SIE Chapter 5

US Treasury Debt Overview

Issued by US Govt
Highly liquid
No credit risk
Backed by the full faith and credit of the govt
Direct Obligations

Taxation on interest of treasury Debt

Taxed at federal ONLY
exempt from state and local taxes

Three main types of treasury securities?

T-Bills, Notes, Bonds

T-Bonds and T-Notes are

Interest bearing securitites, pay semi-annual interest

When something is considered marketable what does that mean?

They are traded in the secondary market

T-Bills

Issued at a discount and mature at face value

Book Entry form means

There is no physical certificate
You go on record

Accrued interest?

Interest that has built up but has not yet been paid.
=Actual # of days/365

T-Bills, unlike the others, are quoted on

a discounted yield basis
The BID IS HIGHER(price is lower) than the ask(higher)

TIPS stands for

Treasury Inflation Protected Securities

TIPS offer____ and adjust____

a stated (fixed)coupon with interest paid semi annually
Principal for inflation and deflation, based on CPI

At maturity you will get

the greater of: par value or the adjusted principal

T-STRIPS

Federal government not issued
Created in the secondary market, where the banks take a treasury, separate out each payment treasury is going to make, they then decide to put each individual payment as a separate security. (ex: 6th month interest, payment, the principal payment are two different t strip payments)
ZERO COUPON with a variety of maturity dates

Competitive Bids

specify a price and a dollar amount of securities to be purchased
Placed by large financial institutions

Non-Competitive Bids

Only quantity specified
Placed by the public
Market order
Filled first
Bidder agrees to pay the lowest pricehighest yield of the accepted competitive bids which determine the price

T-Bill Auctions

Weekly
Mostly Mondays
Settlement for new issue is on Thursday

Settlement date for Secondary Market

Next business when traded between two investors

what yield do the bidders get in an auction

The highest bid at that specific yield(usually the last bid to be filled)

Agency Securities

Debt instruments issued and/or guaranteed by federal agencies and GSEs
Exempt from state and federal registration
Quoted in 32nds
Accrued interest based on 30 days in the month(360 days/year)
Book entry form

What type of government agencies are there?

Farming Loans
Mortgage Backed Securitie

Farming Loans

FederalFarm Credit bank(GSE, non-mortgage backed)
provide agricultural loans to farmers
Subject to federal tax ONLY

mortgage-backed securities

Issued Through GNMA, FMNA, FHLMC
AKA Passthrough certificates--government agency pool mortgages together, then sell interest in that pool, investors own an undivided interest within this pool, homeowners pay interest and principal to a bank that is servicing bank---bank requires a fee--fee goes to the pool
Fully Taxable
Monthly Payments of interest and principal
Subject to pre payment risk--get payment back to you quicker(how? mortgage payments can be paid at any time, when the homeowner moves, interest rates fell and the homeowners can refinance their mortgages)

Refinancing a mortgage

- replacing an existing mortgage loan with a new mortgage loan
- renegotiating the first loan or moving to an alternate lender

GNMA

Government guaranteed

FNMA and FMHLC

Guaranteed by that government agency

What is the most common security issued by government agencies? Why?

mortgage backed pass through certificate
Provide excellent credit quality and a slightly higher YIELD than TREASURIES----often used to supplement retirement income

What is unique to mortgage backed securities?

Prepayment Risk

US territories

Puerto Rico, Guam, US Virgin Islands
Triple tax free

Types of municipal bonds

General obligation bonds and revenue bonds

General Obligation Bonds

backed by full faith and credit and taxing power of municipality
At the state level: Sales taxes & income taxes
At the local level: Property taxes, (assessed value x millage rate = tax bill 1 mill = .001), Parking/Licensing Fees
Rquire VOTER APPROVAL

Revenue Bonds

Backed by revenue produced by the specific facilities
Issued to fund a specific project
Tolls, Stadiums, water, Bridges, Airports
NOT BACKED BY TAXES
No voter approval because its not backed by taxes
Interest is exempt from federal taxes

Feasibility Study

Used for Revenue Bonds
investigation that gauges the probability of success of a proposed project and provides a rough assessment of the project's feasibility

Special Assessment Bonds

payable from the assessment on the benefited property (users of sewer, lighting, electricity districts)

Double-Barreled Bonds

- Revenue Bonds reclassified as a GOs for the municipal government
- Secured by two sources of income
- Greater Safety

Moral Obligation Bonds

- RISKY; payment pf interest and principal is not a legal obligation
- if cannot pay, state legislative appropriations would be required
-Vote to appropriate funds as needed

Private Activity Bonds

A bond which more than 10% of the proceeds will benefit a private entity (Sports team)

