Finance 301 1st Edition Lecture 10Outline of Last Lecture I. Money Market SecuritiesII. Treasury BillsIII. Yield on T-BillIV. T-Bill DiscountV. Commercial PaperVI. Negotiable Certificates of DepositVII. Repurchase AgreementsVIII. Federal FundsIX. Bankers AcceptanceX. RiskXI. Globalization of money marketsCurrent LectureI. Background on bonds II. Bond YieldsIII. Treasury and Federal Agency BondsIV. Municipal bondsOutline of Current LectureXII. 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 marketc. 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 issuede. Do not always pay par value you buy it based on interest ratesf. What you will get paid at maturityg. 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 Yieldsa. Yield from the Issuer’s Perspectivei. Commonly measured by the yield to maturity. What is this?ii. If corporation tells you 10 percent that is their yield on the bondiii. Bonds value change based on interest ratesiv. Buyer- yield= coupon + appreciation or depreciationv. Issuer- yield=yieldb. Yield from the Investor’s Perspectivei. Holding period return is used by bond investors who do not hold the bond until maturity.ii. Yield consists of two componentsc.XIV. Treasury and Federal Agency Bondsa. 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 yearsc. 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 parvalue for mature. Treasury bills are 0 coupon bondsd. Interest is taxed by the federal government as ordinary income, but it is exempt from any state and local taxes.e. Treasury bond auctionsi. 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 ratev. Noncompetitive bids- could be up to 5 million dollars, take interest rate that is givenf. Trading Treasury bondsi. 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 bondsi. 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 stripsiii. I/O strip is the coupon paymentsiv. P/o – principal v. Are these sold by the U.S. Treasury?h. Inflation-indexed Treasury bondsi. 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 notiv. Protects their currency powerv. Start at interest rates so low that you don’t really make any moneyi. 4 types of savings bondsi. EE- 30 year savings bond 25 dollars to 10 thousand dollars. ii. HH- 20 year savings bondiii. I- inflation invest savings bondiv. Patriot-EE bond that if you gave money for this it went against terrorism used for military spendingv. Fed keeping interest rates so lowvi. Technology, people buy stocks instead of getting their kids savings bondsa. Lowest demonationj. Federal Agency bondsi. 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 thism. Federal agency bonds- MBB mortgage backed bond- paid semiannually, higher interest rates because they are riskiern. They went broke because so many homes foreclosedo.XV. Municipal bondsa. County and state governmentsb. General obligations-c. Revenue-d. Difference is that general obligations are bonds that get paid back through taxese. 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 builtf. Call provision- saves them money g. Credit Risk of Municipal Bondsi. Ratings of Municipal Bondsii. Who are these agencies again? SEP, MOODYS , FITCHh. Impact of the Credit Crisis on Municipal Bond Riski. During weak economic conditions, some state and local governments with large budget deficits may not be able to selladditional bonds, even when offering a higher yield, if investors are concerned that the governments may default on their debt.i. Insurance against Credit Risk of Municipal Bonds i. Some municipal bonds are insured to protect against default.j. 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 investorsk. . Tax Advantages of Municipal Bondsi. 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