Finance 301 1st Edition Lecture 10 Outline of Last Lecture I Money Market Securities II Treasury Bills III Yield on T Bill IV T Bill Discount V Commercial Paper VI Negotiable Certificates of Deposit VII Repurchase Agreements VIII Federal Funds IX Bankers Acceptance X Risk XI Globalization of money markets Current Lecture I Background on bonds II Bond Yields III Treasury and Federal Agency Bonds IV Municipal bonds Outline of Current Lecture XII Background on bonds a What is a bond What are the differing types b Debt security for government corop federal agency Investment in a debt treasury municipal federal agency bonds mortgage bonds corporate bonds bigger investment thatn stock market c We often use the term par value Why is this important to bonds d Value paid at maturity on a bond It is the value if you buy the bond at origination which means when it is issued e Do not always pay par value you buy it based on interest rates f What you will get paid at maturity g What are the interest payments called How often do investors get paid interest payments h semianually twice a year They are called coupon payments i Can be issued as bearer bonds or registered bonds j Bearer bonds went to a corp and they gave stack of coupoms had to go back to company with coupns to get paid k Registered bonds 1982 company now registers you electronically instead of you carrying around the couponds l XIII Bond Yields a Yield from the Issuer s Perspective i Commonly measured by the yield to maturity What is this ii If corporation tells you 10 percent that is their yield on the bond iii Bonds value change based on interest rates iv Buyer yield coupon appreciation or depreciation v Issuer yield yield b Yield from the Investor s Perspective i Holding period return is used by bond investors who do not hold the bond until maturity ii Yield consists of two components c XIV Treasury and Federal Agency Bonds a The U S Treasury issues Treasury notes and Treasury bonds to finance federal government expenditures b What is the difference between Treasury bills notes and bonds Bills are 1 year or less notes are 1 10 years bonds are greater than 10 years c Note These are also different in how they are paid How so Treasury bonds and treasury notes you have a par value you can buy it at and a par value for mature Treasury bills are 0 coupon bonds d Interest is taxed by the federal government as ordinary income but it is exempt from any state and local taxes e Treasury bond auctions i Normally held in the middle of each quarter ii Financial institutions submit bids for their own accounts or for their clients iii Bids are submitted on a competitive or a noncompetitive basis iv Competitive bids compete for the interest rate v Noncompetitive bids could be up to 5 million dollars take interest rate that is given f Trading Treasury bonds i Bond dealers serve as intermediaries in the secondary market by matching up buyers and sellers of Treasury bonds ii Treasury bonds are registered at the New York Stock Exchange but the secondary market trading occurs over the counter iii Online Trading Investors can also buy bonds through the Treasury Direct program www treasurydirect gov iv Online Quotations Treasury bond prices are accessible online at www investinginbonds com g Stripped Treasury bonds i The cash flows of bonds are commonly transformed stripped by securities firms to create P O and I O STRIPS What are these ii An investment where the treasury is divided into 2 strips iii I O strip is the coupon payments iv P o principal v Are these sold by the U S Treasury h Inflation indexed Treasury bonds i Commonly referred to as TIPS Treasury Inflation Protected Securities ii How does their value change iii Paid based on inflation pay more if there is inflation or not iv Protects their currency power v Start at interest rates so low that you don t really make any money i 4 types of savings bonds i EE 30 year savings bond 25 dollars to 10 thousand dollars ii HH 20 year savings bond iii I inflation invest savings bond iv Patriot EE bond that if you gave money for this it went against terrorism used for military spending v Fed keeping interest rates so low vi Technology people buy stocks instead of getting their kids savings bonds a Lowest demonation j Federal Agency bonds i Issued by federal agencies such as the Federal National Mortgage Association Fannie Mae FNMA and the Federal Home Loan Mortgage Association Freddie Mac FHLMC k Get money based off mortgage and interest l Freddie mae use money they borrow to buy mortgages and then they issue bonds based on this m Federal agency bonds MBB mortgage backed bond paid semiannually higher interest rates because they are riskier n They went broke because so many homes foreclosed o XV Municipal bonds a County and state governments b General obligationsc Revenued Difference is that general obligations are bonds that get paid back through taxes e Revenue municipal bonds based on money is paid back by the item that the bond creates toll roads you pay 25 cents to go through your paying for the road that they built f Call provision saves them money g Credit Risk of Municipal Bonds i Ratings of Municipal Bonds ii Who are these agencies again SEP MOODYS FITCH h Impact of the Credit Crisis on Municipal Bond Risk i During weak economic conditions some state and local governments with large budget deficits may not be able to sell i j additional bonds even when offering a higher yield if investors are concerned that the governments may default on their debt Insurance against Credit Risk of Municipal Bonds i Some municipal bonds are insured to protect against default Yields Offered on Municipal Bonds Exhibit 7 3 i We said interest rates are structured to include a risk premium This premium often consists of default risk liquidity risk term risk and differing tax status Do municipal bonds have these risks Different don t have to pay taxes on income from municipal bonds preferred tax status lower tax rate to investors k Tax Advantages of Municipal Bonds i How are these different from the previous bonds noted ii The income earned from a municipal bond is exempt from federal taxes allowing municipal bonds to offer a lower before tax yield than Treasury bonds