Series 7 Debt Securities

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Secured Debt

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backed by a specific pledged asset or other form of collateral

Here are some examples of secured bonds

Mortgage bonds

Equipment trust

Certificates Collateral trust bonds

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Debentures

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debt is backed solely by the good faith and credit of the borrower

Unsecure debt

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Income Bond

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bond is a type of debt security in which only the face value of the bond is promised to be paid to the investor, with any coupon payments being paid only if the issuing company has enough earnings to pay for the coupon payment

it can be a useful tool to help a corporation avoid bankruptcy during times of poor financial health or ongoing reorganization

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Zero-Coupon Bond

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is a debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value.

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Speculative bonds

aka

junk bonds

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these instruments have higher yields and are issued at lower prices than "investment-grade bonds" because of their higher risk

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Eurodollar Bond

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is a U.S.-dollar denominated bond issued by an overseas company and held in a foreign institution outside both the U.S. and the issuer's home nation

are an important source of capital for multinational companies and foreign governments.

not issued by the US government

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Repurchase Agreement - Repo

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form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.
raise short-term financing - lower then bank l oan rates

repurchase agreements to affect the money supply by selling and repurchasing them in the open market

agreed upon repurchase price and a maturity date which may or may not be fixed (left open at the buyer's discretion). Interest rate risk is the major risk concern with repos but credit risk can exist as well, although it is negated when the contra party is the FRB.

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Commercial Paper

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unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities.

Maturities on commercial paper rarely range any longer than 270 days.

issued at a discount rate

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Negotiable Certificate Of Deposit (NCD)

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is a certificate of deposit with a minimum face value of $100,000, and they are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed in before maturity

are bought most often by large institutional investors, and these institutions often use these as a way to invest in a low-risk, low-interest security

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Banker's Acceptance - BA

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is a short-term debt instrument issued by a company that is guaranteed by a commercial bank.

issued as part of a commercial transaction.

These instruments are similar to T-Bills, are frequently used in money market funds and are traded at a discount from face value on the secondary market

Often used on import and export transaction

maturity date 30 - 180 days

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call feature on a bond

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it's a time on an exchange when buyers set a maximum price that they are willing to pay for a given security, and sellers set a minimum that they are willing to accept

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Sinking Fund Call

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allows a bond issuer the opportunity to buy outstanding bonds from bondholders for a set rate

from the issuer's earnings saved specifically for security buybacks.

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Refunding

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process of retiring or redeeming an outstanding bond issue at maturity by using the proceeds from a new debt issue

new issue is almost always issued at a lower rate of interest than the refunded issue, ensuring significant reduction in interest expense for the issuer

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Crossover Refunding

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local government's issuance of new municipal bonds (called refunding bonds) in which the proceeds of the refunding bonds are placed in escrow and used to make debt service payments on the refunding bonds until the call date of the original bonds

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The Standard & Poor's Rating Hierarchy:

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The highest ratings - AAA, AA and A - are awarded to companies with a solid, proven record of paying interest and principal in a satisfactory manner. BB, B, CCC and so on down the line indicate less stellar performers

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U.S. Treasury securities

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all negotiable, meaning they can be traded freely.

They are also non-interest bearing, meaning they are sold at a discount and redeemed at face value

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Treasury Bill - T-Bill

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a short-term debt obligation backed by the U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a maximum purchase of $5 million

T-bills have various maturities and are issued at a discount from par

investors do not receive regular payments as with a coupon bond, but a T-Bill pays an interest rate.

Taxable a Fed Level exempt a State and local level

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Treasury Note

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marketable U.S. government debt security with a fixed interest rate and a maturity between one and 10 years

Taxed at the Fed level

Exempt from the state and local level

Backed by the US Government

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Treasury Bond - T-Bond

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marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years

Treasury bonds make interest payments semi-annually, and the income received is only taxed at the federal level.

Backed by the US Government

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noncompetitive

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agreeing to accept whatever rate is determined at auction

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Federal Funds rate

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Rate charge by commercial money center banks other for overnight loans of 1 million or more - considered most volatile

tend to fluctuate in response to the prime rate

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Discount rate

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Rate Charge by the federal reserve to member banks for short time loans

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Broker call loan rate

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Rate charge by banks to BD for money used to lend to margin account customers

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Prime rate

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rate charge by large US money center banks to their most creditworthy corporate customer for unsecured loans

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Taxation for Government agency issues

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Government agency issues that are back by the mortgages are taxed at the federal, state and local government

Other agencies are taxed only at the fed level

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Agency issue Yield and Maturities

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Agencies that have higher yields the Direct obligation of the federal government

Lower yield then corporate debt

maturities range from short to long term

Agencies are quoted % of par

Trade activity in the secondary market

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Farm Credit System

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national network of lending institution that provides agricultural financing and credit

Privately owned

Issues discount notes, bond and master notes

interest paid is exempt from state and local tax

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Collateralized Mortgage Obligation (CMO)

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Asset backed by

value and income come from or back by specific pool of underlying assets

Can be back by the following

Mortgages

auto loans

credit cards

Tranches that are back by mortgages pays principal and interest monthly

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Principal - Only CMO (PO's)

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income comes from principal payments on underlying mortgages

Sell at a discount

tends to be volatile

affected by prepayment risk

value rises as interest rate drop and prepayment risk accelerate

values falls when interest rate rise and prepayment decline

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Interest Only CMO (IO's)

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Revenue stream comes from interest

sells at a discount

cash flow decline overtime

value increase when the interest rate rise

decline when interest rate is low

receive fewer payment when prepayment rates are high

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Planned Amortization Class CMO(PAC)

