Another seminar based on the book "Figuring Out Wall Street. Bond Basics provides a quick overview of how corporate bonds are used for financing the needs of business.
Remembering my Totem _Unity is Strength_ growing in Bophuthatswana_Matthews B...
Bond Basics Seminar
1. The Beginning Investor Series.
Overview of Bonds
Covering Chapter Nine of Figuring Out Wall Street
Saunders Learning Group, LLC May 2012
2. Training from Saunders Learning Group
Saunders Learning Group provides a variety
of training programs, workshops and
seminars targeted to the financial services
industry.
Programs are available in a wide range of
topics, and we are specialists in developing
custom programs that are targeted to your
needs.
Contact the founder, Floyd Saunders at
316-680-6482 or at
floyd@floydsaunders.com for more
information.
Saunders Learning Group, LLC, Andover, KS
2
3. All About Figuring Out Wall Street ...
Everything has changed in the
financial services industry and it
affects your financial well-being.
From bank failures, to record
unemployment, home foreclosures
and panic around the world, Figuring
Out Wall Street, is the concise guide
to help everyone from first time
investors to veterans of banking
understand what to do to persevere
and restore our faith in our financial
systems.
Published by Saunders Learning Group.
Training for financial professionals and consumers. If your interest is financial turn to
Saunders Learning Group for your training needs.
Contact information: email: floyd@floydsaunders.com mobile: 316-680-6482
Saunders Learning Group, LLC, Andover, KS 3
4. What is a Bond?
In finance, a bond is a debt security, in which the authorized
issuer owes the holders a debt and, depending on the terms of
the bond, is obliged to pay interest (the coupon) and/or to
repay the principal at a later date, termed maturity. A bond is
a formal contract to repay borrowed money with interest at
fixed intervals.
“Gentlemen prefer bonds. “
– Andrew Mellon
Saunders Learning Group, LLC, Andover, KS
5. Introduction
This presentation is designed to
give participants information that
will enhance their understanding
of bonds, how they are issued,
how to invest in them and how
they are redeemed.
Saunders Learning Group, LLC, Andover, KS
6. What is a Bond?
In financial terms a bond is a debt
security, in which the authorized
issuer owes the holders a debt and,
depending on the terms of the bond,
is obliged to pay interest (the
coupon) and/or to repay the
principal at a later date, termed
maturity.
A bond is a formal contract to repay
borrowed money with interest at
fixed intervals.
Saunders Learning Group, LLC, Andover, KS
7. Issuing bonds
Bonds are issued by public authorities, credit
institutions, companies and supranational
institutions in the primary markets.
The most common process of issuing bonds is
through underwriting.
In underwriting, one or more securities firms
or banks, forming a syndicate, buy an entire
issue of bonds from an issuer and re-sell them
to investors.
The security firm takes the risk of being
unable to sell on the issue to end investors.
Saunders Learning Group, LLC, Andover, KS
8. Features of bonds
Bonds have a number of
characteristics that play a
role in determining the
value of a bond.
Principal
Coupon
Price
Yield
maturity
credit quality
Saunders Learning Group, LLC, Andover, KS
9. Principal
The Principal is the amount of money the issuer will repay the
bondholder at the maturity of bond
Issuer Bondholder
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10. Coupon (The Interest Rate)
The coupon is the amount the bondholder
will receive as interest payments.
— It's called a "coupon" because sometimes there
are physical coupons on the bond that you tear off
and redeem for interest.
— Now records are more likely to be kept
electronically.
Most bonds pay interest every six months,
but it's possible for them to pay monthly,
quarterly or annually.
The coupon is expressed as a percentage of
the par value.
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11. Price
The price of the a bond
depends on four factors:
Market interest rates
Credit quality
Maturity
Supply & demand
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12. Price of a Bond Varies
Above par value
premium
Below par value
Par value
discount
Bond Bond
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13. Bond Yield
The yield of a bond is the rate of return received from
investing in the bond, is based on the price paid for the bond
and the coupon payment.
current yield=Annual coupon/ Price
Rate of return on investment
price Coupon payment
Saunders Learning Group, LLC,Andover, KS
15. Bond Maturity
The maturity date is the date in the future on which
the investor's principal will be repaid.
As long as all payments have been made, the issuer has no more obligation
to the bond holders after the maturity date.
The length of time until the maturity date is often referred to as the term or tenor
or maturity of a bond.
There are three groups of bond maturities:
— short term (bills): maturities up to one year
— medium term (notes): maturities between one and ten years
— long term (bonds): maturities greater than ten years
A bond that matures in one year is much more predictable and thus less risky
than a bond that matures in 20 years. Therefore, in general, the longer the time
to maturity, the higher the interest rate.
All things being equal, a longer term bond will fluctuate more than a shorter
term bond.
Saunders Learning Group, LLC, Andover, KS
16. Issuer Who is issuing a bond is important to review, as
the issuer's stability is your main assurance of
getting paid back.
For example, the U.S. government is far more
secure than any corporation.
Its default risk (the chance of the debt not being
paid back) is extremely small - so small that U.S.
government securities are known as risk-free
assets.
The general view is that a government will
always be able to bring in future revenue
through taxation.
A company, on the other hand, must continue to
make profits, which is far from guaranteed.
This added risk means corporale bonds must
offer a higher yield in order to entice investors -
this is the risk/return tradeoff in action.
Saunders Learning Group, LLC, Andover, KS
17. Credit quality
The credit rating of a bond is important to
investors as it:
Provides a standardized measures
of relative credit quality
Provides an impartial view of credit quality of
the issue
Allows the investor to compare
issues of similar credit quality
Saunders Learning Group, LLC, Andover, KS
18. credit rating
credit risk Moody's standard & Poor's Fitch IBCA
highest quality Aaa AAA AAA
highest quality (very strong) Aa AA AA
upper mediam grade(strong) A A A
medium grade Baa BBB BBB
lower mediam grade Ba BB BB
(some what speculative)
lower grade (speculative) B B B
poor quality (may default) Caa CCC CCC
most speculative Ca CC CC
no interest in being paid or C C C
bankruptcy petition filed
in default C D D
Saunders Learning Group, LLC,Andover, KS
19. Types of bonds
Fixed rate bonds have a coupon that remains
constant throughout the life of the bond.
