Unit 3 Debt Securities Flashcards
debt securities come in a number of different forms:
bonds, notes, bills, certificates, and various money market instruments
In debt securities, the _____ owes interest and principal to the _____ of the debt
issuer
investor
The characteristics of a bond:
Par Value
Maturities
Coupons and accrued interest
Pricing
Yields
features
ratings
volatility
_____ also called the principal or face value: the amount paid to the investor as principal at maturity.
Par Value=$1000
____ is the date the investor receives the loan principal back.
maturity
Maturities come in different types:
Term Bond
Serial Bond
Balloon Bond
A ____ bond is structured so that the principal of the whole issue matures at once. Because the entire principal is repaid at one time, issuers may establish a sinking fund account (cash reserve) to accumulate money to retire the bond at maturity.
term
A ____ bond issue schedules portions of the principal to mature at intervals over a period of years until the entire balance has been repaid.
serial
A _____ bond is when an issuer sometimes schedules its bond’s maturity using elements of both serial and term maturities. The issuer repays part of the bond’s principal before the final maturity date–as with a serial maturity but pays off the major portion of the bond at final maturity.
balloon
series bond, which normally refers to types of savings bonds ( is or isn’t) a type of maturity used with debt securities.
isn’t
The _____ is the interest rate the bond issuer has agreed to pay the investor.
coupon rate
coupon rate also known as____
nominal yield
Coupon rate x Par Value=
Amount of interest per year
Interest is generally paid on a _____ basis. A 6% coupon bond pays $60 per year, so semiannual payments would be $30 in interest every six months.
semiannually
Once a bond is trading in the ______ , it can trade at a price of par, a premium
to par, or a discount to par.
secondary markets
Bond pricing is measured in _____, with each point equaling 1% of face value, or $10.
points
(bond price x 10)=
the dollar amount of the worth of the bond
because bonds are debt instruments, they have a particular sensitivity to changes in ____.
market interest rates
bond prices have an _____relationship to interest rates.
inverse
If interest rates go up, bond prices for those trading in the secondary markets will go____
down
The coupon is a ____ percentage of par value no matter what the current market value of the bond is.
fixed
A bond’s ___ expresses the cash interest payments in relation to the bond’s value.
yield
_____ yield is set at the time of issue.
Nominal
____ yield measures a bond’s annual coupon payment (interest) relative to its market price,
current yield
current yield=
annual coupon payment / market price
A bond’s ___ reflects the annualized return of the bond if held to maturity.
yield to maturity
If you see a bond that is trading on a “basis “of and the question then provides you a yield, that yield is the ____.
yield to maturity
yield to maturity=
The price that was paid for a bond minus the par value received when the bond matures
Yields are measured in ___.
basis points
An basis point is a measurement of ___
yield equal to 1/100 of 1%.
A feature that allows an issuer to pay a bond of earlier than the maturity date is a ____
call feature
Bonds can be issued with different features:
Call feature
put feature
convertible feature
A ____ feature allows the holder of the
debt to force the issuer to pay off the bond.
put feature
is the opposite of a call feature.
A _____ allows the investor to convert the bond into shares of common stock.
Convertible feature
When the value of a convertible bond equals the value of the shares an investor would receive if the conversion feature were exercised, the bond is said to be at _____.
parity
When bonds are issued with features that benefit the issuer, the issuer generally will need to pay a slightly ____ coupon rate to make the bond attractive to new investors.
higher
A _______, is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value
zero-coupon bond, also known as an accrual bond
Though a zero’s interest payment is paid at maturity, owners of zeroes will pay taxes on the interest ____.
annually
There are three major credit rating agencies:
- Fitch Ratings, nc.I
- Moody’s Investors Service, Inc.
- Standard and Poor’s Rating Service (S&P)
They determine_____
Bond ratings
Bank-Grade (Investment-Grade) Bonds:
Aaa - Highest rating.Capacity to repay principal and interest judged high.
Aa - Very strong. Only slightly less secure than the highest rating.
A- Judged to be slightly more susceptible to adverse economic conditions.
Baa- Adequate capacity to repay principal and interest. Slightly speculative.
Speculative (Noninvestment-Grade) Bonds:
Ba - Speculative. Significant chance that the issuer could miss an interest payment.
B - The issuer has missed one or more interest or principal payments.
Caa - No interest is being paid on bond at this time.
D - The issuer is ni default. Payment of interest or principal is in arrears.
_______ bonds are generally the only quality eligible for purchase by institutions (e.g., banks or insurance companies) and by fiduciaries and, therefore, have greater liquidity
Investment-grade
_____ of their lower ratings (BB or Ba or lower and additional risk of default, high-yield bonds may be subject to substantial price erosion during slow economic times or when a bond issuer’s creditworthiness is questioned.
Speculative (Noninvestment-Grade) Bonds also known as-
High-yield bonds are lower-grade bonds, once known in the industry as junk bonds.
