1、Chapter 22 Fixed-Income Securities,Fabozzi: Investment Management Graphics by,Learning Objectives,You will discover the different types of fixed-income securities. You will understand the fundamental features of bonds. You will learn about the different types of securities issued by the Treasury. Yo
2、u will be able to show how zero-coupon Treasury securities are created. You will study the provisions for paying off a corporate bond issue prior to the maturity date. You will investigate the different credit ratings for a corporate bond issue.,Learning Objectives,You will understand the two types
3、of municipal bonds: general obligation bonds and revenue bonds. You will be able to identify types of securities issued in the Eurobond market. You will discover the characteristics of preferred stock. You will study the cash flow characteristics of a mortgage loan and the meaning of prepayment risk
4、. You will explore the three types of mortgage-backed securities: mortgage pass-through securities, collateralized mortgage obligations, and stripped mortgage-backed securities. You will investigate the different types of asset-backed securities.,Introduction,In this chapter we turn to another major
5、 asset class, fixed-income securities. We will describe basic features and then discuss the variety of investment vehicles available in this asset group. This serves as an introduction to the rest of Section V.,Bond fundamentals,Some definitions Fixed income security issuer (borrower) agrees to make
6、 income payments fixed by contractBonds (debt obligations) borrower makes interest paymentsPreferred stock an equity issue with fixed income payments of dividends Term to maturity date when debt ceases, with maturity being that exact date and term denoting the number of years till that date Par valu
7、e (maturity value, face value) amount issuer agrees to pay at maturity Coupon periodic interest payment made to bondholders Coupon rate rate of interest usually paid semiannually for U.S. issues; multiplied by par value yields dollar value of coupon,Bond fundamentals,Zero-coupon bonds no periodic in
8、terest payments; principal and interest paid at term Floating rate security coupon rate is reset periodicallyInsert Table 22-1,U.S. Treasury securities,Bills matures in one year or less, issued at a discountNotes matures between 2-10 years, issued as a coupon securityBonds maturities longer than 10
9、yearsTreasury inflation protection securities (TIPS) principal is indexed to CPI- U with real rate being fixed,Quotation convention for Treasury bills,Quotes are in terms of yield, not price Yield on bank discount = Yd = D x 360F t Yd = annualized yield on a bank discount basis (expressed as a decim
10、al) D= dollar discount, which is equal to the difference between the face value and the price F= face value t= number of days remaining to maturity Example:T = 100, F = $100,000, Price = $97,569D = $100,000 97,569 = $ 2,431Yd = $2,431 x 360 = 8.75%$100,000 100,Price quotation convention for Treasury
11、 coupon securities,Notes and bonds trade on a dollar price basis in unites of 1/32 of 1% of par ($100). Example: Quote of 92-14 = 92 and 14/32; with a basis of $100,000 par value a change in price of 1% = $1000 with 1/32 = $31.25.,Stripped Treasury securities,Several major brokerages have created an
12、 investment vehicle from Treasury securities. They purchase these securities, deposit them in a bank custody account and then separate out each coupon payment and principal. Then a receipt is issued to investors representing an ownership in the account. In essence, the security is stripped. Trademar
13、k zero-coupon - Treasury securities refer to the firm they are associated with. Treasury receipts (TRs) generic receipts issued by a group of primary dealers in the government market representing ownership of a Treasury security,Stripped Treasury securities,STRIPS U.S. Treasury program issues these
14、direct obligations of the U.S. government, ending trademark and generic receipts Treasury strips - zero-coupons or stripped Treasury securities Treasury coupon strips created from the future coupon Treasury principal strips - created from the principal payment at maturity,Federal agency securities,T
15、here are two categories of federal agency securities:Government-sponsored enterprises securities market Federally related institutions securities markets,Federally related institutions securities,While a number of arms of the federal government are allowed to issue securities directly in the marketp
16、lace, only the Tennessee Valley Authority (TVA) has done so recently. These issues are backed by the full faith and credit of the U.S. government.,Government-sponsored enterprise securities,Federal Farm Credit Bank System Farm Credit Financial Assistance Corporation Federal Home Loan Bank Federal Ho
17、me Loan Mortgage Corporation Federal National Mortgage Association Student Loan Marketing Association Financing Corporation (FDIC) Resolution Trust Corporation Except for farm related securities, these are not backed by the U.S. government.,Corporate bonds,The issuer agrees to make coupon payments a