Industrial Development Bonds

revenue bonds issued by a municipality to obtain funds to purchase land and build facilities for private businesses
SECURED BY LEASE AGREEMENT

Municipal Notes

Short-Term debt instruments. Used for temporary or Interim financing
-TAX Anticipation Notes
-Revenue Anticipation Notes
-Bond Anticipation Notes
-Grant Anticipation Notes

Ratings for Municipal Notes

S&P: (SP 1+, SP 1, SP 2), SP 3
Moody's: (MIG 1, MIG 2, MIG 3), SG

Role of Underwriting for municipalities

acts as a link between the issuer and the investing public by assisting the issuer in pricing the securities, structuring the financing, and preparing he disclosure documents

Disclosure document for municipalities

Official Statement(their form of prospectus)
is NOT required, why? exempt from 1933 act..but if one is made, it must be sent out.

The underwriting process for a municipality

Similar to corporate

Selecting an underwriter for a municipality

Negotiated or Competitive Method

Negotiated Sale for underwriting of a municipality

both issuer and underwriter negotiate terms of the deal

Competitive sale for underwriting of a municipality

issuer invites underwriters to submit sealed bids
The best bid wins the bid

Why do Bds form syndicates?

To share the liability

Syndicate

A group of BDs that get together to underwrite an issue

How do BD's share the liability through a syndicate?

By a Syndicate Letter, where it addresses
Size and type of offering
Percentage required to participate
Responsibility of unsold bonds

Corporate Bonds

issued by corporations to fund capital projects
Corporation does not give up any control or portion of its profits
Corp is required to pay back interest + principal

Bonds do not offer the same potential for

capital appreciation as common stock

Types of Corporate Bonds

Secured Bonds and Unsecured Bonds(Debentures)

Secured bonds

ADDITIONALLY Bonds that have specific assets of the issuer pledged as collateral.

unsecured bonds (debentures)

bonds backed by the general credit of the organization

Secured bonds are secured by

Mortgage bonds, Equipment trust Certificates, Collateral Trust Bonds

Mortgage Bonds

Bonds that are secured by real property
Bondholders are given a lien on the property as additional security for the loan

Equipment Trust Certificates

bonds secured with factory and equipment as collateral
Default, the trustee is titled to the equipment
AKA ROLLING STOCK
Planes, Trains, Trucks

Collateral Trust Bonds

Bonds backed by financial assets.
Securities of another company
Securities are placed in escrow as collateral for the bonds

subordinated debenture

claims of these bonds are subordinate or junior to the claims of the debenture holders

Income Bonds

Type of corp bond
Issued by companies coming out of a bankruptcy or restructuring
Interest is payable only if income is sufficient

Eurodollar Bonds

Type of Corp Bond
Pay their principal and interest in US Dollar, but issued outside the US
Issuers include both US and foreign
Can be traded after 40 day period back in the US

Yankee Bonds

Type of Corp Bonds
Foreign bonds sold in the US
registered with SEC

Eurobonds

Type of corp bond
Sold in one country, but denominated in the currency of another
Issuer, currency, and primary market may all be different places

Money Market Instruments

short-term
liquid
Safe
Good for park of money--unsure RIGHT NOW, see purchase in near future

Types of Money Market Instruments

T-Bills
Banker Acceptances
Commericial Paper
CD's
Repos

Banker Acceptances

often created by foreign trade

Commercial Paper (CP)

Unsecured corporate debt
270 day maturity

Negotiable CDs

Fixed-maturity interest-bearing deposits
MINIMUM DENOMINATION OF $100,000 that can be resold in the secondary market.
UNSECURED OBLIGATION OF BANKS

What does the FDIC ensure for CD's?

250k

repurchase agreements (repos)

short-term sales of government securities with an agreement to repurchase the securities at a higher price

Grant Anticipation Notes (GANs)

Issued with the expectation of receiving grant money from the federal government.

Tax Anticipation Notes (TANs)

Issued with the expectation of receiving grant money from the federal government.

Revenue Anticipation Notes (RANs)

issued to finance current municipal operations in anticipation of revenue from federal or state subsidiaries. they are usually General Obligation (GO) securities.

Bond Anticipation Notes (BANs)

Issued to obtain financing for projects that will eventually be financed through the sale of long-term bonds.

Auction Rate Securities (ARS)

Issued by municipalities, nonprofit hospitals, utilities, housing finance agencies, and universities
long-term variable rate bonds tied to short-term interest rates.
Interest rates are set at specified intervals

Variable Rate Demand Obligation (VRDO)

Long term debt with short term trading features
Put feature
Often issued by municipalities
Interest rates set at specified intervals
Par Value Reset by dealer

Inflation risk is AKA

Purchasing power risk