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VI. DEBT SECURITIES

VI. DEBT SECURITIES. A. Bonds. Defined as debt obligations issued by government, governmental agencies, and corporations Par – Face value (usually $1,000, quoted as a percentage – 100 or more or less) – bonds are issued at par, but the market value of a bond can be more or less than par

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VI. DEBT SECURITIES

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  1. VI. DEBT SECURITIES

  2. A. Bonds • Defined as debt obligations issued by government, governmental agencies, and corporations • Par – Face value (usually $1,000, quoted as a percentage – 100 or more or less) – bonds are issued at par, but the market value of a bond can be more or less than par • Discount – When a bond sells for less than par • Premium – When a bond sells for more than par • Coupon – The annual interest rate paid as a percentage of par. Bonds generally pay semi-annually (twice per year), at one-half of the coupon rate per payment (originally, coupons were attached to the physical bond certificate, then “clipped” and presented to the corporation for payment

  3. A. Bonds • Interest Rate – The fixed percentage of par paid annually (in two payments) to the bondholder • Bondholder – An individual or institution that purchases bonds, becoming a creditor of the corporation • Issuer – The government, governmental agency, or company that sells the bond • Maturity – Date upon which the issuer of a bond must return the original principal amount of the bond plus the final interest payment to the bondholder • Floating an Issue – The government, governmental agencies, and corporations issue bonds with a set coupon, and, based upon demand, may issue more

  4. A. Bonds • Indenture – The legal agreement governing the terms of the bond issue • Book Entry Bond – A bond that is registered electronically, with no physical certificate issued • Bearer Bond – Has no investor name when it is issued, whomever possesses the certificate has a right to receive interest payments and repayment of principal • Secondary Market – Similar to a stock exchange, where bonds are bought or sold by brokers – the money for purchase or sale goes to the seller or purchaser, like stocks, bonds bought on the secondary market do not provide any additional funds to the issuer

  5. A. Bonds • Types of Bonds • Government Securities • Treasury Bills – Issued by the United States government, backed by the full faith and credit of the United States government – the safest security, matures in 26 weeks or less, sold at a discount and matures at par • Treasury Notes – 2, 3, 5 and 10 year maturities, pay interest every six months (semi-annually), with a fixed coupon • Treasury Bonds – 10+ year maturities, pay interest semi-annually, fixed coupon

  6. A. Bonds • Strips – Created by broker-dealers, consist of bonds sold at a discount with no interest payments • Treasury Inflation Protected Securities (TIPS) – Have a semi-annual fixed rate coupon, with par (face) value adjusted twice per year based upon changes in the Consumer Price Index • Municipal Bonds – Issued by state an local governments and governmental agencies, may not be as credit worthy as Treasuries, generally exempt from federal income tax and from state taxes for purchasers who live in the state of issue

  7. A. Bonds • Agency Securities – Issued by government sponsored entities, implicitly backed by the issuing government, but explicitly backed by the issuing agency – provide higher yields than direct government securities, with somewhat higher risk InterNotes Prospectushttp://www.mta.info/mta/investor/pdf/pdf/MTA-Tr_Rev_2005D_10-30-08_Final.pdf

  8. A. Bonds • Corporate Bonds – Debt securities issued by corporations, have a greater claim on the firm’s assets than equity instruments, backed only by the issuing company, with risk quantified by rating agencies • Commercial Paper – Similar to Treasury Bills, issued by corporations at a discount, with a maturity of 90 days or less

  9. A. Bonds

  10. B. Other Types of Debt Securities • Money Market Funds – Short term investments consisting of a pool of short term debt securities, “marked to market” daily so that face value ($1.00) never changes, but interest yields change daily • Asset Backed Securities – Debt obligations backed or “collateralized” by other forms of debt • Government agency asset backed securities – Consist of “pools” of mortgages, with repayment of principal and interest guaranteed by the full faith and credit of the United States government Welcome to Ginnie Mae , http://www.ginniemae.gov/investors/ocs_pdf/2008-088.pdfREMIC Definition

