Unit 2 Flashcards

Question

Zero-coupon Bonds

Answer 1

These have no coupon, the difference between the discounted purchase and the par value is the return the investor receives. These tend to be more volatile than other bonds. Treasury receipts and STRIPS are a type of this bond. Owners pay annual taxes on the gain (total interest payment/years to maturity), called annual accretion of the discount or phantom income.

Answer 2

Consist of secured (backed by assets owned by issuer) and unsecured (backed only by reputation and credit record/financial stability)

Answer 3

Secured bond where the corporation borrows money that is backed by real estate and physical assets. The value of the assets pledged are in excess of the amount borrowed.

Answer 4

Secured bond often used by railroads or other transportation companies. Company issues these and purchases equipment. The equipment is held in trust by a bank perhaps until the debt is paid in full. It then receives the clear title to the equipment from the trustee.

Answer 5

Secured bond where the company deposits securities it owns into a trust to serve as collateral for the lenders. All collateral securities must be marketable, though they can be issued by the corporation itself or securities it owns from other issuers. The better the quality of the securities, the better the quality of the bonds.

Answer 6

An unsecured debt obligation of the corporation backed only by its word and general creditworthiness. A written promise to pay that is sold on the good faith and credit of the company.

Answer 7

Unsecured bond that is backed by a company other than the issuer, such as a parent company. The value of the guarantee is only as good as the strength of the company making the guarantee. Primary responsibility for the debt is to the issuer but if they default, the guarantying company must make the interest or principle payments. No asset is held in security so it is unsecured.

Answer 8

Also known as adjustment bond, unsecured bond used when a company is reorganizing and coming out of bankruptcy. Pay interest only if the corporation has enough to meet it and if the BOD declares they be paid. Not suitable for an investor seeking income!!

Answer 9

A class of debt securities paid after debentures, however it is still senior to stockholders. Increased risk usually gives these a higher coupon rate.

Answer 10

- Secured Debt Holders (paid from proceeds of asset sales) - Unsecured Debt (debentures) and general creditors (wages and taxes are paid out of this level) - Subordinate Debt - Preferred Stockholders - Common Stockholders (probs not getting anything) Note: Administrative claim holders (attorneys, property appraisers, auctioneers, liquidators) are brought in to assist and are paid for their services. Their claim will be honored and paid before unsecured debt, but after secured creditors.

Answer 11

Bonds are the best way to produce current, steady and predictable income for investors. Bonds are generally safer and have less price volatility.

Answer 12

Default/financial/credit Risk: The risk that issuers will fail to pay interest or principle when due. We depend on credit rating agencies to rate financial strength of issuer. Default is the worst outcome. (default risk of US Treasury is effectively zero) Interest Rate Risk: Debt securities fluctuate in response to interest rate changes. Purchasing Power Risk: As bonds produce fixed payments, inflation poses a risk to reduce the value of these payments.

Answer 13

Securities issued by state or local governments, US Territories, authorities, special districts. Money is used for public works. Considered second is safety of principal only to the US government and its agency securities. Interest on municipal bonds is usually tax free on a federal level and tax free on a state level if the investor lives in the state. Capital gains are still taxable.

Answer 14

Issued for capital improvements that benefit the entire community. Principle and interest is paid by taxes collected by the municipal issuer. The amount of debt a municipal government may incur can be limited by state and local statutes to protect taxpayers from excessive taxes. This can also make them safer for investors. A public referendum is required to go beyond this limit, so these can require voter approval.

Answer 15

Used to finance any municipal facility that generate sufficient revenue to pay interest and principal. May be issued by authorities (transit authority, quasi-government entities) and these are not subject to statutory debt limit.

Answer 16

Short term securities that generate funds for a municipality that expects revenues soon. Usually have less than 12 month maturities, may range from 3 months to 3 years. Repaid when anticipated revenue arrives.

Answer 17

Notes that help finance current operations in anticipation of future tax receipts. Helps to even out cash flow between tax collection periods.

Answer 18

Finance current operations waiting for revenues from revenue-producing projects or facilities.

Answer 19

Issues as interim financing that will eventually be converted to long-term funding through the sale of bonds.

Answer 20

Issued to provide interim financing for the construction of housing projects.

Answer 21

To determine if a tax-exempt bond is going to have higher yield than taxed bond, use this equation. Equivalent corporate yield = Municipal (tax-exempt) yield / 100% - Tax bracket percentage

Answer 22

Short-term debt obligations with no interest, issues at a discount and redeemed at par. Maturities run 4, 13, 26 and 52 weeks.

