted purchase price, and the full face value at maturity is the return, or accreted interest, the investor receives.
Example:
Lonsdale Corporation issues zero coupon bonds at a price of 50 maturing in 20 years. At maturity it pays $500 to investors in principle and $500 to investors as profit The bond makes no interest payments. What is the YTM if the par value is $1000? What is the cost in dollars of the bond?
Cost in dollars is $500. YTM = 3.53%
The yield to maturity formula for a zero-coupon bond:
Yield to maturity = [(Face Value / Current Value)(1 / time periods)]
The yield to maturity formula for a coupon bond: Bond Price = [ Coupon x (1 – (1 / (1 + YTM)n) / YTM) ] + [ Face Value x (1 / (1 + YTM)n ) ].
Ex:
Step 1: ( $1,000 / $500)^(1/20) – 1
Step 2: (2)^(1/20) – 1
Step 3: Answer 3.53%
Who are the issuers of zero coupon bonds?
Corporations, municipalities, and the US treasury.
True or false. Zero coupon bonds can be created by BD’s from other types of securities.
True
Zero coupon bonds issued by the US treasury are called?
STRIPS
A common form of zeros built by BDs from a basket of Treasury bonds are called?
Treasury receipts.
They are issued by BD’s and not the treasury. Unlike STRIPS they are not backed by the full faith and credit of the US Treasury.
Though zero’s interest payments are paid at maturity, the total interest payment is divided by what?
The year’s remaining to maturity. Taxes are charged annually however.
Annual accretion to the discount of a zero is also called
Phantom income
What are the 3 major credit agencies for Company Bond ratings?
-Fifth Ratings Inc.
- Moody’s investor services inc
- Standard and Poors
The most important ratings on the exam is Standard and Poors and Moody’s.
What is the highest investment grade for Non investment grade bonds?
BB, Ba refer to diagram below
According to Standard and Poors rating system, the four highest grades of bonds from best to lowest grading are:
A. Aaa, Aa, A, Baa
B. A, Aa, Aaa,B
C. B, A, AamA, AAA
D. AAA, AA, A, BBB
D.
Also called Junk bonds.
High yield bonds. They have lower ratings BB or Ba or lower and additional risk of default, they are subject to high price erosion during slow economic times or when a bond issuers credit worthiness is in question.
True or false a non rated bond is much riskier than a D rated company.
False. Many issuers are too small to justify the expeditor a bond rating. In this case an investor can do its own research to determine the quality of the bond.
A bonds sensitivity to the movements in the market is called
Volatility
The lower a bonds coupon rate:
The more volatile it is
What are the benefits of owning a security?
-income
-safety
What are the risks of owning a debt security?
-Default risk ( financial risk/ credit risk)
- interest rate risk
-purchasing power risk( inflation).
What is the order in which bonds are liquidated?
- Secured debt holders
- Unsecured debt and general creditors
- Subordinate debt holders
- Preferred stock holders
- Common stockholders
Please note, courts may shift some creditors up or down for different reasons. It’s not uncommon for wages and taxes to be moved up in priority if it appears that there will be insufficient assets to pay them otherwise .
These parties ( attorneys, the courts, property appraisers, auctioneers , and claimants are called what?
Administrative claim holders or administrative claimants. They are paid before any unsecured debt but after secured debt holders.
Example;
Your customer calls you with a question. The customer tells you that they received a phone call from the bond is telling them that a trade to purchase 20 bonds at 100 has been executed for their account. The customer would like to know how much they paid for the bonds before any commissions or other charges. The answer to the customer’s question is:
A. 2,000
B. 200,000
C..$1000
D. $20,000
D. 200 at par (1000)= 20,000
A 6% corporate bond is trading on a 7% basis is trading:
A. At a discount
B. At a premium
C. With a current yield above 7%
D. With a coupon rate below 6%
A. Discount
If a bond has a feature that allows a user to pay off a bond prior to maturity, the bond has
A. A put feature
B. A call feature
C. A conversion feature
D. A presale features.
B. A call feature
Lando entertainment INC issued a bond collateralized by a trust holding the deed to the company’s Las Vegas headquarters. This type of bond is called a:
A.Collateral trust bond
B. A guaranteed bond
C. A headquarters debenture
D. A mortgage bond
A. A collateral trust bond
Interest from a zero coupon bond:
A. Pays monthly
B. Pays annually but taken at maturity
C. Pays at maturity and taxed annually.
D. Pays and is taxed at maturity
C. Pays at maturity, taxed annually
What bonds are securities issued by a state or local government or by US territories, and special districts?
Municipal bonds
What do investors invest in when buying a municipal bond?
They are lending money to the issuers for the purpose of public works and construction classes ( eg roads, hospitals,civic centers, sewer systems, airports.
Municipal securities are in general considered are considered semiconductor in class of principal only to
The us government and US government agency securities
Capital gains or trading profits is still be tax free. True or false
False.
