municipal securities out

Normal yield curve

• lower interest rates-beginning
• higher interest rates-later

Inverted yield curve

• higher interest rates-beginning
• lower interest rates-later

flat yield curve

• = maturities or little increase of .2% (20 basis points)

• Always choose long with longest maturity, changes the most in price

par

• nominal yield=current yield=yield to maturity

price change

• current yield,  YTM,YTC-move in opposite direction-inverse
• current yield moves least
• YTC moves most 
• order of yields N,C,B,M,C-nominal, current,basis,YTM,YTC

Inverse relationship of bond prices and yields

• interest rates increase, bond prices decrease
• muni bonds quoted in basis points
• 7% muni serial bond might be priced at 7.20% basis, selling at YTM
• par value: YTM=current yield=nominal yield

flat, 

• trade-bonds trade-no accrued interest-with general obligation and corporate bonds-near bankruptcy? 
• bank interest must be paid to holder
• bearer bonds require past, present and future interest rate coupons be attached for good delivery

When interest rates are rising, which of the following occurs with bond prices and bond yields?

1. bond prices fall, bond yields increase
2. price and yields in opposite direction
3. price and yield-inverse relationships
4. interest rates rise, less demand for bond, bond decreases in price, bond yield increases

Accrued interest

• buyer pay seller accrued interest
• seller gets interest generated for holding bond
• next interest date, buyer gets interest, part was paid to previous owner
• muni bonds-30 day month and 360 day year
• settlement date-last interest payment date=number of months and days

Calling municipal bonds

• in whole call-callable in first 5 years at a premium, deceases to par after 3-5 years-initiated when refunding/advanced refunding has occurred
• partial call, callable in first years at premium, decreases to par after 3-5 years, initiated when issuer has extra money due to more revenues than expected
• defeased call, usually callable in first years at a premium that decreases to par after 3-5 years-initiated when advance refunding has occurred, issuer prefers to keep $ in U.S. government bonds that are paying the issuer more interest more interest than municipality is paying out to holders
• sinking fund call, usually callable in first years at premium that reduces to par after 3-5 years-initiated in term bonds when the issuer has extra money-more revenues than expected or in serial bonds that have a long term maturity as well
• extraordinary call-callable at par-initiated when their is leftover money from the bond issue and the project is completed
• catastrophe call, callable at par, initiated when the project blows up/collapses/destroyed

refunding/advance refunding

• when bonds are issued at high interest rates, issuers will call bonds when interest rates decrease
• call feature, how bonds will be called before maturity date
• call price, at a premium in early call years, decreases to par after 3-5 years 
• refunding, issuer calls bond before maturity and issues new bond-use proceeds to pay off amount of outstanding bond it wants to refund
• outstanding bond must be callable
• premium paid by issuer for right to call bonds early
• in whole call, calling of the bonds
• refunding and pre-refunding-allow issuers to call in bonds-issuer paying high interest rates, reissue with lower interest rates
• refunding can increase credit rating of bond, increase marketability
• advanced refunding, early issuing of new bond to pay off old bond
• prerefunding, muni issues new bonds for purpose of refunding outstanding bonds, outstanding bonds are not callable when new bonds are issued, proceeds are put into government bonds, maturities coincide with callable date of existing bond, securities kept in escrow account, interest from government bonds has to be high enough to cover debt service of new bonds

partial called bonds

• outstanding bond can be called 
• issuer doesn't have to refund if enough $ is available, tax revenues or facility revenues
• reduce interest costs, call in long term maturity bonds
• market price goes to call price, limits price of bond

defeased bonds

• issuer prerefunds outstanding bond with less interest
• issuer invests proceeds from new issue in U.S. government bonds
• U.S. government bonds pay higher interest>municipal bonds
• interest on new municipal bond is paid by income generated from government bond
• issuer may not call bond
• keeps bond paying U.S. government interest
• use taxes or revenues to pay for new bond interest & principal
• old bond-guaranteed by U.S. government, AAA rating
• defeasing, interest received from government bond pays new bond interest
• old bond not called, just pays interest and principal
• eventually call old bond, pay off with proceeds U.S. government interest
• defeased call, called at a premium in early call years, decrease to par in 3-5 years

Sinking fund call

• sinking fund, place where $ is put away to pay for principal when due
• required on term bonds
• optional on serial bonds
• sinking fund $ invested in U.S. government bonds
• partial call, issuers may call part of outstanding bond that is callable if $ in sinking fund
• bonds called at premium in early call years, decrease to par in 3-5 years

Extraordinary called bonds

• part of bond issue not needed to complete project bond was intended to complete
• issuer can do at any time, decreases debt service costs, strengthens rest of issue
• at par ALWAYS

catastrophe called bonds

• used to build a bridge, stadium
• if natural disaster makes project unusable, issuer receives insurance and calls in remaining parts of issue
• project doesn't make $ anymore
• ex. bridge in Minneapolis
• ALWAYs at par

Call protection

• when bond called, investors at disadvantage-forego high interest rate by bond 
• issuer may not be able to call bonds for a period of time
• bond can only be called at premium, helps cover some of investor's loss of interest

A muni has pre-refunded its $30 million outstanding bond. The old bonds will not be called for 3 1/2 years. What can the municipality do with the proceeds from the refunding issue?

• invest in government bonds. 
• muni can only invest in government bonds
• in escrow account
• income from government bonds must cover debt service of new bonds