Types of Debt Securities Chapter 7

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Types of Debt

• Topic 7

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I. Short and Long-Term Federal Government
Securities

• A. Treasury Bills Short
• B. CDs Short
• C. Treasury Notes Medium
• D. Treasury Bonds Long
• E. US Savings Bonds Long

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II. Short and Long-Term Corporate Securities

• A. Negotiable CDs Short
• B. Bankers Acceptances Short
• C. B Commercial Paper Short
• D. Eurodollar Loans Short
• E. Mortgage Bonds Long
• F. Collateral Trust Bonds Long
• G. Debenture Bonds Long
• H. Subordinated Debentures Long
• I. Convertible Debentures Medium

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III. Long-Term State and Local Government
Securities

• A. General Obligation Bonds Long
• Largest category of municipal bonds
• Secured by the full faith, credit, and taxing
  power of the issuing municipality
• Payable from unlimited ad valorem taxes on all
  taxable property
• B. Limited Obligation Bonds Long
• Principal and interest are payable solely from
  the revenues produced by the project they are
  intended to finance

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Note and Bond Quotation

• Date Coupon Bid Ask Change YTM
• 2/10 6 3/4 65.17 66.17 -.3 12.50
• of par can be 1,000, 5000, 10,000, 20,000,
  50,000, 100,000, 1,000,000
• Therefore 65.17 1,000 651.70
• The current yield is defined as interest s
  divided by the cost of the bond (Ask).

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IV. The Determinants of Bond Quality Ratings

• A. Earnings can be
• 1. Stable (Paper Industry)
• 2. Seasonal (Farming Industry)
• 3. Cyclical (Housing)
• 4. Erratic (A firm with a few large customers)

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Riskiness of Bond Issuers Earnings

• (EBIT)TIE Income for Bond
  Servicing Total Interest Payments
• The TIE ratio measures the ability to cover
  the fixed annual interest
• payments.

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IV. The Determinants of Bond Quality Ratings

• 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 (Sweetener)

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V. Debt Securities Yield and Return

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

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The Federal Reserve

• 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 often a follower than a leader.
• 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.

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Bonds General Information

• 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 generally are considered to be
  the safest but that also is beginning to change
  with mounting debt.

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Bonds Short-Term Strategy

• Investors may be able to improve their overall
  yield by shifting their funds among fixed-income
  investments.
• The yield spread or difference between yields on
  different securities, is the key to flexible
  portfolio management.
• 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.

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Review Questions Topic 7

• Why are T-Bills considered risk free?
• What is the difference between a collateral trust
  bond and a mortgage bond?
• The two major types of State and Local government
  bonds include
• A quotation of 87.16 would suggest a price of how
  much?
• What is the difference between current yield and
  YTM?
• What is the yield spread on debt securities?