Debt Instruments Descriptive Issues

1. Chapter 8 Debt Instruments Descriptive Issues

2. Debt Instruments Non-marketable CDs MMDAs Savings Bonds Marketable Money Market Instruments Long-Term Instruments

3. Depository Institution Any institution that holds deposits and makes loans Includes bank, savings and loans, and credit union

4. 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

5. 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

6. 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

7. Treasury Bills Sold at discount to par Interest�difference between purchase and selling price (or maturity value) Competitive and non-competitive bids

8. 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) Days to Ask Maturity �Mat. Bid Ask Chg. Yld. Jun 01 �07 ��29 2.64 �2.60 �0.04 2.64

10. Dealer�s Spread Difference between dealer�s ask price and bid price

11. T-Bill Yields Bank Discount Yield BDY = [(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

12. 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

13. 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

14. Banker�s Acceptances Two-name paper Substitutes credit-worthiness of bank for local merchant Result of international trade

15. 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

16. 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

17. Securities Related to Money Market Securities Repurchase Agreements (Repos) and Reverse Repos Short-term Municipals Money Market Mutual Funds Short-Term Unit Investment Trusts

18. Long-Term Debt Instruments Treasury Securities Treasury notes and bonds Treasury strips Treasury Inflation-Protected securities Agency Issues Mortgage Related Securities (continued)

19. Long-Term Debt Instruments(continued) Municipal bonds Corporate bonds Promissory notes Mortgage Related Securities Insurance-based contracts Guaranteed investment contracts Annuities

20. Maturity Ask Rate �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)

22. 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

23. 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

24. 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

25. 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

26. 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

28. Cur. Net Bonds Yld. Vol. Close Chg. Att6s09 6.6 ���4 90 1/2 � 1/8 Hilton5s06 cv 130 82 � 1 Polaroid11 � 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)

30. Trading Flat Trading of bonds for price that does not reflect any accrued interest

31. 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

32. 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

33. 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

34. 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

35. Maturity Provisions Convertible bonds: can be converted in shares of stock Call Features � Call price � Call premium � Forced conversion Sinking Fund

36. Bond Ratings Investment Grade AAA to BBB (or Aaa to Baa) Junk bonds BB & lower (or Ba & lower) Plusses & minuses used for further definition

37. 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

38. 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

39. Securitization Turning non-marketable securities into marketable pass-through vehicles or collateral on bonds Provides claims on assets not otherwise available to ordinary investors

40. 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

41. 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

42. 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

43. Private Placements Debt instruments sold privately to a few large buyers Do not have to comply with SEC disclosure requirements

44. 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

45. 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

46. 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

47. Types of Annuities Single premium deferred annuities (SPDAs) Flexible premium deferred annuities (FPDAs) CD-type annuities Single premium immediate annuities (SPIAs)

48. 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