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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
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
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.
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
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
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.
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
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
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
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.
Price 
The 
price 
of 
the 
a 
bond 
depends 
on 
four 
factors: 
" 
Market 
interest 
rates 
" 
Credit 
quality 
" 
Maturity 
" 
Supply 
& 
demand 
Saunders Learning Group, Newton, KS
Price of a Bond Varies 
Saunders Learning Group, Newton, KS 
Bond 
discount 
Par value 
premium 
Above par value 
Below par value 
Bond
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
Normal Yield Curve 
Saunders Learning Group, Newton, KS
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
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.
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
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
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
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
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.
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
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
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
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
HOW BOND MARKETS WORK 
Saunders Learning Group, Newton, KS 
subtitle 26 date
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
Primary and Secondary Markets 
Saunders Learning Group, Newton, KS 
subtitle 2d8a te
Bond Markets 
Primary 
market 
– 
New bonds 
Issuer 
Investor 
Saunders Learning Group, Newton, KS
Secondary Market 
bonds bonds 
Sells 
Buys 
Investor 
A 
Broker 
Investor 
B 
Saunders Learning Group, Newton, KS
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
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
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
Bond Ownership 
Saunders Learning Group, Newton, KS
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.
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
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
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
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
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
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
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
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
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
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
FIXED INCOME DERIVATIVES 
Saunders Learning Group, Newton, KS 
46
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
Saunders Learning Group, Newton, KS 
subtitle d4a8t e
Mortgage Securitization 
Collateralized 
Debt 
ObligaCon 
Process 
Of 
SecuriCzaCon 
Saunders Learning Group, Newton, KS
Credit Default Swap 
Saunders Learning Group, Newton, KS
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
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
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
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
Questions 
Saunders Learning Group, Newton, KS
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.
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
Purchase Presentation from 
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purchase of just $1.99 
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Fixed Income Investing Seminar

  • 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
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