Main Steps

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Main Steps

• 1. Setting investment objectives
• 2. Establishing investment policy
• 3. Selecting a portfolio strategy
• 4. Selecting assets
• 5. Measuring and evaluating risk and performance

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General Objective

• S.L.Y. - Safety, Liquidity, Yield
• Dont purchase anything you dont understand.
• Keep investments simple
• Prudent Care
• Due Diligence

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Policy Statement

• It is the policy of the City of X ("the City")
  to deposit and invest public funds in a manner
  which will provide the highest investment return
  with the maximum security while meeting the daily
  cash flow demands of the City and conforming to
  all state and local statutes governing the
  investment of public funds.

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Prudent Investor Rule

• Investments shall be made with judgment and care
  under circumstances then prevailing which persons
  of prudence, discretion, and intelligence
  exercise in the management of their own affairs,
  not for speculation, but for investment,
  considering the probable safety of their capital
  as well as the probable income to be derived.

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Due Diligence

• FINRA Background Check on all brokers and
  dealers
• you do business with.
• Check compliance with capital requirements and
• audited financials
• Check registrations and licensing
• Evidence of adequate insurance coverage
• Acknowledgement and understanding of policy
• Check references
• Ask your auditors what else you might need

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Due Diligence

• WWW.FINRA.ORG FINRA formerly NASD
• Investor Information
• FINRA Broker Check
• Look up Broker / Dealer firm or Individual
• Search by Name
• Search by CRD
• WWW.SEC.GOV
• Advisor Check
• These sites will give you background information
  about compliance with the NASD SEC. It also
  provides additional investor information on
  protecting the investor.

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Portfolio Components

• Short-Term Portfolio Provide liquidity for
  short-term cash needs
• State Pool
• U.S. Treasury Bills
• Federal Discount Notes
• Commercial Paper
• Certificates of Deposit
• Core Portfolio Funds not expected to be spent
• United States Treasury Notes
• Federal Agency Securities/Mortgage Backed
  Securities
• Corporate Notes

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Portfolio Components

• Income (average coupon)
• Yield (call or maturity)
• Duration
• Maturity
• Sector Allocation

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Types of Risk

• Credit Risk or Default Risk
• This is the risk that an issuer will be unable
  to pay the contractual interest or principal on
  its debt obligations.
• Interest Rate Risk
• A rise in interest rates during the term of
  your debt securities hurts the market value or
  pricing. (aka. Market Risk)
• Reinvestment Risk
• The risk that future proceeds will have to be
  reinvested at a lower potential interest rate.

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U.S. Treasuries

• Full Faith Credit of U.S. Government
• T-Bills lt1 year
• Discount, actual / 360 basis no coupon mature at
  Par
• T-Notes 1-10 year
• T-Bills 10-30 year, Notes and Bills
• Pay semi annual interest,
  actual/actual basis
• Highly liquid secondary market

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Certificate of Deposits

• Issued by Banks
• FDIC insured to 100k (250k until 12/31/2009)
• Physical CDs (aka - Direct Deposit)
• CDARS - Certificate of Deposit Account Registry
  Service
• Negotiable CDs (aka - Brokered CDs, DTC
  Eligible CDs)

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Physical CDs
Definition Deposits (Time or CDs) safekept at a
depository held in the name of the investing
entity

• Disadvantages
• Early Withdrawal Penalties
• Auto Rolls
• Method of Interest Disbursement
• May or May not have Placement
• Fees

• Advantages
• Largest Number of Issuers
• Flexible Maturities
• Flexible Settlements
• Competitive Yields
• FDIC Insured
• Early Withdrawal Option

Availability/Transaction Process Readily
available Bank specific transaction
requirements Broker/Dealer or Direct Reverse
Inquiry
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Collateralized CDs
Definition Deposits (Time or CDs) safekept at a
depository held in the name of the
investing entity. Deposits are backed by
eligible assets as collateral.

• Disadvantages
• NOT FDIC insured
• Limited Issuers
• Early Withdraw Penalties
• No Secondary Market
• Cost of Collateral

• Advantages
• Competitive Yields
• Ease of Transaction
• Single Settlement Location
• Business of Scales
• Flexible Terms and Settlement Date
• Qualifies for most Public Units

