Investments Lesson 5 Flashcards
US Treasury Securities
Are all non taxable at state & local level
Non/marketable securities
Not easily bought or sold
EE bonds
HH bonds
I bonds
Series EE Bonds
Sold at face value
$25 min $10,000 annual max
Non marketable, non transferable
Offered at 1/2 face value
Does not pay interest
Redeemable at 1 year, 3 months interest penalty for less than 5 years
Not subject to federal income tax unless not redeemed for education expenses
Series HH Bonds
Pay interest semi/annually
Not issued since August 2004
Series I Bonds
Inflation indexed sold by US gov Sold at face value No guaranteed rate or return Interest consists of: Fixed rate of return & inflation component adjusted every 6 months
Marketable US Treasury Issues
T-Bills: less than 1 year, discounted yield (do not pay interest)
Treasury Notes: maturities between 2-10 years, interest semi-annually
Treasury Bonds: maturities greater than 10 years, interest semi-annually
All sold in denominations of $100 or more
Sold on auction basis (lowest yield wins auction)
Original Issue Discount (OID)
Issued at discount from par
Zero coupon bond
Recognize imputed/phantom income
Treasury Inflation Protected Securities (TIPS)
Inflation & purchasing power protection
Principal/par value adjusts for inflation then coupon applied to new principal
Coupon rate does not change
Separate Trading of Registered Interest & Principal Securities (STRIPS)
Highly liquid
Appropriate for low risk, high liquidity, specific time horizon investors
Example Exam Question:
Which mitigate against purchasing power risk?
A. TIPS & STRIPS B. STRIPS & EE Bonds C. TIPS & EE Bonds D. I Bonds & TIPS E. I Bonds & EE Bonds
D
Exception: direct obligation of government & backed by full faith & credit of US government
GNMAs
GNMAs
Pool of FHA/VA guaranteed mortgages
Each month distributes interest & principal payment to investors
Agency bonds __ backed by full faith & credit of US government
Are not
Biggest risk with mortgage-backed securities is __?
falling interest rates. Mortgages could get repaid early, bond get retired early which leaves reinvestment problem
Secured Bonds
Mortgage backed securities: both principal & interest, biggest risk is prepayment risk
Collateral trust bonds: backed by asset owned by company issuing bonds, held in trust by 3rd party, in event of default, bond holders entitled to asset being held in trust
Collateralized Mortgage Obligations
Investors divided into tranches A-Z which represent short, intermediate, & long term tranches
Interest distributes pro-rata
Principal repayments retire tranches sequentially
Meant to mitigate against prepayment risk associated with mortgage backed securities
Unsecured Corporate Bonds
Debentures: unsecured, backed on belief of creditworthiness that issuing company will repay the debt
Subordinated Debentures: lower claim on assets than other unsecured debt, more risk if company defaults
Income bonds: interest only paid when a specific level of income is attained
Bond Rating Agencies
Moody’s
Standard & Poor’s
Rate on default risk & investment quality
Higher bond rating, lower yield
Analyzes liquidity, total amount of debt, earnings & stability of earnings
Moody’s Ratings:
Aaa-C
Aaa-Baa are investment quality
Ba & below are junk bonds
Standard & Poor’s Ratings
AAA-D
AAA-BBB are investment quality
BB & below are junk bonds
Guaranteed Investment Contract
Issued by insurance companies with guaranteed rate of return
Insurance company agrees to repay principal & guaranteed rate or return for period of time
Yield is higher than treasury securities
Municipal Bonds
Nontaxable (if you live in issuing state)
General Obligation Muni Bond
Backed by full faith, credit, & taxing authority of issuing municipality
Revenue Muni Bonds
Backed by revenue of specific project
Private Activity Muni Bonds
Used to finance construction of stadiums
Insured Muni Bonds
AMBAC
MBIA
If in default, insurance company will pay interest & principal
Difference between Corporate Bond Risk & US Government Bond Risk
Corporate:
Default, Reinvestment, Interest rate, Purchasing power
US:
Reinvestment, Interest rate, Purchasing power
Tax-Equivalent Yield (TEY)
Tax Exempt Yield
Yield to be equivalent to tax exempt Muni
After tax rate of return
If bond is double tax free __?
If triple tax free __?
Double: live in state
Triple: live in muncipality
Example Exam Question:
State income tax 5%. Itemizes deductions. Federal tax 35%. Local municipality issues 4.5% muni bond. What is TEY based on this information?
A. 6.9% B. 8.3% C. 7.3% D. 4.5% E. 9.7%
C
Example Exam Question:
What is TEY on treasury security paying 3.5% if marginal federal rate is 35% & state is 5%?
A. 5.8%
B. 3.7%
C. 5.1%
D. 4.8%
B
US Treasuries are exempt from __ only.
State & local taxes
Example Exam Question:
If yield ratio is Rtf (tax free)/Rt (taxable), how does higher ratio affect attractiveness of muni bonds?
A. Higher ratio, more appealing B. Lower ratio, more appealing C. Both D. Neither E. Investors are indifferent to the ratio
A
Lesson 5 Review:
Client desires minimize risk exposure. Under time classification of markets listed in reading which would best meet requirements?
A. 30 day call option
B. Treasury bond with 60 days to maturity
C. Treasury bill with 1 year maturity
D. 180 day commercial paper
C
Lesson 5 Review:
Series I bonds best described as:
A. Non marketable securities that adjust for inflation
B. Marketable securities that adjust for inflation
C. Non marketable that provide growth
D. Marketable that provide growth to combat inflation
A
Lesson 5 Review:
What is meant by US Treasury Bulls are sold at discount to par?
A. Sold at par value & discount provided to purchasers of large amounts
B. Sold at less than par, return par at maturity
C. Sold in auction format, highest bidders provided with discount
D. Sold at discount & premium to par value
B
Lesson 5 Review:
If muni bond fund designed to be federal & state tax free by investing in municipals & states where client lives, how would it occur that this same muni bond mutual fund could generate capital gains?
A. Muni bonds mutual fund interest not given same tax-exempt status as bonds held by individual holders
B. Muni bond mf profits generated through sale or fund units to new fund participants do not qualify for tax exemption
C. Muni bond mf income generated through bond sales is taxable gain to fund holders
D. Muni bond mf are taxable if not issued by state where participant resides
C
Lesson 5 Review:
Which best explains what it means to a firm to have bond issues downgraded by rating agency?
A. Bonds are downgraded periodically to insure corporate performance is kept at peak at all times
B. Downgraded when corporation engaged in riskier financial positions than bond rating agency deems appropriate for specific rating
C. Downgraded when corporation engaged in riskier projects than bond rating agency approves for certain level of bond rating
D. Bonds are seldom if ever downgraded
B
Lesson 5 Review:
Which of the following is not a marketable security?
A. T-bill
B. EE bond
C. T-note
D. T-bond
B
Lesson 5 Review:
Which of following bond’s par value is adjusted to provide purchasing power protection?
A. TIPS
B. I Bond
C. EE Bond
D. Zero-Coupon Bond
A
Lesson 5 Review:
Which backed by full faith & credit of US government?
A. FNMA
B. GNMA
C. SLMA
D. FFCB
B
