Series 7 Registration



Series 7 Registration

Chapter 7

Types of Treasury Securities

Treasuries: U.S. government debt instruments that are direct obligations of the federal government. (7-1)

Agencies: Securities issued by agencies of the U.S. Government. (7-1)

There are two types of treasury securities, Marketable (Treasuries) and Non-marketable (Nonnegotiable or Savings bonds). (7-1)

Saving Bonds are considered Nonnegotiable because it can’t be sold on the market, just at government agencies. (7-1)

Negotiable: The treasury securities that are allowed to be sold between investors. (7-1)

Interest-bearing securities: Treasury notes and Treasury bonds that pay a fixed rate of interest semiannually and the investor receive face value at maturity. (7-1)

Treasury Notes have maturities from 2 to 10 years and Treasury Bonds have maturities of more than 10 years. Both securities are in book entry form. (7-1)

Prices for Treasury Notes and Bonds are in 1/32s. (7-2)

Listing for T-Notes and Bonds

Column 1: Coupon Rates in eighths. (7-2)

Column 2: Shows the month and year of maturity, and if followed by an ‘n’ means that it is a treasury note. (7-2)

Column 3: Shows the bid and asked quotes as a percentage of the par value. Shown in the 32’s. (7-2)

Ex: 106:17 where 106 is a percent of par and 17/32’s

Column 4: Shows the bid price’s change from the previous day in 32nds. (7-2)

Column 5: Shows the yield to maturity. (7-2)

Treasury Inflation Indexed Securities: Otherwise known as Treasury Inflation-Protected Securities (TIPS). The principal value of the security is inflation adjusted based on the Consumer Price Index (CPI). Rate of interest is fixed. (7-2)

10 year TIPS notes are auctioned 3 times per year in January, July and October. (7-3)

Treasury Bills: Short term securities that mature in one year or less. Also referred to as T-Bills, discount security or non-interest-bearing security. (7-3)

T-Bills come in maturities of one month, three months, and six months and are sold in intervals of $1000. T-Bills only appear in book entry form and are always sold at a discount without interest payments. (7-3)

T-Bills are quoted as the percentage discount from the security also known as a discounted yield basis. The larger the yield, the smaller the price. (7-3)

The Ask Yld field in T-Bill listings represents the yield equivalent in bond or coupon terms and formula.

Cash Management Bills (CMBs): Unscheduled short-term debt offerings used to even out Treasury cash flows. Maturity could be one day and are issued at discount. (7-4)

Stripped Securities: Treasury notes and bonds that had the interest payments tripped away and resold the notes and bonds as zero coupon bonds. (7-4)

Treasury Receipts: Treasury receipts are generic stripped securities that are backed by the broker-dealer’s Treasury securities. (7-4)

Treasury STRIPS: Stands for: Separate Trading of Registered Interest and Principal of Securities. Dealers would have the capabilities of purchasing T-notes and T-bonds separately from the coupon and principal payments after requesting this service through a fed reserve bank. Always sold at a discount. Maturities are from 10 to 30 years and are backed by the U.S. treasury. Quoted on a yield basis. (7-4)

Key Advantages of Treasury Securities for Investors (7-4)

1. Safety

2. Liquidity

3. Interest exempt from states and local income taxes

Nonmarketable U.S. Government Securities: Savings Bonds

Series EE Bonds: 30-year investments issued in denominations from $50 to $10,000 and investors can purchase them at a 50% discount from face value. Investors since May 1, 1997 receive an interest rate equal to 90% of avg. yield on the last 6 months of 5 yr treasury bonds. The rate is reset twice a year. (7-7)

Series HH Bonds: 20-year investments issued in denominations from $500 to $10,000 and pays interest semiannually. Not sold directly to public, and can only acquire HH by exchanging EE bonds. (7-7)

Series I Bonds: Savings bonds indexed for inflation. Available in same denominations as EE bonds but are sold at face value. Interest rate reset twice a year depending on rate of inflation and same restrictions and penalties as EE bonds along with interest up to 30 years. (7-7)

Interest earned on all treasury securities is subject to federal taxation but exempt from state and local taxes. Interest earned on T-bills must be reported in the year the payments were received. All non-interest, non-coupon securities must be accreted and reported each year. (7-7)

