Types Of US Treasuries and Investnent funds Flashcards
Series E and EE Bonds
Sold at face value
Non-marketable, nontransferable
Do NOT pay interest periodically
Interest earned on EE bonds can be tax-free for college if used on qualified education expenses
Series I Bonds
Inflation protection via fixed rate + variable rate
Don’t pay interest periodically
TIPS
Principal adjusts for inflation, apply coupon rate to new principal amount
Coupon rate does NOT change like they do on
I Bonds
STRIPS
Separate trading of coupon payments and principal amount
Creates many zero coupon bonds
US Treasuries Maturity types
Bills = <1 year
Notes = 2 - 10 years
Bonds = greater than 10 yrs
All US Treasuries are
non-taxable at state and local
Which Federal Agency Security is backed by faith and credit of US Govt?
GNMA - Ginnie Mae
Govt Natl Mortgage Association
Which Federal Agency securities are NOT backed by US Govt?
Federal Natl Mortgage Association
(FNMA Fannie Mae)
Fed Home Loan Mortgage Corporation
(FHLMC Freddie Mac)
Student Loan Marketing Association
(SLMA Sallie Mae)
Private Activity Bonds
Used to fund construction of sports stadiums
Muni Bonds Tax Status
Not taxed at Fed, State, and Local level if you live in issuing state
Bonds issued by US territories (puerto Rico) are not subject to Fed, State, and Local Tax
Tax Equivalent Yield
TEY= r / (1-t)
r = tax exempt yield
t = marginal tax rate
After-Tax Yield
=(Corporate Bond rate) x (1-marginal tax rate)
Tax rate is 35%, corporate bond yields 8.5% and Muni yields 5.25%. Which would you recommend?
After tax yield =
8.5% x (1-0.35) = 5.525%
TEY= 5.25% / (1-0.35) = 8.07%
Pick the corporate bond since its after-tax yield is higher than the Muni’s TEY
What’s the TEY on a Treasury paying 3.5% if Marginal Federal tax rate is 35% and state income tax is 5%?
= 3.5% / (1-0.05) = 3.68%
You wanna put the Tax you DON’T have to pay in the denominator
(state tax in this case since it’s a Treasury)
Current Yield
Annual payment in dollars divided by current price of bond
= annual payment / current market price
CY= C / P
Coupon Rate
Annual payment in dollars divided by par value
If bond pays $100 per year with par value of $1,000, then coupon rate
= $100/ $1,000 = 10%
Bought bond for $880 with 9% coupon. You sold it after 1 year when it’s paying a current yield of 10%. What’s the Holding Period Return?
HPR=
(Sell price - PP +/- CF) / PP
(SP - 880 + 90) / 880
CY = C / P
P = C / CY = 90 / .10 = 900
(900 - 880 + 90) / 880 = 12.5%
Yield Curve Theories: Market Segmentation Theory
Yield curve depends on supply and demand at a given maturity
Yield Curve Theories: Liquidity Preference Theory
Yield curve has lower yields for shorter maturities because investors prefer liquidity and are willing to pay for it in form of lower yields
Yield Curve Theories: Expectations Theory
Yield curve reflects investors inflation expectations.
Since investors are uncertain or believe inflation will be higher in future, long term yields are higher
How do you immunize a bond portfolio from interest rate risk and reinvestment rate risk?
Maintain duration equal to investor’s time horizon
Zero coupon bond always has a duration equal to its years to maturity
Bond Duration
Bond price sensitivity to changes in interest rates
Higher is more sensitive
Weighted average time until you receive all coupon payments and principal
Larger coupon payments means Shorter Duration and vice versa
Longer maturity has higher duration
Change in Bond Price formula with changes in interest rates
Change of P =
-D x (change of Y / (1+Y))
Bond has 1,000 par, 5 years to maturity, 6% annual coupon. YTM is 8% and it’s selling for $920.15 and Duration is 4.4 years. What’s the new price if interest rates decrease by 0.5%?
= -4.4 x [ -0.005 / (1+.08)]
= 2.04%
New price is
$920.15 x 1.0204 = $938.92
Convertible Bond Formula
CV= (Par / CP) x Ps
Ps is stock price
CP is conversion price
Bought bond for $1,050. Conversion price is $40 and market price of common stock is $35. What’s the conversion value of the bond?
= (1,000 / $40) x $35
= $875
Property Valuation formula
= NOI / Cap Rate
NOI = Net income + Depreciation + Interest expense
Net Income = Total Income - All Expenses (Dep. Interest)
NOI Formula
= Net Income + Dep. + Int.
Net income is Income - fixed and variable expenses
(Mortgage payment including its interest, and depreciation are NOT operating expenses)
or NOI = Gross income - Operating expenses
(Vacancy rate reduces gross income!)
Condo has $2M in rent annually. Expenses are $300k in maintenance, $500k in salaries, $200k in utilities, $250k depreciation, $250k mortgage payments where $200k is proncipal and $50k is interest expense. Assume 10% required rate return, how much would investor be willing to pay for property?
$2M - $300k - $500k - $200k
= $1,000,000
$1,000,000 / 0.10 = $10M
Don’t include depreciation and mortgage payment expense
Unit Investment Trust
Can be fixed income or equity
Usually are fixed income
Self-Liquidating**
Passive management, no trading of assets w/in the trust
Units, NOT Shares
REIT’s How do they maintain Tax Exempt status?
Must distribute 90% of investment income to shareholders
REITs are also similar to a closed end mutual fund
3 Types of REITs?
Equity: Invest in real estate for capital appreciation
Income is generated from rental income and appreciation
Mortgage: Invest in mortgages and construction loans. Make the spread between the lending and borrowing rate
Hybrid: combo of both above
REITs: Attractive because?
Has low correlation with stock market
ADRs
Foreign stock held in domestic bank
DO NOT eliminate exchange rate risk
Capital gains in ADRs include currency fluctuation
Trade on US exchanges, denominated in US dollars and trade in US $$
Dividends are paid in USD