Floating rate notes (FRNs) have a variable
coupon that is linked to a reference rate of
interest, such as
LIBOR or Euribor.
Inflation linked bonds. in which the principal
amount and the interest payments are
indexed to
inflation. The interest rate is normally lower
than for fixed rate bonds with a comparable
maturity.
Asset-backed securities are bonds whose
interest and principal payments are backed
by underlying cash flows from other assets.
Saunders Learning Group, LLC, Andover, KS
20. Types of bonds
Subordinated bonds are those that have a lower priority than other bonds of
the issuer in case of liquidation.
Perpetual bonds are also often called perpetuities or Perps'. They have no
maturity date.
Bearer bond is an official certificate issued without a named holder. In other
words, the person who
has the paper certificate can claim the value of the bond. Often they are
registered by a number to
prevent counterfeiting, but may be traded like cash. Bearer bonds are very
risky because they can be
lost or stolen.
War bond is a bond issued by a country to fund a war.
Saunders Learning Group, LLC, Andover, KS
21. How To Read A Bond Table
Column 1: Issuer - This is the company, state (or
province) or country that is issuing the bond.
Column 2: Coupon - The coupon refers to the fixed
interest rate that the issuer pays to the lender.
Column 3: Maturity Date - This is the date on
which the borrower will repay the investors their
principal. Typically, only the last two digits of the
year are quoted: 25 means 2025, 04 is 2004, etc.
Column 4: Bid Price - This is the price someone is
willing to pay for the bond. It is quoted in relation
to 100, no matter what the par value is. Think of
the bid price as a percentage: a bond with a bid of
93 is trading at 93% of its par value.
Column 5: Yield - The yield indicates annual return
until the bond matures. Usually, this is the yield to
maturity, not current yield.
Saunders Learning Group, LLC, Andover, KS
22. Bond Issuing & Investing
Corporations issue bonds to provide for a number of financing needs. Some of
this financing could be in the form of:
commercial paper (normally issued for less than 30 days) and used to fund
things like accounts payable, payrolls etc.
Short-term bonds (less than a year) used to fund capital requirements and
provide additional cash flow
Long-term bonds (more than a year) used to fund capital expenses like
new buildings and equipment.
Sovereign govt. issue bonds to cover a shortfall between taxation revenue and
expenditure
Govt. agencies, municipal, & local govt. authorities issue bonds to fund their
service and operations
Saunders Learning Group, LLC, Andover, KS
23. Bond Markets
Primary market –
New bonds
Issuer Investor
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24. Secondary Market
bonds bonds
Sells Buys
Investor A Broker Investor B
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25. Investment Banks
(commonly called the Underwriter)
Role of the Underwriter
To purchase the district’s bonds directly from the district and re-offer (sell)
them to investors.
Types of Bond Sales
Negotiated sale - District hires an investment banking firm (or firms) to underwrite
its bonds at a negotiated price. The financing structure is determined in
accordance with the district’s specific needs or requirements relative to I&S tax
rate preferences and/or refunding objectives.
Size of negotiated underwriting team
With exception of financings under $10, most issuers will hire a team of
from 2 to 6 investment banking firms (depending on the size of the issue).
Selection process
Recommendation
Request For Proposals
Request For Qualifications
Saunders Learning Group, LLC, Andover, KS
26. Investment Banking Specialist
Investment banking firm specialists involved in the underwriting process
The “banker” – called an investment banker, this specialist is part of
the investment banking team.
“Bankers” generally have broad knowledge of the capital markets, debt instruments,
debt structuring, document preparation, and marketing/distribution procedures.
One of their responsibilities is to solicit potential issuers with the goal of being
included as a member of the issuer’s underwriting team.
Once their firm is hired they serve as the key contact/liaison person and coordinate
with all parties to the financing to execute the underwriting.
The “underwriter” – an investment banking firm’s specialist who is
directly responsible for pricing a district’s bond issue; i.e.,
determining the lowest possible combination of coupons and yields
that will “sell” in the marketplace at the time of pricing.
The “sales representatives” – the persons who actually contact
potential investors and sell the district’s bonds to those investors.
Saunders Learning Group, LLC, Andover, KS
27. Steps in the Negotiated Underwriting Process
1. Structuring - the lead investment banking firm (senior managing
underwriter) is usually involved in the initial structuring and/or
determining the plan of finance.
2. Hiring of underwriter’s counsel - the senior managing underwriter, the
financial advisor and the issuer will jointly agree on a firm via
consultation among themselves.
3. Documentation process.
4. Net Designations or Group Net
5. Pre-sale marketing activities by salesforce.
6. Pre-sale pricing calls among the underwriters, the FA and the issuer.
7. Order period - usually 2 hours during which the bonds are sold.
8. Sign bond purchase agreement - the district and the senior managing
underwriter.
Saunders Learning Group, LLC, Andover, KS
28. Conclusion
Bonds are just like lOUs. Buying a bond means you are lending out your money.
Bonds are also called fixed-income securities because the cash flow from them is
fixed.
The issuers of bonds are governments and corporations.
A bond is characterized by its face value, coupon rate, maturity and issuer.
Yield is the rate of return you get on a bond.
When price goes up, yield goes down, and vice versa.
When interest rates rise, the price of bonds in the market falls, and vice versa.
Bills, notes and bonds are all fixed-income securities classified by maturity.
Government bonds are the safest bonds, followed by municipal bonds, and then
corporate bonds.
Bonds are not risk free. It's always possible - especially in the case of corporate
bonds - for the borrower to default on the debt payments.