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target maturity dates

retired first and offer protection from prepayment risk and extension risk

have companion tranche

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Target Amortization Class CMO (TAC)

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only offer protection for prepayment risk

have higher interest rate then PAC

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Zero Tranche CMO (Z Tranche)

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Receives no payment until all the preceding CMO tranches are retired( most volatile CMO tranches

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Inverse Floater CMO

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volatile and risky

thinly traded mortgage security

high leverage

vulnerable to a high degree of price volatility

interest rates rise principal payment may decrease

only sophisticated investors

reduction of principal extends maturity date to 30 years

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CMO Characteristics

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considered relativity safe

Susceptibility to interest rate movements

and results in mortgage repayment rate means CMOs carry several risk

Rate of principal repayment varies

if interest rates fall and homeowner refinancing increases, principal is received sooner anticipated (prepayment risk)

interest rates rise and refinancing declines the CMO investor may have to hold his investment longer than anticipated (extended maturity risk)

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private label CMOs

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issued by investment banks, their subsidiaries or financial institution and can even be issued by home builders

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CMOs, TACs and PACs

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CMOs are not backed by the US government: they are corporate instrument

interest paid taxable at all levels

CMOs are backed by mortgage pools

CMOs yield more than US Treasury securities

CMOs are subject to interest risk

CMOs are issued in $1000 denomination and trade OTC

PACs have reduced prepayment and extension

TACs are protected against prepayment risk but not extension risk

PACs have lower yields than comparable TACs

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Series EE Bond

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Fixed rate of interest for 30 years

saving bond

issue at face value

purchase by investors directly from the US treasury department

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Series I Bonds

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designed for investors seeking to protect the purchasing power of their investment

Based on the changes of inflation

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Treasury STRIPS

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Issued by the US treasury

Mature at par

discount accrete(add, adjust, cost basis up)

Premiums Amortize (subtract, adjust cost basis down

long-term

no-interim income

locked-in yield since it is purchased at a discount from par

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Current Yield

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annual interest/current market vale

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Coupon , Nominal or stated yield

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annual interest /par value

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bond quotes 1 bond point

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1% of par =10

example

-92% of par = .92(1000) =920

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yield quote 1basis point

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.01 of yield

.01(3.70) = .037:3.7%

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Exchange-traded notes

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unsecured debt securities

issued by financial institutions such as banks

prices can be impacted by changes in the credit rating of the issuer.

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Sallie Mae debentures

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debentures pay interest every six months

taxable at the federal level and exempt from state and local taxation.

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Trade Reporting and Compliance Engine (TRACE)

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both sides of the transaction report corporate bond trades that occur in the OTC secondary market

Municipal securities are one of the specific exclusions from the trade reporting system

Trace is not an execution system

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Equipment trust certificates

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Equipment trust certificates are corporate bonds commonly issued by transportation companies

railroads and airlines

bonds are backed by equipment (e.g., aircraft) the issuer uses in their business.

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normal yield curve

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long-term bonds carry higher interest rates than short-term bonds of the same quality

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Trust Indenture act of 1939

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Requires a bond of 50 million or more

maturities greater than 270 days

sold interstate

Federal and Municipal are exempt from the act

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Trust indenture

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legal contract between the bod issuer and the trustee representing bondholder

Specifies the issuers obligation and the bond holders rights

Federal and Municipal are exempt from

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protective covenants'

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debtors corporation agrees to the following

Pay the interest and principal of it bond

specify where the bond can be presented for payment

defend the legal title to the property

maintain the property against fire and other losses

pay all taxes and assessment(property, income and franchise

maintain its corporate and right to do business

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Advantages of convertible securities to the issuer

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corporation adds conversion feature to make it bond more marketable

other reason corporation issue convertible are the following

convertible can be sold with a lower coupon rate than nonconvertible

company can eliminate fixed charges as conversion take place- reduce debt

conversion occurs over time, does not have an adverse effect to the stock price

issuing convertible stock avoids immediate dilution of common stock per share

at issuance, conversion price is higher then market price of common stock

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Disadvantages of convertible Securities to the issuer

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when bonds convert shareholder equity is diluted

more shares outstanding

common stock holder has a voice in the company-could cause shift in control of company

Reducing debt = Loss of leverage

decrease in deductible interest cost

raise taxable income = company pay more taxes

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Market for convertible Securities

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Conversion is not a taxable event

tend to be more during market declines

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parity

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market price of the bond/conversion ratio

market price of common x conversion ration- parity price of convertible

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dilution

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ownership interest occurs when the percentage of ownership is lessened

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Equity Linked (ELN)

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debt instrument

final payment is base on the single stock, a basket of stock or equity of index

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Principal Protected Notes ( PPN)

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Fixed income security

comprise of bond and option component

unsecure debt

back by the full faith of the issuer

credit worthy of the issuer is a factor

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Bond laddering

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Reduce interest risk

reduce reinvestment risk

Maintain flow risk and increase liquidity

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inverted or normal curve

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short-term interest rates are lower than long-term interest rates

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bond with the shortest maturity is the least likely to be called

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it will cost the issuer the least in net interest over the life of the bond

When determining which bonds to call, the comparison in order of priority is

(1) years to maturity,

(2) coupon rate,

(3) call premiums

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spot prices

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quoted for immediate payment and delivery of foreign currencies

Settlement for actively traded currencies will take place in 1 business day and for less actively traded currencies in 2 business days.

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dollar is devalued

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U.S. products become less competitive abroad

foreign products become more competitive in the U.S.

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Defeasance or prefunded

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new issue is sold at a lower coupon before the original bond is issue is called

bonds are usually rated AAA or Aaa