Unit 2 Flashcards
WHO IS THE ISSUER OF A BOND?
ENTITY BORROWING MONEY (CORP, GOV)
PAR VALUE
FACE VALUE OF BOND, TYPICALLY $1,000
COUPON RATE
INTEREST RATE BOND PAYS ANNUALLY (AKA NOMINAL YIELD)
ALWAYS STATED IN ANNUAL PAYMENT (NEED TO DIVIDE FOR SEMIANNUAL)
MATURITY DATE
WHEN PRINCIPAL IS REPAID
CORPORATE BOND
ISSUED BY COMPANIES
TREASURY BOND
ISSUED BY US GOV
MUNICIPAL BOND
ISSUED BY STATE AND LOCAL GOV
FOREIGN BOND
ISSUED BY FOREIGN GOV AND COMPANIES
TYPES OF BONDS
CORPORATE, TREASURY, MUNICIPAL, FOREIGN
CURRENT YIELD OF BOND
EXPECTED ANNUAL RETURN OF A BOND =ANNUAL INTEREST PAYMENT (COUPON)/CURRENT MARKET PRICE
YIELD TO MATURITY
TOTAL RETURN IF HELD TO MATURITY
YIELD TO CALL
TOTAL RETURN IF BOND CALLED EARLY
DISCOUNT
BOND SELLS FOR LESS THAN PAR
PREMIUM
BOND SELLS FOR MORE THAN PAR
TYPES OF CORPORATE BONDS
SECURED & UNSECURED
SECURED BONDS
BACKED BY SPECIFIC ASSETS
UNSECURED BONDS
NOT BACKED BY SPECIFIC ASSETS (DEBENTURES)
TYPE OF TREASURY SECURITIES
TREASURY BILLS, TREASURY NOTES, TREASURY BONDS
TREASURY BILLS
SHORT TERM SECURITIES MATURING IN ONE YEAR OR LESS, ISSUED AT DISCOUNT, NO INTEREST PAYMENTS, MATURE AT PAR
TREASURY NOTES
MEDIUM TERM SECURITIES MATURING IN 2 TO 10 YEARS, PAY SEMIANNUAL INTEREST, MATURE AT PAR, NONCALLABLE
TREASURY BONDS
LONG TERM SECURITIES MATURING IN MORE THAN 10 YEARS, PAY SEMIANNUAL INTEREST, MATURE AT PAR, NONCALLABLE
TYPES OF MUNI BONDS
GENERAL OBLIGATION BONDS , REVENUE BONDS
GENERAL OBLIGATION BONDS
BACKED BY ISSUERS FULL FAITH AND CREDIT, SECURED BY UNLIMITED PROPERTY TAXES, VERY SAFE
REVENUE BONDS
Backed by the revenue from a specific project or source. YIELD IS HIGHER (TAXES ARE MORE SECURE THAN REVENUE)
TAX BENEFITS OF MUNI BONDS
INTEREST IS EXEMPT FROM FEDERAL INCOME TAX
RISKS OF FOREIGN DEBT SECURITIES
CURRENCY RISK, POLITICAL RISK, ECONOMIC RISK
CURRENCY RISK
FLUCTUATIONS IN EXCHANGE RATE
POLITICAL RISK
Changes in government or political instability.
ECONOMIC RISK
Economic instability in the issuing country.
METHODS OF REPAYING A BOND
SINKING FUND, SERIAL BOND, BALLOON PAYMENT
SINKING FUND
FUNDS SET ASIDE TO REPAY DEBT OR BOND
SERIAL BOND
BONDS ISSUED WITH DIFFERENT MATURITY DATES
BALLOON PAYMENT
LARGE PAYMENT DUE AT END OF BOND’S TERM
COMMERICIAL PAPER
MONEY MARKET: Short-term unsecured promissory notes issued by companies.
CERTIFICATE OF DEPOSIT
MONEY MARKET: Time deposits with banks.
TREASURY BILLS
MONEY MARKET: Short-term government securities. DO NOT PAY INTEREST, SOLD AT DISCOUNT FROM PAR
CAN THE GOV (US OR STATE) ISSUE STOCK?
NO, THEY CAN ONLY ISSUE DEBT SECURITIES
BOND’S INDENTURE
STATES THE TERMS OF THE LOAN, AKA DEED OF TRUST
WHAT IS LONG TERM DEBT?