Saunders Learning Group, LLC, Andover, KS
29. How Bond MARKETS WORK
Saunders Learning Group, LLC, Andover, KS subtitle date 29
30. BOND MARKET PLAYERS
Bond: promise to pay back principal at some future date, plus periodic
interest payments for use of investor’s money
Bond issuers: entities that supply new bonds
Bond investors: individuals and institutions that purchase bonds for
interest income and long-term capital gains
Bond dealers: intermediaries between bond issuers and investors
Primary bond market: new bonds only; issuer-to-investor
Secondary bond market: previously issued bonds; investor-to-investor
Saunders Learning Group, LLC, Andover, KS
31. U.S. Bond Market
Market value = $36 trillion
BOND MARKET RELATIVE TO STOCK
MARKET
Average Daily Trading Volume
U.S. Bond Markets = $814.0 Billion
Stock Market = $104.9 Billion
One of largest securities markets in
world
Quickly reflects changes in credit quality and in aggregate economic
conditions, including interest rates
Very efficient market mechanism
Expensive place to trade for small investors
Saunders Learning Group, LLC, Andover, KS
32. Tracking Interest Rates
Federal Funds Rate: overnight bank
lending rate; lowest but most volatile
money market rate
Discount Rate: interest rate charged by the Federal Reserve to
its member banks; key instrument of monetary policy
Eurodollar Rate: interest rate charged for dollar-denominated
loans in European banks
LIBOR: London Interbank Offered Rates; London fed funds rate
Saunders Learning Group, LLC, Andover, KS
33. Bond Trading Activity
Largely an OTC market—no primary physical location
Low trading volume relative to stocks
Par value: face amount, usually $1,000
Round lot: $1 million of par value
Relatively illiquid for small investors
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34. Bond Ownership
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35. Conventions
Debt securities – Issued by borrowers to obtain liquidity or capital for
their short term or long term needs
Promised payment events – Interest payment & Repayment of fixed
amount
Secured & Unsecured
Risk prone – Not absolute risk free
Mid 2009 Debt market valued at $30 Trillion
Saunders Learning Group, LLC, Andover, KS 35
37. Types of bonds
Fixed rate bonds have a coupon that remains
constant throughout the life of the bond.
Floating rate notes (FRNs) have a variable
coupon that is linked to a reference rate of
interest, such as
LIBOR or Euribor.
Inflation linked bonds. in which the principal
amount and the interest payments are
indexed to
inflation. The interest rate is normally lower
than for fixed rate bonds with a comparable
maturity.
Asset-backed securities are bonds whose
interest and principal payments are backed
by underlying cash flows from other assets.
Saunders Learning Group, LLC, Andover, KS
38. Types of bonds
Subordinated bonds are those that have a lower priority than other bonds of
the issuer in case of liquidation.
Perpetual bonds are also often called perpetuities or Perps'. They have no
maturity date.
Bearer bond is an official certificate issued without a named holder. In other
words, the person who
has the paper certificate can claim the value of the bond. Often they are
registered by a number to
prevent counterfeiting, but may be traded like cash. Bearer bonds are very
risky because they can be
lost or stolen.
War bond is a bond issued by a country to fund a war.
Saunders Learning Group, LLC, Andover, KS
39. Types Of Bonds
Callable Bonds - A bond that can be redeemed by
the issuer prior to its maturity.
main cause of a call is a decline in interest rates
Convertible Bonds – A bond that can be converted
into a predetermined amount of the company's
equity at certain times during its life
Eurodollar Bonds - U.S.-dollar denominated bond
issued by an overseas company and held in a
foreign institution outside both the U.S. and the
issuer's home nation
Chinese bank held dollar-denominated bonds issued by a
Japanese company, this would be considered a eurodollar
bond.
Saunders Learning Group, LLC, Andover, KS
40. Types Of Bonds
Eurobond is an international bond that is denominated in a currency
not native to the country where it is issued
Yankee Bond - A bond denominated in U.S. dollars that is publicly
issued in the U.S. by foreign banks and corporations
Bulldog Bond - A sterling denominated bond that is issued in London
by a company that is not British
Saunders Learning Group, LLC, Andover, KS
41. Types Of Bonds
Maple Bond - A bond denominated in Canadian dollars that is sold in
Canada by foreign financial institutions
Matilda/Kangaroo Bond - An bond denominated in the Australian
dollar and issued on the Australian market by a foreign entity
Samurai Bond - Yen-denominated bond issued in Tokyo by a non-
Japanese company
Saunders Learning Group, LLC, Andover, KS
42. CORPORATE BONDS
Uses of Corporate Debt
Corporations must raise money to finance investments:
—inventory,
—plant and equipment,
—research and development,
—general business expansion.
Corporations can issue equity securities (stocks), debt securities
(bonds), or a combination of both
Firms wish to minimize their cost of capital.
Firms match their financing requirements with investor needs to issue a
wide variety of debt instruments.
Most corporate bonds bought by underwriters--no certificate issued,
just book-entry form
Saunders Learning Group, LLC, Andover, KS
43. Corporate Bond Characteristics
Indenture: legal terms of bond agreement
— trustee duties
— how and when principal repaid
— interest rate and when paid
— collateral/security
— callability terms
— steps bondholder can take in case of default
Bearer/coupon bonds vs. registered bonds
Saunders Learning Group, LLC, Andover, KS
45. Fixed Income Products
Treasury Bills – Maturities with 6,12 & 18 months duration
Issued by the Treasury of the state
Always issued at discount
Government Bonds - Medium & long term bonds – known as bonos
& obligaciones
Maturities of 10, 15 & 30 Years
Fixed Interest rate through annual coupons
Saunders Learning Group, LLC, Andover, KS
46. U.S. Government Issues
Primary Dealers overnment-Sponsored Enterprises
T-Bills ools
T-Notes ortgage Securities /Securitization
T-Bonds NMA
annie Mae
Saunders Learning Group, LLC, Andover, KS
47. Federal Sources of Funds
Collect tax revenues
Print more money
Issue public debt
—Treasury Bills: short term, less than 1 year
—Treasury Notes: 1-10 year maturities
—Treasury Bonds: long term; 10-30 year maturities
Saunders Learning Group, LLC, Andover, KS
48. U.S. TREASURY SECURITIES
Implement monetary policy—Federal Reserve System
trades through its New York branch.