Availability/Transaction Process Limited
Inventory Typically a 3rd party
custodial agreement needs to be executed
Broker/Dealer or Direct
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Deposit Insurance for Public Units1
The insurance coverage of a public unit account
depends upon (1) the type of deposit and (2)
the location of the insured depository
institution. All time and savings deposits
owned by a public unit and held by the same
official custodian in an insured depository
institution within the state in which the public
unit is located are added together and insured up
to 100,000. Separately, all demand deposits
owned by a public unit and held by the same
official custodian in an insured depository
institution within the state in which the public
fund is located are added together and insured
up to 100,000. A political subdivision (through
its official custodian) is entitled to its own
insurance coverage. An official custodian is an
officer, employee or agent of a public unit
having official custody of public funds
and lawfully depositing funds in an
insured institution.
1http//www.fdic.gov/deposit/deposits/FactShee
t.html
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CDARS (Certificate of Deposit Account Registry
Service)
Definition Placement service that monitors and
distributes single CD transactions to a number of
issuing banks, as to keep the deposit FDIC
insured

• Advantages
• FDIC Insured (Pass-Through)
• Up to 50MM in Transactions
• Single Transaction
• Complies with many State Public Funds Acts
• Single Interest Disbursement
• Competitive Yields
• No Placement Fees

• Disadvantages
• Limited Number of Issuers (principal limits)
• Limited Availability to Maturity and Settlement
  dates
• Does not satisfy all Public Fund Requirements (by
  State)
• Early Withdrawal Penalties

Availability/Transaction Process Available
through eligible depositories. Can be
purchased through a local bank (pending
availability) or through a national
broker/dealer. Transactions are
individually negotiated. Statements are
originated and provided by the
issuing depository.
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Negotiable CDs
Definition Time deposits that are safekept
(book entry) at the DTC and trade in
primary and secondary market

• Advantages
• Flexible Terms
• Competitive Rates
• Secondary Market (CUSIP)
• Held in Securities Account
• Growing Market
• FDIC Insured (Pass-Through)
• Method of Interest Disbursement
• No Placement Fees

• Disadvantages
• Insurance Limits
• Limited Issuers
• No Early Withdrawal Provision
• Cannot be Collateralized
• Secondary Market Interest Rate Risk

Availability/Transaction Process Must be
purchased from an FINRA broker dealer B/D new
account documentation Ease of transaction
Central holding location Reverse inquiry
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Depository Trust Company-(DTC)

• Depository Trust Company-(DTC) is a member of the
  U.S. Federal Reserve System, a limited-purpose
  trust company under New York State banking law
  and a registered clearing agency with the
  Securities and Exchange Commission. The
  depository brings efficiency to the securities
  industry by retaining custody of some 2 million
  securities issues, effectively dematerializing
  most of them so that they exist only as
  electronic files rather than as countless pieces
  of paper. The depository also provides the
  services necessary for the maintenance of the
  securities it has in custody. 

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FDIC Celebrates 75 Years
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FDIC Insurance

• FDIC issues a temporary increase in insurance
  limits from 100,000 to 250,000 effective
  October 3, 2008
• Increase expires on December 31,2009 unless
  extended
• Full Principal Interest Insurance Coverage
  Limits
• Monthly interest - 249,000 lt 4.85
• Semi-Annual - 245,000 lt 4.00
• _at_Maturity - 240,000 lt 4.00

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US Agencies

• GNMA Government National Mortgage Association
• Mortgage Backed Securities
• Others include SBA, FHA, HUD, GSA, FMHA
• Less frequent debt offerings
• Full Faith Credit of U.S. Government
• AAA Credit Quality

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Government Sponsored Enterprise (GSEs)

• FHLB, FNMA, FHLMC, FFCB, SLMA, TVA
• - Often referred to as Agency Bonds or GSEs
• Sponsored but not guaranteed by Federal
  Government
• Rated AAA
• Government-sponsored enterprises are financing
  entities created by Congress to fund loans to
  certain groups of borrowers such as homeowners,
  farmers and students.

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Agency/Instrumentality Securities

• Full faith and credit or implied backing of the
  U.S. government
• Benchmarks, reference notes and global auctions
• Customized structures
• Various call types
• Bought through broker/dealers
• New issue
• Secondary market

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Normal Yield curve

• Slopes gently upward
• Longer term investors demand more yield
• Normal economic growth

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Flat Yield curve

• Long term Yields are the same as Short Term
  Rates
• Odds are high for economic slowdown

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Inverted (Negative) Sloped Yield Curve

• Short term rates higher than long term
• Expectations are for lower rates
• Could signal an economic slowdown
• or recession

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Investment Strategies

• 1. Expense Matching
• 2. Extension of Term
• Cost of Waiting
• 3. Maturity Ladder
• 4. Barbell
• 5. Diversification

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Expense Matching

• Covering expenses are number 1 priority.
• Dont over extend maturities past obligations.
• Cash management is key.

