Chapter 10 Series 7

Front 1

What is the difference between non-marketable/non-negotiable securities and marketable securities?

Back 1

Marketable securities can be resold after they are issued while non-negotiable secrities like savings bonds cannot be resold

Front 2

T-Notes and T-Bonds

Back 2

Book-Entry interest-bearing securities that have all the attributes of traditional fixed income investments. T-Notes range from two to ten years while T-Bonds have maturities of more than 10 years

Front 3

Treasury Inflation-Protected Securities

Back 3

TIPS are interest bearing, marketable securities where interest is paid based on the consumer price index. During a period of inflation the principal value will rise. TIPS are available in 5, 10 and 30 year increments

Front 4

How are treasury bills different than T-Notes and T-Bonds?

Back 4

They are non-interest-bearing securities adn they are quoted on a discounted yield basis, since the yield represents the percentage discount from the face value, not par.

Front 5

Why is the Bid price higher than the Ask price for T-Bills?

Back 5

This is because the ask price is set against the face value of the bond, not par so the Ask Yld value reflects the typical yield

Front 6

Treasury STRIPS

Back 6

These are treasury bills that have had the interest stripped so they sell as zero-coupon bonds

Front 7

Cash Management Bills (CMBs)

Back 7

Unscheduled, short-term debt offerings that are used to smooth out Treasury cash flow and can mature in as quick as one day

Front 8

Federal Reserve Auctions

Back 8

These are how the treasury sells securities. Securities firms will compete against each other with competitive tenders (where price and yield are specified), while individuals can file noncompetitive tenders (just take the price/yield as determined by auction.

Front 9

Series EE Bonds

Back 9

30-year investments that are purchased at a 50% discount from face value. EE bonds issued after May 1, 2005 have a rate of interest reset twice per year

Front 10

Series I Bonds

Back 10

30 year US Savings Bonds that are indexed for inflation. They are sold at face value, unlike Series EE bonds

Front 11

Federal Farm Credit Banks and Federal Home Loan Banks

Back 11

The first helps make agricultural loans to farmers and the second provides liquidity for savings/loan institutions to meet seasonal demand for money. Both these are subject to federal tax but not state/local tax

Front 12

Student Loan Marketing Association (Sallie Mae)

Back 12

Provides liquidity to student loan makers, is subject to federal tax but state/local taxation is determined by state

Front 13

Pass Through Certificates

Back 13

A pool of mortgages with similar interest rates/maturities is sold to investors as pass-through certificates. Owners can share in the cashflow generated by the pooled mortages. they are fully negotiable

Front 14

Federal Home Loan Mortgage Corporation (Freddie Mac)

Back 14

Provides liquidity to federally insured savings institutions to finance new housing. Interest on Freddie Mac securities is fully taxable

Front 15

Government National Mortgage Association (Ginnie Mae)

Back 15

Provides financing for residential housing, interest is subject to all taxation. Modified pass-through certificates are its most popular securities

Front 16

Prepayment Risk

Back 16

If interest rates go down and people refinance their mortgages a pass through certificate could be cashed out during a period of low interest

Front 17

Prepayment Rate and Average Life

Back 17

The prepayment rate measures the speed at which mortgages in a pool are being paid off and average life measures the average number of years each dollar of principal is expected to remain outstanding

Front 18

Collateralized Mortgage Obligations (CMOs)

Back 18

A mortgage backed security which separates principal/interest payments into tranches that each have a different rate of interest, repayment and priority level. This spreads the risk among the tranches. CMOs fall under the Act of 1933 andthe Trust Indenture Act of 1939

Front 19

The Public Securites Association (PSA) Model

Back 19

PSA assigns a number to each CMO:

Equal to 100 - prepayment speed will remain stable

Greater than 100 - prepayment speed is fast

Less than 100 - prepayment speed will be slow

Front 20

Plain Vanilla or Sequential Pay of CMO's

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Simplest form of paying off tranches. All tranches receive interest but tranche A only gets principal paid to it, when it closes tranche B receives principal, etc.

Front 21

Planned Amortization Class (PAC)

Back 21

Designed for risk-averse investors, sets a predetermined schedule fo principal repayments based on speeds staying within a certain range. PAC tranche has top priority and any excess payments go to a support tranche

Front 22

Targeted Amortization Class (TAC)

Back 22

Similar to a PAC but it only provides protection from contraction risk (a shorter maturity schedule). The degree of protection depends on if the CMO has a PAC with higher priority

Front 23

Companion Bond

Back 23

Absorb prepayments from PAC or TAC tranches. They have greater volatility of cash flow and hihg variability of average life so they have higher yields

Front 24

Z-Tranche

Back 24

During the initial phase of a z-tranche's life they provide no cash flow. After all the other tranches have been retired interest and principal payments willbe made to it

Front 25

Principal Only and Interest Only Securities

Back 25

Principal only mortgage bonds have interest stripped from them while Interest only have little or no principal. IO's increase in value when prepayments are slow since there is more time for interest

Front 26

Floating Rate Tranches

Back 26

These tranches offer interest rates that fluctutate with an interest-rate index, like LIBOR. The rate is set to a max (cap) and min (floor) rate. If the interest rate is adjusted by more than the change in index it is a super-floater, if it moves in the opposite direction of the index it is an inverse floater

Front 27

Disclosure Standards for CMOs

Back 27

All retail communications must include the CMO term within the name of the product and needs to be mentioned that yield and average life fluctuate. Extensive warnings and education must go to the investor. A principal must approve communications before initial use and file it with FINRA within 10 days

Front 28

Private Label CMOs versus Goverment CMOs

Back 28

Private Label CMOs have:

a higher degree of risk

Typically do not carry a AAA rating

An independent agency will provide a different rating based on structure, issuer, collateral

Front 29

Collateralized Debt Obligations (CDOs)

Back 29

Similar to CMOs, except it is backed (collateralized) by bonds, loans, other assets. Retail investors typically do not invest since it is too complex

Front 30

US Government and Agency Debt Securities that are state/local taxable

Back 30

GNMA, FNMA, FHLMC, SLMA (varies), CMOs, CDOs