—Increase money supply: buys Treasuries
—Decrease money supply: sells Treasuries
Efficient means to finance federal deficit
Treasury issues bonds, notes, bills through regularly
scheduled public auctions to primary dealers
—Dealers obligated to bid at every auction
—Must maintain bids, offers and inventories for secondary
market
Saunders Learning Group, LLC, Andover, KS
49. U.S. Treasury Securities Secondary (Capital) Market
Safest bonds in circulation
Enormous trading volume: $190.7 billion per day; most
liquid market in world
T-bills:
—mature in less than one year, usually 3 and 6 months
—face values of $10,000 to $1 million
—do not pay interest; traded at discount from par
T-notes:
—maturities 1-10 yrs
—semiannual interest
—face values of $5,000 to $1 million
T-bonds: 10 to 30 yr. maturities
Saunders Learning Group, LLC, Andover, KS
50. Agency & Asset-Backed Securities
Markets
Government-sponsored enterprises: private corporations with
public purposes
Pools: diversified loan portfolios
Mortgage securitization: creating pools of mortgages and
selling shares of pools;
—Ginnie Maes, Fannie Maes, Freddie Macs
—Active secondary market provides liquidity
—Pay low semiannual interest
Other asset-backed securities:
—credit card debt, auto loans, home equity loans, equipment
leases
Repo market: dealers lend securities short term
Saunders Learning Group, LLC, Andover, KS
51. JUST WHAT IS THE MONEY MARKET?
Buying and selling short-term debt securities; quick cash conversion
Safety: short maturities and diversification
Include Private Paper:
—Commercial paper
—Bankers’ acceptances (Bas)
—Jumbo CDs
State & Local Governments: Project Notes
—tax anticipation notes
—bond anticipation notes
—revenue anticipation notes
Saunders Learning Group, LLC, Andover, KS
52. Municipality-Issued Securities
Municipal Bonds Revenue Bonds
—Bonds anticipating future cash
Industrial Revenue Bonds
Tax-Anticipation Notes
Bond-anticipation Notes Backed by Good Name of
Revenue-Anticipation Notes Municipality
—Moral Obligation Bonds
Clientele Effect
—General Obligation (GO) Bonds
—High tax bracket investors
Double-Barreled Bonds
Limited Tax Bonds
—Backed by 2+ sources of funds
—Payable from cash generated by
specific tax
Saunders Learning Group, LLC, Andover, KS
53. Fixed Income Products
Repo – Repurchase
Agreements (Not
necessarily FI product)
Is a contract in which a
security is sold with an
agreement to
repurchase the security
at a higher price
Saunders Learning Group, LLC, Andover, KS 53
54. Fixed Income Products
Repo
Reverse Repo is a
contract in which a
security is borrowed with
an agreement to
replace the security at a
higher price
Secured lending and
borrowing
Saunders Learning Group, LLC, Andover, KS
55. Fixed Income Products
Commercial Paper – Zero Coupon bonds issued at discount
Short term with maturities 1,3,6,12 & 18 months
Placed in the primary market through competitive auctions
Convertible/Exchangeable Bonds
Enables a financial asset to be transformed into other
Saunders Learning Group, LLC, Andover, KS
56. Fixed Income Products
Commercial Paper - An unsecured, short-term debt
instrument issued by a corporation, typically
for the financing of accounts receivable, inventories
and meeting short-term liabilities.
Maturities on commercial paper rarely range any
longer than 270 days
Certificate of deposit or CD is a time deposit, a
financial product commonly offered to consumers by
banks, thrift institutions, and credit unions
Held until maturity
Saunders Learning Group, LLC, Andover, KS
58. MBS
A mortgage-backed security (MBS) is an asset-backed security or
debt obligation that represents a claim on the cash flows from
mortgage loans, most commonly on residential property.
Residential mortgage-backed security (RMBS)
Commercial mortgage-backed security
Collateralized mortgage obligation
Stripped mortgage-backed securities
Interest-only stripped mortgage-backed securities
Principal-only stripped mortgage-backed securities
Saunders Learning Group, LLC, Andover, KS
59. Weapons Of Financial Destruction
Collateralized Debt Obligation Process Of Securitization
Saunders Learning Group, LLC, Andover, KS
60. Interest Rate Swap
Interest rate swap is a derivative in which one party exchanges a
stream of interest payments for another party's stream of cash flows
Fixed for floating/Vanilla Interest Rate Swaps
Often use LIBOR as reference rates
Hedging/Speculation on interest & FX rates
Saunders Learning Group, LLC, Andover, KS
62. Interest Rate Caps
An interest-rate cap is an OTC derivative in which the buyer
receives payments at the end of each period in which the interest
rate (reference rate/LIBOR) exceeds the agreed strike rate (Cap
rate)
3-year, USD 200MM notional cap
6-month Libor - index rate,
struck at 7.5%.
Protects from int. rate rises
Saunders Learning Group, LLC, Andover, KS
63. Interest Rate Floors
An interest rate floor is a derivative in which the buyer of the floor
receives money if on the maturity the reference rate fixed is below
the agreed strike price of the floor
Protects holder from declines in short-term interest
3-year, USD 200MM notional cap
6-month Libor - index rate,
struck at 7.5%.
Saunders Learning Group, LLC, Andover, KS
64. Swaps
A swapt is an option granting its owner the
right but not the obligation to enter into an
underlying swap
the term "swapt" typically refers to options
on interest rate swaps
A payer swap gives the owner of the
swaption the right to enter into a
swap where they pay the fixed leg
and receive the floating leg.
A receiver swap gives the owner of
the swaption the right to enter into a
swap where they will receive the
fixed leg, and pay the floating leg.
