Series 7 - Corporate and US Government Bonds

Bonds in General

- Corporations and governments can borrow money from investors by selling bonds.
- Considered safer investments than stocks.
- Bondholders are creditors not owners (like stock).
- Money leant for a fixed period of time and receive interest.

Bond Maturity Date

The year the bondholders get paid back for the loan. At maturity, bondholders receive par value.

Bond Par Value

Face value of the bond. Assume $1,000 on the test unless otherwise specified.

Bond Price

Quoted as a percentage of the par value. For example, a bond trading at 100 is trading at 100% of $1,000 par. The price of a bond trading at 85 is $850. A bond trading at 105 is $1,050. Regardless of the price, the bondholder receives par at maturity, wit

Bond Coupon Rate

Tells the investor how much annual interest they will receive. Expressed as a percentage of par. For instance, a bond with a coupon rate of 6% would pay annual interest of $60. Paid semi annually.

The Bond Indenture (Deed of Trust)

The legal agreement including:
- the maturity date
- the par value
- the coupon rate (interest rate) and interest payment dates
- any collateral securing the bond
- any callable or convertible features
- the name of the trustee

The Bond Trustee

Organization that administers the bond for an institution. Ensures the bond issuer meets the terms and conditions.

Bearer Bonds (Coupon Bonds)

- Not registered to a particular person
- Coupons attached to the bond are turned in every six months for an interest payment.
- At maturity, the holder receives the par value.
- No longer issues due to the inherent risk (like cash).
- Some haven't mature

Partially Registered Bonds

- Also know as Registered Coupon Bond or Registered as to Principal Only Bond
- Principal (par value) is registered to a particular person but not the interest coupons.
- No longer issued but old ones still traded.

Fully Registered Bonds

-Most common form.
- Registered to an investors name.
- No bearer coupons attached.
- Registered investor received the interest payment automatically.

Book Entry Certificates

- Recorded in electronic book entry records.
- No certificates or coupons.
- Many US gov securities issued in this form.
- Gaining popularity.

Bonds in Default

- When scheduled interest payments have not been paid.
- Bonds in default should be delivered with any unpaid coupons attached.

Term Bonds

Bonds that are all issued at the same time and have the same maturity date. Usually locks in a set interest rate for a long period of time.

Bond Sinking Fund

Applies to companies with term bonds. Corp. sets aside money over time to pay off debt at maturity. Reduces the risk of a default.

Series Bonds

Issued in successive years but have only one maturity date. Interest paid only on the bond issued so far. For companies that need the money in phases.

Serial Bonds

A portion of the outstanding bonds mature at regular intervals (10% yearly). For companies that want to fund projects that provide regular income streams. Most muni's are serial. If it has more bonds maturing on the final maturity date, called a balloon i

Secured Bonds

Those backed by collateral that will be sold to pay of the debt in the case of a default. Safer for the investor. Lower yield than unsecured bonds.

Mortgage Bonds

Type of secured bond backed by property that the issuer owns. Property liquidated in the case of default or bankruptcy.

Equipment Trusts

Type of secured bond issued by transportation companies and backed by the equipment they own.

Collateral Trusts

Type of secured bond backed by financial assets (stock and bonds) that the issuer owns. A trustee holds the assets and sells them in the case of a default.

Guaranteed Bonds

Type of secured bond backed by a firm other than the issuer, usually a parent company.

Unsecured Bonds

Not backed by any assets. Riskier than secured bonds.


Type of unsecured bond backed by the issuers good word and agreement (the indenture).

Income Bonds

Type of unsecured bond where the issuer promises to pay par value back at maturity and interest only if earnings are high enough. Riskiest bond of all. Usually issued at a deep discount.

Nominal Yield

The coupon rate (interest rate) on the face of the bonds. Remains fixed for the life of the bond.

