Bonds
- debt securities that represent an investors loan to an issuer
- A issuers promise to pay the investor a specific rate fo interest and to repay the face amount
Par Value
- also called the face value
- typically $1000
Duration
- Measures the volatility of the bond
- Duration is inversely proportional to the bond's rate
4 categories of corporate bonds
1. Secured
2. Unsecured
3. Callable
4. Convertible
3 types of corporate secured bonds
1. Mortgage Bonds
2. Equipment trust certificates
3. Collateral trust bonds
Mortgage Bonds
- A corporate secured bond
- a\A bond that is collateralized by a mortgage
Equipment trust certificates
- A corporate secured bond
- A bond that is collateralized by equipment
- Usually by railcars or airplanes
Collateral trust bonds
- A corporate secured bond
- Issued by corporation that owns portions of other companies and can pledge the stock as collateral
Types of corporate unsecured bonds (2)
1. Debentures
2. Subordinate debentures
Debentures
- A corporate unsecured bond
- Secured by the good faith of the issuer
- In the event of default, debenture are junior to secured bondholders
Subordinate Debentures
- corporate unsecured bond
- junior to normal debentures
- the riskiest type of corporate bond which also means it has the highest yield
Callable bond
- feature where issuers can refund a currently issued bond
- this is done if the current market rates are much more beneficial to the issuer than what they originally provided.
Convertible bond
- possible feature of a corporate bond
- allows the shareholder to convert their bond into common shares
- Usually carry a lower interest rate because they have this option built in which can allow them to increase value
- Conversion price and ratio are d
Treasuries: How risky are they
- US government securities
- extremely safe with direct obligations of US
Tresuries: How are they taxed
- US government securities
- Only subject to federal taxes, but not state
Two types of Tresuries
1. Marketable
2. non marketable
Marketable treasuries
ownership can be transferred to another party in a negotiated market
- Included treasury bills, notes, and bonds
Nonmarketable treasuries
Can only be redeemed by the issuer and cannot be transferred to another party
Treasury Bills
- Short term obligations of less than 1 year
- Non- interest bearing due to time frame doesn't allow for it
How are treasury bills quoted
-on a discount yield basis which denotes the discount from the face value
- Bid is typically lower than the ask
Treasury bills are issued at what maturities? (4)
4 weeks
13 weeks
26 weeks
52 weeks
Treasury notes are issued with what maturities? (4)
2 years
3 years
5 years
10 years
How to treasury notes pay interest?
semiannual payments
Difference between ask and bod
Ask= highest price someone will pay
Bid= lowest price someone will sell
T- notes are quoted as...
- points as a percentage to the par
- in 1/32 increments
What is a T-bond quote of 102.20 mean?
102.20 = 102 and 20/32
102 and 20/32= 102.626
102.625% x $1000 = $1,026.25
Major mortgage securities are issued by which agencies?
1. US government
2. Government National Mortgage Association (Ginnie Mae)
3. Government Sponsored Enterprises (such as Fannie Mae and Freddie Mac)
Government National Mortgage Association
- Ginnie Mae
- A government-owned corporation within the Department of Housing and Urban Development
Federal National Mortgage Association
- Fannie Mae
- A government-sponsored enterprise (GSE)
- Chartered by Congress, but owned by stockholders
Federal Home Loan Mortgage Corporation FHLMC
- Freddie Mac
- A government-sponsored enterprise (GSE)
- Chartered by Congress, but owned by stockholders
T- Bill, notes, and bonds: Compare maturity
T- Bill: 4, 13, 26, and 52 weeks
T- Notes: 2, 3, 5, and 10 years
T- Bonds: 30 years
T- Bill, notes, and bonds: Compare interest pid
T- Bill: At maturity
T- Notes: 1/2 year
T- Bonds: 1/2 year
T- Bill, notes, and bonds: Compare price
T- Bill: discount to the par
T- Notes: par
T- Bonds: par
Generally how are mortgage securities crated
when the loans are packaged, or pooled by the issuer for sale to investors
- As the loans are paid off by the homeowners the investors receive payments as interest and principle
- Typically paid as a monthly basis
When can investors buy mortgage securities?
