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Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
Fixed Income Investing Seminar
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Fixed Income Investing Seminar

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From simple corporate bonds, and government securities to derivatives, credit default swaps, and mortgaged back securities this seminar from Saunders Learning Group covers all of the details of fixed …

From simple corporate bonds, and government securities to derivatives, credit default swaps, and mortgaged back securities this seminar from Saunders Learning Group covers all of the details of fixed income investing. Contact at us 316-680-6482 or floyd@floydsaunders.com to arrange a seminar today.

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  • 1. Fixed Income Investing Covering Chapter Nine of the book “Figuring Out Wall Street” Saunders Learning Group, Newton, KS May 2012 Part of the Common Sense Investor Series
  • 2. All About Figuring Out Wall Street ... Saunders Learning Group, Newton, KS Everything has changed in the financial services industry and it effects your financial well-­‐being. From bank failures, to record unemployment, home foreclosures and panic around the world, Figuring Out Wall Street, is the concise guide to help everyone from first Cme investors to veterans of banking understand what to do to persevere and restore our faith in our financial systems. 2 This presentation is from Chapter Nine of Figuring Out Wall Street
  • 3. Summary of Book Saunders Learning Group, Newton, KS Figuring Out Wall Street Consumer’s Guide To Financial Markets By Floyd Saunders Publisher: Saunders Learning Group ISBN: 978-0-9824019-0-3 available from Amazon, B&N, and http://www.figuringout wallstreet.com or www.floydsaunders.com Author Contact email: floyd@floydsaunders.com Blog: www/money/floydsaunders.com Twitter @floydsaunders LinkedIn: http://www.linkedin.com/profile/view? id=14740656&trk=tab_pro Facebook: Figuring Out Wall Street Sideshare: http://www.slideshare.net/FloydSaunders Book summary: From bank failures to home foreclosures and panic around the world, Figuring Out Wall Street, is the concise guide to help everyone understand how this latest crisis happened, who was responsible and what to do now to restore our financial systems. Written in an easy to understand manner, even the most complex financial concepts are easy to digest. This book provides help to monitor investments with a review of investment products, financial regulators and economic indicators. Learn how the stock market exchanges work and the world of investment banking, hedge funds, venture capital and private equity. Every chapter includes action plans for investing.
  • 4. Saunders Learning Group provides a variety of training programs, workshops and seminars targeted to the financial services industry. Programs are available in a wide range of topics, and we are specialists in developing custom programs that are targeted to your needs. Contact the founder, Floyd Saunders at 316-­‐680-­‐6482 or at floyd@floydsaunders.com for more informaCon. Saunders Learning Group, Newton, KS 4 Training from Saunders Learning Group
  • 5. Saunders Learning Group, Newton, KS This presentation is designed to give participants information that will enhance their understanding of bonds, how they are issued, how to invest in them and how they are redeemed. Introduction
  • 6. What is a Bond? Saunders Learning Group, Newton, KS ! In financial terms a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. ! A bond is a formal contract to repay borrowed money with interest at fixed intervals.
  • 7. Issuing bonds ! Bonds are issued by public authoriCes, credit insCtuCons, companies and supranaConal insCtuCons in the primary markets. ! The most common process of issuing bonds is through underwriCng. ! In underwriCng, one or more securiCes firms or banks, forming a syndicate, buy an enCre issue of bonds from an issuer and re-­‐sell them to investors. ! The security firm takes the risk of being unable to sell on the issue to end investors. Saunders Learning Group, Newton, KS
  • 8. Features of bonds Saunders Learning Group, Newton, KS ! Bonds have a number of characterisCcs that play a role in determining the value of a bond. ! Principal ! Coupon ! Price ! Yield ! maturity ! credit quality
  • 9. Principal The Principal is the amount of money the issuer will repay the bondholder at the maturity of bond Issuer Bondholder Saunders Learning Group, Newton, KS
  • 10. Coupon (The Interest Rate) Saunders Learning Group, Newton, KS ! The coupon is the amount the bondholder will receive as interest payments. — It's called a "coupon" because someCmes there are physical coupons on the bond that you tear off and redeem for interest. — Now records are more likely to be kept electronically. ! Most bonds pay interest every six months, but it's possible for them to pay monthly, quarterly or annually. ! The coupon is expressed as a percentage of the par value.
  • 11. Price The price of the a bond depends on four factors: " Market interest rates " Credit quality " Maturity " Supply & demand Saunders Learning Group, Newton, KS
  • 12. Price of a Bond Varies Saunders Learning Group, Newton, KS Bond discount Par value premium Above par value Below par value Bond
  • 13. Bond Yield The yield of a bond is the rate of return received from invesCng in the bond, is based on the price paid for the bond and the coupon payment. current yield=Annual coupon/ Price Rate of return on investment price Coupon payment Saunders Learning Group, Newton, KS
  • 14. Normal Yield Curve Saunders Learning Group, Newton, KS
  • 15. Bond Maturity ! The maturity date is the date in the future on which the investor's principal will be repaid. ! As long as all payments have been made, the issuer has no more obligaCon to the bond holders a`er the maturity date. ! The length of Cme unCl the maturity date is o`en referred to as the term or tenor or maturity of a bond. ! There are three groups of bond maturiCes: — short term (bills): maturiCes up to one year — medium term (notes): maturiCes between one and ten years — long term (bonds): maturiCes greater than ten years ! A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years. Therefore, in general, the longer the Cme to maturity, the higher the interest rate. ! All things being equal, a longer term bond will fluctuate more than a shorter term bond. Saunders Learning Group, Newton, KS
  • 16. Issuer Saunders Learning Group, Newton, KS ! Who is issuing a bond is important to review, as the issuer's stability is your main assurance of gebng paid back. ! For example, the U.S. government is far more secure than any corporaCon. Its default risk (the chance of the debt not being paid back) is extremely small -­‐ so small that U.S. government securiCes are known as risk-­‐free assets. ! The general view is that a government will always be able to bring in future revenue through taxaCon. ! A company, on the other hand, must conCnue to make profits, which is far from guaranteed. ! This added risk means corporale bonds must offer a higher yield in order to enCce investors -­‐ this is the risk/return tradeoff in acCon.