Saunders Learning Group, LLC, Andover, KS
65. Swaption
Designed to give the holder the benefit of the agreed-upon strike
rate if the market rates are higher
American swaption, in which the owner is allowed to
enter the swap on any day that falls within a range of two
dates.
European swaption, in which the owner is allowed to enter
the swap only on the maturity date.
Bermudan swaption, in which the owner is allowed to
enter the swap only on certain dates that fall within a
range of the start (roll) date and end date.
Saunders Learning Group, LLC, Andover, KS
66. Investment Banks
(commonly called the Underwriter)
Role of the Underwriter
To purchase the district’s bonds directly from the district and re-offer (sell)
them to investors.
Types of Bond Sales
Negotiated sale - District hires an investment banking firm (or firms) to underwrite
its bonds at a negotiated price. The financing structure is determined in
accordance with the district’s specific needs or requirements relative to I&S tax
rate preferences and/or refunding objectives.
Size of negotiated underwriting team
With exception of financings under $10, most issuers will hire a team of
from 2 to 6 investment banking firms (depending on the size of the issue).
Selection process
Recommendation
Request For Proposals
Request For Qualifications
Saunders Learning Group, LLC, Andover, KS
67. Investment Banking Specialist
Investment banking firm specialists involved in the underwriting process
The “banker” – called an investment banker, this specialist is part of
the investment banking team.
“Bankers” generally have broad knowledge of the capital markets, debt instruments,
debt structuring, document preparation, and marketing/distribution procedures.
One of their responsibilities is to solicit potential issuers with the goal of being
included as a member of the issuer’s underwriting team.
Once their firm is hired they serve as the key contact/liaison person and coordinate
with all parties to the financing to execute the underwriting.
The “underwriter” – an investment banking firm’s specialist who is
directly responsible for pricing a district’s bond issue; i.e.,
determining the lowest possible combination of coupons and yields
that will “sell” in the marketplace at the time of pricing.
The “sales representatives” – the persons who actually contact
potential investors and sell the district’s bonds to those investors.
Saunders Learning Group, LLC, Andover, KS
68. Steps in the Negotiated Underwriting Process
1. Structuring - the lead investment banking firm (senior managing
underwriter) is usually involved in the initial structuring and/or
determining the plan of finance.
2. Hiring of underwriter’s counsel - the senior managing underwriter, the
financial advisor and the issuer will jointly agree on a firm via
consultation among themselves.
3. Documentation process.
4. Net Designations or Group Net
5. Pre-sale marketing activities by salesforce.
6. Pre-sale pricing calls among the underwriters, the FA and the issuer.
7. Order period - usually 2 hours during which the bonds are sold.
8. Sign bond purchase agreement - the district and the senior managing
underwriter.
Saunders Learning Group, LLC, Andover, KS
69. Conclusion
Bonds are just like lOUs. Buying a bond means you are lending out your money.
Bonds are also called fixed-income securities because the cash flow from them is
fixed.
The issuers of bonds are governments and corporations.
A bond is characterized by its face value, coupon rate, maturity and issuer.
Yield is the rate of return you get on a bond.
When price goes up, yield goes down, and vice versa.
When interest rates rise, the price of bonds in the market falls, and vice versa.
Bills, notes and bonds are all fixed-income securities classified by maturity.
Government bonds are the safest bonds, followed by municipal bonds, and then
corporate bonds.
Bonds are not risk free. It's always possible - especially in the case of corporate
bonds - for the borrower to default on the debt payments.
Saunders Learning Group, LLC, Andover, KS
71. Reference Material
Figuring Out Wall Street Consumer’s Guide To
Financial Markets
By Floyd Saunders
Publisher: Saunders Learning Group
ISBN: 978-0-9824019-0-3
available from Amazon, B&N, and
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Book summary: From bank failures to home foreclosures and panic
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funds, venture capital and private equity. Every chapter includes action plans
for investing.
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72. Glossary of Bond Finance Terms - A
Accrued interest. Coupon interest accumulated on a bond or other obligation since the last interest payment or, for a new
issue, from the dated date to the date of delivery. Usually interest on municipal bonds is payable semi-annually, every six
months. When you buy a bond in mid-term you are only entitled to the interest the bond earns after you buy it. The interest
earned previously, the accrued interest, belongs to the seller.
Ad Valorem Tax. A state or local government tax based on the value of real property as determined by the county tax assessor.
Advanced Refunded Bonds. A municipality or school district may sell a second bond issue at a lower interest rate cost, placing
the proceeds of the issue in an escrow account from which the first issue's principal and interest will be repaid when due.
Amortization of Debt. The annual reduction of principal through the use of serial bonds or term bonds with a sinking fund.
Arbitrage. The interest rate differential that exists when proceeds from a municipal bond - which is tax-free and carries a lower
yield - are invested in taxable securities with a yield that is higher. The 1986 Tax Reform Act made this practice by
municipalities illegal solely as a borrowing tactic, except under certain safe-harbor conditions.
Assessed Valuation. A municipality's worth in dollars based on real estate and/or other property for the purpose of taxation,
sometimes expressed as a percent of the full market value of the community.
Authorizing Ordinance. A law that when enacted allows the unit of government to sell a specific bond issue or finance a
specific project.
Average Life. The average length of time an issue of serial bonds and/or term bonds with mandatory sinking funds and/or
estimated prepayments is expected to be outstanding. It also can be the average maturity of a bond portfolio.
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73. Glossary of Bond Finance Terms - B
Balloon Maturity. An inordinately large amount of bond principal maturing in any single year. This is also referred to as a Term Bond.
Bond Anticipation Note. A short-term security, one year or less, used for interim financing to be repaid from the proceeds of a planned
long-term bond issue.
Basis Point. One one-hundredth of one percent (1/100 % or 0.01 percent). Thus 25 basis points equal one-quarter of one percent, 100
basis points equal one percent. This is typical in-group, professional bond talk.