Answer 23

Debt that pays semiannual interest (percentage of par value) with intermediate maturities (2-10 years)

Answer 24

Debt that pays semiannual interest and mature at par value. Have long term maturities (greater than 10 and up to 30 years)

Answer 25

Bonds created by brokerage firms from T-Notes and T-Bonds. These receipts are sold against the coupon or principal payments of these securities held in trust at a bank. This stripping process creates new securities with several maturities to choose from and yields more profit for the BD. These are zero-coupon bonds

Answer 26

The treasury department's version of receipts. The treasury department designates what issues are suitable for stripping and then banks and BDs perform the separation of interest coupon and principal in trading the STRIPS. These are zero-coupon bonds

Answer 27

Treasury security issues with 5, 10 or 20 year maturities. Have a fixed coupon rate and pay interest every 6 months. The principal value of this bond is adjusted every six months based on the inflation rate. Coupon rate will remain the same percentage but will pay different amounts depending on the principal. Interest payments will increase during inflation and decrease during deflation. The final principal payment at maturity will have been adjusted for inflation over the term of the bond, though it will never be less that the original $1,000

Answer 28

Debt issued with the authorization of the US Government. Most agencies are entities that are not technically government agencies, but hav entities to the government (sponsored by the gov). Examples are FCS, Ginnie Mae, Freddie Mac, Fannie Mae.

Answer 29

Network of lending institutions that provide agricultural financing and credit. Privately owned, government sponsored and the funds are made available to famers through a nationwide network of banks and lending institutions. Overseen by the Farm Credit Administration (FCA).

Answer 30

Government owned corporation that supports the department of housing and urban development. Backed by the full faith and credit of the federal gov. Issues are backed by mortgages, so they are based on the average life expectancy.

Answer 31

In connection with a GNMA or Ginnie Mae bond, when a mortgage is paid off before its stated maturity, the investor receives back all of the outstanding principal of the loan at par. Early payout.

Answer 32

A public corporation created to promote the development of a nationwide secondary market in mortgages. Buys residential mortgages from financial institutions and packages them into mortgage-backed securities for sale to investors.

Answer 33

A publicly held corporation that also buys residential mortgages from financial institutions and packages them together into mortgage-backed securities for sale to investors.

Answer 34

- Capital market serves as a source of intermediate to long term financing usually in the form of equity or debt with maturities greater than 1 year. - Money market provides short term, highly liquid, and very safe. They are fixed-income (debt) securities with 1 year or less left to maturity. Have a lower return generally, and usually don't pay interest but are purchased at a discount and return the full principal at maturity (think of T-bills).

Answer 35

CDs are issued by banks. Negotiable CDs are time deposits that carry fixed rates of interest and generally mature in 1 year or less (min is 7 days and no max). Have a minimum denomination of $100,000 but often trade in the millions (jumbo CDs).Active secondary market for these. Only these are considered money market instruments. Insured by FDIC up to $250,000. Long-Term CDs mature over 2-20 years and may have additional risk.

Answer 36

Short term time draft with a specified payment date drawn on a bank. Usually used to finance international trade (pay for goods/services in foreign country). Payment is usually between 1 and 270 days(9 months).

Answer 37

Short term, unsecured paper used to raise cash to finance accounts receivable and seasonal inventory gluts. Matures in 1 to 270 days (9 months), though usually in 90 days. Used typically by companies with excellent credit rating.

Answer 38

A bank or BD raises cash by temporarily selling assets it holds with an agreement to buy them back at a later date at a slightly higher price. Contract includes repurchase price and maturity date. Reverse Repos are the same but the dealer purchases from an investor and sells back.

Answer 39

The Federal Reserve Board (FRB) mandates the money member banks must keep in reserve. Deposits in excess of this amount are "federal funds" and can be loaned from one member bank to another to meet reserve requirements. These are very short term, sometimes overnight.

Answer 40

Asset backed security backed by large pool of mortgages (usually single family homes). Issued by private sector financing corporation and often backed by Ginnie Mae, Fannie Mae, and Freddie Mac. These, backed by government agency securities, have historically had a high rating. Pays principal and interest from pool monthly, repays principal to only 1 tranche at a time and will not pay next tranche until current tranche is fully paid. Changes in interest rate affect the flow of interest payments and principal repayments.

Answer 41

Pooling assets into financial instruments and sold to general investors. Lowers the risk of investing in the underlying assets because they are diversified.

Answer 42

Maturity classes in a pool of debt. May carry different levels of risk and therefore higher or lower interest rates.

Answer 43

Complex asset-backed securities generally with pools consisting of nonmortgage loans. Can be credit card debt, auto loans, leases, etc. Risk levels are organized into tranches and are paid different interests depending on this risk level.