  • 17. Credit Quality The credit raCng of a bond is important to investors as it: ! Provides a standardized measures of relaCve credit quality ! Provides an imparCal view of credit quality of the issue ! Allows the investor to compare issues of similar credit quality Saunders Learning Group, Newton, KS
  • 18. credit rating credit risk Moody's standard & Poor's Fitch IBCA highest quality Aaa AAA AAA highest quality (very strong) Aa AA AA upper mediam grade(strong) A A A medium grade Baa BBB BBB lower mediam grade Ba BB BB (some what speculative) lower grade (speculative) B B B poor quality (may default) Caa CCC CCC most speculative Ca CC CC no interest in being paid or C C C bankruptcy petition filed in default C D D Saunders Learning Group, Newton, KS
  • 19. Types of bonds ! Fixed rate bonds have a coupon that remains constant throughout the life of the bond. ! FloaCng rate notes (FRNs) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor. ! InflaCon linked bonds. in which the principal amount and the interest payments are indexed to inflaCon. The interest rate is normally lower than for fixed rate bonds with a comparable maturity. ! Asset-­‐backed securiCes are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Saunders Learning Group, Newton, KS
  • 20. Types of bonds ! Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation. ! Perpetual bonds are also often called perpetuities or Perps'. They have no maturity date. ! Bearer bond is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. ! War bond is a bond issued by a country to fund a war. Saunders Learning Group, Newton, KS
  • 21. How To Read A Bond Table Saunders Learning Group, Newton, KS Column 1: Issuer - This is the company, state (or province) or country that is issuing the bond. Column 2: Coupon - The coupon refers to the fixed interest rate that the issuer pays to the lender. Column 3: Maturity Date - This is the date on which the borrower will repay the investors their principal. Typically, only the last two digits of the year are quoted: 25 means 2025, 04 is 2004, etc. Column 4: Bid Price - This is the price someone is willing to pay for the bond. It is quoted in relation to 100, no matter what the par value is. Think of the bid price as a percentage: a bond with a bid of 93 is trading at 93% of its par value. Column 5: Yield - The yield indicates annual return until the bond matures. Usually, this is the yield to maturity, not current yield.
  • 22. Bond Issuing & Investing ! CorporaCons issue bonds to provide for a number of financing needs. Some of this financing could be in the form of: ! commercial paper (normally issued for less than 30 days) and used to fund things like accounts payable, payrolls etc. ! Short-­‐term bonds (less than a year) used to fund capital requirements and provide addiConal cash flow ! Long-­‐term bonds (more than a year) used to fund capital expenses like new buildings and equipment. ! Sovereign govt. issue bonds to cover a shorfall between taxaCon revenue and expenditure ! Govt. agencies, municipal, & local govt. authoriCes issue bonds to fund their service and operaCons Saunders Learning Group, Newton, KS
  • 23. Investment Banks (commonly called the Underwriter) Role of the Underwriter # To purchase the district’s bonds directly from the district and re-offer (sell) them to investors. Types of Bond Sales Negotiated sale - District hires an investment banking firm (or firms) to underwrite its bonds at a negotiated price. The financing structure is determined in accordance with the district’s specific needs or requirements relative to I&S tax rate preferences and/or refunding objectives. # Size of negotiated underwriting team # With exception of financings under $10, most issuers will hire a team of from 2 to 6 investment banking firms (depending on the size of the issue). # Selection process # Recommendation # Request For Proposals # Request For Qualifications Saunders Learning Group, Newton, KS
  • 24. Investment Banking Specialist # Investment banking firm specialists involved in the underwriting process $ The “banker” – called an investment banker, this specialist is part of the investment banking team. $ “Bankers” generally have broad knowledge of the capital markets, debt instruments, debt structuring, document preparation, and marketing/distribution procedures. $ One of their responsibilities is to solicit potential issuers with the goal of being included as a member of the issuer’s underwriting team. $ Once their firm is hired they serve as the key contact/liaison person and coordinate with all parties to the financing to execute the underwriting. $ The “underwriter” – an investment banking firm’s specialist who is directly responsible for pricing a district’s bond issue; i.e., determining the lowest possible combination of coupons and yields that will “sell” in the marketplace at the time of pricing. $ The “sales representatives” – the persons who actually contact potential investors and sell the district’s bonds to those investors. Saunders Learning Group, Newton, KS
  • 25. Steps in the Negotiated Underwriting Process 1. Structuring - the lead investment banking firm (senior managing underwriter) is usually involved in the initial structuring and/or determining the plan of finance. 2. Hiring of underwriter’s counsel - the senior managing underwriter, the financial advisor and the issuer will jointly agree on a firm via consultation among themselves. 3. Documentation process. 4. Net Designations or Group Net 5. Pre-sale marketing activities by sales force. 6. Pre-sale pricing calls among the underwriters, the FA and the issuer. 7. Order period - usually 2 hours during which the bonds are sold. 8. Sign bond purchase agreement - the district and the senior managing underwriter. Saunders Learning Group, Newton, KS
  • 26. HOW BOND MARKETS WORK Saunders Learning Group, Newton, KS subtitle 26 date
  • 27. Bond Trading Activity ! Largely an OTC market—no primary physical location ! Low trading volume relative to stocks ! Par value: face amount, usually $1,000 ! Round lot: $1 million of par value ! Relatively illiquid for small investors Saunders Learning Group, Newton, KS
  • 28. Primary and Secondary Markets Saunders Learning Group, Newton, KS subtitle 2d8a te
  • 29. Bond Markets Primary market – New bonds Issuer Investor Saunders Learning Group, Newton, KS
