Unit 4 Flashcards
municipal securities
debt security issued by state or local govt to raise money for a public project. Interest payable on these instruments might be free of federal tax
bond
legal obligation of an issuing company or govt to repay the principal of a loan to bond investors at a specific future date.
represents the issuers indebtedness.
Fixed annual interest rate - coupon or nominal yield
indenture/deed of trust
terms of the loan.
states issuers obligation to pay back a specific amt of money on a specific date and specific amt of interest and any collateral.
indenture/deed of trust
terms of the loan.
states issuers obligation to pay back a specific amt of money on a specific date and specific amt of interest and any collateral.
long term debt financing
minimum of 5 years. frequently 20-30 years
money market instruments
market for buying and selling short terms (1 yr or less) loanable funds.
high quality low risk = low yield
issued at a discount, do not pay interest. principal amt repaid at maturity.
primary purchasers: banks, insurance companies, money market mutual funds
No indenture.
- T bills, commercial paper, negotiable certificate of deposit, Bankers’ acceptances, Repurchase agreement
characteristics of debt securities
- inverse relationship btw interest rates and price of debt securities
- interest payment always remained fixed
- indenture: legal doc describing conditions
- negotiability: readily transferable. can sell before maturity date.
- specified maturity date: redeemed on a certain date
- payment of interest: bonds = interest is paid semiannually (1st or 15th) based on coupon rate. Money market = issued at discount to face value with difference paid at maturity
- accrued interest
- paying agent: transmit payments of interest and principal to investors
- pricing (quotes): bonds are quoted as a % of par or face value
- Trustee: financial institution (trust company) who represents the investors. often serves as paying agent
- secured: has collateral; or unsecured: not collateral, only credit standing of the issuer.
- callable or noncallable
characteristics of debt securities
- inverse relationship btw interest rates and price of debt securities
- interest payment always remained fixed
- indenture: legal doc describing conditions
trust indenture act of 1939
corporate bonds
callable
call feature permits the issuer to redeem the bond (pay off principal) before maturity. Typical when interest rates decline - refunding.
“in whole call” entire issue is called or partial call by random draw.
when issuer calls the bond, investors sell back their bonds at the call price.
call protection
number of yrs into the issue before the issuer can exercise the call provision.
noncallable
the issuer cannot call in the issue early.
US treasury bills
- safest money market security
- available in maturities of 4, 8, 13, 26 and 52 weeks (no longer than 52 weeks)
- always issued at a discount from face value
commercial paper
-short term unsecured paper issued by corporations, sold in blocks of 100,000 primarily to raise working capital.
- issuers normally have excellent credit.
- maturities range from 1 to 270 days, most mature within 90 days.
- always issued at a discount from face value
- Commercial paper is unsecured, short-term corporate debt most commonly issued by finance companies but also by industrial corporations and broker-dealers.
negotiable certificate of deposit/ jumbo CDs
- min size = 100,000 but most common is 1mm
- unsecured bank deposits and money is loaned to the bank for a specific time period.
- negotiable = transferable. owner can sell on open market before maturity date.
- the bank that issues the CD redeems the CD at face value + interest at maturity.
- insured by FDIC up to 250,000 but they are not secured by any collateral.
- Negotiable CDs are issued primarily by banks and backed by the issuing bank. They are issued at face value, and the minimum denomination is $100,000. These are sometimes referred to as jumbo CDs.
brokered CDs
- BD sells them
- typically longer holding period than jumbo CDs
- not part of money market
- generally more complex than jumbo CDs
- commission or fees are higher than other CDs
- may or may not be covered by FDIC insurance.
- usually not redeemable before maturity. BD might buy it back for fees and potentially not full value
bankers’ acceptances
- used by corporations in import/export
- short term time draft with a specified payment date drawn on a bank
- post dated check or line of credit.
- payment btw 1 and 180 days, no more than 270 days
- bank accepts the responsibility to make payment upon maturity
- very marketable
- always issued at a discount from the face value
repurchase agreement
- the sale of securities with an agreement to repurchase them at a higher price at an agreed upon future date.
- overnight repo: repurchase date is the next day.
- difference btw the sale price and repurchase price represents interest earned.
- always purchased at a discount
-trade as money market instruments - security that is exchanged stands as collateral for the loan advanced to the seller - Tbills are most common.
reverse repo
- same as above but, the purchaser initiates the deal
- agreement to resell the securities at a higher price on an agreed on future date.
sovereign debt
debt securities issued by foreign govts
- safety depends on the economy of the issuing country
- FX risk
foreign corporate debt securities
typically purchased by institutions
Eurobond
any long-term debt instrument issued and sold outside the country of the FX in which it is denominated
Eurodollar bond
- USD denominated
- issued by a corporation or govt, sold outside the US and the issuer’s country but principal and interest are stated and paid in USD
nominal yield/coupon rate
- fixed interest rate on a bond
- percentage of par value
annual interest payment in dollars = nominal yield x face amt (1000)
- interest rate is stated annually but paid twice a year
current yield of bonds
- current return on investment
current yield = annual interest/current market price or return/investment
premium
- when a bond is selling above par or face value
- you pay more, you get less
discount
- when a bond is selling below par or face value
- if you pay less, you get more
yield to maturity (basis)
- measurement take that takes gains/losses into account at maturity
YTM for a premium bond
YTM for a premium bond = (annual interest - (premium / yrs to maturity))/average price of the bond
average price of the bond
midway between purchase price and par
YTM for a discount bond
YTM for a discount bond = (annual interest + (discount / yrs to maturity))/average price of the bond
yield to call
- rate of return the bond provides from the purchase date to the call date and price
current yield of common stock
current yield of common stock = current dividend/current market price
duration
used to measure the sensitivity of a debt security when interest rates change in the market place.
the time it takes for the cash flow (interest payments) to repay the principal
the higher the coupon rate, the shorter the duration
the lower the coupon rate, the longer the duration
duration = the length to maturity
zero coupon bond
corporate or muni debt security traded at a deep discount from face value. Pays no interest. Redeemed for full face value
investment grade debt
- top 4 categories (BBB or Baa and higher)
- purchased by institutions
- greater liquidity than lower grade instruments
high yield bonds (junk bonds)
- BB or Ba lower
- additional risk of default, price erosion, bond issuers creditworthiness
alternative investments
- ETNs, ETFs, derivatives
- structured products
- complex, not easy to understand
- suitability determined on case by case basis
special considerations:
- lack of regulation
- low transparency
- low liquidity
- high fees
- lack of historical data
Equity linked notes (ELNs)
debt instruments where the final at maturity is based on the return of a single stock , basket of stocks or an equity index.
risks include: credit risk, market risk, liquidity risk, call/early redemption/acceleration risk, conflicts of interest
private placement debt
- money is loaned on a private basis
- commonly used ad mezzanine debt
- risks are high
- investors are sometimes repaid in stocks
