Fixed income secuities Flashcards
Money Market Security
Debt securities that have a maturity of less than one year are also called money market instruments. Debt securities that mature in over one year’s time are typically called bonds.
Bonds indenture
the terms of a fixed-income security are stated on its certificate, which is known as the bond’s indenture.
Call provision
A call provision is a provision on a bond or other fixed-income instrument that allows the issuer to repurchase and retire its bonds. The call provision can be triggered by a preset price and can have a specified period in which the issuer can call the bond.
if the call feature exists on a bond, then the coupon rate is higher.
Put provision
A put provision allows a bondholder to resell a bond back to the issuer at par, or face value, after a specified period but prior to the bond’s maturity date. Put provisions protect bondholders from reinvestment risks and issuer default. A put provision is to the bondholder what a call provision is to the bond issuer.
If the put provision exists on the bond then the coupon rate is lower.
Money Market Mutual Funds
Not protected by FDIC since they are considered an investment vehicle and not a bank account.
Commercial Paper
Commercial paper is an unsecured (not backed by any assets) short-term promissory note. Both financial and non-financial companies issue instruments of this type. The dollar amount of commercial paper outstanding exceeds the amount of any other type of money market instrument except for Treasury bills, with the majority being issued by financial companies.
Commercial Paper Features:
Denominations of $100,000 or more
Maturities of up to 270 days
Large institutional investors
Terms are non-negotiable
Issuer may prepay the note
Bankers’ Acceptance (BA)
Earlier bankers’ acceptances were created to finance goods in transit but now they are used to finance foreign trade. For example, the buyer of the goods may issue a written promise to the seller to pay a given sum within 180 days or less. A bank then “accepts” this promise, obligating itself to pay the amount when requested, and obtains in return a claim on the goods as collateral. The written promise becomes a liability of both the bank and the buyer of the goods and is known as a bankers’ acceptance.
Eurodollars
In the world of international finance, large short-term CDs denominated in U.S. dollars and issued by banks outside the United States are known as Eurodollar CDs or Euro CDs. Also available for investment are U.S. dollar-denominated time deposits in banks outside the United States, known as Eurodollar deposits.
Repurchase Agreement (Repo)
For example, investor A might sell investor B a number of Treasury bills that mature in 180 days for a price of $10 million. As part of the sale, investor A has signed a repurchase agreement or “repo” with investor B. This agreement specifies that after 30 days, investor A will repurchase these Treasury bills for $10.1 million. Thus investor A will have paid investor B $100,000 in interest for 30 days’ use of $10 million, meaning that investor B has, in essence, purchased a money market instrument that matures in 30 days. The annualized interest rate is known as the repo rate, which in this case is equal to 12%.
Money Rates Listing
If there was a money market instrument with a $1,000,000 denomination quoted with a discount rate of 1.5%, how much would the investor pay for the security and what would be the investor’s real interest rate?
T Bills, T Notes or T Bonds
T Bills < 1 year maturity in denominations of $1000 or more. Sold on discount basis and matures on face value.
T Notes are 1 - 5 years maturity. Sold on face value and coupons for interest payment.
T Bonda are > 10 years maturity. These are the only loan instrument with “Call” feature.
T Bills
Treasury Bills are money market instruments issued on a discount basis, with maturities of up to 52 weeks and in denominations of $1,000 or more. All are issued in book-entry form. The buyer receives a receipt at the time of purchase and the bill’s face value at maturity.
The current price of the T-Bill can be determined by applying the following equation:
Current Price=Face Value×[1−(Days to Maturity360)×Discount Yield]
Inflation-Adjusted Securities (TIPS)
In January of 1997, the United States Treasury issued its first inflation-adjusted securities called Treasury Inflation-Protected Securities (TIPS). They are similar to U.S. Treasury Bonds in every way, except their principal amount increases by the change in the Consumer Price Index (CPI) and their coupon payments are then calculated based on the inflated principal. This difference gives investors protection against inflation eroding the purchase power of future payments of interest and principal.
Mortgage-Backed Securities
Mortgage-Backed Securities (MBS) are securities that are backed by pools of mortgage loans. Because the underlying mortgages can be prepaid, prepayment risk is a major concern for MBS investors.
Municipal Bonds
State and local governments borrow money to finance their operations. Their securities are called municipal bonds or simply “municipals” or “munis”. Municipal bonds and notes are similar to other bonds in every way, except that investors of municipal debt securities enjoy a federal tax break on the interest generated from these securities.
