Types of Debt Securities Topic 7

I. Short and Long-Term Federal Government Securities u A. Treasury BillsShort u B. CD’sShort u C. Treasury NotesMedium u D. Treasury BondsLong u E. US Savings BondsLong

II. Short and Long-Term Corporate Securities u A. Negotiable CD’sShort u B. Bankers’ AcceptancesShort u C. B Commercial PaperShort u D. Eurodollar LoansShort u E. Mortgage BondsLong u F. Collateral Trust Bonds Long u G. Debenture BondsLong u H. Subordinated DebenturesLong u I. Convertible DebenturesMedium

III. Long-Term State and Local Government Securities u A. General Obligation Bonds Long –The largest category of municipal bonds. They are secured by the full faith, credit, and taxing power of the issuing municipality. Payable from unlimited ad valorem taxes on all taxable property. u B. Limited Obligation Bonds Long –The principal and interest on these bonds are payable solely from the revenues produced by the project they are intended to finance.

Note and Bond Quotation u Date Coupon Bid Ask ChangeYTM u 2/10 6 3/ u % of par can be 1000, 5000, 10,000, 20,000, 50,000, 100,000, 1,000,000 u Therefore: * $1000 = $ u The current yield is defined as interest $’s divided by the cost of the bond (Ask).

IV. The Determinants of Bond Quality Ratings u A. Earnings can be: –1. Stable (Paper Industry) –2. Seasonal (Farming Industry) –3. Cyclical (Housing) –4. Erratic (A firm with a few large customers)

Riskiness of Bond Issuer’s Earnings (EBIT) TIE =Income for Bond Servicing Total Interest Payments (EBIT) TIE =Income for Bond Servicing Total Interest Payments The TIE ratio measures the ability to “cover” the fixed annual interest The TIE ratio measures the ability to “cover” the fixed annual interest payments payments

IV. The Determinants of Bond Quality Ratings u B. Protective Legal Provisions in the Indenture –1. Subordination –2. Call Provision –3. Sinking Fund Provision –4. Serial Bonds –5. Restrictions on Future Issues –6. Collateral –7. Convertibility (Sweetner)

V. Debt Securities Yield and Return u A. Four ways to measure investment performance –1. Coupon Rate - this is a stated rate and does not measure performance per se. not measure performance per se. –2. Holding Period Return –3. Current Yield –4. Yield to Maturity

The Federal Reserve u Federal Reserve Policies: Most monetary analysts agree that the Fed has no control over long-term interest rates. Some believe the Fed controls or strongly influences short rates through its hammer-lock control of the rate on Federal funds. But we are increasingly finding that the Fed is more ofter a follower than a leader. u Interest Rate Spreads: Interest rate spreads offer investors vital information about the course of the economy and financial markets and the trend direction in interest rates. Until early summer, spreads like the differential between the long T-bond and the Fed funds rate were opening up enough to cause concern about the Fed change in course to higher short rates. In recent weeks, most of the spreads have narrowed, thus lessening the chances of a run-up in short rates.

Bonds: General Information u What you should know about a bond: All bonds are not created equal. The ability of the issuer of a bond to meet its obligations vary. Bonds issued or guaranteed by the United States government gernerally are considered to be the safest but that also is beginning to change with mounting debt.

Bonds: Short-Term Strategy u Investors may be able to improve their overall yield by shifting their funds among fixed-income investments. u The yield spread or difference between yields on different securities, is the key to flexible portfolio management. u As a general rule, maturities should be lengthened when interest rates are expected to decline and should be shortened when interest rates are expected to rise.

Review Questions: Topic 7 u Why are T-Bills considered risk free? u What is the difference between a collateral trust bond and a mortgage bond? u The two major types of State and Local government bonds include: u A quotation of would suggest a price of how much? u What is the difference between current yield and YTM? u What is the yield spread on debt securities?