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Debt Instruments

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Includes bank, savings and loans, and credit union. Depository Insurance ... Short-term IOUs issued by large corporations with solid credit ratings ... – PowerPoint PPT presentation

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Title: Debt Instruments


1
Chapter 8
  • Debt Instruments
  • Descriptive Issues

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

3
  • Depository Institution
  • Any institution that holds deposits and makes
    loans
  • Includes bank, savings and loans, and credit union
  • Depository Insurance
  • Accounts, up to 100,000, at most banks, mutual
  • savings banks, and savings and loans are
    insured
  • by the Federal Deposit Insurance Corporation
  • (FDIC)

4
  • Certificates of Deposit (CDs)
  • Issued by a bank and other depository institution
  • Brokered CDs
  • Special terms
  • Money Market Deposit Accounts
  • Withdrawals limited to specified number
  • Carry nontrivial minimum balance requirement
  • Savings Bonds
  • Low-denomination Treasury issue
  • Designed to appeal to small investor
  • Types Series EE, HH, I

5
Liquidity
  • Ability to convert securities to cash at a price
    similar to price of previous trade in security
  • Assumes no significant new information has
    arrived since previous trade
  • Also ability to sell an asset quickly without
    having to make substantial price concession

6
Money Market Debt Securities
  • Available in large denominations that appeal
    primarily to large investors
  • Yields move together
  • Examples
  • Treasury bills
  • Commercial paper
  • Negotiable Certificates of Deposit
  • Bankers acceptances
  • Eurodollar deposits

7
Treasury Bills
  • Sold at discount to par
  • Interestdifference between purchase and selling
    price (or maturity value)
  • Competitive and non-competitive bids

8
Days
to Ask Maturity  Mat. Bid Ask C
hg. Yld. Jun 01 07   29 2.64  2.60 0.04 2.64
Example Treasury Bill Quotation
  • Maturity date on which Treasury bill will be
    paid off
  • Days to Mat. number of days remaining (from the
    previous trading day) until T-bill matures
  • Bid price (as a discount percentage) that a
    dealer is willing to pay for the T-bill
  • (continued)

9
Example Treasury Bill Quotation (continued)
Days
to Ask Maturity  Mat. Bid Ask C
hg. Yld. Jun 01 07   29 2.64  2.60 0.04 2.64
Days to Ask Maturity  Mat. Bid Ask Chg. Yl
d. Jun 01 00   49 5.64  5.60 0.04 5.72
  • Ask price (as a discount percentage) that dealer
    is willing to sell T-bill for
  • Chg. change between bid price as listed in bid
    column and bid price from previous trading day
    (which is two trading days previous)
  • In example, 0.04 indicates a decrease of 4/100
  • Ask Yld. bond equivalent yield for T-bill based
    on its ask price

10
Dealers Spread
  • Difference between dealers ask price and bid
    price

11
T-Bill Yields
  • Bank Discount Yield
  • BDY (10,000 Price)/10,000 x (360/DTM)
  • where BDY bank discount yield
  • Price actual T-bill price
  • DTM days to maturity
  • Bond Equivalent Yield
  • BEY((10,000 Price)/Price) x (365/DTM)
  • where BEY bond equivalent yield

12
Commercial Paper
  • Short-term IOUs issued by large corporations with
    solid credit ratings
  • Maximum maturity 270 days, but most commercial
    paper issued with a shorter maturity
  • Corporations can borrow at a lower rate from
    investors than from bank

13
Negotiable CDs
  • Only interest bearing money market security
  • Trades have minimum denomination of 1,000,000
  • Trading ceases when 14 or fewer days to maturity

14
Bankers Acceptances
  • Two-name paper
  • Substitutes credit-worthiness of bank for local
    merchant
  • Result of international trade

15
Eurodollar Deposits
  • Dollar-denominated liabilities of banks located
    outside of the US, usually Europe
  • Slightly higher than other MM rates
  • Less regulatory constraints on these banks
  • Smaller spread gt higher deposit rates lower
    loan rates

