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64 Cards in this Set

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define Capital Market Instruments
are long term financial instruments with an original maturity of greater than 1 year.
What is the motive to use a money market?
In money markets firms are warehousing idle funds until needed or borrowing temporarily until cash is collected.
What is the motive to use a capital market?
Firms buy capital goods such as plant and equipment to produce some product to earn a profit. Cpital goods normally have a long economic life, ranging from a few years to 10,20,or more. Firms like to finance capital goods with long term debt or equity to lock in their borrowing cost for the life of the project and the problems with periodically refinancing assets.
_____-term interest rates tend to be higher than ______-term rates due to risk premiums.
long, short
Who is the largest purchaser of capital market securities?
Individuals, Households and from time to time foreign investors.
How do individuals and households most likely participate in capital markets?
they purchase stocks and bonds through financial institutions such as commercial banks, insurance companies, mutual funds, and pension funds. Possibly directly.
Who are the major issuers of capital market securities?
Federal Government, State and Local governments, and corporations.
What type of Capital Market Securities do the federal Government issue?
Notes and Bonds
What type of Capital Market Securities do State and Local Government issue?
issue debt
What is the largest single capital market?
Equity Market
What is the fastest growing debt market during the last 30 years?
Federal Agency debt
Why do businesses use the capital markets?
: Businesses use the capital market to finance long-term investments and to provide a "market value" evaluation of company performance. The use of long-term securities allows issuers to be certain of the cost of funds for the life of the investment and reduces refinancing problems
How are T-Notes and bonds similar to T-bills?
They are issued by the U.S. Treasury and are backed by the full faith and credit of the US government. They are considered to be free of default risk
How are T-Notes and bonds different from T-bills?
They pay coupons (pay interest semi annually). T-notes are issued with maturities of 1 to 10 years and T-bonds have maturities of more than 10 years. T-bills are short term and the lwest denomination is 10,000
What are TIPS?
Treasury Inflation Protected Securities. T-Notes and Bonds that adjust for inflation
Why use Tips?
TIPS are designed to provide investors with a way to protect their investment against inflation.
Why are tips important?
TIPs provide government with a way to calculate the expected rate of inflation in the economy. The pricipal and interest payments are adjusted for changes in the price levels, and the interst rate on these bonds provides a direct measure of the real rate of interest.
How can you calculate the expected inflation from TIPS?
Subtract the real rate of interest from the nominal interest rate of a comparible security. ^Pe=i-r
What is a STRIP?
Seperate Trading of Registered Interest and Principal (STRIPS) is a tresury security that has been seperated into its component parts.
How does a STRIP work?
A ten year bond would become 21 seperate securities; 20 coupon payments received at different times and 1 face value.
Why are STRIPS valuable?
All the securities become the equivalent of zero coupon bonds. Their maturity=their duration making it easier to use them to eliminate interest rate risk in a portfolio.
What are Municipal bonds?
State and Local government bonds. The risk varies by issuer, some states and local governments have better credit ratings than others. They are tax deductible so the interest rates are lower.
General Obligation Bonds are?
backed by the taxing power of politcal entity. Usually to support basic government services. Often require Voter Approval.
Revenue Bonds are?
financed and paid back with cash flows from a specific project. Usually for public utility projects, college dorms, parking facilities, toll roads, etc.
What has been the slowest growing portion of the municipal debt market?
General Obligation bonds since they usually require voter approval.
Which bonds are riskier General Obligation or Revenue?
Revenue, because only the revenue from the project backs the bonds.
What happens when revenue bonds default?
The bondholders can take control of the assets and liquidate them.
What are Industrial Development Bonds?
a controversial type of revenue bond.When issuing an IDB the municipality merely gives its approval to the sale of the bonds and assumes no legal liability in the event of default. Public Financing of Private Business. Due to abuses limits were added in 1984.
What are Mortgage Backed Bonds?
Another area of abuse in the tax exempt market. Because interest paid on the bond is tax exempt, the issuer can borrow funds at low interest and then make low interest mortgage loans. Congress has added restrictions due to abuse.
Who are the three groups of investors in Municipal Bonds that face high Marginal Tax rates?
*High Income Individuals
*Commercial banks
*Property and Casualty
insurance Companies
What is the underwriting process for a municipal security?
An investment bank finds buyers for the securities
Why are bid-ask spreads usually large on municipal bonds compared to corporate bonds?