Agency Securities

Agency Securities: Debt instruments issued by federal and government sponsored enterprises. Not the direct obligation of the U.S. Government but credit risk is still low. Although unrated, these securities are assumed to be AAA and are issued in book entry form with quotes in 1/32nds. Yields for agency securities are considered higher than other treasury securities. (7-10)

Federal Agencies: Direct arms of the U.S. Government. Securities issued by them are backed by the government. (7-10)

Government Sponsored Enterprises

Government Sponsored Enterprises: Publicly chartered but privately owned enterprises. Congress created these organizations to provide low-cost loans for certain groups. The enterprise issues securities through a group of dealers and the proceeds are lent to a bank to lend to the individual of the group the security was created for. Although not backed by the government their risk is still considered minimal. (7-10)

Federal Farm Credit Banks (FFCBs): Provides funds for three separate entities: Banks for Cooperatives, Intermediate Credit Banks, and Federal Land Banks. They issue short-term discount notes and interest bearing bonds. Interest is only subject to federal law. (7-10)

Federal Home Loan Banks (FHLBs): They provide liquidity for savings and loans institutions which need extra funds to meet seasonal demands for money. The treasury is allowed to buy up to $4billion of FHLB issues. Interest is subject to federal rules. (7-11)

Student Loan Marketing Association (SLMA): Sallie Mae provides liquidity to student loan makers and financing for state student loan agencies. Authorized to deal in student loans insured in the federal Guaranteed Student Loan Program as well as uninsured loans. Trade on NYSE. Taxed by Federal Government. (7-11)

Mortgage-Backed Securities

Pass-Through Certificates: An agency purchases a pool of mortgages and the interests in the pool are sold to investors as pass-through certificates. Each certificate represents an undivided interest in the pool, which entitles the owner to a share in the cash flow generated. When the homeowners make their mortgage payments and after charges are deducted the bulk of these payments are passed to the investors. Fully negotiable and may be sold to other investors after issuance. (7-11, 7-12)

Federal Home Loan Mortgage Association: Otherwise known as Freddie Mac and is used to proved liquidity to Federally insured savings institutions to finance housing. Works by purchasing residential mortgages and by issuing mortgage-backed bonds, pass-through certificates and guaranteed mortgage-backed certificates. Interest is triple taxed. FHLMC issues notes, bonds and stock. (7-12)

Federal National Mortgage Association: Otherwise known as Fannie Mae raises money to buy residential, Federal Housing Administration, and Veteran’s Administration mortgages from lenders. Issues are backed by the treasury but not the U.S. government; they are triple taxed and are issued in notes, bonds and stock. (7-12)

Government National Mortgage Association: Otherwise known as Ginnie Mae and is a part of the department of Housing and Urban Development. Backed by the U.S. Treasury as a government agency and provides financing for residential housing. Triple taxed securities include mortgage-backed securities, participation certificates and pass-through certificates backed by federal housing admin and/or Veterans Administration. GNMA guarantees monthly payments even if the homeowner doesn’t pay. Monthly payments from GNMA represent interest and principal. (7-12)

Prepayment Risk: A special risk for mortgage-backed securities in which the homeowner takes advantage of lower interest rates and refinances with another group. (7-13)

Collateralized Mortgage Obligations

Collateralized Mortgage Obligations: Mortgage-backed security that takes the principal and interest payments from the underlying mortgages and creates various classes of bonds called tranches. (7-16)

Tranches: The principal and interest payments from a CMO turned into bonds with different rates of interest, repayment schedules and priority levels. Can customize yield maturity and risk exposure. Simply Put: A way to combine people of the same mortgage repayments in the same group for financing. (7-16)

Ex: A 6% Tranche would contain mortgages with a repayment rate of %6.

