cheatsheet 1 - T-Bill Auctions 0 Bids can be competitive or...

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Unformatted text preview: T-Bill Auctions 0 Bids can be competitive or noncompetitive o competitive bids specify the bid price and the desired quantity of T-bills o noncompetitive bidders get preferential allocation and agree to pay the lowest price of the winning competitive bids; bids awarded in full. 0 The maximum purchase amount is $5 million for non-competitive bids and 35 percent of the offering amount for competitive bids. - All accepted bidders pay the same price (the lowest accepted bid) T-Bill Auctions Quantity or T—bills Types of Treasury Securities - Discount or coupon . Bills, notes, and bonds - T-bills offered in 4—, 13-, 26-, and 52-week maturities. 0 Treasury notes are offered in Z-, 3-, 5-, 7-, and 10-year maturities. I Treasury bonds currently offered in 30 years. - Treasury Inflation Protection Securities (TIPS) 0 Every six months, Treasury adjusts the principal value based on the Consumer Price Index. 0 TIPS sold in terms of 5. 10 and 30 years. Repurchase Agreement (Repo) o Repo financing has been used by the FRB to provide credit to member banks since 1917; used by FRB, primary dealers, financial institutions, firms, etc. a A repo is the sale of a security with an agreement to buy the security back at a set price in the future. - Repos are short-term collateralized loans (typical collateral is U.S. Treasury securities), with repo rate slightly below fed funds rate due to collateralized borrowing. o A reverse repo is the opposite side of a repo (i.e.. purchase of a security with an agreement to sell it back in the future). A REPO Transaction . SID niliwi In us 'IIIMI'I W" “t 23;: < __________________________ can: inmtnr 59 Milan cash payment $10 Hilton In us Yum (WI k! m' ____________________ > mii Investor "1.... m... w. W... interest me: 196 haircut: mt Stripped Treasury Securities (STRIPS) - Zero-coupon instruments created from coupon- stripping process. 0 Allow investors to hold interest and principal parts of eligible notes or bonds as separate securities. - Any Treasury issue with a maturity of 10 years or longer is eligible for the STRIPS process. - Not issued by the U.S. government; first created by Merrill Lynch & Salomon Brothers. - Can only be bought and sold through financial institutions, government securities brokers and dealers. Stripped Treasury Securities (STRIPS) - Advantages: - Backed by Treasury securities from which they are created - Investors are allowed to invest without large fund requirements - Predictable cash flows - More choices of maturity dates - Eligible for inclusion in tax—deferred retirement plans Coupon Stripping Dealer purchaser sun million par at: 10%, icyaarrruasury securily Security hr. 510) million Coupon: ms. semhnnunl Maturity: 10 years Cash flow Coupon: Coupon: Coupon: Coupon: Maturity value: $5 million Smillion $5 million £5 million $1“! million mom in: Receipt in: mm in: Receipt in: Receipt in: smomitr 1you isyears ioyears 1Dyears Zeraroupun rmsury seturuies (vealed Mltuflly value: Matulllyvalus: Muufllyv-lue: Muturityvulue Mlturlr/ value: $5 million $5 milrion $5 million _ . . $5 ml‘llion $100 million Maturity. Maturity Maturity: Mawiily: Maturity: Gmamhi war 15ml! lflyurs inynrs STRIP Example 5-year T—note, 8% coupon rate, 7.9% YTM Maturity (yuan can. Flow received PI! of mi. flow at maturity at 73% 0.5 S 400 3 384.30 1 .0 400 310.18 LS 400 356.1 1 2.0 400 342.58 2.5 400 329.56 3.0 400 317.04 3.5 400 304.99 4.0 400 290.40 4.5 400 232.25 5.0 400 211.53 5.0 I0.DDO 5.75121 Total $10,040.65 T-Bill Yields 0 T-bills (and other discount securities) values are quoted on a discount basis, not on a price basis . Discount yields, (ij4) uma 360-day year ill = P xT / o P, = the face value of the security a P0 = the discount price of the security a h = the number of days until maturity Purpose of Municipal Securities - Issued by state and local governments, and entities (such as school districts, public utilities). 0 Short term notes to fund seasonal and temporary imbalances between expenditures and tax receipts. 