  • 30. Secondary Market bonds bonds Sells Buys Investor A Broker Investor B Saunders Learning Group, Newton, KS
  • 31. Bond Market Players ! Bond: promise to pay back principal at some future date, plus periodic interest payments for use of investor’s money ! Bond issuers: entities that supply new bonds ! Bond investors: individuals and institutions that purchase bonds for interest income and long-term capital gains ! Bond dealers: intermediaries between bond issuers and investors ! Primary bond market: new bonds only; issuer-to-investor ! Secondary bond market: previously issued bonds; investor-to-investor Saunders Learning Group, Newton, KS
  • 32. U.S. Bond Market ! Market value = $36 trillion ! BOND MARKET RELATIVE TO STOCK MARKET # Average Daily Trading Volume # U.S. Bond Markets = $814.0 Billion # Stock Market = $104.9 Billion ! One of largest securiCes markets in world ! Quickly reflects changes in credit quality and in aggregate economic condiCons, including interest rates ! Very efficient market mechanism ! Expensive place to trade for small investors Saunders Learning Group, Newton, KS
  • 33. Tracking Interest Rates ! Federal Funds Rate: overnight bank lending rate; lowest but most volatile money market rate ! Discount Rate: interest rate charged by the Federal Reserve to its member banks; key instrument of monetary policy ! Eurodollar Rate: interest rate charged for dollar-denominated loans in European banks ! LIBOR: London Interbank Offered Rates; London fed funds rate Saunders Learning Group, Newton, KS
  • 34. Bond Ownership Saunders Learning Group, Newton, KS
  • 35. Types of bonds ! Fixed rate bonds have a coupon that remains constant throughout the life of the bond. ! FloaCng rate notes (FRNs) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor. ! InflaCon linked bonds. in which the principal amount and the interest payments are indexed to inflaCon. The interest rate is normally lower than for fixed rate bonds with a comparable maturity. Saunders Learning Group, Newton, KS ! Asset-­‐backed securiCes are bonds whose interest and principal payments are backed by underlying cash flows from other assets. ! Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidaCon. ! Perpetual bonds are also o`en called perpetuiCes or Perps'. They have no maturity date. ! Bearer bond is an official cerCficate issued without a named holder. In other words, the person who has the paper cerCficate can claim the value of the bond. O`en they are registered by a number to prevent counterfeiCng, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. ! War bond is a bond issued by a country to fund a war.
  • 36. Types Of Bonds $ Callable Bonds - A bond that can be redeemed by the issuer prior to its maturity. The main cause of a call is a decline in interest rates $ Convertible Bonds – A bond that can be converted into a predetermined amount of the company's equity at certain times during its life $ Eurodollar Bonds - U.S.-dollar denominated bond issued by an overseas company and held in a foreign institution outside both the U.S. and the issuer's home nation. Chinese bank held dollar-denominated bonds issued by a Japanese company, this would be considered a eurodollar bond. $ Eurobond – An international bond that is denominated in a currency not native to the country where it is issued $ Yankee Bond - A bond denominated in U.S. dollars that is publicly issued in the U.S. by foreign banks and corporations $ Bulldog Bond - A sterling denominated bond that is issued in London by a company that is not British Maple Bond - A bond denominated in Canadian dollars that is sold in Canada by foreign financial institutions $ Matilda/Kangaroo Bond - An bond denominated in the Australian dollar and issued on the Australian market by a foreign entity $ Samurai Bond - Yen-denominated bond issued in Tokyo by a non-Japanese company Saunders Learning Group, Newton, KS 36
  • 37. Corporate Bonds Uses of Corporate Debt ! Corporations must raise money to finance investments: — inventory, — plant and equipment, — research and development, — general business expansion. ! Corporations can issue equity securities (stocks), debt securities (bonds), or a combination of both ! Firms wish to minimize their cost of capital. ! Firms match their financing requirements with investor needs to issue a wide variety of debt instruments. ! Most corporate bonds bought by underwriters--no certificate issued, just book-entry form Saunders Learning Group, Newton, KS
  • 38. Corporate Debt Securities ! Bridge financing ! Bearer /coupon bonds ! Registered bonds ! Unsecured corporate bonds/ debentures ! Senior bonds ! Mortgage bonds ! Equipment trust certificates ! Subordinated debenture Saunders Learning Group, Newton, KS ! Closed-end mortgage bond ! Open-end mortgage bond ! Serial bonds income bonds ! Repo market ! Money market ! Basis points ! Commercial paper ! Bankers’ acceptances (bas) ! Negotiable CD/jumbo CD
  • 39. Government Debt Government Sources of Funds: $ Collect tax revenues $ Print more money $ Issue public debt $ Treasury Bills: Maturities with 6,12 & 18 months duration $ Issued by the government Treasury department $ Always issued at discount $ Treasury Notes: 1-10 year maturities $ Treasury Bonds: long term; 10-30 year maturities $ Fixed interest rate with annual coupon payments $ Government-Sponsored Enterprises $ Pools $ Mortgage Securities /Securitization $ GNMA $ Fannie Mae $ Freddie Mac Saunders Learning Group, Newton, KS U.S. TREASURY SECURITIES $ Implement monetary policy— Federal Reserve System trades through its New York branch. $ Increase money supply: buys Treasuries $ Decrease money supply: sells Treasuries $ Efficient means to finance federal deficit $ Treasury issues bonds, notes, bills through regularly scheduled public auctions to primary dealers $ Dealers obligated to bid at every auction $ Must maintain bids, offers and inventories for secondary market