When they are issued or after issued in the secondary market
What is a Pass-Through
- Also called a Participation Certificate (PC)
- The most basic mortgage security
- Represents a direct ownership interest in a pool of mortgage loans
What happens when pass-throughs are pooled together again to create collateral?
- Creates a Collateralized Mortgage Obligations (CMO) or also called Real Estate Mortgage Investment Conduit (REMIC)
- Allow for cash flow to be directed so that different classes of securities with different maturity coupons can be created
Collateralized Mortgage Obligations
- CMO's
- Backed by an underlying pool of mortgages
- Vary in maturity length (known as tranche)
- Each tranche is paid semiannually at a fixed rate
- Only one maturity at a time receives principle payments
Zero Coupon
- pay no periodic interest
- Purchased at a discount and redeemed at par
- For taxes, the holder must increase their cost basis annually and this is called accretion
- Accretion amounts must be claimed as taxable income each year even though the money has
What is it called if a zero coupon bond is issued directly from the US government
- a treasury STRIPS (Separate Trading of Registered Interest and Principles Securities)
- Can only be purchased through broker/ dealer and depository institutions
Treasurt Inflation Protections Securities
- TIPS
- Have a fixed interest rate; however, their principle amount adjusts semi-annually based on the consumer price index
ex. CPI is 4% annually (2% semiannually aka two payments a year)
#1 $1000 x 102%= $1020
#2 $1020 x 102% = $1040.40
Who issues municipal bonds?
States, possessions of the US, cities, counties, districts, and other political subdivisions.
Political subdivisions include: school districts, water and sewer, and other public serivces
3 types of Municipal bonds
1. General Obligations
2. Revenue Bonds
3. Industrial Revenue Bonds
General Obligations Bonds
- A type of Municipal Bond
- Only issued by issuers who can levy and collect taxes
- Backed by the full faith, credit, and taxing power of the issuer
Revenue Bonds
- A type of Municipal Bond
- Issued to finance distinct projects
- The issuer pledges the revenues and user fees generated by the project to support the bond issue
Industrial Revenue Bonds
- A type of Municipal Bond
- issued but not backed .by municipalities
- Supported by the lease agreement with a cooperation
- ex. Third party building something in the city such as parking garage or ball park
Taxes on municipal bonds
- Interest received from municipal bonds is exempt from federal taxation
- Many also exempt from local and state taxes but depends on the location
- Not smart for retirement plans that are tax-deferred
- Capital gains are still taxable
Capital Gains
The positive difference between the purchase price of a stock and its sale price.
How do you compare the specific tax benefit between a tax-free Municipal bond compared to a taxable corporate bond
- Must calculate their tax-equivalent yield
ex. investor in 28% tax bracket thinking about buying a muni with a 5% yield. What would be the tax-equivalent yield?
Municipal yield/ 100%- tax bracket = 5%/100%- 28%
= 6.9%
This means to get the same return on
ex. investor in 28% tax bracket thinking about buying a municipal bond with a 5% interest rate. What would be the tax-equivalent yield? Meaning what return would be needed on a taxable investment to equal the tax-free muni?
Municipal yield/ 100%- tax bracket = 5%/100%- 28%
= 6.9%
A municipal bond with a rate of 5% will produce the same return as a corporate bond with an interest rate of 6.9%
ex. investor in 28% tax bracket thinking about buying a corporate bond yielding 6%. What type of interest rate would the investor need from a municipal bond to have the same return?
corporate bond= taxable
municipal bond= not taxable
Tax-free yield= taxable yield x (100% - tax bracket)
= 6% x (100%-28%)
= 6% x (72%)
= 4.32%
A municipal bond with a rate of 4.32% will produce the same return as a corporate bond with an interest rate of
Money Market
term used for lending, borrowing, and investment of short term instruments
Who are issuers of money market instruments?
banks, corporations, and the US government and its agencies.