16
Rates Related to Money Market Rates
  • Prime Rate
  • Indexed
  • Used by banks to price loans
  • Discount Rate
  • Charged by Federal Reserve Bank on loans to banks
  • Federal Funds Rate
  • Charged by banks to each other for lending
    federal funds
  • LIBOR
  • Charged by London banks on loans to each other

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

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

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

20
Maturity Ask Rate  Mo./Yr. Bid Ask Chg. Yld.
6 1/3 May 10n 11205 11209 5 4.16 7 June
10-15 11002 11005 . 4.20
Treasury Note and Bond QuotationsSample Quotes
from the OTC Market
  • Rate coupon rate at which interest is paid as
    percentage of par value
  • Maturity Mo./Yr. month and year in which
    note/bond will be paid off
  • small n after maturity date identifies the
    security as a note
  • range of years given as maturity date identifies
    security as callable bond
  • Bid price (in 32nds) that dealer is willing to
    pay for note/bond
  • (continued)

21
Treasury Note and Bond QuotationsSample Quotes
from the OTC Market (continued)
Maturity Ask Rate  Mo./Yr. Bid Ask Chg. Yld.
6 1/3 May 10n 11205 11209 5 4.16 7 June
10-15 11002 11005 . 4.20
  • Ask price (in 32nds) that dealer is willing to
    sell note/bond for
  • Chg. change (in 32nds) between bid price as
    listed in bid column (see Bid above) and the bid
    price from the previous trading day (which is
    really 2 trading days previous)
  • Example a 1 means a decrease of 1/32
  • Ask Yld. yield to maturity for note/bond based
    on its ask price

22
Treasury STRIPS
  • Government program that allows a financial
    institution, government securities broker, or
    government securities dealer to convert an
    eligible Treasury security into interest and
    principal components

23
Treasury Inflation-Protected Securities
  • Coupon rate set lower than on bonds without
    inflation protection
  • Par value of bond adjusted on a semiannual basis
    by amount of inflation rate to compensate for
    lower coupon rate
  • Inflation rate reported by BLS in its CPI
  • Coupon rate applied to par value to determine
    interest payment due

24
Agency Issues
  • Slightly higher returns than Treasury bonds of
    comparable maturity
  • Lack full faith and credit guarantee of Treasury
  • Less marketable
  • Wider bid-ask spreads

25
Municipal Bonds
  • Revenue bond
  • municipal bond backed only by revenues of project
    that it finances
  • General obligation bond
  • municipal bond secured by issuers full faith and
    credit and taxing power

26
Corporate Bonds
  • Corporations are the largest issuers of bonds
  • More complex than government bonds and have
    varying degrees of risk
  • Corporate Bond Indentures
  • Legal contract between the issuer of the bond and
    the investor

27
  • Typical Indenture Provisions
  • Principal and maturity
  • Coupon
  • Collateral
  • Full faith and credit (debenture)
  • Subordination
  • Call provisions
  • Dividend restrictions
  • Current ratio minimum
  • Me-first rule
  • Trustee
  • Sinking fund
  • Grace Period

28
Cur. Net Bonds Yld. Vol. Close Chg. Att6s09 6.
6    4 90 1/2 1/8 Hilton5s06 cv 130 82
1 Polaroid11 ½ f 489 14 1/2 1/2
Examples Corporate Bond Quotations
  • Bonds name of company issuing bond, interest or
    coupon rate as a percentage of face or par value
    (typically 1,000), and year in which the bond
    will be paid off
  • s that sometimes appears separates interest rate
    from year of maturity when interest rate does not
    include a fraction
  • Other letters used described in explanatory notes
    in financial media
  • Cur. Yld. current yield or annual percentage
    return to purchaser at current price
  • Calculated by dividing coupon amount by current
    price
  • Flat bonds show no current yield
  • Convertible bonds have the letters cv listed
  • (continued)

