Knowledge Flashcards
What is the Net Present Value formula?
CF1/(1+i) + CF2/(1+i)2 + CF3/(1+i)3 …
CFx is cash flow in the given year and i is the interest rate.
What is the bond yield hierarchy
Nominal rate
Current rate
Yield to maturity (YTM)
Yield to call (YTC)
Discounted rates: nominal is the lowest
Premium: YTC is the lowest
When will a bond be called?
It will not be called if selling at a discount (interest rates are higher than the issued rate).
It will be called if selling at a premium (interest rates are lower than the issued rate).
Bonds sell at a premium when interest rates are low. If interest rates are low, the issuer can call the bond and issue new bonds at a lower rate.
Yield curve theories
Liquidity Preference Investors demand a higher return when bonds are issued for a longer term.
Market Expectation The shape of the curve shows the direction rates will move in the future.
Market Segmentation The shape of the curve is determined by supply and demand in each segment.
None of these adequately match the reality of what we see.
Yield spread
Compares AAA Corporate bonds to government bonds.
In theory, the spread widens when the economy is heading into a recession. It narrows when the economy is heading into prosperity.
Future value formula
FV = PV(1+i)n
FV: future value
PV: present value
i: interest rate
n: number of years
Characteristics of various price/x ratios
Price/sales: No earnings impact Unusual 1-time charges
Price/cash flow: Unusually high Non-cash deductions
Convertible debt characteristics
Above par - acts like a stock. It’s in the money.
Below par - acts like a bond.
In what increments are Treasury Bonds sold?
$100
Federal Farm Credit System investments
The banks:
- Federal Intermediate Credit Bank
- Federal Land Banks
- Banks for Cooperatives
Discount notes
- 1 year or less maturity
- $5,000 minimum investment
- $1,000 increments
Designated bond
- 2-10 year maturity
- Not callable
- Pay interest twice per year
- $5,000 minimum investment
- $1,000 increments
Bonds Up to 30 years
- Callable
- Fixed rate:
- $5,000 minimum
- $1,000 increment
- Floating rate:
- $100,000 minimum
- $1,000 increment
Homeownership promotion
Federal Home Loan Banks (FHLB)
Federal National Mortgage Association (FNMA, Fannie Mae)
Government National Mortgage Association (GNMA, Ginnie Mae)
Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac)
What investment vehicles are available from the Federal Home Loan Banks (FHLB)?
- Notes
- $100,000 minimum
- $1,000 increments
- Bonds
- $10,000 increments
- These bonds are callable
- Bullet bonds
- Not callable
Discuss Mortgage-Backed Securities (MBS).
- Applies to FNMA (Fannie Mae), FHLMC (Freddie Mac), GNMA (Ginnie Mae).
- Agency buys mortgages from banks.
- Agency creates packages of about $1 billion and divides the package into $25,000 MBS.
- MBS are subject to prepayment risk.
- FNMA buys VA & FHA loans.
- GNMA buys government-insured mortgages.
- FHLMC buys conventional mortgages.
What are Brady bonds?
Bonds that are issued by the governments of developing countries.
Named after former U. S. Treasury secretary Nicholas Brady.
Most issued by Latin American countries.
How is interest from GNMA investments taxed?
Unlike Treasuries, it is fully taxable at both the federal and state levels.
What are adjustment bonds (aka income bonds)?
Bonds that are issued when a corporations is recapitalized during bankruptcy. They are issued in exchange for the outstanding debt of the organization, typically with terms that will help the corporation emerge from bankruptcy.
What is a negotiable certificate of deposit (NCD)?
- These are CDs with a minimum face value of $100,000.
- They are guaranteed by the banks.
- They can usually be sold in highly liquid secondary markets, but cannot be redeemed before their maturation date.
- They are considered to be low-risk and pay low interest rates.
- Most commonly purchased by institutional investors.
What is the 75/5/10 rule for diversified funds?
The fund must be invested at least 75% in securities.
No more than 5% can be invested in one issurer.
Cannot own any more than 10% of the voting securities of one issuer.
What are the classes of 12b-1 funds?
Class A
- Lower 12b-1 fees.
- Front-loaded charges.
- Reduce up-front charges for larger investments.
- Considered better for wealthy investors and for long-term investments.
Class B
- High exit fees.
- Higher expense ratios.
- Considered to be better for intermediate-term investments.
Class C
- Higher expense ratios than Class A shares.
- No up-front costs.
- Smaller exit fee.
- Considered to be better for short-term investments.
Discuss Regulation M (aka Subchapter M) investments.
IRS regulation that allows regulated investment companies to pass taxes from capital gains, dividends, and interest distibutions through to the individual investors. It conforms to the “conduit theory” which allows these to be passed through without double taxation.
What is a Regulated Investment Company?
- Can be mutual fund, ETF, REIT, or UIT.
- Must be deemed eligible by the IRS to pass through taxes for capital gains, dividends, or interest earned to the investor (conduit theory).
- Must exist as a corporation or other entity that would be taxed like a corporation.
- Must be registered with the SEC.
- Must elect to be deemed as a RIC by the Investment Company Act of 1940 as long as its income source and diversification of assets meets specified requirements.
- Must derive a minimum of 90% of its income from capital gains, interest, or dividends earned on investments.
- Must distribute a minimum of 90% of that income to shareholders.
- Must have at least 50% of total assets invested in cash, cash equivalents, or securities.
- They cannot have more than 25% of totals assets invested in the securities of a single issuer unless the investments are government securities or the securities of other RICs.