  • 40. Treasury Securities Secondary Market Secondary Market for U.S. Treasury SecuriCes $ Safest bonds in circulaCon $ Enormous trading volume: $190.7 billion per day; most liquid market in world $ T-­‐bills: $ mature in less than one year, usually 3 and 6 months $ face values of $10,000 to $1 million $ do not pay interest; traded at discount from par $ T-­‐notes: $ maturiCes 1-­‐10 yrs $ semiannual interest $ face values of $5,000 to $1 million $ T-­‐bonds: 10 to 30 yr. maturiCes Saunders Learning Group, Newton, KS Agency & Asset-­‐Backed SecuriCes Markets $ Government-­‐sponsored enterprises: private corporaCons with public purposes $ Pools: diversified loan porfolios $ Mortgage securiCzaCon: creaCng pools of mortgages and selling shares of pools $ Ginnie Maes, Fannie Maes, Freddie Macs $ Ac1ve secondary market provides liquidity $ Pay low semiannual interest $ Other asset-­‐backed securiCes: $ credit card debt, auto loans, home equity loans, equipment leases $ Repo market: dealers lend securiCes short term
  • 41. U.S. Treasury Securities Secondary Market Secondary Market for U.S. Treasury SecuriCes $ Safest bonds in circulaCon $ Enormous trading volume: $190.7 billion per day; most liquid market in world $ T-­‐bills: $ mature in less than one year, usually 3 and 6 months $ face values of $10,000 to $1 million $ do not pay interest; traded at discount from par $ T-­‐notes: $ maturiCes 1-­‐10 yrs $ semiannual interest $ face values of $5,000 to $1 million $ T-­‐bonds: 10 to 30 yr. maturiCes Saunders Learning Group, Newton, KS Agency & Asset-­‐Backed SecuriCes Markets $ Government-­‐sponsored enterprises: private corporaCons with public purposes $ Pools: diversified loan porfolios $ Mortgage securiCzaCon: creaCng pools of mortgages and selling shares of pools $ Ginnie Maes, Fannie Maes, Freddie Macs $ Ac1ve secondary market provides liquidity $ Pay low semiannual interest $ Other asset-­‐backed securiCes: $ credit card debt, auto loans, home equity loans, equipment leases $ Repo market: dealers lend securiCes short term
  • 42. THE MONEY MARKET $ Buying and selling short-term debt securities; quick cash conversion $ Safety: short maturities and diversification $ Include Private Paper: $ Commercial paper $ Bankers’ acceptances (Bas) $ Jumbo CDs $ State & Local Governments: Project Notes $ tax anticipation notes $ bond anticipation notes $ revenue anticipation notes Saunders Learning Group, Newton, KS
  • 43. Municipal Securities $ Municipal Bonds $ Bonds anCcipaCng future cash $ Tax-­‐AnCcipaCon Notes $ Bond-­‐anCcipaCon Notes $ Revenue-­‐AnCcipaCon Notes $ Clientele Effect $ High tax bracket investors Saunders Learning Group, Newton, KS $ Limited Tax Bonds $ Payable from cash generated by specific tax $ Revenue Bonds $ Industrial Revenue Bonds $ Backed by Good Name of Municipality $ Moral ObligaCon Bonds $ General ObligaCon (GO) Bonds $ Double-­‐Barreled Bonds $ Backed by 2+ sources of funds
  • 44. Fixed Income Products $ Repo – Repurchase Agreements $ Is a contract in which a security is sold with an agreement to repurchase the security at a higher price $ Reverse Repo is a contract in which a security is borrowed with an agreement to replace the security at a higher price $ Secured lending and borrowing Saunders Learning Group, Newton, KS
  • 45. Fixed Income Products $ Commercial Paper – An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. $ Short term with maturities 1,3, 6,12 & 18 months $ Maturities on commercial paper rarely range any longer than 270 days $ Placed in the primary market through competitive auctions $ Convertible/Exchangeable Bonds $ Enables a financial asset to be transformed into other $ Certificate of Deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions $ Held until maturity Saunders Learning Group, Newton, KS
  • 46. FIXED INCOME DERIVATIVES Saunders Learning Group, Newton, KS 46
  • 47. Mortgage-Backed Security (MBS) A mortgage-backed security (MBS) is an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans, most commonly on residential property. $ Residential mortgage-backed security (RMBS) $ Commercial mortgage-backed security $ Collateralized mortgage obligation $ Stripped mortgage-backed securities $ Interest-only stripped mortgage-backed securities $ Principal-only stripped mortgage-backed securities Saunders Learning Group, Newton, KS
  • 48. Saunders Learning Group, Newton, KS subtitle d4a8t e
  • 49. Mortgage Securitization Collateralized Debt ObligaCon Process Of SecuriCzaCon Saunders Learning Group, Newton, KS
  • 50. Credit Default Swap Saunders Learning Group, Newton, KS
  • 51. Interest Rate Swap $ Interest rate swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows $ Fixed for floating/Vanilla Interest Rate Swaps $ Often use LIBOR as reference rates $ Hedging/Speculation on interest & FX rates Saunders Learning Group, Newton, KS 51 Understanding Fixed Income Instruments
  • 52. Interest Swaps – Illustrated Time 6-­‐Month Fixed Rate FloaCng Rate Swap 0 2.80% –100.0 –100.0 0 0.5 3.40% 2.3 1.4 0.9 1 4.40% 2.3 1.7 0.6 1.5 4.20% 2.3 2.2 0.1 2 5.00% 2.3 2.1 0.2 2.5 5.60% 2.3 2.5 –0.2 3 5.20% 2.3 2.8 –0.5 3.5 4.40% 2.3 2.6 –0.3 4 3.80% 102.3 102.2 0.1 Cash Flows During the Life of a Hypothetical USD 100MM 4.6% Four-Year Swap Saunders Learning Group, Newton, KS
  • 53. Swaps $ A swap is an option granting its owner the right but not the obligation to enter into an underlying swap $ A payer swap gives the owner of the swap the right to enter into a swap where they pay the fixed leg and receive the floating leg. $ A receiver swap gives the owner of the swap the right to enter into a swap where they will receive the fixed leg, and pay the floating leg. Saunders Learning Group, Newton, KS
  • 54. Conclusion ! Bonds are just like lOUs. Buying a bond means you are lending out your money. ! Bonds are also called fixed-­‐income securiCes because the cash flow from them is fixed. ! The issuers of bonds are governments and corporaCons. ! A bond is characterized by its face value, coupon rate, maturity and issuer. ! Yield is the rate of return you get on a bond. ! When price goes up, yield goes down, and vice versa. ! When interest rates rise, the price of bonds in the market falls, and vice versa. ! Bills, notes and bonds are all fixed-­‐income securiCes classified by maturity. ! Government bonds are the safest bonds, followed by municipal bonds, and then corporate bonds. ! Bonds are not risk free. It's always possible -­‐ especially in the case of corporate bonds -­‐ for the borrower to default on the debt payments. Saunders Learning Group, Newton, KS
  • 55. Questions Saunders Learning Group, Newton, KS