dealers find it difficult to match buyers and sellers of such bonds due to inactive secondary market.
What are corporate Bonds?
debt contracts requiring borrowers to make periodic payments of interest and to repay principal at the maturity date. (usually $1,000) Bearer bonds and registered. Term Bonds or serial bonds.
What is a bearer bond?
coupons are attached that the holder presents for payment when they come due.
What are registered bonds?
the owner is recorded and payment due is mailed to the owner
What are term bonds?
most corporate bonds are term bonds which means that all the bonds in a particular issue mature on a single date.
What are serial bonds?
bonds mature at varying future dates.
What is an indenture?
bond contract states the rights, priviledges, and obligations of the bond issuer and the bond holder. States the security or assets to which bondholders have prior claim in the event of default.
Types of Collateral Bonds?
*Mortgage Bonds
*Equipment trust Certificate
*Collateral Bonds-secured by financial assets
What is a debenture bond?
bond that is only secured by the firms potential to generate cash flows.
What is a senior debt bond?
first priority to general assets in the event of default
Subordinated debt bond?
asset claim ranking below senior or specific general creditors.
2 types of sinking fund?
1. building a sum for retirement of issue
2. the periodic retirement of a number of bonds selected randomly
What is a call provision?
is an option that grants the issuer the right to retire the bonds before their maturity.
What are convertible bonds?
Bonds that can be converted into common shares at the discretion of the bondholder. Usually have lower yields since the opportunity for greater profits is available if stock prices rise.
Who are the major investors in Corporate bonds?
*Life insurance companies (domiant purchaser)
*Pension Funds (domiant purchaser)
*Households
*Foreign Investors
Why are corporate bonds attractive to insurance companies and pension funds?
the stability of the cash flows they experience and they long term nature of their liabilities.
What are the usual investor requirement s of corporate bonds?
Long term investment horizon
Liquidity not always needed
safety-investment grade
tax considerations
What two methods can be used to bring new corporate bond issues to market?
Public sale or private placement
Define Public Sale?
a public sale means that the bond issue is offered publicly in the open market to all interested buyers. Competitive or negotiated
What is a competitive public sale?
public auction among underwriters that then sell them to the public
What is a negotiated public sale?
underwriting contract signed with specific underwriters that then sell them to the public.
What is a private placement?
the bonds are sold privately to a number of investors.
Describe the secondary market for corporate bonds?
most secondary sells take place through either an organized exchange (NYSE) or through dealers/ the OTC market. Less marketable due to sinking funds, call provisions, and they are long term which makes them riskier.
What are junks bonds?
they are corporate bonds with high default risk and low bond rating. Below Baa or BBB.
Explain how and why the junk bond market had an impact on commercial bank lending?
Prior to the development of the junk bond market, low credit quality firms depended on bank loans for their funds. Banks would only offer short-term or variable rate medium-term loans regardless of the borrowers’ need, thus passing on any interest rate risk to the borrower. These firms had no alternative until the junk bond market developed and allowed these low quality firms to replace bank loans with marketable debt with longer maturities that matched their cash flow needs.
Financial Guarantees cover ...
the payment of principal and interest in the event of default. Guarantee lowers the default risk of the issue and increases marketability leading to a lower yield to investors.
The quality of a financial guarantee depends ....
on the reputation and financial strength of the guarantor.
Financial Guarantees are Provided for a fee by
Commercial banks - letters of credit to back commercial paper or swaps.
Insurance companies - insurance policies to back bond issues.
describe securitization?
process of combining a lot of small loans (mortgages, auto-loans, credit card debt) into a single security for resale.
What are tranches and how do they work?
process of breaking the underlying loans into separate parts.
Lets suppose you combine $200 million in auto loans with an average interest rate of 10% together.

Tranche A – 100 million principal and 6% rate but they get first 100 million in payments from loan holders. lower risk

Tranche B - 100 million principal and 12% rate but they get second 100 million in payments from loan holders. higher risk
2. Why are private placements of securities often popular with both the buyer and seller of the securities?
Private placements are direct sales between borrowers and the ultimate investor. The costly and time-consuming SEC registration is not required for private placements. In general, both issuers and investors believe they can negotiate a better deal than if they transacted in the public market.
what are yankee bonds?
Are bonds issued by foreign entities in the US
What are Samurai Bonds?
bonds issued by foreign companies in japan. Issued in yen and must be repaid in yen.