Current Yield

the annual rate of return on a security. Changes when the market price changes.
CY = Annual Interest in $ / Market Price

Yield to Maturity (YTM)

Yield an investor can expect if holding the bond until maturity. Answers "what's that bond yielding"?
YTM= Annual Interest $ + Annual Accretion or - Annual Amortization / (Market Price + Par Value)/2

Annual Accretion =

Par Value - Market Price / Years Until Maturity

Annual Amortization =

Market Price - Par Value / Years Until Maturity

Yield to Call (YTC)

The amount the investor receives if the bond is called prior to maturity. Same calculation as for YTM but substitute the call price for par value. Rarely tested.
YTM= Annual Interest $ + Annual Accretion or - Annual Amortization / (Market Price + Call Pri

Yield to Worst (YTW)

Calculate the YTM and YTC for all call dates and choose the lowest.

Accrued Interest

Number of days of interest that the buyer of a bond owes the seller when sold in between coupon dates (interest payments). Corp. and munis calculated on 360 day year and 30 day months. US gov bonds calculated using the actual days per year and month. Use

Callable Bonds

Bond that the issuer has the right to buy back from investors at the price stated on the indenture. Riskier for investors due to lack of control over how long they hold onto them, usually issued with a higher coupon rate to compensate.

Bond Call Protection

Most callable bonds are issued with this, the amount of time that an issuer has to wait before calling its bonds.

Bond Call Premium

An amount over par that an issuer has to pay if calling its bonds in the year or years immediately following the expiration of the call protection. The difference between par and the call price.

Make Whole Call Provision

Issuer can call the bonds providing they make a lump sum payment for the par value of the bond and the present value of the future interest payments the investors will miss due to the call.

Step Coupon Bond

Callable bond that start at a low coupon rate that increases at predetermined intervals (ie every 5 years). Issuer can call the bonds at par value at any time the coupon rate is due to increase.

Put Bonds

Allow the investor to "put" the bonds back (redeem them) to the issuer at any time at the price stated on the indenture. Better for investors due to control, rarely issued, lower coupon rate.

When to Call or Put

Issuers call bonds when interest rates decrease; investors put bonds when interest rates increase. For the Series 7, when interest rates increase, bond yields increase.

Convertible Bonds

Bonds that are convertible into common stock. Parity occurs when the bonds and underlying stock are equal. Use the conversion ratio and Parity Price to determine if the bonds should be converted to stock:
Conversion Ration = Par Value / Conversion Price


Short Term US Gov Security issued at a discount and mature at par. Initial Maturity of 4, 13, 26 and 52 weeks. Interest exempt from State and Local taxes.


Intermediate term US Gov Security that pays interest every 6 months. Initial Maturity of 2, 3, 5, 7 and 10 years. Interest exempt from State and Local taxes. Quoted as a percentage of par in 1/32s. ex. 98.01 is 98 1/32% or $980.3125


Long term US Gov Security that pays interest every 6 months. Initial Maturity of 10 to 30 years.
Interest exempt from State and Local taxes. Quoted as a percentage of par in 1/32s. ex. 98.01 is 98 1/32% or $980.3125


Separate Trading of Registered Interest and Principal Securities. US Gov Security issued at a discount and mature at par. Initial Maturity of 6 months to 30 years.
Interest exempt from State and Local taxes.


Treasury Inflation Protected Securities are US Gov Security that pays interest every 6 months; par value and interest payment adjust according to inflation or deflation. Initial Maturity of 5, 10 and 20 years.
Interest exempt from State and Local taxes.

Collateralized Mortgage Obligations (CMOs)

Debt securities backed by pools of mortgages. No set maturity date. Safe but subject to extension risk, prepayment risk and interest rate risk. Broken down into tranches (slices) of varying maturity dates. Not backed by the US gov, they are corp securitie

Plain Vanilla Offering (CMO)

All tranches receive interest payments, but only the tranche (slice) with the shortest maturity receives principal payments. After the shortest is retired, the one with the second shortest maturity receives the principal payments until that tranche is ret

CMO Average Life

The average amount of time until a mortgage is refinanced or paid off.