  • 56. Reference Material Saunders Learning Group, Newton, KS Figuring Out Wall Street Consumer’s Guide To Financial Markets By Floyd Saunders Publisher: Saunders Learning Group ISBN: 978-0-9824019-0-3 available from Amazon, B&N, and http:// www.figuringout wallstreet.com or www.floydsaunders.com Book summary: From bank failures to home foreclosures and panic around the world, Figuring Out Wall Street, is the concise guide to help everyone understand how this latest crisis happened, who was responsible and what to do now to restore our financial systems. Written in an easy to understand manner, even the most complex financial concepts are easy to digest. This book provides help to monitor investments with a review of investment products, financial regulators and economic indicators. Learn how the stock market exchanges work and the world of investment banking, hedge funds, venture capital and private equity. Every chapter includes action plans for investing.
  • 57. Glossary of Bond Finance Terms - A Accrued interest. Coupon interest accumulated on a bond or other obligation since the last interest payment or, for a new issue, from the dated date to the date of delivery. Usually interest on municipal bonds is payable semi-annually, every six months. When you buy a bond in mid-term you are only entitled to the interest the bond earns after you buy it. The interest earned previously, the accrued interest, belongs to the seller. Ad Valorem Tax. A state or local government tax based on the value of real property as determined by the county tax assessor. Advanced Refunded Bonds. A municipality or school district may sell a second bond issue at a lower interest rate cost, placing the proceeds of the issue in an escrow account from which the first issue's principal and interest will be repaid when due. Amortization of Debt. The annual reduction of principal through the use of serial bonds or term bonds with a sinking fund. Arbitrage. The interest rate differential that exists when proceeds from a municipal bond - which is tax-free and carries a lower yield - are invested in taxable securities with a yield that is higher. The 1986 Tax Reform Act made this practice by municipalities illegal solely as a borrowing tactic, except under certain safe-harbor conditions. Assessed Valuation. A municipality's worth in dollars based on real estate and/or other property for the purpose of taxation, sometimes expressed as a percent of the full market value of the community. Authorizing Ordinance. A law that when enacted allows the unit of government to sell a specific bond issue or finance a specific project. Average Life. The average length of time an issue of serial bonds and/or term bonds with mandatory sinking funds and/or estimated prepayments is expected to be outstanding. It also can be the average maturity of a bond portfolio. Saunders Learning Group, Newton, KS
  • 58. Glossary of Bond Finance Terms - B Balloon Maturity. An inordinately large amount of bond principal maturing in any single year. This is also referred to as a Term Bond. Bond Anticipation Note. A short-term security, one year or less, used for interim financing to be repaid from the proceeds of a planned long-term bond issue. Basis Point. One one-hundredth of one percent (1/100 % or 0.01 percent). Thus 25 basis points equal one-quarter of one percent, 100 basis points equal one percent. This is typical in-group, professional bond talk. Bid. An offer to buy at a fixed price or yield. As opposed to Ask, which is an offering to sell. Bond or note. A security whereby an issuer borrows money from an investor and agrees and promises, by written contract, to pay a fixed principal sum on a specified date (maturity date) and at a specified rate of interest. Bond Fund (Tax-Exempt). A Bond Fund is a portfolio of municipal bonds sponsored or administered by registered investment companies. These companies offer shares to investors either through (1) closed-end funds or unit investment trusts, which offer shares of a fixed portfolio of municipal bonds; or (2) open-end or managed funds, which offer shares in a managed portfolio of municipal bonds whose size will vary as shares are purchased or redeemed. Bond Insurance. Insurance issued by a private insurance company for either an entire issue or specific maturities that guarantees to pay principal and interest when due. Bond Premium. The amount at which a bond or note is bought or sold above its par value or face value without including accrued interest. Bonded Debt. The portion of an issuer's debt structure represented by outstanding bonds, sometimes limited by constitutional or legislative restraints. Book Entry. A system of security ownership in which the ownership is held as a computer entry on the records of a central company for its owner. The bond owner gets a computer printout as proof of ownership. Broker. Technically a broker is a bond trader in the secondary market buying from and selling to bond dealers. Its most common usage is as a description of a bond salesperson. Saunders Learning Group, Newton, KS
  • 59. Glossary of Bond Finance Terms - C Callable Bond. A bond or note that is subject to redemption at the option of the issuer prior to its stated maturity. The call date and call premium, if any, is stated in the offering statement or broker's confirmation. Certificates of Participation (COPs). A form of a lease revenue bond that permits the investor to participate in a stream of installment payments, lease payments or loan payments relating to the acquisition or construction of specific equipment, land or facilities. COPs are not viewed legally as "debt" because payment is tied to an annual appropriation by the government body. As a result, COPs are seen by investors as providing weaker security and often carry ratings that are a notch or two below an agency's general obligation rating. Coupon. The Coupon is the detachable part of a bond that displays the rate of interest due, and the interest payment date. When there were bearer bonds, coupons were often detached from the bonds and presented to the paying agent for payment just as one might cash a government check. Coupon Rate. The specified annual interest rate payable to the bond or note holder as printed on the bond. This term is still used even though there are no coupon bonds anymore. Covenant. A legally binding commitment by the issuer of municipal bonds to the bondholder. This is the issuer’s promise to perform or repay, conversely, an impairment of a covenant can lead to a Technical Default. Current Refunding. A refunding transaction where the municipal securities being refunding will all mature or be redeemed within 90 days or less from the date of issuance of the refunding issue. Current Yield. The ratio of the coupon rate on a bond to the dollar purchase price expressed as a percentage. Cushion Bonds. Bonds selling at a premium are called "cushion" bonds because they cushion the price volatility in an up and down market. A premium bond, by definition, has a higher-than-market coupon interest rate. The dollar price movement of a high interest rate bond is less than that of a lower interest rate bond of the same maturity when general interest rates move up or down a few basis points. Saunders Learning Group, Newton, KS