0 Long term bonds to finance long-term capital projects, such as school, public utility, transportation, or long term budget deficits. Types of Municipal Securities - Tax-backed: secured by some form of tax revenue, such as corporate and individual income taxes, sales taxes, property taxes. - General obligation (GO) bonds a Revenue bonds are sold to finance specific revenue generating projects, such as airport, college and university, student loan, mortgage revenue, gas tax. 0 Asset-backed: debt paid from dedicated revenues such as tobacco settlement Davments. Miw'flmflmfirmnh so mmmnimmu IM 60% srm 5101!. m . our”: m use." - smolous m M rmmm mm ?SJP. “hm" 25s .67 53a soc nu m straw ’ - 2m: Ina-s- m l u 5 so u as w m .- mm Mam-urn m 35x 535 o as, m 7 on m a mum“ WW", m am on 1 at 1 95 es: (fit a “may 51m in m 921 ion mm amt Taxequivaattyieia-taxexeimtyieid/(1—taxrate) Municipal Bond Yields a Tax equivalent rate of return 0 the taxable rate of return equivalent to muni rate - After-tax return for corporate bonds: ' iMun/s =iTER(1 — t) t= marginal total income tax rate of the bond holder 0 The tax equivalent rates of return iTER = [Mm/(1 — t) o Ex: Munis paying 6.5% annually. marginal tax rate = 21%, iTER(1v0.21) = 6.5% => iTER = 8.23% Use of Mortgages by Originators - Mortgage originators can either: 0 hold the mortgage in their portfolio - sell the mortgage to an investor - use the mortgage as collateral for the issuance of a security called securitization 0 Sale of mortgage - Conforming loans that meet agency underwriting standards are more likely to be purchased by GSEs and be packaged to create MBS; therefore conforming loans have lower interest rates than nonconforming loans. Mortgage Characteristics 0 Amortized vs. balloon payment mortgages . Fixed monthly payment consists of repayment toward the principal and interest 0 Balloon payment: fixed monthly interest payments +full payment of the principal at maturity e Fixed—rate mortgages vs ARM 0 Fixed rate: fixed monthly payments; lenders assume interest rate risk a ARM: variable monthly payments; tie to market rate; yearly interest rate changes are often capped; borrowers assume interest rate risk; can increase default risk Sectors of Residential Mortgage- Backed Securities 0 Agency MBS (MBS) - Loans that satisfy the underwriting standard of the agencies used to create RMBS a Represents 45% of the investment—grade securities market (2008) a Includes agency mortgage pass-through; agency CMOs and stripped MBS (created based on pass- through) . Non-agency MBS (NA MBS) - private label MBS: where prime loans are collateral o subnrime MBS: where suhnrime loans are collateral Agency Pass-Through Securities . The first mortgage pass-through security was created in 1968. o Issuers 0 Guaranteed by Ginnie Mae and issued by approved lenders 0 Freddie Mac o Fannie Mae 0 Each pass-through security represents a pro -rata share of principal and interest payment cash flows in the pool. Agency Pass-through Securities: Cash Flow Characteristics - Cash flow on the security depends on cash flow of the undertying mortgages. - Monthly mortgage payments: interest, principal repayment, any prepayments - Monthly cash flow for pass-through securities is less, due to servicing and other fees . Delay in passing through monthly cash flows from mortgages Yields on Mortgage-Backed Securities ~ Yields are a function of prepayment risk - As rates fall, it gives borrow incentive to prepay the loan and refinance at a lower rate - Yield calculation 0 Projection of cash flow requires making assumptions about the prepayment rate - PSA benchmark: assumes prepayment rates are low for newly originated mortgages, and then speed up as mortgages become seasoned. Collateralized Mortgage Obligations (CMO) - The problem with MBS is that you never know when you are going to get your principal back (prepayment risk) - Repackaging the cash flows from mortgages in a different way - Create different bonds from the same mortgage to please different kinds of investors - E.g., package 30-year mortgage into bonds of different length: principal only and interest only bonds - Retire mortgage prepayments only one tranche at a time, so all other trenches are sequentially prepayment protected ...
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  • Spring '14
  • Interest, Mortgage loan, Repurchase agreement, Mortgage-backed security, Treasury securities

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