Bid. An offer to buy at a fixed price or yield. As opposed to Ask, which is an offering to sell.
Bond or note. A security whereby an issuer borrows money from an investor and agrees and promises, by written contract, to pay a
fixed principal sum on a specified date (maturity date) and at a specified rate of interest.
Bond Fund (Tax-Exempt). A Bond Fund is a portfolio of municipal bonds sponsored or administered by registered investment
companies. These companies offer shares to investors either through (1) closed-end funds or unit investment trusts, which offer shares
of a fixed portfolio of municipal bonds; or (2) open-end or managed funds, which offer shares in a managed portfolio of municipal
bonds whose size will vary as shares are purchased or redeemed.
Bond Insurance. Insurance issued by a private insurance company for either an entire issue or specific maturities that guarantees to
pay principal and interest when due.
Bond Premium. The amount at which a bond or note is bought or sold above its par value or face value without including accrued
interest.
Bonded Debt. The portion of an issuer's debt structure represented by outstanding bonds, sometimes limited by constitutional or
legislative restraints.
Book Entry. A system of security ownership in which the ownership is held as a computer entry on the records of a central company for
its owner. The bond owner gets a computer printout as proof of ownership.
Broker. Technically a broker is a bond trader in the secondary market buying from and selling to bond dealers. Its most common usage
is as a description of a bond salesperson.
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74. Glossary of Bond Finance Terms - C
Callable Bond. A bond or note that is subject to redemption at the option of the issuer prior to its stated
maturity. The call date and call premium, if any, is stated in the offering statement or broker's confirmation.
Certificates of Participation (COPs). A form of a lease revenue bond that permits the investor to participate in a
stream of installment payments, lease payments or loan payments relating to the acquisition or construction of
specific equipment, land or facilities. COPs are not viewed legally as "debt" because payment is tied to an annual
appropriation by the government body. As a result, COPs are seen by investors as providing weaker security and
often carry ratings that are a notch or two below an agency's general obligation rating.
Coupon. The Coupon is the detachable part of a bond that displays the rate of interest due, and the interest
payment date. When there were bearer bonds, coupons were often detached from the bonds and presented to
the paying agent for payment just as one might cash a government check.
Coupon Rate. The specified annual interest rate payable to the bond or note holder as printed on the bond. This
term is still used even though there are no coupon bonds anymore.
Covenant. A legally binding commitment by the issuer of municipal bonds to the bondholder. This is the issuer’s
promise to perform or repay, conversely, an impairment of a covenant can lead to a Technical Default.
Current Refunding. A refunding transaction where the municipal securities being refunding will all mature or be
redeemed within 90 days or less from the date of issuance of the refunding issue.
Current Yield. The ratio of the coupon rate on a bond to the dollar purchase price expressed as a percentage.
Cushion Bonds. Bonds selling at a premium are called "cushion" bonds because they cushion the price volatility in
an up and down market. A premium bond, by definition, has a higher-than-market coupon interest rate. The
dollar price movement of a high interest rate bond is less than that of a lower interest rate bond of the same
maturity when general interest rates move up or down a few basis points.
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75. Glossary of Bond Finance Terms - D
Dated Date. The date carried on the face of a bond or note from which interest normally begins to accrue, the
“dated date”.
Dealer. A dealer is a corporation or partnership that buys and sells and maintains an ongoing position in bonds
and/or notes. They are also authorized to underwrite new issues.
Debt Limited. The debt limit is the maximum statutory or constitutional amount of debt that the general
obligation bond issuer can either issue or have outstanding at any time.
Debt Ratio. The ratio of the issuer's general obligation debt to a measure of value, like real property valuations,
personal income, general fund resources, or population.
Debt Service. Required payments for principal and interest.
Default. Failure to pay in a timely manner principal and/or interest when due, or a Technical Default, the
occurrence of an event as stipulated in the Indenture of Trust resulting in an abrogation of that agreement. A
Technical Default can be a warning sign that a default on debt service is coming, however in the real world actual
debt service interruption does not always occur if the problems are resolved in time.
Defeased Bonds. Refunded bonds for which the payment of principal and interest has been assured through the
structuring of a portfolio of government securities, the principal and interest on which will be sufficient to pay
debt service on the refunded, outstanding bonds. When a bond issue is defeased, the claim on the revenues of the
issuer is usually eliminated.
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76. Glossary of Bond Finance Terms - D
Delivery. Delivery and payment must be in three business days for bonds bought or sold in the secondary market.
For new issues, the time when payment is made to, and the executed bonds and notes are received from, the
issuer. New-issue delivery takes place several weeks after the sale to allow the bonds and notes to be printed and
signed.
Denomination. The face or par amount - normally $1000 or $5000 but can be $100,000 or more in the case of a
note - that the issuer promises to pay at a specific bond or note maturity.
Direct Debt. In general obligation bond analysis, the amount of debt that a particular local unit of government
has incurred in its own name or assumed through annexation.
Discount. The amount of dollars by which market value of a bond is less than par value or face value.
Discount Bonds. Bonds which sell at a dollar price below par in which case the yield would exceed the coupon
rate. The difference between the discount price and the maturity price is subject to federal capital gains tax
except in the case of Original Issue Discount Bonds.
Dollar Bond. Generally a term bond that is quoted and traded in dollars rather than in yield-to-maturity. They are
well known issues of well known names in the market.
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77. Glossary of Bond Finance Terms – E to F
Escrow Fund. A fund that contains monies that only can be used to pay debt service.
Escrowed to Maturity. Also called an “Advanced Refunded” bond. When interest rates fall, an issuer may chose to
sell a new issue called a refunding issue and use the proceeds of the second issue to pay off the original issue,
much the same as a home owner refinancing a mortgage in an effort to save interest costs. The proceeds of the
refunding issue are used to structure a portfolio of U.S. government securities, the principal and interest
payments of which exactly match the principal and interest payments of the refunded bonds. The portfolio is
placed in escrow at the paying agent and the bond issue is said to be fully defeased and escrowed to maturity. In
actual practice the bonds are usually called on the first call date. Because of the U.S. Treasury backing, advanced
refunded or escrowed to maturity bonds are considered the safest municipal bonds available and trade on the
market as a rich triple-A.
