Investment Analysis Exam 1 - Part 3 and 4

Bonds

Issued by a borrower to obtain funds, bought and held by investors to recieve a return

Lowest cost over time while regular and predictable

The stated goal of treasury debt management is to meet the financing needs of the federal government at the lowest cost over time while operating debt management policies in a regular and predictable manner

types of marketable treasury

• bills- maturities less than 1 year, sold at discount

• notes- maturities from 1 - 10 years, semi annual coupon payments

• bonds > maturities of over 10 years, semi annual coupon payments

Treasury Inflation Protected Securities (TIPS)

have a coupon rate that fluctuates with inflation, this is meant to protect investors from inflation

Floating Rate Notes (FRN)

The interest rate floats with the interest rate of the market

competitive vs non-competitive bid during a treasury auction

competitive bid: bidder is willing to purchase treasury if they receive a specific rate, up for negotiation

noncompetitive bid: bidder is willing to purchase treasury at whatever yield rate

What is the maturity date?

date on which the principle amount of the bond is due

coupon interest rate

the percentage rate of interest paid on the bonds face value every year

yield to maturity

the interest rate that will make the present value of the cash flows equal to the price

Par value/ face value/ maturity value/ principal amount

the amount that an issuer agrees to pau upon redemption at the maturity date

liquidity

describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the assets price

premium vs par vs discount

premium: the market price is higher than the par value

par: the par value is equivalent to the market price

discount: market price is cheaper than par value

flat price

quoted market price for a bond that does not include accrued interest

full price

the flat price plus accrued interest

accrued interest

interest on the bond that has accrued since the last coupon payment

Separate trading of registered interest and principal of securities (STRIPS)

can only be purchased and held through financial institutions. allows investors to hold and trade the individual interest and principal components of eligible treasury notes and bonds as separate securities.

typically sold at a significant discount

breakeven inflation rates

approximately the yield difference between nominal treasury and a similar maturity TIPS

What are the two major types of Agency securities?

• Bonds issued by US federal government

• Bonds issued by government-sponsored enterprises (GSEs)

GSEs

private financial institutions created by the US government to help create certain markets. They were created by Congress but operate as seperate companies

Exps:

Fannie Mae

Freddie Mac: Federal Home Loan Mortgage Corporation

Federal Home Loan Banks

Fannie Mae

Federal National Mortgage Association

Freddie Mac

Federal Home Loan Mortgage Corporation

What is implicit guarantee of GSEs

That the government would step in and bail out these organization from financial trouble

Proved to be true during the financial crisis

Step- up securities

Has a schedule of the years and yield rate

• pre-set schedule

Indexed Amortization Notes (IANs)

Interest is paid at a fixed rate but the amount of principal you pay back changes depending on an interest rate index

Callable Securities

Give issuers the right to redeem the security on a given date or dates prior to maturity

Types of callable securities

European: one opportunity to call back

Bermudan: multiple opportunities to call back but it has a predetermined schedule

American: can call back at anytime after certain time period

GSE fixed rate debt, types of securities

• standard fixed rate

• callable

• step-up

• indexed amortization notes

Floating-Rate Note

interest rate periodically resets on predetermined dates on a reference rate

Terminology of a floating rate note

Spread: the adjustment on the reference rate when calculating the new coupon rate

Reference rate: the base interest rate

reset periods: when the interest rates reset, on predetermined dates

Payment periods: how often interest payments are made

maturity: floaters can be issued with any maturity, typically 2 - 5 years