18、nd repay the principal value of the bond at maturity. If the institution cannot pay, it is in default. Bondholders have first claim to the income and assets of a corporation. Embedded option options are embedded in the bond issue Bare option trades separately from the underlying security Term bonds
19、(bullet) can be retired by payment at final maturity or paid off earlier if so stated in the bond indenture or contract Serial bonds specified principal amounts are due on specified dates Medium-term notes continuously offered to investors over a period of time,Security for bonds,Beyond the general
20、credit standing, real or personal property may be pledged. Insert Table 22-2,Provisions for paying off bonds,Call provision issuer can buy back all or part of the issue prior to maturity Various types Call and refund provisions Sinking-fund provision Convertible and exchangeable bonds Issues of debt
21、 with warrants Putable bonds Floating-rate securities Special features in high-yield bonds,Call and refund provisions,Call provision Issuers want to be able to take advantage of falling interest rates in the future (i.e. lower their debt costs) and call provisions are an embedded option for the issu
22、er. Corporate bonds are usually callable at a premium above par with the amount declining as the bond approaches maturity, often reaching par after a certain number of years have passed since issuance. Refunding Issuer cannot redeem bonds during first 5-10 years following issue unless the funds come
23、 from other than lower-interest cost money (cash flow, common stock sale proceeds).,Sinking-fund provision,Indenture requires issuer to retire a specified portion of an issue each year in order to reduce credit risk if only part is paid, remainder is a balloon maturitySinking fund can be satisfied b
24、y-Making a cash payment of the face amount of the bond to be retired to the corporate trustee who then calls bonds using a lottery system Delivering bonds to the trustee with a total face value = amount that must be retired from bonds purchased in the open market Embedded option issuer can accelerat
25、e repayment of principal,Convertible and exchangeable bonds,Convertible bonds Bondholder has the right to convert the bond to a predetermined amount of common stock of the issuerExchangeable bonds bondholder has the right to exchange the bonds for common stock of a firm other than issuer,Issues of d
26、ebt with warrants,Warrants may allow holder the-Right to purchase a designated security at a specified price-Right to purchase the common stock of the debt issuer or another firm-Right to purchase a debt obligation of the issuerWarrants can be sold separately from the bond,Putable bonds and floating
27、 rate securities,Putable bonds Bondholder can sell the issue back to the issuer at par value on designated dates If interest rates rise after bond is issued, which lowers the bond value, the bondholder can put the bond to the issuer for par Investor receives 1.Non-putable corporate bond and 2.Long p
28、ut option on the bond Floating-rate securities Coupon interest is reset periodically based on some contrived interest rate (i.e. spread over Treasury bill,Special features in high-yield bonds,High-yield or junk bonds have a rating below triple B. When used for an LBO or recapitalization, where cash
29、flow is severely restricted, deferred coupon structures are created.Deferred interest bonds sell at deep discount and do not pay interest for 3 7 years Step-up bonds low coupon rate for initial period and then increases to a higher rate for the remainder of the term Payment-in-kind (PIK) bonds issue
30、r can pay cash at a coupon date or give the bondholder a similar bond equal to the amount of the cash payment,Credit ratings,Insert Table 22-3Ratings apply to the issue, not the issuer and are an opinion as to the issuers ability to meet its obligations.,Municipal securities,These debt obligations a
31、re issued by state and local governments. Their structures are either serial maturity or term maturity. Serial maturity portion of the debt is retired each year Term maturity - debt is retired in maturities ranging from 20-40 years with sinking fund provisions beginning 5 10 years prior to maturity
32、Types of municipal securities General obligation bonds Revenue bonds Hybrid bonds,General obligation bonds,Many general obligation bonds are secured by the issuers unlimited taxing power. Limited-tax general obligation bonds - backed by taxes that are limited as to revenue sourceFull faith and credi
33、t obligations used by larger issuers who have access to taxes beyond property taxesDouble-barreled revenue source includes fees, grants, etc. as well as taxing power,Revenue bonds,These are bonds issued for project or enterprise financings where the revenues from the project are promised to the bond