DEBT ISSUED FOR MORE THAN 5 YEARS
WHAT HAPPENS TO BONDS WHEN INTEREST RATES GO UP?
BOND PRICES GO DOWN AND VICE VERSA. KNOWN AS INTEREST RATE RISK
DO BOND INTEREST RATE PAYMENTS FLUCTUATE WITH THE PRICE OF BONDS?
NO, INTEREST RATES WILL STAY THE SAME
HOW FREQUENT IS INTEREST PAID ON BONDS?
GENERALLY SEMIANNUALLY
IS INTEREST ON BONDS AN OBLIGATION?
YES, COULD LEAD TO FORCLOSURE IF UNPAID
HOW DO MONEY MARKET BONDS WORK?
THEY ARE ISSUED AT A DISCOUNT WITH DIFFERENCE PAID AT MATURITY, REPRESENTING INTEREST
HOW IS INTEREST PAID ON A BOND IF IT IS SOLD BEFORE NEXT INTEREST PAYMENT?
BUYER PAYS SELLER INTEREST THAT HAS ACCRUED TO DATE AND THEN RECEIVES THE FULL PAYMENT
TWO PRIMARY RATING ORGANIZATIONS FOR BONDS
STANDARD & POORS(AAA, AA A, BBB) MOODY’S (Aaa, Aa, A, Baa)
INVESTMENT GRADE BONDS
TOP RATED BONDS (BBB OR Baa or higher). ONLY BONDS ELIGIBLE TO PURCHASE BY INSTITUTIONS (BANKS, INSURANCE COMPANIES) AND FIDUCIARIES
HIGH YIELD BONDS
AKA JUNK BONDS, LOWER GRADE, HIGH RISK COULD LEAD TO HIGH RETURN
WHAT DOES IT MEAN TO BE SPECULATIVE?
HIGH RISK OF LOSS
PRICING OF CORPORATE AND MUNI BONDS
QUOTED AS A PERCENTAGE OF PAR
EACH BOND POINT IS $10 (1% OF $1,000)
WHAT IS THE PRICE OF A CORP OR MUNI BOND QUOTED AT:
90 1/4
101 /4
901,000 = 900 1/4$10= 2.50 $902.50
1011,000=1010 3.410=7.50 $1017.50
PRICING OF A TREASURY BOND
90.8 OR 90.08
101.24
QUOTED AS A PERCENTAGE OF PAR
901,000=900 8/3210= 2.50 902.50
1011000=1010 24/3210=7.50 1017.50
WHAT DOES DEF 5s35 @106 MEAN?
DEF IS ISSUE
5 IS COUPON/NOMINAL RATE
35 IS MATURITY DATE (2035)
106 IS PRICE (1060)
CONVERTIBLE DEBT
50:1
CONVERSION PRICE OF 20
DEBENTURE
ISSUED BY CORPORATIONS ONLY
CONVERTED OR EXCHANGED FOR COMMON STOCK AT THE CONVERSION PRICE
MEANS 50 SHARES FOR 1 BOND
1,000/20 = 50 SHARES
BONDS ARE ALWAYS REPRESENTED IN INCREMENTS OF WHAT DOLLAR AMOUNT?
$1,000
PARITY
CONVERSION PRICE AND BOND PRICE ARE THE SAME
PAR VALUE
DOLLAR AMOUNT RETURNED TO INVESTOR AT MATURITY
THE YTM ON A DISCOUNT BOND WILL BE HIGHER OR LOWER THAN BONDS CURRENT YIELD?
HIGHER. REVERSE IT TRUE
BUYING A BOND AT A DISCOUNT WILL RESULT IN GETTING BACK?
PAR RESULTING IN A PROFIT
BUYING A BOND AT A PREMIUM WILL RESULT IN GETTING BACK
PAR RESULTING IN A LOSS
IF A BOND IS SELLING AT A PREMIUM, WHAT IS THE RELATIONSHIP OF CY, YTM, YTC, AND NOMINAL
YTC
YTM
CY
NOMINAL
IF A BOND IS SELLING AT A DISCOUNT, WHAT IS THE RELATIONSHIP OF CY, YTM, YTC, AND NOMINAL
NOMINAL
CY
YTM
YTC
CALCULATE CURRENT YIELD OF COMMON STOCK
DIVIDEND DIVIDED BY STOCK PRICE
WHAT MARKET DO GOV BONDS USUALLY TRADE?
