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U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities)are also a popular government investment. Much like bills, STRIPS are sold at a discount to face value, since the interest accrues to the face value of the security rather than as a semi-annual payment to the bondholder. Unlike bills, though, STRIPS offer investors a wide range of longer-dated maturities to choose from.
U.S. federal agencies, which are fully owned by the U.S. government, and Government-Sponsored Enterprises (GSEs), which are privately owned entities created by Congress, together issue debt securities known as Agencies. This implicit connection to the federal branch has led Agency structures to be considered second in quality only to U.S. Government securities. Agencies use the proceeds raised in the capital markets to provide funding for public policy purposes, such as housing, education and farming.
GSEs are the most active issuers in the Agency market. You might be familiar with the two largest shareholder-owned companies: Fannie Mae and Freddie Mac.
Mortgage-backed securities, commonly known as mortgages, are bonds created from mortgage loans. These loans are originated by a variety of financial institutions in order to provide financing for home loans and other real estate. Mortgage lenders typically package, or «pool», these loans and then sell them to mortgage-backed securities issuers. The bonds are generally issued in multiples of $1,000.
At approximately $2.5 trillion in outstanding securities, mortgages are now a major segment of the US bond market. Mortgage bonds generally retain high credit quality since most are either explicitly, or implicitly, backed by the federal government.
Mortgage securities are generally classified as either pass-throughsor Collateralised Mortgage Obligations (CMOs). Pass-throughs basically collect mortgage payments from homeowners and pass this cash flow onto investors. CMOs provide a more predictable payment stream than pass-throughs by creating separate «tranches», designed to meet different investment objectives.
Public and private companies issue corporate bonds, commonly known as corporates in order to meet both short– and long-term financing needs. The proceeds from a bond sale are therefore used for a wide variety of purposes, such as for the purchase of new equipment, the funding of general operating expenses or for the financing of a company M&As. Corporates are typically issued in multiples of $1,000, have a maturity range between one and 30 years and pay semi-annual interest. The vast majority of corporate bonds are fully taxable.
Corporate Bond Credit Quality
Credit quality is the most important concern for corporate bond investors. Most corporates are assigned credit ratings by Moody’s and S&P. These ratings classify an issuer as «high-grade» or «high-yield». High-grade bonds are considered fairly conservative investments since these companies are deemed to be in good financial health and are unlikely to have trouble meeting their debt obligation. These bonds are rated from «Aaa» to «Baa» by Moody’s, and from «AAA» to «BBB» by S&P.
High-yield bonds are considered speculative since they are issued by companies with more credit risk. These bonds are rated on a scale from «Ba» to «C» by Moody’s, and from «BB» to «D» by S&P. These bonds pay a higher rate of interest – and have a potentially higher rate of return – than their high-grade counterparts. However, high-yield bonds are only appropriate for risk-tolerant investors.
States, cities, counties and towns issue municipal bonds. The proceeds from bond sales are used for the building and maintenance of a variety of public works projects – such as for the construction of schools, roads, hospitals and sport stadiums.
There are two types of municipal securities: General Obligation (GO) and Revenue Bonds. GOs are backed by the full taxing authority of the issuer, while Revenue Bonds are backed by the income generated from the project being financed.
Since municipalities can vary in credit quality, most municipal bonds are assigned a credit rating from either Moody’s or Standard & Poor’s. However, municipal buyers have the luxury of opting for no credit risk. Today, approximately 40% of all new issuance is «insured» by a major municipal bond insurance company. Insured bonds automatically receive the highest «AAA/Aaa» ratings since the insurance company guarantees that if a municipality is not able to meet its debt obligations, it will provide the payments of principal and interest.
Municipals are not taxed by the federal government, and are generally exempt from state and local taxes for residents of the issuing state. Since municipals are exempt from federal income taxes, investors in the 28% tax bracket or above would typically receive better returns with municipal bonds in their taxable accounts than with other higher-yielding, taxable fixed-income securities.
Certificates of deposit, or CDs, are time deposits issued by a bank, which pay a fixed rate of interest for a specified period of time. Since CDs are FDIC-insured, up to a maximum of $100,000 (per depositor, per financial institution, including principal and interest combined in each insurable legal capacity), credit risk is not a concern. CDs are generally offered in multiples of $1,000, while «Jumbo» CDs are sold in $100,000 denominations. CDs may also contain call provisions. CDs may be purchased directly from a bank or brokerage firm.
There is only one way to begin building a bond portfolio that is right for you. In fact, it is no different from the advice that you might receive if you decided to construct a stock portfolio: Start with a plan that works.
The best strategies for bond investors are the laddered portfolio and the diversified portfolio approach. Regardless of the shape of the yield curve, your interest rate outlook or the performance of a particular sector, these two basic strategies will help prepare the proper foundation to meet your specific financial objectives.
In a laddered portfolio, bonds mature in sequence over a period of years. As each security matures, the proceeds are reinvested in the longest maturity «rung» of the ladder. This is a rather conservative approach, but it is widely and successfully employed by individual investors since it minimizes reinvestment and interest rate risk.