CMO’s help minimize the prepayment risk by repackaging the payments and interests on the mortgages and by spreading out the mortgages among many tranches. Secured by Fannie Mae, Ginnie Mae, Freddie Mac, and mortgage pools and have the assets placed into a protective trust for bondholders. Triple taxed with an AAA rating and comes in denominations of $1000. (7-16)

Average Life Method: Compares CMO’s to other types of fixed-income securities and essentially provides an average maturity for each tranche. (7-16)

Plain Vanilla bond or Sequential Pay: The simplest form of Tranches. Where only one tranche receives principal repayments at a time. (7-16)

Planned Amortization Class: A structure that is designed for more risk averse investors that provides a predetermined schedule of principal repayment. Prepayment speeds all have to be within a certain range. Accomplished by creating a sinking fund type of schedule. The PAC tranche is top priority and receives principal payments first. (7-17)

Targeted Amortization Class: Developed to protect investors from prepayment risk more than a vanilla bond. Does not protect against an extension risk(longer maturity schedules). (7-18)

Companion or Support Bonds: Tranches that support the prepayment risk by taking only the excess or short fall in the payments. Very volatile and a high variability of average life but with high yields. (7-18)

Z-Tranches: Deferred interest bonds with the longest average life of the tranches where the first phase collects no payments and will instead have the interest compound like a zero-coupon bond. This is the last tranche to accept payments. (7-18)

Principal Only Securities: Created by stripping only the interest from the underlying mortgages. Sold at a deep discount and is paid through scheduled and early payments of principal. High Yield since it is an earlier payment. (7-18)

Interest Only Securities: Bonds that receive some or the entire interest portion of the collateral with little or no principal. This cash flow will decline since the principal balance will decline. IO’s increase in value when prepayments are slow. (7-18)

Floating-Rate Tranches: Tranche with a fluctuating interest rate such as the London Interbank Offered Rate or the Cost of Funds Index. Subject to a Max and a Min rate. Any interest rate that is adjusted by more than the change in index is called a SuperFloater and it is called an Inverse Floater if it moves in the opposite direction of the index. (7-18)

All CMO ads must be filed with NASD ten days in advance of use and can’t be used until the material is approved. In the communications with the public, CMOs must be spelled out for the clients and can’t be compared to any other type of investments. Claims about any aspect of the product must be accurate and not misleading. Must offer educational material. (7-19)

All CMO ads must contain the following disclaimer: (7-19)

The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions.

NASD has a CMO format Ad that could be used. (7-19)

Money Market Securities

Funded Debt: Debt with a maturity of more than one year. (7-19)

Money Market Securities: Debt with a maturity of less than one year. (7-19)

Ex: Commercial Paper, Bankers’ Acceptances, Negotiable Certificates of Deposit, Federal Funds, Money-Market Funds, and Repurchase Agreements.

Cash Equivalents: The asset class that Money-Market Securities are classified as. Considered to be same as cash – very safe. (7-20)

Commercial Paper: Similar to Treasury Notes – Short term security options for corporations that mature in 270 days or less. Exempt from the prospectus requirement. Considered safe since issued usually by corporations with good credit. (7-20)

Directly Placed Commercial Paper: When the issuers of commercial paper sell their paper directly to the client using their own sales force. (7-20)

Dealer-Placed Commercial Paper: When the issuers of commercial paper use a commercial paper dealer to sell the commercial paper. (7-20)

Banker’s Acceptances: A time draft check that is used to cover the monetary transaction of a foreign trade and is backed by the issuing bank. Considered safe since backed by import goods. (7-20)

Repurchase Agreements (Repos): When a dealer sells securities and guarantees to buy them back at a specified time or price. Sort of like a collateralized loan. (7-20)

Reverse Repo or Matched Sale: When a dealer purchases securities and guarantees to sell them back at a specified time or price. (7-21)

Negotiable Certificates of Deposit (CDs): A secured deposit that earns a fixed interest and comes due at a fixed time with a minimum of 7 days and an unlimited maximum. Insured by FDIC and the holders are penalized if they redeem prior to the maturity date. (7-21)

Jumbo CDs: A CD with a minimum deposits of $100,000 and is not insured by the FDIC. These are negotiable securities in the secondary market. (7-21)

Long-Term CDs: CDs that have maturities from 2 to 20 years and are not considered money market securities. Limited liquidity, loss of principal if redeemed early, call features may occur, FDIC insurance does not apply and variable rates all plague these securities. Broker-Dealers must disclose all potential risks when selling these CDs. (7-21)

Federal Funds: Money borrowed overnight from bank to bank in order to make the reserve requirement with the Federal Reserve. The lending bank will earn interest on this money. (7-21)

Fed Funds Rate: The rate at which federal funds are charged in interest. This is a leading indicator of interest rate trends. (7-21, 7-22)

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