CAPITAL MARKET SOME TRADE IN MONEY MARKET
WHAT BONDS ARE THE SAFEST
US GOV BONDS
TREASURY INFLATION-PROTECTED SECURITIES (TIPS)
ISSUED WITH A FIXED INTEREST RATE BUT PRINCIPAL IS ADJUSTED SEMIANUALLY BY AMOUNT EQUAL TO CONSUMER PRICE INDEX (=FIXED INTEREST*ADJUSTED PRINCIPAL), SOLD IN DENOMINTIONS OF $100. ONLY FED TAXED, ADDS PROTECTION FROM PURCHASING POWER RISK
WHAT IS THE STANDARD MEASUREMENT OF INFLATION?
CONSUMER PRICE INDEX
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) (GINNIE MAES)
MORTGAGE BACKED SECURITY BACKED BY FEDERAL GOV. FHA AND VA GUARANTEED MORTGAGES. INTEREST PAID MONTHLY
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA)(FANNIE MAE)
MORTGAGE BACKED SECURITY QUASI GOV ORGANIZATION. NOT BACKED BY GOV BUT A “MORGAL” OBLIGATION OF GOV. FHA AND VA MORTGAGES
PREPAYMENT RISK
RISK TO GNMA AND FNMA OF MORTGAGES BEING PAID OFF EARLY. FORM OF REINVESTMENT RISK
ADVANTAGES AND DISADVANTAGES OF MORTGAGE BACKED SECURITES
ADVANTAGE: HIGHER RETURN
DISADVANTAGE: DIFFICULT TO UNDERSTAND, PREPAYMENT RISK, DEFAULT RISK, REINVEMENT RISK, LIQUIDITY RISK
TENESSEE VALLEY AUTHORITY (TVA)
LARGEST PUBLIC POWER PROVIDER, CORP OF US GOV, BACKED BY GENERATED REVENUE, “IMPLICIT” BACKED BY GOV
SECURED DEBT
MORTGAGE BONDS
EQUIPMENT TRUST CERTIFICATES
COLLATERAL TRUST CERTIFICATES
BACKED BY ASSETS
-BACKED BY REAL ESTATE/ASSETS OF CORPORATION (IE:MORTGAGE)
-BACKED BY ASSETS (IE:CAR LOAN)
-CORP DEPOSITS SECUITIES IT OWNS INTO A TRUST AS COLLATERAL
UNSECURED DEBT
DEBENTURE
GUARANTEED BOND
SUBORDINATED
BACKED ONLY BY WORD AND CREDITWORTHINESS
-WRITTEN PROMISE, IOU
-GUARANTEE GIVEN BY A CORP ENTITY OTHER THAN ISSUER
- LOWER OR INFERIOR CLASS TO OTHER CREDITORS
CAPITAL STRUCTURE OF A CORPORATION
SECURED CREDITOR
UNSECURED CREDITOR
SUBORDINATED DEBT HOLDER
PREFERRED STOCKHOLDER
COMMON STOCKHOLDER
TAXES OF CORPORATE BONDS
VS
TAXES OF GOV BONDS
VS
TAXES OF MUNI
CORPORATE TAXES AS ORDINARY INCOME ON BOTH STATE AND FED
TREASURY DEBT TAXES AT FEDERAL LEVEL
MUNI FREE FROM FEDERAL AND STATE IF INVESTOR RESIDES IN SAME STATE AS ISSUER
TAX EQUIVALENT YIELD (TEY)
=MUNI BOND COUPON
DIVIDED BY (100%-INVESTOR’S TAX BRACKET)
ADVANTAGES AND DISADVANTAGES OF FROEIGN BONDS
ADVANTAGE: POTENTIAL HIGHER RETURNS, DIVERISIFIATION, HEDGE AGAINST VALUE OF US DOLLAR DROP
RISK: CURRENCY RISK, HIGHER RISK OF DEFAULT, LESS LIQUIDITY, HIGHER TRADING COSTS
EUROBOND
LONG TERM DEBT ISSUED AND SOLD OUTSIDE THE COUNTRY OF THE CURRENTY IN WHICH IT IS DENOMINATED. PAYS IN FOREIGN CURRENCY. DO NOT HAVE TO REGISTER WITH SEC.
