chapter 8 debt instruments descriptive issues. debt instruments non-marketable –cds –mmdas...
TRANSCRIPT
Chapter 8
Debt Instruments
Descriptive Issues
Debt Instruments
• Non-marketable– CDs– MMDAs– Savings Bonds
• Marketable– Money Market Instruments– Long-Term Instruments
Depository Institution• Any institution that holds deposits and makes
loans• Includes bank, savings and loans, and credit
union
Depository Insurance• Accounts, up to $100,000, at most banks, mutual savings banks, and savings and loans are insured by the Federal Deposit Insurance Corporation (FDIC)
Certificates of Deposit (CDs)
• Issued by a bank and other depository institution
• Brokered CDs
• Special terms
Money Market Deposit Accounts• Withdrawals limited to specified number
• Carry nontrivial minimum balance requirement
Savings Bonds
• Low-denomination Treasury issue
• Designed to appeal to small investor
• Types: Series EE, HH, I
Liquidity
• Ability to convert securities to cash at a price similar to price of previous trade in security
• Assumes no significant new information has arrived since previous trade
• Also ability to sell an asset quickly without having to make substantial price concession
Money Market Debt Securities
• Available in large denominations that appeal primarily to large investors– Yields move together
• Examples
– Treasury bills– Commercial paper– Negotiable Certificates of Deposit– Banker’s acceptances– Eurodollar deposits
Treasury Bills
• Sold at discount to par
• Interest—difference between purchase and selling price (or maturity value)
• Competitive and non-competitive bids
• Maturity: date on which Treasury bill will be paid off
• Days to Mat.: number of days remaining (from the previous trading day) until T-bill matures
• Bid: price (as a discount percentage) that a dealer is willing to pay for the T-bill
(continued)
Example: Treasury Bill Quotation
Days to Ask
Maturity Mat. Bid Ask Chg. Yld.Jun 01 ’07 29 2.64 2.60 –0.04 2.64
• Ask: price (as a discount percentage) that dealer is willing to sell T-bill for
• Chg.: change between bid price as listed in bid column and bid price from previous trading day (which is two trading days previous)
– In example, –0.04 indicates a decrease of 4/100
• Ask Yld.: bond equivalent yield for T-bill based on its ask price
Example: Treasury Bill Quotation(continued)
Daysto Ask
Maturity Mat. Bid Ask Chg. Yld.Jun 01 ’00 49 5.64 5.60 –0.04 5.72
Days to Ask
Maturity Mat. Bid Ask Chg. Yld.Jun 01 ’07 29 2.64 2.60 –0.04 2.64
Dealer’s Spread
• Difference between dealer’s ask price and bid price
T-Bill Yields
Bank Discount YieldBDY = [(10,000 – Price)/10,000] x (360/DTM)
where BDY = bank discount yield
Price = actual T-bill price
DTM = days to maturity
Bond Equivalent Yield BEY=((10,000 – Price)/Price) x (365/DTM)
where BEY = bond equivalent yield
Commercial Paper
• Short-term IOUs issued by large corporations with solid credit ratings
• Maximum maturity 270 days, but most commercial paper issued with a shorter maturity
• Corporations can borrow at a lower rate from investors than from bank
Negotiable CDs
• Only interest bearing money market security
• Trades have minimum denomination of $1,000,000
• Trading ceases when 14 or fewer days to maturity
Banker’s Acceptances
• Two-name paper– Substitutes credit-worthiness of bank for
local merchant
• Result of international trade
Eurodollar Deposits
• Dollar-denominated liabilities of banks located outside of the US, usually Europe
• Slightly higher than other MM rates– Less regulatory constraints on these banks– Smaller spread => higher deposit rates & lower
loan rates
Rates Related to Money Market Rates
• Prime Rate– Indexed– Used by banks to price loans
• Discount Rate– Charged by Federal Reserve Bank on loans to banks
• Federal Funds Rate– Charged by banks to each other for lending federal
funds• LIBOR
– Charged by London banks on loans to each other
Securities Related to Money Market Securities
• Repurchase Agreements (Repos) and Reverse Repos
• Short-term Municipals• Money Market Mutual Funds• Short-Term Unit Investment Trusts
Long-Term Debt Instruments