It is important to understand that when the credit rating agency evaluates a bond, they look at all the factors, including ____. A bond with ____ is generally considered safer than one without.
collateral
The fact that a bond is not rated does not indicate its _____. Many issues are too small to justify the expense of a bond rating
quality
A bond’s sensitivity to interest rates is called ____.
volatility
The more a bond moves in response to a change in interest rates, the ____ volatile it is said to be; the less it moves, the ___ volatility it has.
more
less
A way of measuring a bond’s volatility that combines maturity and coupon rate is called _____.
duration
A _____ duration means a more volatile price; ____ duration brings less price volatility.
higher
lower
Benefits of owning debt securites
Income
safety
Risks of Owning Debt Securities
Default
Interest Rate Risk
Purchasing Power (inflation)
Corporate debt securities, like any other loan, may be either _____
secured or unsecured
_____ debt securities are backed by various kinds of assets owned by the issuer,
Secured debt
_____ debt securities are backed only by the reputation, credit record, and financial stability of the issuer.
unsecured
Secured debt types:
Mortgage Bonds, Equipment Trust Certificates, Collateral Trust Bonds
Unsecured debt types:
Debentures, Guaranteed Bonds, Income Bonds, Subordinated Debt
A ____ is a debt obligation of the corporation backed only by its word and general creditworthiness. _____ are written promises of the corporation to pay the principal at its due date and interest on a regular basis.
debenture
______ bonds are backed by a company other than the issuing corporation, such as a parent company. The value of the guarantee is only as good as the strength of the company
Guaranteed - Still UNSECURED
_____ bonds are a true oxymoron: they do not provide income. If an investor is seeking income, an ___ bond is not a suitable recommendation.
Income
_____ bonds, also known as adjustment bonds, are used when a company is reorganizing and coming out of bankruptcy. ____ bonds pay interest only if the corporation has enough income to meet the interest on debt obligations and if the board of directors (BOD) declares that the interest payment be made.
Income
____ debt is the lowest level of unsecured debt. A _____debenture has a claim that is behind (junior to) that of any other creditor.
Subordinated
Order of Liquidation:
Secured debt holders are first
Unsecured debt (debentures) and general creditors are second.
Subordinated debt holders are third in line.
Preferred stockholders come in next.
Common stockholders are last.
Parties (attorneys, the courts, property appraisers, auctioneers, and liquidators) are brought in to assist with the liquidation will be paid for their services. Their claim will be honored, and paid, _______ but after secured creditors.
before any other unsecured debt
____ bonds trade above par value while ____ bonds trade below par value.
Premium
discount
____ are securities issued by state or local governments or by U.S. territories, authorities, and special districts.
Municipal bonds
interest on most municipal bonds is:
tax free (tax exempt) on a federal level and tax free on a state level if the investor lives in the state of issuance.
Two categories of municipal securities exist:
general obligation (GO) bonds and revenue bonds.
___ bonds are municipal bonds issued for capital improvements that benefit the entire community
General Obligation
____ Mutual bonds are known as full faith and credit issues and are backed by the municipality’s taxing power.
General Obligation
_____ can be used to finance any municipal facility that generates sufficient income. These municipal bonds are considered to be self-supporting debt because principal and interest payments are made exclusively from revenues generated by the project or facility for which the debt was issued.
Revenue bonds
____ are short-term securities that generate funds for a municipality that expects other revenues soon. These have less-than-12-month maturities, although maturities may range from 3 months to 3 years are are repaid when the municipality receives the anticipated funds.
Municipal anticipation notes
Municipal notes fall into several categories:
Tax anticipation notes
Revenue anticipation notes
Tax and revenue anticipation notes
Bond anticipation notes
Tax-exempt commercial paper
Construction loan notes
Variable-rate demand notes
Grant anticipation notes
the ___ of the investor is used to determine whether corporate or municipal bonds are the right investment choice.
tax bracket
To determine a municipal bond investment’s tax benefit, an investor must calculate the tax-equivalent yield:
tax free yield/ (100%- tax bracket)
To determine a municipal bond investment’s tax benefit, an investor must calculate the tax-equivalent yield:
tax free yield x (100%- tax bracket)
Types of Treasury Securities:
Treasury Bills (T-Bills)
Treasury Notes (T-Notes)
Treasury Bonds (T-Bonds)
TIPS & STRIPS
T Bills:
Maturity Less than a year
Pricing issued at a discount
No Accrued interest
T-bills and STRIPS (Treasury zero-coupon bonds) are the only Treasury securities issued at a discount;
T-bills and STRIPS are the only Treasury securities issued without a stated interest rate;
T-bills are highly liquid; and
the 13-week (a.k.a. 91-day) T-bills are used in market analysis as the stereotypical risk-free investment.
T-Notes:
U.S. T-notes are direct debt obligations of the U.S. government.
‘They pay semiannual interest as a percentage of the stated par value,and they mature at par value.
T-notes have intermediate maturities (2-10 years).
T-Bonds:
U.S. T-bonds are direct debt obligations of the U.S. government.