CMO Prepayment Risk

The risk that a tranche (slice) of the loan will be called sooner than expected due to decreasing interest rates; more people refinance when interest rates are low.

CMO Extension Risk

The risk that a tranche (slice) of the loan will be called later than expected due to less than normal amount of refinancing; extension occurs when interest rates are high.

Planned Amortization Class Tranches (PAC)

Most common, most certain prepayment date, usually have the lowest yields. Safest so lowest yield. Reduced prepayment and extension risk.

Targeted Amortization Class Tranches (TAC)

Second safest, somewhat less certain principal payments, more subject to extension risk, low yields, but not as low as PAC.

Companion Tranches (Support Bonds)

Included in every PAC or TAC tranche, absorb prepayment risk, more risk, higher yields.

Z Tranches (Accrual Bonds)

Usually the last tranche, have the longest maturity, don't receive interest or principal until all other tranches in the series are retired. Market value can fluctuate widely.

Principal-Only Tranches (PO)

Purchased at a deeply discounted price below face value. Investors receive face value through regularly scheduled mortgage payments and prepayments. Market value increases if interest rates drop.

Interest Only Tranches (IO)

All CMOs with PO tranches have IO tranches. Sold at a deep discount. Market value increases if interest rates increase.

Floating Rate Tranches

Appear with CMOs in which the interest rates are tied to an interest rate index Can be used to hedge interest rate risk on other investments.

Collateralized Debt Obligations (CDOs)

Similar to CMOs but backed by pools of bonds, loans and other debt instruments (not mortgages).

Money Market Instruments

Debt securities, including treasuries with less than 1 year maturity and negotiable CDs. Relatively safe, short term loans that can be issued by corporations, banks, US gov., and municipalities. Most have maturities of a year or less, issued at a discount

Repurchase Agreements

A money market instrument; A contract between buyer and seller, a short term loan. The seller of securities (usually T-Bills) aggress to buy the securities back at a previously determined price and time. Subject to interest rate risk.

Federal Funds

A money market instrument; Loans between banks to help meet reserve requirements. Usually overnight loans, rates change constantly depending on supply and demand.

Reserve Requirements

A money market instrument; The percentage of deposits that member banks must hold each night. Banks that can't meet the reserve can borrow from other banks at the Fed Funds rate.

Corporate Commercial Paper

A money market instrument; Unsecured corporate debt. Issued at a discount and matures at par value, issued with initial maturity of 270 days or less and is exempt from SEC registration. Quoted in yield.

Brokered (Negotiable) Certificates of Deposit

A money market instrument; Low risk investments, originate from a bank and are outsourced to broker dealers to sell to investors. Can be traded on the market. Jumbo CDs require a minimum investment of $100K.


A money market instrument; American dollars held by foreign banks outside the US. Usually the result of payments made to overseas companies.

Bankers' Acceptances

A money market instrument; A time draft (short term credit investment) created by a company whose payment is guaranteed by a bank. Used for importing and exporting goods. Sold at a discount, matures at par and quoted in yield.

EE Bonds (US Savings Bonds)

Regular savings bonds. Purchased from a discount from the face value and mature at their face value. Very safe, low risk of default. Can be purchased in very small denominations.

HH Bonds

Discontinued. Did not increase in value, paid interest every 6 months, paid at face value at maturity.

I Bonds

Have variable yield based on inflation.

Federal Farm Credit Consolidated Systemwide Bank

Congress established this bank system to provide a reliable source of credit for the nation's farmers and ranchers.

Federal Home Loan Bank

11 U.S. government-sponsored banks that provide stable, on-demand, low-cost funding to American financial institutions (not individuals) for home mortgage loans, small business, rural, agricultural, and economic development lending.