  • 60. Glossary of Bond Finance Terms - D Dated Date. The date carried on the face of a bond or note from which interest normally begins to accrue, the “dated date”. Dealer. A dealer is a corporation or partnership that buys and sells and maintains an ongoing position in bonds and/or notes. They are also authorized to underwrite new issues. Debt Limited. The debt limit is the maximum statutory or constitutional amount of debt that the general obligation bond issuer can either issue or have outstanding at any time. Debt Ratio. The ratio of the issuer's general obligation debt to a measure of value, like real property valuations, personal income, general fund resources, or population. Debt Service. Required payments for principal and interest. Default. Failure to pay in a timely manner principal and/or interest when due, or a Technical Default, the occurrence of an event as stipulated in the Indenture of Trust resulting in an abrogation of that agreement. A Technical Default can be a warning sign that a default on debt service is coming, however in the real world actual debt service interruption does not always occur if the problems are resolved in time. Defeased Bonds. Refunded bonds for which the payment of principal and interest has been assured through the structuring of a portfolio of government securities, the principal and interest on which will be sufficient to pay debt service on the refunded, outstanding bonds. When a bond issue is defeased, the claim on the revenues of the issuer is usually eliminated. Saunders Learning Group, Newton, KS
  • 61. Glossary of Bond Finance Terms - D Delivery. Delivery and payment must be in three business days for bonds bought or sold in the secondary market. For new issues, the time when payment is made to, and the executed bonds and notes are received from, the issuer. New-issue delivery takes place several weeks after the sale to allow the bonds and notes to be printed and signed. Denomination. The face or par amount - normally $1000 or $5000 but can be $100,000 or more in the case of a note - that the issuer promises to pay at a specific bond or note maturity. Direct Debt. In general obligation bond analysis, the amount of debt that a particular local unit of government has incurred in its own name or assumed through annexation. Discount. The amount of dollars by which market value of a bond is less than par value or face value. Discount Bonds. Bonds which sell at a dollar price below par in which case the yield would exceed the coupon rate. The difference between the discount price and the maturity price is subject to federal capital gains tax except in the case of Original Issue Discount Bonds. Dollar Bond. Generally a term bond that is quoted and traded in dollars rather than in yield-to-maturity. They are well known issues of well known names in the market. Saunders Learning Group, Newton, KS
  • 62. Glossary of Bond Finance Terms – E to F Escrow Fund. A fund that contains monies that only can be used to pay debt service. Escrowed to Maturity. Also called an “Advanced Refunded” bond. When interest rates fall, an issuer may chose to sell a new issue called a refunding issue and use the proceeds of the second issue to pay off the original issue, much the same as a home owner refinancing a mortgage in an effort to save interest costs. The proceeds of the refunding issue are used to structure a portfolio of U.S. government securities, the principal and interest payments of which exactly match the principal and interest payments of the refunded bonds. The portfolio is placed in escrow at the paying agent and the bond issue is said to be fully defeased and escrowed to maturity. In actual practice the bonds are usually called on the first call date. Because of the U.S. Treasury backing, advanced refunded or escrowed to maturity bonds are considered the safest municipal bonds available and trade on the market as a rich triple-A. Financial Advisor. Generally an independent consulting firm, an investment-banking company, individual, or bank that advises the issuer on financial matters regarding a proposed issue and is not part of the underwriting syndicate. Fiscal Agent. Also known as the Paying Agent, the bank, designated by the issuer, to pay interest and principal to the bondholder. Fiscal Year. A 12-month time horizon by which state and local governments annually budget their respective revenues and expenditures. Often this time horizon is from July to June but can vary. Flow of Funds. The annual legal sequence by which enterprise revenues are paid out for operating and maintenance costs, debt service, sinking fund payments, and so on. Full Faith and Credit. The pledge of "the full faith and credit and taxing power without limitation as to rate or amount." This phrase is generally used regarding General Obligation bonds to express the pledge of utilizing all taxing powers and resources, if necessary, to pay the bond holders. Saunders Learning Group, Newton, KS