• Fixed Rate
• Fixed Term

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Extension of Term
Overnight Rate (Money Market) vs. 1 year
investment The following examples show the
benefit of extending the maturity from an
overnight rate to a 1 year maturity. Current
Overnight Rate vs. Current 12 month
investment Rate 2.25
Rate 3.75 After 3 months time the
investor will need to receive an overnight rate
of 4.25 to break even with the investor that
bought a 12-month term. In other words the
investor that purchased the 12-month investment
would receive 3750 in interest on a 100k
investment. The investor that kept the funds in
an overnight investment with a rate of 2.25 for
the first 3 months would receive 562.50, which
means that the investor would need to get a rate
of 4.25 for the 9 remaining months to break even.
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Laddered Maturity

• Bonds in the portfolio are evenly distributed
  between short-term rungs, intermediate rungs, and
  long-term rungs. 
• As short-term bonds mature, the funds are
  returned or reinvested into long-term bonds. 
• Securities are held to maturity.

5-year bond at 5.00
4-year bond at 4.50
3-year bond at 4.00
2-year bond at 3.50
1-year bond at 3.00
This example is for institutional investors only
and is not meant for public customers.
Information contained herein has been obtained
from sources believed to be reliable however,
Multi-Bank Securities, Inc. does not guarantee or
warrant its completeness or accuracy.
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Barbell Strategy

• A bond investment strategy that concentrates
  holdings in both short-term and long-term
  maturities.
• When charting the strategy on a timeline it looks
  like a
• barbell (dumbbell). 
• This strategy allows one portion of the portfolio
  to achieve high yields while the other portion
  minimizes risk.

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Diversification

• Dont put all your eggs in one basket
• Maximize Full Faith Credit coverage
• Mix bullets, callable and structured securities
• Ladder maturities and call dates
• Think SLY , safety, liquidity and yield (In that
  order)

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Callable Securities
A bond that can be redeemed by the issuer prior
to maturity.

• The main cause of a call is a decline in
  interest rates since the first date of issue. If
  the interest rate is lower on the call date, the
  issuer would likely call the current issue of
  bonds and distribute a new issue at a lower
  interest rate. 

Cmon Back
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Callable Terminology

• Lockout (or call protection) refers to the
  period between the issue date and the first
  exercise date during which the issuer may not
  exercise the option.
• Call frequency refers to the frequency of call
  dates on which the issuer
• can redeem the bond. Callable structures
  incorporate one of three differentoption types
  American, Bermudan, or European.
• American options gives the issuer the ability to
  call the bond any time after the lockout date. It
  provides the greatest flexibility in timing the
  call decision and imparts the greatest call risk
  to the investor, since each day after the initial
  lockout represents a potential call date.
• Bermudan options give the issuer the ability to
  call the note at several points in time, but not
  continuously examples include monthly,
  quarterly, or semi-annually. The most typical
  Bermudan structure allows the issuer to call the
  bond on any coupon date after the initial
  lockout.
• European options may be called
  only once during the life of the
  bond, on the call date.

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Callable Spreads
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Relationships Among Bond Prices,Yields and
Maturities

• Prices and Yields An Inverse Relationship
• YIELD
• PRICE

101
6.00
100
5.00
99
4.00
1 year maturity
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Callable Agency Risk

• Negative Convexity
• Bond will not participate in a rally because it
  will be called
• When interest rates rise, the duration of
  callable bonds extend
• A callable that is discounted but still has
  optionality left (American call) will not trade
  like a bullet
• Reinvestment Risk
• Rates fall, bonds are called, proceeds invested
  at lower rates

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Valuing Callable Securities

• Yield Calculation
• Yield to Maturity
• Yield to Call
• Yield to Worst
• Always ask for the Yield to Worst

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New Issue Monitor
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Step Up Coupons

• A step-up security is a security that has an
  initial fixed interest rate which is paid up to a
  specific date, usually a call date. The coupons
  will automatically reset on specific dates if it
  is not called.

• A step-up security can have more than one step,
  as well as call structures.

• Step up securities are typically structured so
  that they are callable by the issuer at specific
  call dates.

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Canary Bond

• A step-up bond that cannot be called after
  completing its first-step period. The issuer of
  the bond reserves the option to call back the
  bond until the first step is reached. A canary
  call may only be exercised on predetermined
  dates.

• The canary call is similar to a Bermuda option,
  as it must be called on specific dates. If the
  issuer of the bond chooses not to call before the
  canary call expires, the bond will remain a
  standard step-up bond, where the coupon rate will
  increase with each step-up period.

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Helpful Websites

• Due Diligence Website
• www.finra.com Broker Check
• www.fdic.gov Bank Info
• www.sec.gov Advisor Check

• Research Websites
• www.bondmarkets.com
• www.bloomberg.com
• www.bondtalk.com
• www.costofwaiting.com
•  
• Agency Websites
• www.fhlb-of.com/
• www.freddiemac.com/
• www.fanniemae.com/
• www.ginniemae.gov
• www.fdic.gov

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