Student Loan Marketing Assoc. (Sallie Mae)

A publicly traded U.S. corp that provides consumer banking. Its nature has changed dramatically since it was set up in 1973. At first, it was a government entity that serviced federal educational loans. It then became private and started offering private

GNMAs (Ginnie Maes)

Established in the United States in 1968 to promote home ownership. Mission is to expand affordable housing finance in America by linking domestic and global capital to the nation's housing finance markets, providing liquidity to federally sponsored mortg

FNMAs (Fannie Maes)

Founded in 1938 during the Great Depression as part of the New Deal. It is a government-sponsored enterprise and has been a publicly traded company since 1968. The corporation's purpose is to expand the secondary mortgage market by securitizing mortgages

FHLMCs (Freddie Macs)

The FHLMC was created in 1970 to expand the secondary market for mortgages in the US. Along with Fannie Mae, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage-backed security to investors on the open market.


In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market pric

Forced Conversion

The occurrence of an issuer of a convertible security exercising the right to call the issue, forcing investors to convert their securities into the predetermined number of shares.

Short and Long Coupons

A payment made on a bond within a shorter time interval than is normal for the bond. Most often, a short coupon is a bond's first coupon. A short coupon is used if the issuer wishes to make payments on certain dates.

Trust Indenture Act of 1939

A law passed in 1939 that prohibits bond issues valued at over $5 million from being offered for sale without a formal written agreement (an indenture), signed by both the bond issuer and the bondholder, that fully discloses the particulars of the bond is

Anti-Dilution Covenants

A provision in an option or a convertible security. It protects an investor from dilution resulting from later issues of stock at a lower price than the investor originally paid. Also known as an "anti-dilution clause.

Bonds Trading Flat

A debt instrument that is sold or traded without accrued interest, the fraction of the bond's coupon payment that the holder earns between periods of bond payments. There are three possible reasons that a bond would not have any accrued interest:
1.No int

Variable Rate Preferred Stock

A type of preferred stock where the dividends issued will vary with a benchmark, most often a T-bill rate. The value of the dividend from the preferred share is set by a predetermined formula to move with rates, and because of this flexibility preferred p

Auction Rate Securities

Auction rate securities (ARS) are debt or preferred equity securities that have interest rates that are periodically re-set through auctions, typically every 7, 14, 28, or 35 days. ARS are generally structured as bonds with long-term maturities (20 to 30

Variable (Adjustable) Rate Bonds

A bond with floating coupon payments that are adjusted at specific intervals. The bond is payable to the bondholder upon demand following an interest rate change. Generally, the current money market rate is what is used to set the interest rate, plus or m

Escrowed to Maturity

The condition of a bond that has been repaid in advance by means of an escrow account, which holds the funds needed to pay the periodic coupon payments and the principal.

Sovereign Debt

Bonds issued by a national government in a foreign currency, in order to finance the issuing country's growth. Sovereign debt is generally a riskier investment when it comes from a developing country, and a safer investment when it comes from a developed

Corporations Refunding Bonds

Issuer will always refund the bonds that are costing it the most money over the life.
- Refund highest coupon rate first.
- Next would refund the lowest call premium.
- Next would refund the earliest call date first.
- Next would refund the longest maturi

How Gov Notes and Bonds are Quoted

Quoted in 32nds. A quote of 101-12 means 101 12/32, which translates to 101.375. Multiply this by 1,000 to get the price.

Liquidation Hierarchy of Claims

1. Unpaid Wages
2. IRS (taxes)
3. Secured Debt (Bonds and Mortgages)
4. Unsecured Liabilities (Debentures) and General Creditors
5. Subordinated Debt
6. Preferred Stockholders
7. Common Stockholders

Interest Rates Ranked High to Low

1. Prime (rate banks charge their best customers)
2. Call Loan Rate (what brokers are charged on margin accounts)
3. Discount Rate (what Fed Reserve charges member banks)
4. Fed Funds Rate (what banks charge each other overnight) * The most volatile rate.

Eurobond vs. Eurodollar Bond

Eurodollar pays in US dollars, Eurobond pays in foreign currency, both issued outside the US. Issued in bearer form, interest paid once a year, holders not subject to withholding tax.

Yellow Sheets

Publication of dealer quotes for corporate bonds.


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