• Treasury Securities– Treasury notes and bonds– Treasury strips– Treasury Inflation-Protected securities
• Agency Issues
• Mortgage Related Securities(continued)
Long-Term Debt Instruments(continued)
• Municipal bonds
• Corporate bonds
• Promissory notes
• Mortgage Related Securities
• Insurance-based contracts– Guaranteed investment contracts– Annuities
Maturity AskRate Mo./Yr. Bid Ask Chg. Yld.6 1/3 May 10n 112:05 112:09 –5 4.16
7 June 10-15 110:02 110:05 …. 4.20
• Rate: coupon rate at which interest is paid as percentage of par value
• Maturity Mo./Yr.: month and year in which note/bond will be paid off – small n after maturity date identifies the security as a note
– range of years given as maturity date identifies security as callable bond
• Bid: price (in 32nds) that dealer is willing to pay for note/bond
(continued)
Treasury Note and Bond Quotations:Sample Quotes from the OTC Market
• Ask: price (in 32nds) that dealer is willing to sell note/bond for
• Chg.: change (in 32nds) between bid price as listed in bid column (see Bid above) and the bid price from the previous trading day (which is really 2 trading days previous)– Example: a –1 means a decrease of 1/32
• Ask Yld.: yield to maturity for note/bond based on its ask price
Maturity AskRate Mo./Yr. Bid Ask Chg. Yld.6 1/3 May 10n 112:05 112:09 –5 4.16
7 June 10-15 110:02 110:05 …. 4.20
Treasury Note and Bond Quotations:Sample Quotes from the OTC Market
(continued)
Treasury STRIPS
• Government program that allows a financial institution, government securities broker, or government securities dealer to convert an eligible Treasury security into interest and principal components
Treasury Inflation-Protected Securities
• Coupon rate set lower than on bonds without inflation protection
• Par value of bond adjusted on a semiannual basis by amount of inflation rate to compensate for lower coupon rate– Inflation rate reported by BLS in its CPI
• Coupon rate applied to par value to determine interest payment due
Agency Issues
• Slightly higher returns than Treasury bonds of comparable maturity– Lack full faith and credit guarantee of Treasury– Less marketable
• Wider bid-ask spreads
Municipal Bonds
• Revenue bond
– municipal bond backed only by revenues of project that it finances
• General obligation bond– municipal bond secured by issuer’s full faith and credit and
taxing power
Corporate Bonds
• Corporations are the largest issuers of bonds• More complex than government bonds and
have varying degrees of risk
Corporate Bond Indentures• Legal contract between the issuer of the bond
and the investor
Typical Indenture Provisions
•Principal and maturity•Coupon•Collateral•Full faith and credit (debenture)•Subordination•Call provisions•Dividend restrictions•Current ratio minimum•Me-first rule•Trustee•Sinking fund•Grace Period
Cur. NetBonds Yld. Vol. Close Chg.Att6s09 6.6 4 90 1/2 – 1/8Hilton5s06 cv 130 82 – 1Polaroid11 ½ f 489 14 1/2 – 1/2
• Bonds: name of company issuing bond, interest or coupon rate as a percentage of face or par value (typically $1,000), and year in which the bond will be paid off – s that sometimes appears separates interest rate from year of maturity when
interest rate does not include a fraction– Other letters used described in explanatory notes in financial media
• Cur. Yld.: current yield or annual percentage return to purchaser at current price – Calculated by dividing coupon amount by current price– Flat bonds show no current yield – Convertible bonds have the letters cv listed
(continued)
Examples: Corporate Bond Quotations
• Vol.: number of bonds traded
• Close: price– percentage of par value
• Net Chg.: difference between closing price as listed in close column and closing price from whatever day bond previously traded—usually the previous trading day, two trading days previous
Examples: Corporate Bond Quotations(continued)
Cur. NetBonds Yld. Vol. Close Chg.Att6s09 6.6 4 90 1/2 – 1/8Hilton5s06 cv 130 82 – 1Polaroid11 ½ f 489 14 1/2 – 1/2
Trading Flat
• Trading of bonds for price that does not reflect any accrued interest
Collateralized Bonds
• Debentures
• Mortgage Bonds
• Equipment Trust Certificates
Debenture