Financial Advisor. Generally an independent consulting firm, an investment-banking company, individual, or bank
that advises the issuer on financial matters regarding a proposed issue and is not part of the underwriting
syndicate.
Fiscal Agent. Also known as the Paying Agent, the bank, designated by the issuer, to pay interest and principal to
the bondholder.
Fiscal Year. A 12-month time horizon by which state and local governments annually budget their respective
revenues and expenditures. Often this time horizon is from July to June but can vary.
Flow of Funds. The annual legal sequence by which enterprise revenues are paid out for operating and
maintenance costs, debt service, sinking fund payments, and so on.
Full Faith and Credit. The pledge of "the full faith and credit and taxing power without limitation as to rate or
amount." This phrase is generally used regarding General Obligation bonds to express the pledge of utilizing all
taxing powers and resources, if necessary, to pay the bond holders.
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78. Glossary of Bond Finance Terms – G, H , I
General Obligation Bond. (G.O.) A bond secured by a pledge of the issuer's taxing powers (limited or unlimited).
Considered the most secure of all municipal debt. General obligation bonds of local governments are paid from
ad valorem property taxes and other general revenues.
Guaranteed Yield: The guaranteed yield is a school finance plan in which the state specifies a revenue yield that
it will guarantee in terms of revenue per student per penny of local tax effort. Districts adopt tax rates and levy
taxes. The state makes up the difference between what each district levies locally per student and the
guaranteed yield per student. High-wealth districts may raise all of their guaranteed yield revenue from local tax
sources.
Hold Harmless: Hold harmless provisions are common when a significant change is made to a formula or funding
source. "Hold harmless" is a term used to describe a provision in new law that is designed to protect a school
district from a loss of local revenue or state aid.
Indenture of Trust. A legal document describing in specific detail the terms and conditions of a bond offering,
the rights of the bondholder, and the obligations of the issuer to the bondholder; such document is alternatively
referred to as a bond resolution.
Interest and Sinking Fund (I&S) Tax Rate: Also referred to as the debt service tax rate, the I&S taxes pay for
bonded indebtedness, facilities, and other capital needs.
Interim Borrowing. (1) Short-term loans to be repaid from general revenues or tax collections during the current
fiscal year (TRANs or RANs); (2) short-term loans in anticipation of bond issuance or grant receipts (BANs).
Investment Grade. Bond issues that the three major bond rating agencies, Moody's, Standard & Poor's, and Fitch
rate BBB or Baa or better. Many fiduciaries, trustees, some mutual fund managers can only invest in securities
with an investment grade rating.
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79. Glossary of Bond Finance Terms – J & L
Junk Bonds. Most non-rated bonds and bonds rated below investment grade.
Legal Opinion. A written opinion from bond counsel that an issue of bonds was duly authorized and issued. The
opinion usually includes the statement, "interest received thereon is exempt from federal taxes and, in certain
circumstances, from state and local taxes."
Letter of Credit. A form of supplement or, in some cases, direct security for a municipal bond under which a
commercial bank or private corporation guarantees payment on the bond under certain specified conditions.
Level Debt Service. Principal and interest payments that, together, represent more or less equal annual
payments over the life of the loan. Principal may be serial maturities or sinking fund installments.
Lien. A claim on revenues, assessments or taxes made for a specific issue of bonds.
Limited Tax Bond. A bond secured by a pledge of a tax that is limited as to rate or amount.
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80. Glossary of Bond Finance Terms – M & N
Maximum Annual Debt Service. The maximum amount of principal and interest due by a revenue bond issuer on
its outstanding bonds in any future fiscal year. This is sometimes the amount to be maintained in the Debt Service
Reserve Fund.
Municipal Bond. Bonds issued by any of the 50 states, the territories and their subdivisions, counties, cities,
towns, villages and school districts, agencies, such as authorities and special districts created by the states, and
certain federally sponsored agencies such as local housing authorities. Historically, the interest paid on theses
bonds has been exempt from federal income taxes and is generally exempt from state and local taxes in the state
of issuance.
Municipal Securities Rulemaking Board (MSRB). An independent self-regulatory organization established by
Congress in 1975 which is charged with primary rulemaking authority - under the SEC - over dealers, dealer banks,
and brokers in the municipal securities industry.
Net Bonded Debt. Gross general obligation debt minus self-supporting general obligation debt, housing bonds,
water revenue bonds, etc.
Net Interest Cost (NIC). In general, issuers award competitive bond sales to the underwriter bidding the lowest
NIC. This represents the average coupon rate weighted to reflect the time until repayment of principal and
adjusted for the premium or discount.
Net Revenue Available for Debt Service. Usually, gross operating revenues of an enterprise less operating and
maintenance expenses but exclusive of depreciation and bond principal and interest. Thus, net revenue is
defined to determine coverage on revenue bond issues.
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81. Glossary of Bond Finance Terms - O
Official Statement (OS) or Offering Circular (OC). A document or prospectus circulated for an issuer prior to a
bond sale with relevant facts pertaining to the proposed financing. Usually there are two OSs, the first of which is
known as the preliminary, or "red herring" - so named because some of the type on its cover is printed in red. The
prospectus or red herring is supposed to be available to the investor prior to the sale often used to determine
interest from investors.
Original Issue Discount. Certain maturities of a new bond issue may have an offering price substantially below
par. The appreciation from the original price to par over the life of the bonds is treated as tax-exempt income
and is not subject to capital gains tax. Pleas see Zero Coupon Bond.
O.T.C. Over The Counter. Not on an exchange. OTC refers to the buying and selling method used in the
secondary market for municipal bonds and unlisted stocks.