Municipal securities settle on ______ and pay interest based on a ________
T *2
30 day 360
Bonds issued for capital improvements that benefit the entire community are called?
General obligation municipal bonds (GO). Because of this backing GO bonds are also known as full faith and credit issues and are back by the municipalities taxing power
The amount of debt a state can incur is unlimited and back by the government? True or false.
False. The amount of debt may be limited to state or local statues to protect tax payers from excessive tax
These are backed by income taxes license, fees, and sales taxes.
Municipal state bonds
What are bonds backed by property taxes, license fees, fines and all other direct sources of income taxes
State issued municipal bond
Which bonds represent a debt of the municipal often requires voter approval?
General obligation municipal bonds. GO
What bonds are used to finance any municipal facility that generates sufficient income?
Revenue bonds
What are some examples of revenue bonds?
- Utilities
- Housing
- Transportation
- Education
-Health - industrial
- sports
What bonds are supported by the issuers’ authority to tax and do not require voter approval?
Revenue bonds. They are not subject to statutory debt limits .
What are authorities?
Quasi governmental entries often tasked with building roads, tunnels,bridges, and other infrastructure.
True or false. The interest from bonds issued by or from a territory of the United States is tax free to US tax payers at levels except federal.
False. They are tax free on all levels: Federal, state, and local.
Municipal notes have maturities of
Usually less than 12 months. Maturities may range from 3 months to 3 years. The are repaid when the municipality receives the anticipated funds.
Categories of municipal notes are :
- Tax anticipation notes( TANS)
- Revenue anticipation notes ( RANS)
- Tax and revenue anticipation notes (TRANS)
- Bond appreciation notes ( BANs)
-Tax exemptions commercial paper( maturity is up to 270 days. Maturities are most often 30, 60,90 days
-Construction Loan notes - Variable - rate demand notes
- Grant application notes
How do you calculate Tax - equivalent yields for tax exempt bonds?
Divide the tax free yield by 100 less the investors tax rate
Example: an investor is in the 30% tax bracket. A municipal bond currently yields 7%. To offer an equivalent year what must a corporate bond yield?
Use the tax equivalent yield formula:
Divide the municipal yield by 100% minus the investors tax bracket.
7%
———
(100% - 30%)
7%
———— = 10%
70%
Example: Assume the same investor is in the 30% tax bracket. If a corporate bond currently yields 11% . What would be the equivalent municipal yield?
11% *(100% - 30%)
11% * 70%= equivalent municipal yield=7.7%
( remember to divide by 100 to get municipal equivalent yield).
What types of agency issued debt is the safest?
Securities issued by the US government. They are backed by the full faith and credit, based on its power on the ability to tax.
What settlement cycle do Securities issued by the US government have?
T +1 cycle. Accrued interest on these securities is calculated based on the actual calendar days elapsed.
What are T-Bills?
Direct short term obligations of the US government.
What maturities do T-bills typically have?
4 weeks, 8 weeks, 13 weeks, 26 weeks, and on a monthly schedule of 52. They are always short term instruments, 1 year or less
Pays no interest. They are issued as a discount from the par value and are redeemed at par.
T bills or treasury bills.
What are some other key points about T Bills?
- T Bills and STRIPS ( Treasury zero coupon bonds) are the only Treasury securities offered at a discount.
- T Bills and STRIPS are the only treasury securities issued without a stated interest rate
-T-Bills are highly liquid - The 13 week (91 day) T Bills in market analysis as the stereotypical risk free investment
What are treasury notes?
Direct obligations of the U.S government. They pay semiannual interest as a percentage of stated par value and mature at par value. They have long term maturities greater than 10 years and up to 30 years.
Brokerage firms can create a type of bond from US T notes and bonds. What do they form with this combination?
A treasury receipt. This action of bundling separates the coupon interest payments from the principal to create a new security.
This separating process yield more profit for BD than offering the original securities outright.
Stripping
True or false. Although treasury securities held in a trust collateralize the treasury receipts, the receipts , unlike treasury securities are not back by the full faith and credit of the US government .
True.
The treasury department also have their own version of stops called
Treasury STRIPS
Both Treasury Receipts and STRIPS are zero coupon bonds.
TIPS also called _______are a special type of security with maturities of 5, 10, or 20 years. The principal value of this type of bond is adjusted every 6 months based on the inflation rate.
Treasury inflation- protected securities.They all have a fixed coupon rate and pay interest every 6 months. Note that the final principle payment will never be less than the original $1000 par.
Which agencies has the US Congress authorized to issue debt securities?
- Farm Credit Association) FCA
- Government National Mortgage Association (GNMA or Ginnie Mae)
*Federal Home Mortgage Loan Association (FHLMV or Freddie Mac) - Student Loan Marketing Association ( SALLIE Mae)
These are agency own privately by corporations. They are only government sponsored.
What is the settlement of agency issued securities?
