Conduct and Practices Handbook Course (CPH) Quiz 40

The bond is a debt security, under which the issuer owes the holders a debt and (depending on the terms of the bond) is obliged to pay them interest (the coupon) or to repay the principal at a later date, termed the maturity date.

Many bonds are rated by bond rating companies. The three best known are Moody’s, Standard &Poor’s, and Fitch. These companies assign ratings to bonds based on their evaluation of the creditworthiness of the bond issuer.

Any particular bond always has a particular maturity date, but bond issuers can attempt to strategically issue bonds of different durations for the sake of financing their own activities. Term bonds are bonds of the same issuance which have the same maturity date.

In arbitrage pricing theory, the required returns are functioned of two factors which have dividend policy and historical policy.

Limited-tax general obligation (LTGO) bonds repay the bondholders solely through taxation (as all general obligations do), but contains provisions limiting how much the municipality can increase taxes to repay the bonds.

A certificate of participation (COP) grants an investor the right to some lease revenues for a facility that is constructed through a municipal bond issuance. Rather than entitling the investor to the rights of the bondholder, a COP participates in the ownership of the facility and the municipality
leases it until all the lease payments are made. COPs provide investors with a solid backup plan if the municipality defaults, for they then can sell or utilize the facility as they see fit.

Zero-coupon bonds don’t pay interest. Instead, their price is heavily discounted from face value. When the bond matures, bondholders receive the full face value, but they gain no interest in the meantime.

Open-end MICs are more commonly known as mutual funds.

Grant anticipation notes (GANs) are issued by municipalities who expect to repay the debts with grants from the federal government.

Treasury bills (T-bills) are short-term obligations issued by the United States Treasury Department of the federal government. Like zero-coupon bonds, Treasury bills don’t pay interest, but are sold at less than face value, and the buyer collects face value at maturity.

Separate Trading of Registered Interest and Principal Securities (STRIPS) Long-term notes and bonds divided into principal and interest-paying components, which may be transferred and sold in amounts as small as $1000.

Every six months, the interest rate paid on TIPS is adjusted to reflect changes in the Consumer Price Index (CPI). When inflation is rising, the interest payment paid on TIPS rises; if the CPI were to drop,interest payments would be lowered.

Yield to maturity is also called basis. If the bondholder bought the bond on the market, the yield to maturity (YTM) will depend on whether he bought the bond at a discount or at a premium

Yield to worst (YTW) is the lowest possible yield for a bond without the issuer defaulting. It is obtained by calculating the YTM and the YTC for all the call dates and selecting the lowest.

The calculation for discount yield assumes 30-day durations for months and 360-day durations for years. The discount yield of a bond is the return to a bondholder for short-term bonds and T-bills sold at a discount.

The main difference between the two is that Fannie generally purchases mortgages issued by banks whereas Freddie generally purchases mortgages issued by
thrifts (i.e. savings and loan associations). Fannie Mae (and thus called Fannie’s “little brother”).

Fannie generally purchases mortgages issued by banks, Fannie Mae is the Federal National Mortgage Association, or FNMA. It is a publicly-traded company aimed at increasing homeownership among Americans with low to middle incomes by expanding the secondary mortgage market.

Sallie Mae is the Student Loan Market Association or SLMA. It is a publicly-traded company that manages student loans, both by providing them and by buying them from other lenders.

Collateralized mortgage obligations (CMOs) are issued by private financial institutions. They are bundles of private mortgages, much like the pass-throughs that are put together by the various federal agencies. In a standard CMO, all tranches receive interest payments every month, but only one tranche at a time receives principal payments.

Mortgages are bundled by maturity dates into groups is called Tranches

One particular kind of CMO is the ‘mortgage pass through strip.’ It has just two classes of securities, known as the Interest- only & principle only. Their yield is higher than that of government securities, and payments are received monthly, instead of every six months.

Bond issuers will call bonds if the market interest rate is lower than the bond rate, so that they can refinance their bonds to pay less interest.

Secured bonds are bonds backed by some collateral, such that if the issuer defaults, the bond investor has claims on the collateralized asset.

The conversion ratio gives the number of shares a convertible bond may be converted into. It is calculated by the following formula:
Conversion ratio = (par value of bond) / (conversion price of stock)

Special tax bonds are municipal bonds where bondholders are repaid through a particular tax levied specifically for their repayment. Generally, this tax will be related to the project which the bonds have funded.

The tax-equivalent yield is the yield that a taxable bond needs to have before taxes in order to
achieve the same return as a nontaxable bond.
Tax-equivalent yield = (desired yield) / (1 – tax rate)

Under the Tax Reform Act of 1986, banks can’t deduct the carrying cost of holding municipal bonds in inventory; that is, they can’t deduct the interest expenses which are incurred to purchase or carry those bonds.

A professional experienced investment adviser uses his knowledge and skill for the investors’ benefit. Their investment dollars are automatically diversified, giving them the benefit of reduced risk and opportunities for gains in several areas.

Growth funds are only suitable for aggressive investors who are comfortable with a high degree of risk. Because growth funds invest in younger, less established companies that are growing fast, the risk with this type of fund is greater than that of investing in an index fund of established companies across the spectrum of the American economy.

Value funds are mutual funds which aim to hold stocks that have an undervalued price and tend to pay out dividends. Since the share prices are undervalued, they are expected to rise in time and give the fund investors capital gains.