You may also construct a diversified portfolio. This method uses a wide variety of bond classes and structures. This approach is designed to garner incremental yield by taking on a variety of risks – many of which tend to cancel out one another over time.
Source: SalomonSmithBarney, 2002, www.citibank.com
1. upside potential – потенциал роста цены или курса
2. downside risk – риск падения цены или курса
3. bondholder n – владелец облигации
4. public sector – государственный сектор
5. municipality n – муниципалитет
6. privately held company – частная компания
7. fixed-income security – ценная бумага с фиксированным доходом
8. outstanding a – неоплаченный долг; ценные бумаги в обращении
9. face value – номинал
10. callable bond – отзывная облигация
11. bullet n – зд. безотзывная облигация
12. redemption (Red) n – погашение, выкуп
redeem v – погашать
redeemable a – погашаемый
13. buyback n – обратная покупка, выкуп
buy back v – выкупать
14. Treasury Department (US) – Казначейство США
15. bill n – переводной вексель (тратта), казначейский вексель; банкнота; счет; документ о передаче прав собственности на товар; свидетельство долга заемщика кредитору; билль (закон)
16. note n – краткосрочная ценная бумага; долговое обязательство; банкнота; письменное обязательство выплатить определенную сумму на оговоренных условиях
17. Treasury Inflation-Protected Security (TIPS) – казначейская облигация, защищенная от инфляции
18. accrual n – начисление
accrue v – начислять
19. hedge n – хедж, хеджирование
hedge v – хеджировать
20. Consumer Price Index (CPI) – индекс потребительских цен
21. Separate Trading of Registered Interest and Principal of Securities (STRIPS) – раздельная торговля основной суммой и купонами казначейских облигаций
22. Government-Sponsored Enterprise (GSE) – предприятия, созданные при поддержке правительства
23. Agencies n – ценные бумаги федеральных агентств США
24. Fannie Mae (Federal National Mortgage Association) – Федеральная национальная ипотечная ассоциация
25. Freddie Mac (Federal Home Loan Mortgage Corporation) – Федеральная корпорация жилищного ипотечного кредита
26. mortgage-backed securities (mortgages) – ценные бумаги, обеспеченные ипотекой
27. pass-through securities – «пропускающие» ценные бумаги
28. Сollateralized Mortgage Obligation (CMO) – обеспеченная ипотечная облигация
29. corporate bond (corporate) – корпоративная облигация
30. high-grade bond – облигация с высоким рейтингом
31. high-yield bond – высокодоходная облигация
32. risk-tolerant investor – инвестор, приемлющий риск
33. municipal bond – муниципальная облигация
34. General Obligation (GO) bond – облигация общих обязательств
35. revenue bond – доходная облигация
36. tax bracket – налоговый разряд
37. taxable а – налогооблагаемый
38. certificate of deposit (CD) – депозитный сертификат
39. Federal Deposit Insurance Corporation (FDIC) – Федеральная корпорация страхования депозитов (США)
40. jumbo CD – крупный депозитный сертификат
41. laddered portfolio – портфель-лестница
42. yield curve – кривая доходности
Exercise 1. Answer the following questions.
1. Why do investors like bonds? 2. What are callable and bullet structures? 3. What are the key benefits of government securities? 4. What are the most popular types of Treasuries? 5. Why are Agencies considered second in quality only to the US government securities? 6. What is the mechanism of mortgages? 7. Why do companies issue corporates? 8. What is credit quality? 9. What are the main types of municipals? 10. Why isn’t credit risk a concern with CDs? 11. How can you construct an optimum investment portfolio? 12. What are the best strategies for bond investors?
Exercise 2*. Find terms in the text that match definitions given below and make sentences of your own with each term.
1. the issuer can redeem the bond before maturity due to specific conditions
2. certificate that indicates a specific deposit has been given to the bank; the bank pays interest on the funds until the maturity date
3. the likelihood of default rated from AAA and below
4. credit quality of AA or AAA
5. an obligation with a maturity of more than one year from when it was issued
6. the date that a contract expires
7. a bond offered by state and local government
8. a company’s purchase of its outstanding stock
9. a negotiable debt obligation issued by the U.S. Treasury with maturities of 13, 26, and 52 weeks; non interest bearing but issued on a discount basis instead
10. coupon securities issued by the U.S. Treasury with semi-annual interest and maturities of 10 to 30 years
11. securities issued by the U.S. Treasury bearing interest and with maturities of 2 to 10 years
12. annual percentage rate of return, determined by dividing income by principal; or the effective rate of interest paid on a note or bond
13. the normal tendency of yields to rise with the increasing maturity of the security
Exercise 3. Read the following text describing different types of investors. Identify which type is closest to your personality and devise an investment strategy for yourself, and for the following individuals: 1. A semi-retired professor; 2. A 40-something engineer with two teenage children; 3. A housewife in her early thirties married to a rich businessman; 4. A computer genius in his mid twenties.
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