They pay semiannual interest as a percentage of the stated par value and mature at par value.
‘These government obligations have long-term maturities, greater than 10 years and up to 30 years.
Both Treasury receipts and STRIPS are ____ bonds.
zero-coupon
Treasury Inflation-Protected Securities (TIPS) are a special type of Treasury security:
They are issued with maturities of 5, 10, or 20 years.
They have a fixed coupon rate and pay interest every six months.
What is different is that the principal value of the bond is adjusted every six months based on the INFLATION rate.
The interest payments will increase with the principal during periods of inflation and decrease during periods of deflation.
In addition to the U.S.-Treasury-issued securities T-bills, T-notes, and T-bonds–the
U.S. Congress authorizes the following agencies of the federal government to issue debt securities:
Farm Credit Administration (FCA)
Government National Mortgage Association (GNMA or Ginnie Mae)
Other agency-like organizations operated by private corporationsL
- Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)
- Federal National Mortgage Association (FNMA or Fannie Mae)
- Student Loan Marketing Association (SLMA or Sallie Mae)
The settelment for asset-backed securities, in the case of GNMA, FNMA, and FHLMC, mortgage-backed securities is:
regular way-trade plus two business days (T+2).
Farm Credit System (FCS)
not backed by governemt
interest taxed at fed level but tax free at state
Government National Mortgage Association (GNMA or Ginnie Mae):
Mortgage backed securities
Only one backed by the Government
taxed at the federal and state level
monthly payment is of interest and priniciple
Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) and Federal National Mortgage Association (FNMA or Fannie Mae)
publicly help corporations
both are not backed by the Government
paid semiannual payments of interest and principal
interest is taxed at all levels
____ instruments are fixed-income (debt) securities with one year or less left to maturity. They are highly liquid and also provide a relatively high degree of safety.
Money market
Characteristics of Money market Securities:
high quality
liqiuid
have to be 1 year or less to maturity
lower returns due to higher degree of safety
Types of Money market Securities:
Jumbo Certificate of Deposit (CD)
Bankers’Acceptances (BAs)
Commercial Paper (Prime Paper, Promissory Notes)
Treasury bills
Repurchase Agreements (Repos)
Federal Funds Loans
Though T-notes and T-bonds are issued with longer maturities than T-bills, once the notes and bonds have only a year left ot maturity, they are considered to be ____
money market instruments.
_______ securities are ones whose value and income payments are derived from or backed by a specific pool of underlying assets.
Asset-backed
Types of asset-backed securities:
Collateralized Mortgage Obligations (CMOs)
Collateralized Debt Obligations (CDOs)
A pool of mortgages is structured into maturity classes called ____
tranches
Characteristics of Collateralized Mortgage Obligations (CMOs):
no gov backing (backed by repayment of mortgages)
they are sorted into tranches which have different risk profiles and maturity
have special discourse and suitability rules
pays principal and interest from the mortgage pool monthly; however, it repays principal to only one tranche at a time.
___ are typically complex asset-backed securities that do not specialize in any single type of debt, usually their portfolios consist
of nonmortgage loans or bonds.
Collateralized Debt Obligations (CDOs)
have similar characteristics to CMOs
_____ are the excess amounts above the amount of a bank’s deposits required to be held on reserve at the Federal Reserve member banks can lend these funds to one another to meet the FRB reserve requirements
Federal funds
Current Yield=
annual income (coupon rate)/ current market price
A negotiable CD is an _____ money market instrument issued by banks.
unsecured
During Bankruptcy the court protects _____ filers from creditors
corporate and individual
Treasury receipts:
are issued by broker-dealers, and they are backed by the good faith and credit of those that issue them
All debt securities are ____ to equity securities.
senior
Income from debt securities is known as ____.
interest
When a company issues issues a collateral trust bond:
This is a secured bond backed by marketable securities owned by the issuer.
____ have the shortest maturities with a maximum of one year (52 weeks), ____ are from two to ten years, and ____have maturities of more than ten years.
Bills
notes
bonds
what are the terms are commonly used in describing a B-rated bond?
noninvestment grade.
high-yield.
junk bond
What are the characteristics of Government National Mortgage Association?
they are called pass-through securities because the payments are made up of both interest and principal.
they are backed by the federal government.
they pay monthly.
Your customer calls you with a question. They tell you that they received a phone call from the bond desk telling them that they bought 20 bonds at 100. They want to know how much they paid for the bonds before any commission or other charges. You tell them
$20,000.
100 means they paid 100% of par ($1,000) per bond. They purchased 20 bonds, so the total amounts to $20,000. Note that the question asked how much they paid for the bonds, not the price per bond.
Securities issued by the federal government produce interest that is not taxed at the _____. It is taxed at the _____.
state or local level
federal level
Bonds issued by or from a territory of the United States have tax-free income at ____ to U.S. citizens.
all levels
If a bond is trading at par, the nominal yield (coupon rate) = current yield (CY) = YTC = YTM. YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.