29
Examples Corporate Bond Quotations (continued)
Cur. Net Bonds Yld. Vol. Close Chg. Att6s09 6.
6    4 90 1/2 1/8 Hilton5s06 cv 130 82
1 Polaroid11 ½ f 489 14 1/2 1/2
  • Vol. number of bonds traded
  • Close price
  • percentage of par value
  • Net Chg. difference between closing price as
    listed in close column and closing price from
    whatever day bond previously tradedusually the
    previous trading day, two trading days previous

30
Trading Flat
  • Trading of bonds for price that does not reflect
    any accrued interest
  • Collateralized Bonds
  • Debentures
  • Mortgage Bonds
  • Equipment Trust Certificates

31
Debenture
  • Long-term debt obligation that gives lender only
    general claim against borrowers assets
  • Unlike a collateralized bond
  • Holder has no claim against any specific assets
    in a default

32
Mortgage Bonds
  • Plant and equipment pledged as collateral
  • Subordination property pledged as collateral
    on more than one bond issue, with the claims of
    one set of bondholders subordinate to the claims
    of a second set of bondholders
  • Senior debt nomenclature for the second
    set of bondholders

33
Equipment Trust Certificates
  • Certificates used to purchase an asset and lease
    to a lessee
  • Lessee payments used to pay off certificates, at
    which point title and ownership of asset
    transfers to the lessee

34
Coupon Rates of Bonds
  • Zero-coupon bonds
  • Original-issue discount bonds
  • Split coupon bonds
  • Floating-rate notes, Adjustable rate securities,
    Reset bonds
  • Calls and Collars
  • Step-up notes
  • Income bonds

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

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

37
Corporate Bankruptcy
  • An issuer is in technical default whenever any of
    the indenture provisions are violated
  • Filing for Bankruptcy
  • Chapter XI reorganization
  • Chapter VII liquidation assets distributed
  • according to absolute-priority-of-claims
    principle

38
Collateral Status
  • Senior
  • Must be paid first with proceeds from property
    pledged as collateral
  • Become general creditors for the balance
  • May receive Sub Debs or pref. stock
  • Junior
  • Cant be paid till seniors paid in full
  • May receive common stock or warrants

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

40
Mortgage Loans
  • FNMA purchases mortgages from original mortgage
    lenders with the proceeds of its own debt
    security sales
  • GNMA bundles packages of similar mortgages
  • FHLMC purchases conventional mortgages, pools
    them, and sells participations
  • Can be FHA insured and VA guaranteed

41
Mortgage-Backed Securities
  • Cash flow is dependent on the cash flows of an
    underlying pool of mortgages
  • Mortgage Pass-Throughs
  • Collateralized Mortgage Obligations
  • Stripped Mortgage-Backed Securities

42
Domestic, Foreign and Euro Bonds
  • Foreign bonds are issued and traded within a
    country, in local currency, by borrower located
    in a different country
  • Yankee bonds is denominated in U.S. dollars
    and issued in the United States by foreign banks
    and corporations
  • Eurobonds
  • Underwritten by an international syndicate
    and traded in multiple domestic markets
  • Euro refers to offshore, not that the bond is
    traded in Euros

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

44
Promissory Note
  • Formal loan agreement
  • Used if loan amount significant
  • Examples
  • Business issues to investor when borrowing money
  • Business issues to officers or key employees when
    lending money

45
Guaranteed Investment Contracts
  • Stable value contract
  • Available in 401(k) retirement plans,
    profit-sharing plans, IRAs, and mutual funds
  • Investment choice provided by plan sponsor, but
    contract between insurance company and employee
  • Specified maturity date and rate of return
    guaranteed through maturity by insurance company
  • Not insured

46
Annuities
  • Qualified Annuity is purchased through a tax
    sheltered program
  • Non-qualified annuity is purchased outside a
    tax-sheltered program
  • Accumulation value is the annuity value before
    any surrender charges have been deducted
  • Surrender value is the account value after
    surrender charges have been deducted

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

48
Payout Options
  • Straight life annuity
  • Life income with period certain annuity
  • Life with cash or installment refund annuity
  • Joint and survivor life annuity
  • Fixed period annuity
  • Fixed amount annuity
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