Overlapping Debt. Overlapping debt is the proportionate share of the general obligation bonds of local
governments located wholly or in part within the limits of the reporting governmental entity that must be paid by
property owners within the unit.
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82. Glossary of Bond Finance Terms - P
Par Value. Par Value is the principal or face value of a bond, usually $5,000 due the holder at maturity. It has no
relation to the market value. It is considered to be 100 for pricing purposes.
Parity Bonds. Revenue bonds that have an equal lien on the revenues of the issuer.
Paying Agent. Also Fiscal Agent. Generally a bank that performs the function of paying interest and principal for
the issuing body.
Premium. A premium is the amount by which the price exceeds the principal amount (par value) of a bond. The
current yield of a premium bond will be less than its coupon rate.
Price to Call. The yield of a bond priced to the first call date rather than maturity.
Primary Market. The new issue market
Principal. The face value of a bond, not including interest.
Put Bond. A put bond that can be redeemed by the bondholder on a date or on a date or dates prior to the stated
maturity date.
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83. Glossary of Bond Finance Terms Q & R
Qualified Legal Opinion. Conditional affirmation of the legal basis for the bond or note issue. The average
investor should avoid any but the strongest opinion by the most recognized bond approving attorneys.
Rate Covenant. A legal commitment by a revenue bond issuer to maintain rates at levels to generate a specified
debt-service coverage.
Ratings. Various alphabetical and numerical designations used by institutional investors, Wall Street underwriters,
and commercial rating companies to give relative indications of bond and note creditworthiness. Standard &
Poor's and Fitch Investors Service Inc. use the same system, starting with their highest rating of AAA, AA, A, BBB,
BB, B, CCC, CC, C, and D for default. Moody's Investors Services uses Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, and D .
Recapture: Also referred to as the “Robin Hood” provision. Recapture is a characteristic of school finance where
local districts give the state locally collected property tax revenues for reallocation through the Foundation
School Program. Chapter 41 of the Texas Education Code is where the recapture provision can be found and is a
significant feature of the Texas school finance equalization system.
Red Herring. A preliminary offering statement, subject to final change and update upon completion of sale of
bonds. The name comes from the red type along the side on the cover.
Redemption. Process of retiring existing bonds prior to maturity from excess earnings or proceeds of refunding
bonds. It also refers to redeeming shares in a mutual fund by selling the shares back to the sponsor.
Refunding Bond. The issuance of a new bond for the purpose of retiring an already outstanding bond issue.
Registered Bond. A non-negotiable instrument in the name of the holder either registered as to principal or as to
principal and interest.
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84. Glossary of Bond Finance Terms - S
Security. The legally available revenues and assets that are used to pay the bond holders. This is the key
component that supports debt service.
Serial Bond. As opposed to a Term Bond, which is a large block of bonds maturing in a single year, a serial bond is
an issue that features maturities every year, annually or semiannually over a period of years.
Short Term. Bonds or notes sold on an interim basis with tax-exempt securities for a period of from one to five
years.
Sinking Fund. A sinking fund is where monies are escrowed on a periodic basis to retire term bonds at or prior to
maturity.
Sinking Fund Schedule. A schedule of payments required under the original revenue bond resolutions to be
placed each year into a special fund, called the sinking fund, and to be used for retiring a specified portion of a
term bond issue prior to maturity.
Special Assessment Bond. A bond secured by a levy of special assessments, as opposed to property taxes, made
by a local unit of government on certain properties to pay the cost of local improvements and/or services that
represents the specific benefit to the property owner resulting from the improvement.
Street Name. Street name refers to the registration of bonds in the name of a dealer or other third party instead
of the owner, usually for custodial or safe keeping purposes.
Swap. The exchange of one bond for another. Generally, the act of selling a bond to establish an income tax loss
and replacing the bond with a new item of comparable value.
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85. Glossary of Bond Finance Terms - T
Tax Base. The total resource of the community that is legally available for taxation.
Taxable Equivalent Yield. The yield an investor would have to obtain on a taxable corporate or U.S. government bond to
match the same after-tax yield on a municipal bond.
Tax-exempt Bond. Bonds exempt from federal income, state income, or state tax and local personal property taxes. This
tax exemption results from the theory of reciprocal immunity: States do not tax instruments of the federal government
and the federal government does not tax interest of securities of state and local governments.
Technical Default. Failure by the issuer to meet the requirements of a bond covenant. These defaults do not necessarily
result in losses to the bond holder. The default may be cured by simple changes of policy or actions by the issuer.
Tender. The act of offering bonds to a sinking fund.
Term Bond. A large block of bonds of long maturity. They may be part of a serial Bond issue; there may be more than one
term bond in an issue or a single maturity. Some are subject to a sinking fund redemption.
Tombstone. An advertisement placed for information purposes, after bonds or notes are sold, that describes certain
details of the issue and lists the managing underwriters and or the members of the underwriting syndicate.
Trustee. A bank designated as the custodian of funds and official representative of bondholders. Trustees are appointed
to insure compliance with the trust indenture and represents bondholders to enforce their contract with the issuer.
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86. Glossary of Bond Finance Terms U to Z
Underwrite. An agreement to purchase an issuer's unsold securities at a set price, thereby guaranteeing the
issuer proceeds and a fixed borrowing cost.
Variable Rate Bond. A bond whose yield is adjusted periodically according to a prescribed formula.
Yield Curve. Graph depicting the relationship between yields and current maturity for securities with identical
default risk.
Yield-to-call. Return available to call date taking into consideration the current value of the call premium, if any.
Yield-to-maturity. (YTM) Return available taking into account the interest rate, length of time to maturity, and
price paid. It is assumed that the coupon reinvestment rate for the life of the bonds will be the same as the yield-
to-maturity.
Zero-coupon Bonds. A deep discount municipal bond on which no current interest is paid. Instead, at bond
maturity, the investor receives compounded interest at a specified rate. The difference between the discount
price at purchase and the accreted value at maturity is not taxed as a capital gain but is considered tax-exempt
interest. Often used for college savings bonds.
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