  • 63. Glossary of Bond Finance Terms – G, H , I General Obligation Bond. (G.O.) A bond secured by a pledge of the issuer's taxing powers (limited or unlimited). Considered the most secure of all municipal debt. General obligation bonds of local governments are paid from ad valorem property taxes and other general revenues. Guaranteed Yield: The guaranteed yield is a school finance plan in which the state specifies a revenue yield that it will guarantee in terms of revenue per student per penny of local tax effort. Districts adopt tax rates and levy taxes. The state makes up the difference between what each district levies locally per student and the guaranteed yield per student. High-wealth districts may raise all of their guaranteed yield revenue from local tax sources. Hold Harmless: Hold harmless provisions are common when a significant change is made to a formula or funding source. "Hold harmless" is a term used to describe a provision in new law that is designed to protect a school district from a loss of local revenue or state aid. Indenture of Trust. A legal document describing in specific detail the terms and conditions of a bond offering, the rights of the bondholder, and the obligations of the issuer to the bondholder; such document is alternatively referred to as a bond resolution. Interest and Sinking Fund (I&S) Tax Rate: Also referred to as the debt service tax rate, the I&S taxes pay for bonded indebtedness, facilities, and other capital needs. Interim Borrowing. (1) Short-term loans to be repaid from general revenues or tax collections during the current fiscal year (TRANs or RANs); (2) short-term loans in anticipation of bond issuance or grant receipts (BANs). Investment Grade. Bond issues that the three major bond rating agencies, Moody's, Standard & Poor's, and Fitch rate BBB or Baa or better. Many fiduciaries, trustees, some mutual fund managers can only invest in securities with an investment grade rating. Saunders Learning Group, Newton, KS
  • 64. Glossary of Bond Finance Terms – J & L Junk Bonds. Most non-rated bonds and bonds rated below investment grade. Legal Opinion. A written opinion from bond counsel that an issue of bonds was duly authorized and issued. The opinion usually includes the statement, "interest received thereon is exempt from federal taxes and, in certain circumstances, from state and local taxes." Letter of Credit. A form of supplement or, in some cases, direct security for a municipal bond under which a commercial bank or private corporation guarantees payment on the bond under certain specified conditions. Level Debt Service. Principal and interest payments that, together, represent more or less equal annual payments over the life of the loan. Principal may be serial maturities or sinking fund installments. Lien. A claim on revenues, assessments or taxes made for a specific issue of bonds. Limited Tax Bond. A bond secured by a pledge of a tax that is limited as to rate or amount. Saunders Learning Group, Newton, KS
  • 65. Glossary of Bond Finance Terms – M & N Maximum Annual Debt Service. The maximum amount of principal and interest due by a revenue bond issuer on its outstanding bonds in any future fiscal year. This is sometimes the amount to be maintained in the Debt Service Reserve Fund. Municipal Bond. Bonds issued by any of the 50 states, the territories and their subdivisions, counties, cities, towns, villages and school districts, agencies, such as authorities and special districts created by the states, and certain federally sponsored agencies such as local housing authorities. Historically, the interest paid on theses bonds has been exempt from federal income taxes and is generally exempt from state and local taxes in the state of issuance. Municipal Securities Rulemaking Board (MSRB). An independent self-regulatory organization established by Congress in 1975 which is charged with primary rulemaking authority - under the SEC - over dealers, dealer banks, and brokers in the municipal securities industry. Net Bonded Debt. Gross general obligation debt minus self-supporting general obligation debt, housing bonds, water revenue bonds, etc. Net Interest Cost (NIC). In general, issuers award competitive bond sales to the underwriter bidding the lowest NIC. This represents the average coupon rate weighted to reflect the time until repayment of principal and adjusted for the premium or discount. Net Revenue Available for Debt Service. Usually, gross operating revenues of an enterprise less operating and maintenance expenses but exclusive of depreciation and bond principal and interest. Thus, net revenue is defined to determine coverage on revenue bond issues. Saunders Learning Group, Newton, KS
  • 66. Glossary of Bond Finance Terms - O Official Statement (OS) or Offering Circular (OC). A document or prospectus circulated for an issuer prior to a bond sale with relevant facts pertaining to the proposed financing. Usually there are two OSs, the first of which is known as the preliminary, or "red herring" - so named because some of the type on its cover is printed in red. The prospectus or red herring is supposed to be available to the investor prior to the sale often used to determine interest from investors. Original Issue Discount. Certain maturities of a new bond issue may have an offering price substantially below par. The appreciation from the original price to par over the life of the bonds is treated as tax-exempt income and is not subject to capital gains tax. Pleas see Zero Coupon Bond. O.T.C. Over The Counter. Not on an exchange. OTC refers to the buying and selling method used in the secondary market for municipal bonds and unlisted stocks. Overlapping Debt. Overlapping debt is the proportionate share of the general obligation bonds of local governments located wholly or in part within the limits of the reporting governmental entity that must be paid by property owners within the unit. Saunders Learning Group, Newton, KS
  • 67. Glossary of Bond Finance Terms - P Par Value. Par Value is the principal or face value of a bond, usually $5,000 due the holder at maturity. It has no relation to the market value. It is considered to be 100 for pricing purposes. Parity Bonds. Revenue bonds that have an equal lien on the revenues of the issuer. Paying Agent. Also Fiscal Agent. Generally a bank that performs the function of paying interest and principal for the issuing body. Premium. A premium is the amount by which the price exceeds the principal amount (par value) of a bond. The current yield of a premium bond will be less than its coupon rate. Price to Call. The yield of a bond priced to the first call date rather than maturity. Primary Market. The new issue market Principal. The face value of a bond, not including interest. Put Bond. A put bond that can be redeemed by the bondholder on a date or on a date or dates prior to the stated maturity date. Saunders Learning Group, Newton, KS