EURODOLLAR
BOND ISSUED AND SOLD OUTSIDE OF US BUT PRINCIPAL AND INTEREST ARE STATED IN US DOLLARS. PAYS IN US CURRENCY
YANKEE BOND
US DOLLAR DENOMINATED BOND ISSUED BY NON US ENTITY IN US MARKET
ADVANTAGES AND DISADVANTES OF EUROBONDS
ADVANTAGES: NO CURRENCY RISK, RATED BY US AGENCIES, HIGHER YIELDS
RISKS: LACK OF TRANSPARENCY, POLITICAL AND COUNTRY RISK, LESS LIQUIDITY, CURRENCY RISK IF DENOMINATED IN A CURRENCY OTHER THAN YOUR OWN
BRADY BONDS
EXCHANGE DEFAULTED BANK LOANS IN LESS DEVELOPED COUNTRIES WITH A SECURITY THAT COULD BE CARRIED ON THE BANK’S BOOKS AS A PERFORING ASSET, 10-30 YEARS. NOT GUARANTEED BY GOV
ZERO COUPON BONDS
NOMINAL/COUPON RATE IS 0
ISSUED AT SUBSTANTIAL DISCOUNT FROM PAR
PAY NO INTEREST
MATURE AT PAR
TAXES PAID ON PHANTOM INCOME
ALLOWS INVESTORS TO LOCK IN YIELD
RISK OF ZERO COUPON BOND
CREDIT RISK IF ISSUER BECOMES INSOLVENT AT TIME OF BOND MATURITY
SEPARATE TRADING OF REGISTERED INTEREST AND PRINCIPAL OF SECURITIES (STRIPS)
ZERO COUPON TREASURIES
NO CREDIT RISK EXISTS
CALLABLE BONDS
ISSUER CAN PAY OFF BONDS BEFORE MATURITY, IF THEY DESIRE
USUALLY WHEN INTEREST RATES DECLINE
CALL PROTECTION
NUMB ERO FYEARS BEFORE ISSUER MAY EXERCISE CALL PROVISION
CONVERTIBLE BOND
CAN BE CONVERTED TO COMMON STOCK WHEN STOCK PRICE INCREASES ABOVE CONVERSION PRICE. LOWER INTEREST RATE
ADVANTAGES AND RISKS OF CONVERTIBLE BOND
ADVANTAGES: DOWNSIDE PROTECTION (WILL SELL ON BASIS OF YIELD ALONE IF STOCK PRICE DOES NOT INCREASE)
UPSIDE POTENTIAL (HAS ALL THE UPSIDE POTENTIAL OF COMMONSTOCK)
RISKS: ANTIDILUTIVE PROTECTION (IF COMPANY DOES A STOCK SPLIT, SHARES ARE WORTH HALF)
MONEY MARKET
MARKET FOR BUYING AND SELLING SHORT TERM LOANABLE FUNDS IN THE FORM OF SECURITIES AND LOANS.
BUYER IS LENDER, SELLER BORROWING MONEY.
1 YEAR OR LESS.
ISSUED AT DISCOUNT. DO NOT PAY INTEREST.
PAID BACK AT PAR.
CD
UNSECURED TIME DEPOSIT
DO NOT HAVE PREPAYMENT PENALTY
FDIC INSURED TO $250K
JUMBO CD’S (UNSECURED) PAY INTEREST SEMIANNUALLY
MONEY MARKET ISSUED AT PAR (NOT DISCOUNT)
COMMERCIAL PAPER
SHORT TERM UNSECURED PAPER ISSUED BY CORPORATIONS TO RAISE WORKING CAPITAL.
EXEMPT FROM REGISTRATION IF NO LONGER THAN 270 DAYS.
ISSUED AT DISCOUNT
WHAT DOES “EURO” MEAN?
BANK DEPOSIT MADE OUTSIDE OF CURRENCY’S HOME COUNTRY
INTEREST RATE BASED ON LIBOR
WHAT IS THE WORLD’S MOST WIDELY USED BENCHMARK FOR SHORT TERM INTEREST RATES?
LIBOR
ADVANTAGES AND DISADVANTAGES OF MONEY MARKET
ADVANTAGES: HIGH LIQUIDITY, VERY SAFE, BEST PLACE TO STORE IF NEEDED SOON
RISK: LOW RETURN, FLUCTUATING INCOME DUE TO SHORT TERM MATURITIES
DEMAND DEPOSIT (DDA)
CASH IN THE BANK
SHORT TERM FUNDS WITH LOW RETURN