  11. B. Other Types of Debt Securities • Quasi Governmental Agency Securities – Issued by corporations originally organized as governmental agencies, with the implicit understanding that repayments of principal and interest are guaranteed by the federal government Debt Securities: Understanding Fannie Mae Debt: Introduction to Fannie Mae Debt Securities • Collateralized Mortgage Obligations – Backed by “pools” of mortgages, can be issued by GNMA, FNMA, FHLMC, or by investment banks http://www.freddiemac.com/mbs/docs/investors_guide_CMOs.pdf • Certificates of Automobile Receivables – Backed by pools of car loans Presale: AmeriCredit Automobile Receivables Trust 2008-1 - 2008/10/06 - S&P Credit Research - AlacraStore.com

  12. B. Other Types of Debt Securities • Certificates of Deposit (CDs) – Issued by banks, fully federally insured through the FDIC up to $100,000 per person or corporation per bank • Annuities – Issued by insurance companies, designed to provide retirement income – provides a future stream of monthly payments for investment of a lump sum, often with a fixed interest rate – the dollar value of payments varies depending upon the assumed interest rate • Guaranteed Investment Contracts – Issued by an insurance company with a guaranteed interest rate and a specific term (similar to a bond), however, not marketable

  13. B. Other Types of Debt Securities • Hybrid Securities • Preferred Stock – An equity security with a specified, obligated dividend payment rate with no specific maturity – does not have the voting rights of common shares • Convertible Bonds and Convertible Preferred Stocks – Pay regular dividends or interest, but can be exchanged for a set number of shares of common stock at a set price

  14. C. The Yield Curve and Interest Rates • Maturity – The term of a bond – the period after which the fixed income security must return principal and accrued interest to the purchaser • Short term = 1 year or less • Intermediate term = Greater than 1 year through 10 years • Long term = Greater than 10 years • Yield to Maturity – A measure of rate of return adjusting for both the selling price of the bond (discount or premium from face value) and the bond’s interest coupon rate

  15. C. The Yield Curve and Interest Rates • Generally, the longer the term of a fixed income security, the greater its interest yield and/or yield to maturity • The yield curve changes constantly, and can be a predictor of economic activity http://www.smartmoney.com/onebond/index.cfm?story=yieldcurve • If interest rates in the market are greater than the coupon rate of a debt security, that security will sell at a discount – if market interest rates are lower than the coupon rate of a debt security, that security will sell at a premium

  16. C. The Yield Curve and Interest Rates • Capital Appreciation (Depreciation) – Gain or loss in a fixed income security’s market value due to market interest rate changes • Duration – A formula accounting for a debt security’s interest coupon and its term to maturity • The higher the coupon interest rate, the shorter the duration for fixed income securities of a similar term to maturity • The lower the coupon interest rate, the longer the duration for fixed income securities of a similar term to maturity • The longer the duration of a fixed income security, the more volatile the security’s price (similar to maturity – the longer the maturity of a fixed income security, the greater will be its price volatility

  17. C. The Yield Curve and Interest Rates • Buy and Hold – Purchasing bonds with no intention of selling them, bonds are held to maturity to avoid capital gains and losses • Riding the Yield Curve – Purchasing bonds at the “long end” of the yield curve, holding them until they become short term securities, then selling them for a capital gain • Bond Laddering – Buying bonds with different maturities, then reinvesting the proceeds at maturity into longer term securities

  18. D. Risks of Fixed Income Security Investing • Inflation Risk – Inflation increases to a rate greater than the fixed income security coupon, decreasing the market value of the security, and penalizing investors for purchasing fixed income securities • Reinvestment Risk – The risk that the investor will not, upon maturity and/or upon coupon payment dates, be able to obtain a yield as great as the coupon rate of the fixed income security

  19. D. Risks of Fixed Income Security Investing • Risk of Capital Loss -

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