  • 68. Glossary of Bond Finance Terms Q & R Qualified Legal Opinion. Conditional affirmation of the legal basis for the bond or note issue. The average investor should avoid any but the strongest opinion by the most recognized bond approving attorneys. Rate Covenant. A legal commitment by a revenue bond issuer to maintain rates at levels to generate a specified debt-service coverage. Ratings. Various alphabetical and numerical designations used by institutional investors, Wall Street underwriters, and commercial rating companies to give relative indications of bond and note creditworthiness. Standard & Poor's and Fitch Investors Service Inc. use the same system, starting with their highest rating of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D for default. Moody's Investors Services uses Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, and D . Recapture: Also referred to as the “Robin Hood” provision. Recapture is a characteristic of school finance where local districts give the state locally collected property tax revenues for reallocation through the Foundation School Program. Chapter 41 of the Texas Education Code is where the recapture provision can be found and is a significant feature of the Texas school finance equalization system. Red Herring. A preliminary offering statement, subject to final change and update upon completion of sale of bonds. The name comes from the red type along the side on the cover. Redemption. Process of retiring existing bonds prior to maturity from excess earnings or proceeds of refunding bonds. It also refers to redeeming shares in a mutual fund by selling the shares back to the sponsor. Refunding Bond. The issuance of a new bond for the purpose of retiring an already outstanding bond issue. Registered Bond. A non-negotiable instrument in the name of the holder either registered as to principal or as to principal and interest. Saunders Learning Group, Newton, KS
  • 69. Glossary of Bond Finance Terms - S Security. The legally available revenues and assets that are used to pay the bond holders. This is the key component that supports debt service. Serial Bond. As opposed to a Term Bond, which is a large block of bonds maturing in a single year, a serial bond is an issue that features maturities every year, annually or semiannually over a period of years. Short Term. Bonds or notes sold on an interim basis with tax-exempt securities for a period of from one to five years. Sinking Fund. A sinking fund is where monies are escrowed on a periodic basis to retire term bonds at or prior to maturity. Sinking Fund Schedule. A schedule of payments required under the original revenue bond resolutions to be placed each year into a special fund, called the sinking fund, and to be used for retiring a specified portion of a term bond issue prior to maturity. Special Assessment Bond. A bond secured by a levy of special assessments, as opposed to property taxes, made by a local unit of government on certain properties to pay the cost of local improvements and/or services that represents the specific benefit to the property owner resulting from the improvement. Street Name. Street name refers to the registration of bonds in the name of a dealer or other third party instead of the owner, usually for custodial or safe keeping purposes. Swap. The exchange of one bond for another. Generally, the act of selling a bond to establish an income tax loss and replacing the bond with a new item of comparable value. Saunders Learning Group, Newton, KS
  • 70. Glossary of Bond Finance Terms - T Tax Base. The total resource of the community that is legally available for taxation. Taxable Equivalent Yield. The yield an investor would have to obtain on a taxable corporate or U.S. government bond to match the same after-tax yield on a municipal bond. Tax-exempt Bond. Bonds exempt from federal income, state income, or state tax and local personal property taxes. This tax exemption results from the theory of reciprocal immunity: States do not tax instruments of the federal government and the federal government does not tax interest of securities of state and local governments. Technical Default. Failure by the issuer to meet the requirements of a bond covenant. These defaults do not necessarily result in losses to the bond holder. The default may be cured by simple changes of policy or actions by the issuer. Tender. The act of offering bonds to a sinking fund. Term Bond. A large block of bonds of long maturity. They may be part of a serial Bond issue; there may be more than one term bond in an issue or a single maturity. Some are subject to a sinking fund redemption. Tombstone. An advertisement placed for information purposes, after bonds or notes are sold, that describes certain details of the issue and lists the managing underwriters and or the members of the underwriting syndicate. Trustee. A bank designated as the custodian of funds and official representative of bondholders. Trustees are appointed to insure compliance with the trust indenture and represents bondholders to enforce their contract with the issuer. Saunders Learning Group, Newton, KS
  • 71. Glossary of Bond Finance Terms U to Z Underwrite. An agreement to purchase an issuer's unsold securities at a set price, thereby guaranteeing the issuer proceeds and a fixed borrowing cost. Variable Rate Bond. A bond whose yield is adjusted periodically according to a prescribed formula. Yield Curve. Graph depicting the relationship between yields and current maturity for securities with identical default risk. Yield-to-call. Return available to call date taking into consideration the current value of the call premium, if any. Yield-to-maturity. (YTM) Return available taking into account the interest rate, length of time to maturity, and price paid. It is assumed that the coupon reinvestment rate for the life of the bonds will be the same as the yield-to- maturity. Zero-coupon Bonds. A deep discount municipal bond on which no current interest is paid. Instead, at bond maturity, the investor receives compounded interest at a specified rate. The difference between the discount price at purchase and the accreted value at maturity is not taxed as a capital gain but is considered tax-exempt interest. Often used for college savings bonds. Saunders Learning Group, Newton, KS
  • 72. Purchase Presentation from If you like this presentation it is available for purchase of just $1.99 Saunders Learning Group, Newton, KS Scribd 72 Link to Scribd offering: https://www.scribd.com/doc/ 243717202/Fixed-Income-Investing- Seminar

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