Investments: Bonds Flashcards
US Treasury Securities
Non taxable at the state and local level
Non marketable securities
- are not easily bought and sold
Series EE/E bonds
Series HH/H bonds
Series I Bonds
Series EE/E Bonds
- $25 minimum purchase, $10000 maximum
- sold at face value, only on TreasuryDirect
- Non marketable/non transferable
- fixed rate at time of purchase
- interest not subject to federal income taxes until redeemed, may qualify for tax free treatment if redeemed for education expenses.
Series HH/H bonds
- Pay interest semiannually
- have not been issued since 2004
Series I bonds
- inflation indexed bonds issued by the us government
- I bonds are sold at face value and have no guaranteed rate or return
-interest consists of two parts:
- Fixed rate of return
- Inflation component that is adjusted every six months.
Marketable US Treasury issues
US Treasury Bills
US Treasury Notes
US Treasury Bonds
- sold in denominations of $100 or more
- sold on an auction basis with lowest yield winning the auction
US Treasury Bills (T-Bills)
- Maturities less than 1 year
- sold in a discounted yield basis, means they do not pay interest; bonds mature at par value
US Treasury Notes
- have maturities between 2 and 10 years
- interest is paid semi-annually
US Treasury Bonds
- have maturities greater than 10 years
- interest is paid semi-annually
Original Issue Discount (OID)
- bond issued at a discount from par value.
- zero coupon bonds is an example - $1000 par value zero coupon bond may sell for $600. Increases over life of bond and sold at par value.
- zero coupon bond - bond holder must recognize income each year even if no income was received. “Phantom income”
Treasury Inflation Protected Securities (TIPS)
- provide inflation and purchasing power protection.
- par value adjust for inflation, coupon rate is applied to the new par value
- coupon rate does not change
Separate trading of registered interest and principal securities (STRIPS)
- periodic coupon payments are separated from the bond and each coupon payment, including par value trade separately
- good for investors looking for low risk, highly liquid, and specific time horizon.
Federal Agency Securities
Agency bonds are not backed by the full faith and credit of the US Government.
Exception - GNMA bonds are backed by the full faith and credit of the US government
On Budget Debt - Agency Securities/Bonds
- Government national Mortgage association (GNMA-Ginnie MAE)
- Farmers Home Administration
Off Budget Debt - Agency Securities/Bonds
Federal National Mortgage Association (FNMA - Fannie Mae).
Federal Home Loan Mortgage Corporation (FHLMC - Freddie Mac).
Student Loan Marketing Association (SLMA - Sallie Mae).
Federal Farm Credit Banks (FFCB).
Federal Intermediate Credit Banks (FICB).
Federal Home Loan Bank (FHLB).
What agencies offer Mortgage Backed Securities?
- GNMA - Ginnie Mae
- FNMA - Fannie Mae
Biggest risk is falling interest rates. Mortgages could get repaid early, the bond would get retired early, leaving investors with reinvestment issue
Ginnie Mae - GNMA
- mortgage backed security
- pool of FHA/VA guaranteed mortgages.
- each month GNMA distributed interest and principal payments to investors.
- interest it subject to both state and federal income tax, component that is return of principal is not taxable.
FNMA (Fannie MAE) and FHLMC (Freddie Mac)
- mortgage backed securities
- not backed by the US Government
What are some corporate bonds?
-secured bonds:
Mortgage backed securities, collateral trust bonds, Collateralized Mortgage obligations
-unsecured corporate bonds:
debentures, subordinated debentures, income bonds
Collateral Trust Bonds
- backed by asset owned by the company issuing the bonds.
- asset held in trust by a third part
- In event of default, bond holders receive asset in trust
Collateralized Mortgage Obligations (CMOs)
- investors divided into tranches A-Z by maturity length to determine which investors will receive principal repayment.
- tranches separated by short, intermediate, & long term.
- short term tranche receive principal repayment first. Interest distributed pro-rata.
- meant to mitigate prepayment risk associated with mortgage backed securities
Debentures
- simply unsecured debt that is not backed by an asset (unsecured bond)
- backed on the belief of the creditworthiness that the issuing company will repay the debt.
Subordinated debentures
- have a Lower claim on assets than other unsecured debt.
- have more risk because of the lower claim on assets if the company defaults on the bond repayments.
Income bonds
Interest is only paid when a specific level of income is attained.
Only guaranteed to receive the par value back
Bond Rating Agencies
- Moodys and Standard and Poor’s
- higher the bond rating, the lower the yield.
Analyze a firms:
Liquidity
Total amount of debt
Earnings and stability of those earnings
What are Moody’s ratings?
Ratings are AAA-C
Aaa-Baa are investment quality bonds
Ba and below are junk bonds
What are Standard and Poor’s ratings?
Ratings are AAA-D
AAA-BBB are investment quality bonds
BB and below are junk bonds
Guaranteed investment Contract (GIC)
- Issued by insurance companies with a guaranteed rate of return.
- The insurance company agrees to repay the principal and guaranteed rate of return for a period of time
- Yield is higher than treasury securities.
Municipal Bonds
- non taxable at the federal, state and local level if you live in the state.
- used to finance capital expenditures, for the state or municipality
- three types of municipal bonds:
- General obligation bonds
- Revenue bonds
- Private activity bonds
General Obligation Bonds
- backed by full faith, credit, and taxing authority of the municipality that issued the bond.
- Municipal Bond
Revenue Bonds
- municipal Bond
- backed by the revenue of a specific project
Private Activity Bonds
-used to finance the construction of stadiums
What companies insure Municipal Bonds?
- American Municipal Bond Assurance Corp. (AMBAC)
- Municipal Bond Insurance Association Corp. (MBIA)
- insurance company will pay interest/principal amounts if a bond is in default.
What are risk to corporate bonds?
Default Risk.
Reinvestment Rate Risk.
Interest Rate Risk.
Purchasing Power Risk.
What are risk to government Bonds?
Reinvestment Rate risk
Interest rate risk
Purchasing power risk
Tax Equivalent Yield
Yield a taxable corporate bond would need to pay to be equivalent to the yield of a tax- exempt muni.
Tax-Exempt Yield
After tax rate of return a taxable corporate bond pays
How to calculate tax equivalent yield and tax exempt yield?
Tax equivalent yield & Tax Exempt yield example
When is a Muni Bond double tax free?
Bond holder must live in the state that issued the municipal bond.
When is a muni bond triple tax free?
Bond holder must live in the local municipality that issued the bond.
How to calculate tax exempt yield for double tax free bond:
-only use this formula if client itemizes deduction in their return!!!!!
If they don’t itemize just add the state and local taxes together and use that for marginal rate
