Comprehensive Guide to Bonds, Mortgages, and Financial Markets

Money Markets

Short term, low risk

Capital Markets

Long term, more risk/return

T notes and T Bonds

Free of default risks but inflation risk, price risk, and reinvestment risk is a concern

STRIPS

Breakdown of a bond into smaller bonds by the treasury

Dirty Price

Accrued Interest + Clean Price

Clean Price

Price Quoted

Accrued Interest

(Annual coupon payment/2) x (# days since last coupon payment/# days between payments)

TIPS

Amount received locks in real yield

Municipal Bonds

Issued by state and local gov and interest except from federal taxes

General Obligation

If gov cant pay then they will raise taxes

Revenue Bonds

Paid for by revenue earned from Toll Road or hospital

Corporate bonds

Company issued debt of 1,000 denominations

Bond Indenture

Legal contract between issuer and holder

Bearer

Owns bond at maturity gets value

Registered

Payments go to bond holder on record

Term

Maturity on 1 date

Convertible

Can swap for shares in stock (upside potential)

Callable

Can call maturity date early (Riskier)

Sinking Fund

Issuer calls a certain percent each year to lower default risk or buy the holders selling the debt on the open market

Credit rating impact yield

AAA to BBB- is investment grade

Tax status

The classification of an entity's tax obligations.

Default risk

The risk that a borrower will not be able to make the required payments on their debt.

Bond futures

Contracts to buy or sell a bond at a future date at a predetermined price.

Liquidity

The ease with which an asset can be converted into cash without affecting its market price.

Spread

The difference between the bid and ask price, which tends to widen during turbulent times.

EuroBonds

Bonds issued in a currency not in the country where they are sold, typically sold through investment banks.

Foreign Bonds

Bonds sold in another country and denominated in that country's currency.

Sovereign Bonds

Government-issued debt in a foreign currency.

Required rate of return

The minimum return an investor expects to achieve from an investment.

Expected rate of return

The return an investor anticipates based on current market prices.

Realized rate of return

The actual income earned from an investment.

Buy signal

An indication that an investment should be purchased, often when expected return exceeds required return.

Sell signal

An indication that an investment should be sold, often when intrinsic value is less than price.

Bond price sensitivity

The degree to which bond prices change in response to changes in interest rates.

Premium

When a bond is sold for more than its par value.

Discount

When a bond is sold for less than its par value.

Convexity

The measure of the curvature in the relationship between bond prices and interest rates.

Bond duration

A measure of the sensitivity of a bond's price to changes in interest rates.

Securitization

The process of pooling various types of debt and selling them as securities.

Mortgage application factors

Considerations such as credit history, income, and down payment that lenders evaluate.

Collateral

An asset pledged as security for a loan that can be seized if the loan is defaulted.

Lien

A legal right or interest that a lender has in the borrower's property, which must be paid off upon sale.

Down payment

The initial upfront portion of the total amount due on a purchase, typically expressed as a percentage.

Loan-to-value ratio

A financial term used by lenders to express the ratio of a loan to the value of an asset purchased.

PMI

Private Mortgage Insurance, required when the loan-to-value ratio is more than 80%.

Federally insured mortgage

A mortgage backed by a federal agency, such as the VA or FHA, making it cheaper for borrowers.

Conventional mortgage

A mortgage that is not insured or guaranteed by the federal government.

Amortizing mortgage

A mortgage with regular payments that cover both principal and interest.

Balloon payment mortgage

A mortgage that requires a large final payment at the end of the loan term.

Amortized Mortgage

Paying off principal in interest

Balloon payment

Smaller interest payments and final payment is int payment + all of principal

Adjustable Rate Mortgages (ARM)

Adjustable rate mortgages based on interest rate

5/2/5

5% max rate for first adjustment, max 2% per period, lifetime 5% lifetime

30 year fixed rate mortgage

30 year have highest rates

Discount points

Upfront fee to mortgage lender for lower rate over life of loan (Point = 1% of par value)

Mortgage fees

Fees Application, Title Search, Insurance, Appraisal, Loan Organization, Closing

Mortgage refinancing

Pay off old mortgage by getting a new one and if rates drop you would want to

Jumbo mortgage

Loan amount over 640,000 with higher down payment and risk

Subprime mortgages

Weak Credit History and higher default and interest rate

Alt-A mortgage

Not as risky as subprime but more than Prime

Minimum payment (ARM)

1% for 1 year

Interest only payment (ARM)

Only pay off interest for first 5 years no principal

Fully amortizing payment (ARM)

Payments change based on rate

Home equity loan

Own half of house in equity and can use that as collateral for loan for expenses

Reverse-annuity mortgage

Older homeowners can sell ownership for payments and can live in until death

Benefits of securitization of mortgages

Reduce risk and generate income from fees

Mortgage-backed securities (MBS)

Pass Through: Homeowner pays interest to bank who sells to group of mortgages as claim on mortgages to investors

Collateralized MBS

Split investors into groups of risk taken and money goes from safest to riskiest tranches

Mortgage backed bond

Bank owns mortgage and sells off a bond backed by mortgage as collateral

Ginnie Mae

Backed by Fed does not own just sponsors

Fannie Mae

Owned by shareholders, sponsored by gov with tax breaks, and buys and holds mortgages and creates MBS

Freddie Mac

Same as Fannie, but focuses on local area