• Long-term debt obligation that gives lender only general claim against borrower’s assets – Unlike a collateralized bond
• Holder has no claim against any specific assets in a default
Mortgage Bonds
• Plant and equipment pledged as collateral
– Subordination: property pledged as collateral on more than one bond issue, with the claims of one set of bondholders subordinate to the claims of a second set of bondholders
– Senior debt: nomenclature for the second set of bondholders
Equipment Trust Certificates
• Certificates used to purchase an asset and lease to a lessee
• Lessee payments used to pay off certificates, at which point title and ownership of asset transfers to the lessee
Coupon Rates of Bonds
• Zero-coupon bonds• Original-issue discount bonds• Split coupon bonds• Floating-rate notes, Adjustable rate securities,
Reset bonds• Calls and Collars• Step-up notes• Income bonds
Maturity Provisions
• Convertible bonds: can be converted in shares of stock
• Call Features
– Call price
– Call premium
– Forced conversion• Sinking Fund
Bond Ratings
• Investment Grade– AAA to BBB (or Aaa to Baa)
• Junk bonds– BB & lower (or Ba & lower)
• Plusses & minuses used for further definition
Corporate Bankruptcy
• An issuer is in technical default whenever any of the indenture provisions are violated
• Filing for Bankruptcy
– Chapter XI reorganization
– Chapter VII liquidation: assets distributed according to absolute-priority-of-claims principle
Collateral Status
• Senior – Must be paid first with proceeds from property
pledged as collateral– Become general creditors for the balance– May receive Sub Debs or pref. stock
• Junior– Can’t be paid till seniors paid in full– May receive common stock or warrants
Securitization
• Turning non-marketable securities into marketable– pass-through vehicles or collateral on bonds
• Provides claims on assets not otherwise available to ordinary investors
Mortgage Loans
• FNMA: purchases mortgages from original mortgage lenders with the proceeds of its own debt security sales
• GNMA: bundles packages of similar mortgages• FHLMC: purchases conventional mortgages,
pools them, and sells participations • Can be FHA insured and VA guaranteed
Mortgage-Backed Securities
• Cash flow is dependent on the cash flows of an underlying pool of mortgages
– Mortgage Pass-Throughs
– Collateralized Mortgage Obligations
– Stripped Mortgage-Backed Securities
Domestic, Foreign and Euro Bonds
• Foreign bonds are issued and traded within a country, in local currency, by borrower located in a different country
– Yankee bonds is denominated in U.S. dollars and issued in the United States by foreign banks and corporations
• Eurobonds– Underwritten by an international syndicate and traded in multiple domestic markets
– Euro refers to offshore, not that the bond is traded in Euros
Private Placements
• Debt instruments sold privately to a few large buyers
• Do not have to comply with SEC disclosure requirements
Promissory Note
• Formal loan agreement• Used if loan amount significant• Examples:
– Business issues to investor when borrowing money
– Business issues to officers or key employees when lending money
Guaranteed Investment Contracts
• Stable value contract• Available in 401(k) retirement plans, profit-sharing plans,
IRAs, and mutual funds • Investment choice provided by plan sponsor, but contract
between insurance company and employee• Specified maturity date and rate of return guaranteed
through maturity by insurance company• Not insured
Annuities
• Qualified Annuity is purchased through a tax sheltered program
• Non-qualified annuity is purchased outside a tax-sheltered program
• Accumulation value is the annuity value before any surrender charges have been deducted
• Surrender value is the account value after surrender charges have been deducted
Types of Annuities
• Single premium deferred annuities (SPDAs)
• Flexible premium deferred annuities (FPDAs)
• CD-type annuities
• Single premium immediate annuities (SPIAs)
Payout Options
• Straight life annuity
• Life income with period certain annuity
• Life with cash or installment refund annuity
• Joint and survivor life annuity
• Fixed period annuity
• Fixed amount annuity