They occur the regular way trade plus 2 days.
These are generally known as asset backed securities or mortgage back securities.
A national network of lending institutions that provide agricultural financing and credit.
Farm Credit System. This is another agency security
A government - owned corporation that supports the Department of housing and Urban Development
This agency is called GNMA or Ginnie Mae. ( Government national mortgage association)
A publically held corporation that provides mortgage capital. They purchase conventional and insured mortgages from agencies.
FNMA or Fannie Mae agency. The securities they create are back by FNMA general credit.
Please note that Fannie Mae and Freddie Mac are publicly owned corporations. They are also called government sponsored enterprises
Serves as a source of intermediate to long term financing in the form of equity or debts securities with maturities of more than 1 year
Capital markets
They provide very short term funds to a corporation, banks, BD’s, governments, municipalities. And the US federal government.
Money market securities.
Fixed income ( debt) securities with one year or less left to maturity.
Money Market instruments. They are highly liquid and provide a relatively high degree of safety. Usually lower returns bc of it being less risky.
These securities do not generally receive interest payments. They are issued at a discount and redeemed at face value.
Money market Securities
When bank issues and guarantee these with fixed interest rates and min face values of $100,000
Jumbo Certificate. Most mature in one year or less.
Jumbo CDs sold in the secondary market are called
Negotiable CD. Only Negotiable are considered to be money market instruments. Unlike most money market CDcs are issued at face value and pay interest. Longer maturities will pay interest every 6 months.
A short term draft with a specific payment date drawn on a bank. They are always issued as a discount.
Bankers Acceptances. (BA). They are always between 2 and 189 days and never more than 270.
What are BA’s used for?
US corporations us them extensively to finance international trade. They usually pay for goods and services in a foreign country.
What are promissory notes?
What corporations use for short term, unsecured commercial paper. Also called commercial paper, prime paper). Typically companies with excellent credit ratings issue these. Maturities range from 1 to 270 days.
What are T Bills?
Money market Securities.
When a financial institution raises cash temporarily selling some of its assets it holds with the agreement to buy back some of the assets at a later date for a slightly higher price.
Repurchase agreements (repo). These are also called reverse repurchase agreements or reverse repos.
Which board mandates how much money it’s member banks must keep on reserve.
Federal fund loans. All deposits in excess of the required amount reserved can be loaned to member banks to another to keep the reserve requirement. These loans are very short term and in most cases overnight.
Why would you place money market securities in a client’s portfolio?
-Money market securities are highly liquid
-Very safe
- A good place to invest money that would be needed soon
Please note returns on these investments are low and not suitable for long term investors
What type of security whose value and income payments are derived from a pool of under lying assets?
Asset backed securities
What is a CMO? What is the process of pooling them?
Collateralized mortgage obligations. Pooling assets into financial instruments allows them to be sold to general investors more easily than selling them individually. Securitization allows the risk of investing in underlying assets to be diversified.
What is another term for asset based security?
Collateralized Mortgage Obligations.They usually pool large numbers of mortgages usually single family homes. They are often backed by Ginnie Mae, Fannie Mae and Freddie Mac in the private sector as pass through securities.
What pays interest and principal from the mortgage pool month, however it pays principle back one tranche at a time.
CMO. Collateralized Mortgage Obligations
Complex asset back securities.
Collateralized Debt Obligations.
Relate the rules on the taxation of interest bonds
Example: The Alta Loma High School District is asking voters to approve a bond to fund the purchase of new computers and software. The bond will mature in 40 years and the interest and principal payments will be funded from real estate taxes. This is an example of a :
A. A GO Bond
B. A revenue bond
C. A debenture
D. An equipment trust bond
A. If a municipal bond requires a vote, it is most likely a GO Bond. Generally revenue bonds do not require a vote( note there is no revenue sharing source here). Debentures and equipment trust certificates are issued by corporations, not municipalities
Your customer is in the 30% federal tax bracket. He is considering purchasing a 7% corporate bond. The After tax yield would be :
A. 4.9%
B. 2.1%
C. 10%
D. 7%
A. The formula for the calculation is 7% (corporate rate) x (100% - 30%(tax bracket)); 7 x (1-.3) =7 *.7= 4.9%
A newly issued Treasury Security that matures in 5 years is:
A. A T Bill
B. A T note
C. A T Bond
D. A treasury receipt
B. T -Notes are issued with maturities between 2 and 10 years. A T-Bills longest maturity is 1 year, and T bonds have maturities over 10 years.Treasury Receipts are not issued by the treasury.
CMO’s are backed by
A. The M in CMO stands for Mortgage
All of the following would most likely be found in a money market funds portfolio except
A. T Bills
B. T- Bonds with less than one year to maturity
C. Negotiable CD,s
D. Common stock
D. Common stock does not meet the criteria for the money market. Though highly liquid, it has no maturity date, nor is it relatively safe compared to debt instruments