34、holders. Examples include airports, universities, sports complex bonds and water revenue bonds.All revenues from the enterprise are placed in a revenue fund with disbursements to funds covering -operation and maintenance fund-sinking fund-debt service reserve fund-renewal and replacement fund-reserv
35、e maintenance fund-surplus fund,Hybrid bond securities,Insured bonds backed by insurance policies written commercially in addition to the credit of municipal issuerRefunded bonds (prerefunded bonds) originally issued as G.O. or revenue bonds but are now secured by an escrow fund consisting of U.S. g
36、overnment obligations,Eurobonds,A Eurobond is1.underwritten by an international syndicate2.offered, at issuance, simultaneously to investors in a number of countries3.issued outside the jurisdiction of any single country4.mostly traded in OTC marketEuro straights fixed-rate coupon bond with annual c
37、oupons Dual currency issues interest and principal are paid in different currencies Convertible Eurobond can be converted to another assetMany Eurobonds trade with attached warrants.,Preferred stock,Preferred stock is not a debt instrument, but a senior security with dividends set at a percentage of
38、 par value (dividend rate). -Dividends are a distribution of earnings. However, 70% of this income is exempt from federal taxation if the recipient is a qualified corporation. -Promised returns to holders of preferred are fixed-Preferred holders have priority over common stockholders for dividends a
39、nd liquidation distributions Cumulative preferred if issuer cannot make a payment, the dividend accrues until fully paid Non-cumulative preferred if issuer cannot make a payment, owner forgos the payment Perpetual preferred issues without a maturity date,Mortgages and mortgage-backed securities,Mort
40、gage market is the largest sector of the fixed-income market, and includes mortgage-backed securities such as-Mortgage pass-through securities-Collateralized mortgage obligations-Stripped mortgage-backed securities,Mortgages,A mortgage is a loan secured by the collateral of some specified real estat
41、e property which obliges the borrower to make a predetermined series of payments. The lender can foreclose on the borrower is the debt is paid. Interest rate = mortgage rateConventional mortgage loan is based on the credit of the borrower and the collateral for the mortgage (a residence).,Cash flow
42、characteristics of a mortgage loan,Level-payment mortgageBorrower pays interest and principal in equal installments over a set period (maturity/term of mortgage) Each monthly payment consists of1.Interest of 1/12th of the fixed annual mortgage rate times the amount of the outstanding mortgage balanc
43、e at the beginning of the previous month2.A repayment of a portion of the principal The portion of the monthly payment applied to the interest declines each month, while the payment towards principal increases. This describes a self-amortizing loan. Insert Table 22-4,Mortgage cash flow with servicin
44、g fee,Servicing responsibilities include Collecting monthly payments Forwarding proceeds to owners of the loan Sending payment notices to mortgagors Maintaining records of principal balances Maintaining escrow accounts for property taxes and insurance Initiating foreclosure proceedings Cash flow fro
45、m loan goes to 1.servicing fee 2.interest payment net of servicing fee 3.scheduled principal repayment,Prepayments and cash flow uncertainty,Loan holders can, and do, pay off mortgages early by making prepayments (payments scheduled payments) making cash flow uncertain. This occurs when-Homes are so
46、ld-If market rates fall, there is incentive to pay off the higher mortgage loan. -Repossessed property-Destroyed property: insurance pay off the mortgage,Mortgage pass-through securities,A pass-through is created when mortgage holders form a collection or pool of mortgages and sell shares in the poo
47、l. This securitization causes payments to be made to shareholders each month. pass-through coupon rate pools mortgage rate = servicing fees Due to cash flow uncertainty, the prepayment speed is variable. Insert Figure 22-1 Insert Figure 22-2,Types of pass-throughs,Agency pass-throughs-Government Nat
48、ional Mortgage Association (Ginnie Mae)-Federally related institution, so is based on full faith and credit of U.S. government-Federal Home Loan Mortgage Corporation (Freddie Mac)-Federal National Mortgage Association (Fannie Mae) Agency can guarantee two ways:-Fully modified - timely payment of bot
49、h interest and principal -Modified - timely payment of interest only, with principal payment simply guaranteed Non-agency pass throughs-Conventional pass throughs -Private-label pass-throughs,Collateralized mortgage obligations (CMO),CMO - a security backed by a pool of pass-throughs Several classes of bondholders (tranches) with varying maturities Principal payments from the underlying are used to retire bonds Set rules for prioritizing the distribution of principal payments among tranches Prepayment risk is distributed among the tranches, lowering cash flow uncertaintyInsert Figure 22-3,