Triple tax exempt
exempt from taxes from: federal, state, and local
Money Market Instruments
- debt instruments that trade in the money market
- considered highly liquid and safe investments
Types of money market instruments (5)
1. Certificates of Deposit
2. Commercial Paper
3. Bankers Acceptances
4. Repurchase Agreements
5. Municipal Money Market Instruments
Certificate of Deposit
- Money Market Instrument
- Short term investments because secured by the general credit of the issuing bank
Minimum denomination of a Certificate of depost
$100,000 but usually trade in amount of $1 million or more
What is called when a CD is traded in the secondary market as opposed to a conventional bank CD?
Brokered or jumbo CD
Commercial Paper
- Money Market Instrument
- Short term
- Issued by highly rated corporations
- Maximum maturity of 270 days
- Not collateralized but backed by the corporation
- Usually bought at a discount and redeemed at par
What is the maximum maturity for Commercial Paper
270 days
Banker Acceptance
- Money Market Instrument
- Checks payable at a specified future date
- Safe
- Used to provide a means of payment for merchandise in import and export transactions
- Backed by both bank and merchandise originally purchased by the importer
Repurchase Agreements
- Money Market Instrument
- An agreement for exempt securities (T- bills, T- Notes, T- Bonds) for the seller to buy them back on a later date
- The difference in price represents the interest earned on the transactions
- Frequently used by the Federal Res
Municipal Money Market Instruments
- Money Market Instrument
- Short-term debt instruments like Tax Anticipations Notes (TANS) that are paid back with the municipalities future tax collections
Tax Anticipations Notes
- A short-term Municipal Money Market Instrument that are paid back with the municipalities future tax collection
Municipal Fund Securities: who issues them
state or local government
Municipal Fund Securities: Who do they register with
- Exempt from SEC
- Regulated by Municipal Securities Rule Making Board (MSRB)
Municipal Fund Securities: examples of specific securities (2)
- 529 college savings plan
- ABLE account (529a)
- Local Government Investment Pools (LGIPs)
MSRB rule G-17
When conducting with municipal security, each broker/ dealer must deal fairly with all persons and must not engage in deceptive practices
MSRB Rule G-45
- underwriters of primary offerings of municipal fund securities (that are not interests in local government investment pools) must report information related to the offering no later than 60 days following the end of each semi-annual reporting period on
529 Plans
-state sponsored
- Also called pre-paid tuition plan
- Contributions are made with after-tax dollars
- Grow tax deferred
- Withdrawals are tax deferred if used on qualifying education expenses
- Withdrawals on non-qualifying education expense will have a
Prepaid tuition plans
- Similar to 529 but stricter
- Covers future tuition and mandatory fees
- Does not cover room and board like 529
Is the 529 plan taxable?
- the income that is contributed has been taxed
- qualifying withdrawals are not taxed
- Non-qualifying can receive a 10% tax
How much can you contribute to 529 before a gift tax occurs
- up to $15,000 per person per year
- Or accelerated at $75,000 (5 years worth) but cannot contribute for 5 years
ex. Ted and Carol opened a 529 plan for their granddaughter. For the initial contribution, they want to contribute the largest amount permitted without paying a gift tax. What would the maximum contribution be?
$150,000
This is because both can contribute $75,000 each as an accelerated gift.
Advisor Sold Plans
529 plans bought from a broker but they tend to be more expensive due to having a lot more fees
Direct-sold plans
-529 plans by many states that are less expensive due to no additional fees charged by the broker
ABLE account
- Also called the 529a
- For individuals with disabilities that provide a tax advantage
- Can contribute $15,000 per year but total contributions depend on state
- Must begin before age 26
- Can have up to $100,000 in ABLE without affecting chances of get
How much can a person have in their savings to receive SSI? How much in an ABLE?
Cannot have more than $2,000 in savings and cannot have more than $100,000 in ABLE
Local Government Investment Pools (LGIP)
- investment pool established by state or local government to invest public funds
- short term with little volatility
- Pooled investments by professional portfolio managers
- Not required to register with SEC
Types of Local Government Investment Pools (6)
1. Obligations issued by the US Government
2. Negotiable Certificates of deposit from domestic banks
3. Commercial Paper
4. Corporate Notes
5. Money market mutual funds that are registered with SEC
6. Municipal Obligations issued by the state and local go